A New York City Administrative Law Judge held that an assortment of charges related to long-distance telephone services were not subject to the New York City utility tax ("Utility Tax") because they were for exempt transactions "originating or consummated outside the territorial limits" of New York City. Further, the ALJ held that New York City was barred by the Internet Tax Freedom Act ("ITFA") from imposing the Utility Tax upon "local DSL fee[s] for Internet access." Matter of U.S. Sprint Communications Company, LP, TAT(H)14-12(UT) et al. (N.Y.C. Tax App. Trib., Admin. Law Judge Div., Dec. 29, 2016).

Facts. U.S. Sprint Communications Company, LP ("Sprint") provided local and long-distance telephone service in New York City. Sprint's local telephone service involved telephone calls both initiated from and received within the City, while long-distance telephone service involved calls that either were initiated from the City and received outside the City or initiated outside the City and received within the City.

Sprint owned no local telephone equipment but instead paid access charges to use the facilities of a local exchange carrier ("LEC") to bring long-distance calls the "last mile" between the customer's location and Sprint's "point of presence," meaning Sprint's long-distance switch. Such access charges were based on a schedule set by the Federal Communications Commission. Some of the access charges were based on usage and others were a fixed monthly fee per line.

Sprint charged its long-distance customers a "perminute" rate for long-distance calls, accompanied by a series of other charges ("Charges at Issue") that the ALJ placed into five categories: (1) the recoupment of taxes and fees attributed to long-distance telephone calls; (2) access charges paid to LECs based on usage; (3) access charges paid to LECs on a fixed, per-customer basis; (4) charges for additional services, including voicemail, access to toll-free telephone numbers, call routing, three-way calling, call waiting, and caller ID; and (5) charges for the sale and installation of telephone equipment at the customer's premises. Separately, Sprint provided some of its customers with digital subscriber line ("DSL") Internet access, and such customers were charged for the lines that provided that access.

Tax Law. New York City imposes the Utility Tax under the authority of New York State's General City Law ("GCL") 20-b, which enables cities to impose a utility tax on certain utility services, including telecommunication services. However, GCL 20-b prohibits cities from imposing a utility tax on "any transaction originating or consummated outside the territorial limits of any such city, notwithstanding that some act be necessarily performed with respect to such transaction within such limits." (Emphasis added.) Therefore, the Utility Tax may not be assessed on a long-distance telephone call even if some part of the call occurs within the City.

The Decision. The ALJ concluded that GCL 20-b prohibited most of the Charges at Issue from being subject to the Utility Tax. The ALJ first examined the language of GCL 20-b to determine its scope and concluded that "once a long-distance transaction is identified, all of the revenue associated with it is exempted" by GCL 20-b, so the all charges "related" to a long-distance telephone call, including "cost-recovery charges," are not subject to tax.

Next, the ALJ examined all of the Charges at Issue to determine whether they relate to long-distance telephone calls. With respect to charges for the recoupment of taxes and fees attributed to long-distance telephone calls, the ALJ concluded that all of the taxes recouped by such charges were imposed on Sprint solely because it provided long-distance telephone services and thus were not subject to the Utility Tax. Similarly, the access charges paid to LECs based on usage and on a fixed, per-customer basis were associated solely with long-distance telephone calls and therefore not subject to Utility Tax. The ALJ gave special attention to the fixed access charges, which the City claimed "relate to a purely local transaction between Sprint and the LEC" i.e., the "last mile" access. While the ALJ agreed that the charges related to local transactions "so far as the cost is concerned," he concluded that such charges are paid exclusively "in order to provide long-distance telephone service," and the language of GCL 20-b states that the exemption applies "notwithstanding that some act be necessarily performed with respect to such transaction within such limits."

The ALJ . . . concluded that "once a long-distance transaction is identified, all of the revenue associated with it is exempted" by GCL 20-b . . .

With respect to the charges for additional services, including access to toll-free telephone numbers, call routing, three-way calling, call waiting, caller ID, and voicemail, the ALJ found that, except for charges for voicemail and the sale and installation of telephone equipment, the charges were not subject to tax because they "correspond to Sprint's long-distance telephone service, and . . . were billed only to long-distance customers who received the service." However, the ALJ determined that Sprint did not demonstrate that charges related to voicemail service were exempt because "[v]oicemail can exist apart from a long-distance call." The ALJ also rejected Sprint's claim that charges for the sale and installation of telephone equipment at the customer's premises were not subject to the Utility Tax because the plain language of the statute specifically includes "equipment and services provided therewith." Admin. Code 11-1101(9).

Finally, the ALJ agreed with Sprint that its DSL Internet access charges were exempt from the Utility Tax under the ITFA. The ALJ reasoned that the ITFA specifically imposed a moratorium on "taxes on Internet access" imposed and actually enforced subsequent to September 30, 1998, and the New York City Department of Finance specifically released guidance both in 1999 and 2007 stating that it was the Department's policy "not to treat Internet access service as [taxable] telecommunications services for Utility Tax purposes."

Additional Insights

While this case involves a tax that applies to a relatively narrow industry, and the case is still subject to appeal to the New York City Tax Appeals Tribunal, it may serve as a general reminder to taxpayers that the City and State departments of taxation often interpret very narrowly the categories of transactions that are not subject to tax. Taxpayers should closely scrutinize any audit assessment for adjustments imposing tax on transactions that were treated as exempt and consider whether the reversal may not be supported by the tax law.