VoIP: To tax or not to tax

For nearly two decades, Florida's Substitute Communications statute has gone relatively unnoticed and has not been widely enforced. But as the state looks for new sources of revenue, the law has emerged as an unexpected--and controversial--potential cash source. Using a broad interpretation of the statute, the state revenue office as soon as this summer could begin taxing voice over Internet Protocol (VoIP) service providers and businesses that use local area networks (LANs) to transmit voice calls.

State lawmakers have until Friday to revise or postpone enforcement of the statute, at which point local officials said they will have no choice but to begin enforcing the law.

"I do think this is a law of unintended consequences," said Dave Bruns, a spokesman for the State Revenue Department in Florida. "It was written before anyone outside of Silicon Valley had even thought of local area networks or VoIP. It's our responsibility to administer the tax policy. If the guidance we get from the legislature is to maintain the current course, we will enforce it to the best of our ability."

Florida lawmakers have opposed VoIP taxation in the past, and they may well vote to limit or postpone the law. In addition, the measure has not been tested in court and could yet be struck down. VoIP rules have already led to legal clashes between state and federal regulators, with at least one ruling limiting state control of Internet phone services.

Last year, a federal judge barred the Minnesota Public Utilities Commission from requiring VoIP providers to register as a phone company or submit to local telephone rules--a decision that raised significant questions over whether states have the authority to regulate VoIP carriers. Since then, states have largely held back from asserting broad regulatory authority over VoIP carriers such as Vonage, 8x8 and VoicePulse.

Despite such hurdles, opponents to VoIP taxation say the Florida law underscores deep ambiguities in telecommunications policy brought on by the Internet. In a worst-case scenario, some say, other states might use Florida's law as a template for VoIP regulation and taxation.

"I'm afraid that states that tend to tax heavily, will look at Florida as a model of how to apply similar taxes in their own state," said Jeff Pulver, the founder of Free World Dialup, a free Net phone service. "I just hope that Florida can straighten this out before it becomes a problem."

VoIP calling
VoIP has been around for years, but until recently it existed as a novelty for hobbyists interested in connecting one computer to another. Over the last few years, many companies large and small have been putting voice traffic on their data networks to bypass local and long-distance phone networks. And now as companies such as Vonage and AT&T unveil VoIP services to consumers, regulators and lawmakers have started to pay attention.

But because VoIP doesn't fit into the conventional telecom regulatory model, many regulators aren't sure how it should be treated. The technology clearly provides telephone service. But it does so over the Internet instead of the heavily taxed and regulated public switched telephone networks.

Local lawmakers fear the loss of tax revenue from communication services, which they use to fund projects such as the building of new schools. They view VoIP as a threat to their tax base. California and New York are two of about 20 states that are considering regulating VoIP. Some experts say that if Florida pushes ahead with a tax on VoIP it will spur these other states to push forward with their own laws.

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Meanwhile, the Federal Communications Commission is still working out its own stance. In February, the agency handed a partial victory to Internet phone providers, when it ruled that voice communications flowing entirely over the Internet are not subject to traditional government regulations. But last week, it ruled that AT&T should pay traditional telecom access fees. AT&T argued that because its traffic traverses the Internet at some point, it should be exempt from traditional access fees. The FCC said that because AT&T's calls begin and end on the public-switched telephone network and use Internet Protocol networks in between, it still needs to pay these fees.

Ultimately, the fate of VoIP taxation could be handled at the federal level. This week the U.S. Senate kicked off a debate that will decide if and how the Internet should be taxed. At issue is whether or not to renew a lapsed ban that would prevent state and local governments from applying additional taxes on dial-up, DSL (digital subscriber line), cable modem, wireless or satellite access to the Internet.

The moratorium expired in November but has been tied up in debate as congressional leaders grapple with the definition of "Internet access." Some say that VoIP services, which are now required to adhere to many telecommunications regulations like E911 and wiretapping should be exempt from the moratorium. Others argue that it is an information service and not a telecom service and should be lumped in with the broad Internet access definition.

Florida's law
Florida's Substitute Communications law, passed in 1985, was designed to ensure that companies operating their own communication systems via satellite or microwave technology would have to pay the same tax as those using the regular phone network. In 2001, the law was rewritten as part of a broad overhaul of the communications tax code. During the process, the nearly forgotten provision was rediscovered and reworded to apply the tax to "any system that is used for voice or data that connects multiple users with the use of switching or routing technology".

Last summer, the Florida Department of Revenue drafted a series of rules to help clarify who should pay the tax. In this interpretation it became apparent that the law could push the definition of communications systems to include LANs, as well as wide area networks, or WANs. As a result, businesses and home users that have linked two or more computers together could be subject to more than 9 percent in state tax, plus local option taxes. Some experts fear it could also be applied to two-way radio transmissions used by taxi and bus dispatchers, home intercom systems or security systems.

The broad interpretation has ignited a firestorm in the corporate community, which views the tax as a direct assault on businesses. As a result of the controversy, the state legislature is reviewing the statute during its current session, which ends Friday. With only three days left, Florida lawmakers must decide to revise the law or postpone the enforcement of the law until further study. If no action is taken, the state revenue department will begin enforcing the tax law according to its rules this summer.

Florida officials, who are pushing for enforcement of the law, recognize that the wording of the statute is too broad and may include services that were never intended to be taxed. But they believe that companies that clearly fall under the parameters of the tax should have to pay.

"It would be difficult, if not impossible, to administer a tax on things like a local area network," said Sharon Fox, the tax revenue coordinator for the city of Tampa. "But the city of Tampa feels that we should be collecting tax for services that clearly fall within the provision of the statute."

While most experts agree that local area networks and home security systems shouldn't be taxed, no one is sure whether the statute should be applied to service providers offering VoIP or businesses that use their own VoIP networks to bypass the public phone network. But levying a tax on VoIP could be in conflict with another Florida law that prohibits the taxation of Internet access. This law states that Internet services like e-mail or basic dial-up and broadband should not be taxed. But it does not explicitly exempt VoIP services, leaving room for the Substitute Communications tax to be applied.

"Right now, we aren't sure how to treat VoIP," Bruns said. "First, we have to define if VoIP is actually a communications service. Then we have to see how the FCC treats it in its rulings. And finally, we need to see how federal legislation on this topic will play out."

It's this uncertainty that has lawmakers in Florida leery about making any sweeping changes to the Substitute Communications statute, said John Stargel, a Republican in the Florida House of Representatives. He has proposed a bill that, if passed this week, would postpone the enforcement of the law until Jan. 1, 2006.

"We really have to examine all the tax implications," he said. "The VoIP question is one of the reasons why we will probably end up with a holiday on this matter rather than a repeal of the statute."