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Cities try last-minute grab for Net phone taxes

A day before federal regulators are expected to free VoIP providers from state taxes, two California cities want their cut.

Two southern California cities want to tax Internet phone calls, a potentially nightmarish problem surfacing just as federal utility regulators are expected to make things easier for providers of this cheaper version of telephony.

The cities, Burbank and El Monte, have asked dozens of Internet phone service providers to collect a monthly fee of about $1.40 from each subscriber that claims their "place of primary use" is within their cities, a tax similar to what traditional phone providers pay.

The cities' requests are an unexpected wrinkle in the hours before a Federal Communications Commission meeting at which the agency is widely expected to further deregulate Internet phone services by barring states from imposing their telecommunications fees. The FCC action, expected Tuesday, is meant to erase the threat of a patchwork of state telephone rules that Net phone providers would stumble over.

Voice over Internet Protocol, in which phone calls are routed over the Internet rather than via traditional, heavily regulated phone networks, is expected to hit 1 million homes this year, and grow to about 10 million by the end of the decade. Traditional phone carriers have been adding their own VoIP-based services after seeing Internet upstarts drawing more and more traffic. VoIP calls are cheaper because the providers don't have to pay the many taxes on traditional phone lines--which worries the recipients of those tax dollars.

Derek Hanway, Burbank financial services director, said the city was motivated to act for fear of funding for things like police services drying up. Last year, Burbank collected $3.7 million in utilities taxes on phone calls, half of which went to pay for emergency services.

"I would think a big piece of that $3.7 million ultimately will transition to the Internet," Hanway said. "That's why cities are so concerned. We expect them to comply, always. Ultimately, we have to take legal action, but that's getting way ahead of the game."

Net phone provider VoicePulse was among the carriers to receive the cities' demands, according to Chief Executive Officer Ravi Sakaria. While just the two cities have asked VoicePulse to comply, Sakaria expects to hear from more, particularly because Burbank and El Monte administrators say they were acting on suggestions from analysts they had hired to identify threats to their tax bases. Sakaria said cities' involvement brings his fears to a whole new level.

"Never did I think of the potential for us to deal with not just a few dozen different sets of rules, but at a city level," Sakaria said. "Now instead of 51, we're talking about potentially thousands of different authorities."

But the problem might disappear as quickly as it surfaced. Should the FCC claim sole jurisdiction over Net phone providers, as is expected, Hanway said the city would have to revisit whether it would still have a right to collect the taxes.

CNET writer Declan McCullagh contributed to this report.