How did Illinois tax a separately billed wireless phone-replacement program, replacement phones, and customer deductibles?

Plain-English summary

The described phone-replacement program appeared to be a separately sold maintenance agreement. It was shown as a feature of the wireless service plan rather than part of the phone's original selling price.

Illinois treated maintenance agreements in two ways:

• If the agreement charge was included in the tangible property's selling price, it formed part of taxable retail gross receipts. Later maintenance services and parts supplied under that included agreement were not separately taxed.
• If the agreement was sold separately, the sale of the agreement was not a taxable transaction. When the provider later supplied a replacement phone or other property, the provider incurred Use Tax on its cost price under the Service Occupation Tax rules.

For a separately sold agreement, the customer's gross payments were not taxable receipts from property. The letter specifically says this included any deductible charged under the agreement. Because the provider was the taxable user of replacement property, it could not give suppliers resale certificates for that property.

The Department declined to issue the requested PLR and did not adopt the requester's broader characterization of the program as a mandatory warranty.

What this means for you

The billing and contract structure control. If phone-replacement coverage is genuinely separate from the phone sale, do not collect tax on the agreement or deductible under the rule described; instead, account for Use Tax on the provider's cost of replacement phones or parts. If the coverage is built into the phone's selling price, the upfront charge follows the retail sale.

Common questions

Q: Was the separately sold replacement agreement taxable?
A: No under the general rule described; the provider instead owed Use Tax on property later transferred.

Q: Was the customer's deductible taxable?
A: The letter says gross receipts from the separately sold agreement, including a deductible, were not subject to tax.

Q: Could the provider buy replacement phones for resale?
A: No. Because the provider incurred Use Tax on the transferred property, it could not give suppliers resale certificates.

Subject

Repairs

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2011.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2011/st-11-0020.pdf

Original ruling text

ST 11-0020-GIL 03/31/2011 REPAIRS
The taxability of maintenance agreements depends upon whether charges for the agreements
are included in the selling price of the tangible personal property. See 86 Ill. Adm. Code
140.301. (This is a GIL.)

March 31, 2011

Dear Xxxxx:
This letter is in response to your letter dated November 1, 2010, in which you request
information. The Department issues two types of letter rulings. Private Letter Rulings (“PLRs”) are
issued by the Department in response to specific taxpayer inquiries concerning the application of a
tax statute or rule to a particular fact situation. A PLR is binding on the Department, but only as to the
taxpayer who is the subject of the request for ruling and only to the extent the facts recited in the PLR
are correct and complete. Persons seeking PLRs must comply with the procedures for PLRs found in
the Department’s regulations at 2 Ill. Adm. Code 1200.110. The purpose of a General Information
Letter (“GIL”) is to direct taxpayers to Department regulations or other sources of information
regarding the topic about which they have inquired. A GIL is not a statement of Department policy
and is not binding on the Department. See 2 Ill. Adm. Code 1200.120. You may access our website
at www.tax.illinois.gov to review regulations, letter rulings and other types of information relevant to
your inquiry.
The nature of your inquiry and the information you have provided require that we respond with
a GIL. In your letter you have stated and made inquiry as follows:
The purpose of this letter (‘Letter’) is to request a sales, use and telecommunications
tax ruling on behalf of CORPORATION’s operating subsidiaries in your state under 35
ILCS § 120/2, et seq. (‘Sales Tax’), 35 ILCS § 105/3, et seq. (‘Use Tax’) and 35 ILCS §
630/1 et seq. (‘Telecommunications Tax’). CORPORATION is a holding company that
is not licensed to, and does not provide, wireless telecommunications service. Its
operating subsidiaries listed in the Appendix to this letter are licensed to, and do
provide, wireless telecommunications service in your state, including voice service, data
service, and wireless Internet access; they do so under the trade name
‘CORPORATION.’
CORPORATION has recently introduced a ‘PROGRAM’ that is included with certain
eligible wireless communication plans. The PROGRAM is a combination of a wireless
handset service contract and an insurance policy underwritten by COMPANYi that will,
in the case of accidental damage, mechanical breakdown, warranty claims, or lost or
stolen phones, provide a replacement phone to customers who have purchased a
phone from CORPORATION in connection with subscribing to such an eligible wireless
service plan.ii

This Letter specifically requests a ruling that CORPORATION’s acquisition of
replacement phones to be provided to customers under the PROGRAM is not subject to
tax, and that CORPORATION is not required to collect tax on the phones so provided.
Background
PROGRAM Background and Structure
CORPORATION currently offers the PROGRAM as one of many non-optional features
it includes in its premium wireless plans (referred to as ‘Enhanced Plans’). The
PROGRAM is not sold separately and is not available with plans other than the
Enhanced Plans. For regulatory reasons, CORPORATION has entered into an
agreement (the ‘Agreement’) arranging for COMPANY to provide the coverage under
the PROGRAM through a non-contributory group ‘Wireless Equipment Insurance Policy’
(sometimes referred to herein as the ‘Insurance Policy’) that will cover lost or stolen
handsets, and a non-contributory group ‘Wireless Equipment Service Contract’
(sometimes referred to herein as the ‘Service Contract’) that covers certain handset
mechanical or electric failures, accidental water and certain other specified damages.
CORPORATION pays COMPANY a single premium of a specified amount per month
per PROGRAM Subscriber (the exact figure varies depending on the number of total
Subscribers) for both the Insurance Policy and the Service Contract. Upon enrollment,
a Subscriber (i) becomes a certificate holder (i.e., a beneficiary) of the Insurance Policy,
which is underwritten by COMPANY, and (ii) becomes a direct contracting party with
COMPANY under the Service Contract. In both cases, CORPORATION pays the
premium (on behalf of the Subscribers, in the case of the Service Contract)—for which
no separate charge is ever made to the Subscriber—and COMPANY is the obligor.
Under the Insurance Policy, a Subscriber whose phone is lost or stolen pays a $100
deductible and receives a new phone (the ‘Replacement Phone’). Under the Service
Contract, the Subscriber is required to exchange the damaged phone for the
Replacement Phone.
In both cases, the Replacement Phone will be the same as or similar to the lost, broken,
inoperable or damaged phone. Pursuant to its obligations under the Agreement,
CORPORATION maintains a pool of new and used phones (the ‘Pool’) from which it
provides Replacement Phones to Subscribers. CORPORATION-owned stores maintain
a small supply of Replacement Phones for walk-in Subscriber claimants, which phones
are treated as part of the Pool. As explained further below, phones turned in by
Subscribers pursuant to the Service Contract are refurbished and added to the Pool, to
be provided as Replacement Phones.
A subscriber is entitled to a maximum of three exchanges (although only one can be for
a lost or stolen phone) under the PROGRAM during the 18-month coverage period that
begins when a Subscriber receives a new phone.iii
Customer Enrollment and Billing
A CORPORATION wireless customer who purchases a CORPORATION handset and
signs up for an Enhanced Plan is automatically enrolled as a ‘Subscriber’ in the
PROGRAM. Upon enrollment, a Subscriber receives an enrollment package directly
from the program provider, COMPANY. It is possible for a wireless customer to decline

enrollment, but the customer receives no reduction in the price of his or her (referred to
hereafter as ‘his’) monthly plan for doing so (nor may a customer subscribe to a lower
price plan with identical service, other than the PROGRAM, as CORPORATION does
not offer any such plan).
The PROGRAM is listed on the customer’s wireless bill as a feature of the wireless
service Enhanced Plan, but the bill is not itemized. There is a single, bundled charge
for all of the services included in the Enhanced Plan (the ‘Wireless Monthly Fee’),
including voice, messaging, data, Internet access (if applicable), Phone Replacement,
and points.
The Wireless Monthly Fee, including the PROGRAM, is generally subject to
Telecommunications Tax. Internet access is nontaxable under the Internet Tax
Freedom Act (‘Nontaxable Internet Service’), except in a few states that were
grandfathered. To that end, the Streamlined Sales Tax Act and the federal Mobile
Telecommunications Sourcing Act exclude from tax that portion of the bundled Wireless
Monthly Fee allocable to Nontaxable Internet Service. CORPORATION has determined
that apportion of the data supplied over its wireless network qualifies as Internet access.
Other than in those grandfathered states, a small portion of the Wireless Monthly Fee is
accordingly allocated by CORPORATION each month to Nontaxable Internet Service
and is not subject to tax.
Obligations under the Agreement between CORPORATION and COMPANY
Under the Agreement, CORPORATION has agreed to provide the following services to
COMPANY:
1.

2.
3.
4.
5.

Maintain sufficient quantities of Replacement Phones and components to satisfy
claims under the PROGRAM (in the event CORPORATION is unable to fulfill a
claim under the PROGRAM, COMPANY will fulfill the claim and be reimbursed
by CORPORATION for its expenses and the cost of the equipment)
Develop, market and make available the PROGRAM in its service areas
Provide training to its employees and agents
Cooperate with COMPANY’s support and administrative services
Record-keeping

Under the Agreement, COMPANY has agreed to provide the following services:
1.
2.
3.
4.

Track Subscriber enrollment
Provide Subscribers with notification regarding enrollment, cancellation, privacy
policies, and an explanation of benefits
Claims administration and adjustment
Report to CORPORATION regarding operational and administration status

Claims Processing and Handling
A claim under the Service Contract is initiated when a Subscriber submits a request
along with his damaged phone at a CORPORATION retail store, or files a claim through
CORPORATION’s Customer Service Center over the phone. The claim is then
submitted to Assurance for adjudication and administration.
Section 6.1 of the Agreement provides:

[CORPORATION] shall maintain sufficient quantities (to the extent
available) of Eligible Products and components to fulfill all claims, which
[CORPORATION] will do only pursuant to instructions received from
[COMPANY]. Any new equipment shall be accompanied by a full Product
Warranty. [CORPORATION] agrees that any refurbished equipment will
come with a fifteen (15) day mechanical and electrical failure repair or
replacement limited warranty.
Assuming the damage is covered under the Service Contract, CORPORATION will,
upon receiving direction from COMPANY, take the damaged phone from the Subscriber
and replace it with a phone from the pool. If the claim is submitted in person at a
CORPORATION store, and is approved by COMPANY, a Replacement Phone will be
given immediately out of the Pool phones at the CORPORATION store (if no Pool
phone is available, one is shipped overnight to the Subscriber from the pool maintained
at CORPORATION’s third party fulfillment center in STATE). If the claim is submitted
via telephone and approved by COMPANY, the replacement Pool phone is shipped
overnight to the Subscriber. In that case, the Subscriber must ship the broken or
damaged phone to CORPORATION, or be charged the full undiscounted retail price of
the Replacement Phone. CORPORATION gives the Subscriber an invoice showing
that the Replacement Phone has been exchanged for the Subscriber’s damaged phone,
and that no balance is due.
COMPANY pays CORPORATION a ‘Handset Reimbursement Fee’ in the amount of
$188 for each Replacement Phone CORPORATION provides to a customer at
COMPANY’s direction. CORPORATION retains the broken or damaged phone and
refurbishes it. If that is successful, it is added to the Pool, otherwise it is sold for scrap.
As under the Service Contract, a claim under the Insurance Policy can be initiated by
filing a claim at a CORPORATION retail store or over the phone for adjudication and
administration by COMPANY. If COMPANY approves the claim, CORPORATION will,
upon direction from COMPANY, provide the Subscriber with a Replacement Phone from
the Pool.
If an Insurance Policy claim is submitted in person at a CORPORATION store, a
Replacement Phone will be given immediately out of the Pool phones at the store (if no
Pool phone is available, one is shipped overnight to the Subscriber from the pool
maintained at CORPORATION’s third party fulfillment center in STATE).
The
Subscriber must pay a $100 deductible before CORPORATION delivers the
Replacement Phone to the customer for any lost or stolen phone. CORPORATION
invoices COMPANY $188 for the Replacement Phone, in satisfaction of which
CORPORATION retains the $100 deducible paid by the Subscriber and COMPANY
pays CORPORATION the balance of $89.
RULINGS REQUESTED
1.

No Sales Tax is imposed on CORPORATION, and no Use Tax is imposed on
Subscribers or on COMPANY, for the provision of Replacement Phones to
Subscribers at the direction of COMPANY under the PROGRAM.

2.

CORPORATION’s acquisition of phones for the Pool are purchases for resale
and are not subject to Sales Tax or Use Tax.

ANALYSIS
1.

No Sales Tax is imposed on CORPORATION, and no Use Tax is imposed on
Subscribers or on COMPANY, for the provision of Replacement Phones to
Subscribers at the direction of COMPANY under the PROGRAM.

The PROGRAM comprises an integrated triangular arrangement among
CORPORATION, COMPANY, and the Subscriber, that, taken as a whole, constitutes a
retailer’s warranty that is included as an inseparable part of the original taxable sale and
is thus for tax purposes a ‘mandatory warranty.’ See Hellerstein, State Taxation at
1504[4]. Hellerstein describes a mandatory warranty this way: ‘Mandatory warranties
are sold as an inseparable (and, in some cases, legally required) part of the product
itself, with no separate charge for the warranty.’ Id.
The PROGRAM constitutes a mandatory retailer’s warranty for the following reasons.
First, Subscribers who purchase a CORPORATION phone and subscribe to an
Enhanced Plan are automatically enrolled in the PROGRAM, and each Subscriber is
entitled to PROGRAM benefits as a result of his original purchase of the phone and
Enhanced Plan subscription without separate charge for the PROGRAM. The fact that
a Subscriber by law can decline coverage in the PROGRAM does not change this
conclusion. There is no reduction in the Wireless Monthly Fee for doing so, and a
customer cannot avoid the PROGRAM by opting for a lower price plan with identical
service other than the PROGRAM as CORPORATION does not offer any such plan.
Second, Replacement Phones are functionally equivalent to the phone originally
purchased, as is the case in a manufacturer’s warranty, and the PROGRAM is therefore
not a means to a hidden upgrade. Finally, because the Replacement Phone is
functionally equivalent to the replaced phone, the Subscriber is not consuming any
additional tangible goods, but is merely being restored to the position he was in after the
original purchase.
There could be no sales or use tax imposed on the goods provided under a mandatory
retailer’s warranty. Hellerstein, State Taxation at ¶ 15.04[4][a][i]-[ii]. The rationale for
this treatment is that the full value of the warranty has been subjected to tax as part of
the initial purchase. A retail customer would be double taxed if forced to pay tax on the
value of the PROGRAM, and then again on the benefits accorded under the
PROGRAM. Hellerstein confirms this reasoning, stating, ‘[i]n fact, no state takes that
position. Rather, the repair of an article under a warranty agreement without further
charge to the customer is treated as a nontaxable transaction as between the
[warrantor] and the customer.’ Id. at ¶ 1504[4][a][ii]. See also, e.g., Fla. Admin. Code
Ann. R. 12A-1.006(6) (Westlaw through July 2000) (‘Materials and supplies used in the
performance of a factory or manufacturer’s warranty are exempt when the contract is
furnished with the new equipment guaranteed thereunder at no extra charge and such
materials and supplies are paid for by the factory or manufacturer’); NY Comp. Codes
R. & Regs. tit. 20, § 527.5(d)(1) (Westlaw through July 2000) (‘[r]epair or maintenance
services rendered, without charge to a customer under a warranty agreement are not
taxable’); Ohio Rev. Code Ann. § 5739.01(E)(10) (Banks-Baldwin Supp. 2000); 34 Tex.
Admin. Code § 3.292(e)(1) (Westlaw through July 2000). Following the general practice
of the states, there should not be any tax due on the exchange by the Subscriber of a
damaged phone for a Replacement Phone.

In this case, because the value of the PROGRAM is already reflected in the price of the
Enhanced Plans and CORPORATION collects Telecommunications Tax on the Taxable
Portion of the Wireless Monthly Fee (i.e., on the portion not allocated to Internet
access), the value of the PROGRAM has already been taxed on the full extent
permitted by law. Imposing tax again when the Replacement Phone is provided to the
Subscriber would result in double tax.
The fact that COMPANY pays CORPORATION a handset reimbursement fee of $188
for each Replacement Phone provided under the PROGRAM does not change this
result, as that is merely one integral leg of the triangle comprising the warranty
arrangement, and therefore is not amenable to analysis as a separate transaction and
should not be taxed as a separate transaction. The $100 deductible in the case of lost
or stolen phones is not a taxable sale, but rather an anti-fraud and abuse device as no
physical phone is turned in by the Subscriber when such a claim is made and granted.
No such potential for abuse exists when a customer can produce proof of loss; hence,
no deductible is required for claims under the Service Contract, as a customer is
required to turn in the damaged phone. For the same reason, a customer is only
allowed to file a claim for a lost or stolen phone once during each 18-month period.
2.

CORPORATION’s acquisition of phones for the Pool are purchases for resale
and are not subject to Sales Tax or Use Tax.

No Sales or Use tax [sic] should be due on purchases by CORPORATION of the
phones added to the Pool. Addressing whether a warranty provider should pay sales or
use tax on the goods used in repairing a piece of tangible personal property, Hellerstein
correctly notes that the value of such goods are included in the cost of the warranty, and
therefore already subject to tax:
In a real sense, the manufacturer’s purchase of parts and services from
the dealer to fulfill its warranty obligation is a purchase for resale to the
consumer, but a resale for which the consumer has already paid (and paid
tax), although in the form of consideration allocable to the warranty. There
is no good reason for taxing this transaction a second time.
Id. at ¶ 1504[4][a][iii]. Hellerstein’s rationale applies with equal force in this case. See
also, Fla. Admin. Code Ann. R. 12A-1.006(6) (Westlaw through July 2000) (‘materials
and supplies used in the performance of a factory or manufacturer’s warranty are
exempt when the contract is furnished with the new equipment guaranteed thereunder
at no extra charge and such materials and suppliers are paid for by the factory or
manufacturer’); NY Comp. Codes R. & Regs. tit. 20, § 527.5(d)(4) (Westlaw through
July 2000) (‘[w]here a manufacturer reimburses a vendor or repairman performing
warranty work, the reimbursement is not taxable, as it was for resale’); Ohio Rev. Code
Ann. § 5739.01(E)(13) (Banks-Baldwin Supp. 2002); Mitsubishi Motor Sales of Amer.,
Inc. v. Zaino, No. 01-V-181, Ohio Bd. of Tax Appeals, Oct. 11, 2002; Mitsubishi Motor
Sales of America, Inc. v. Zaino, No. 01-V-181, Ohio Bd. of Tax Appeals, Oct. 11, 2002;
34 Tex. Admin. Code § 3.292(e)(1) (Westlaw through July 2000) (‘[n]o tax is due on
parts or labor furnished by the manufacturer to repair tangible personal property under a
manufacturer’s warranty’). See also Transitowne Dodge Associates L.P. (Advisory
Opinion), NY Comm’r of Taxation and Finance, Petition No. S040810A, TSB-A-05(27)S,
June 23, 2005 (excluding from use tax vehicles used exclusively by extended warranty
customers entitled to loaner vehicles under terms of the warranty); Letter of Finding No.
08-0704 (Ind. Dep’t of Revenue June 24, 2009).

•

Thank you for your consideration of this request. Please do not hesitate to call me if
you have any questions, or would like any additional information. We respectfully
request a conference in the event the Department tentatively concludes an adverse
ruling would be warranted. A power of attorney authorizing the undersigned to
represent CORPORATION in this matter is attached. This ruling request pertains only
to periods beginning October 1, 2010, and none of CORPORATION or any of its
affiliates operating in your state is under audit for such periods.

DEPARTMENT’S RESPONSE:
The Department’s regulation “Public Information, Rulemaking and Organization” provides that
“[w]hether to issue a private letter ruling in response to a letter ruling request is within the discretion of
the Department. The Department will respond to all requests for private letter rulings either by
issuance of a ruling or by a letter explaining that the request for ruling will not be honored.” 2 Ill. Adm.
Code 1200.110(a)(4). The Department declines to issue a Private Letter Ruling. Although we are not
providing you with a Private Letter Ruling, we hope the following general information will be of
assistance.
The taxation of maintenance agreements has long been established as discussed in
subsection (b)(3) of Section 140.301 of the Department’s administrative rules under the Service
Occupation Tax Act. See 86 Ill. Adm. Code Sec. 140.301(b)(3). The taxability of maintenance
agreements depends upon if charges for the agreements are included in the selling price of the
tangible personal property. If the charges for the agreements are included in the selling price of the
tangible personal property, those charges are part of the gross receipts of the retail transaction and
are subject to tax. In those instances, no tax is incurred on the maintenance services or parts when
the repair or servicing is performed.
If maintenance agreements are sold separately from tangible personal property, sales of the
agreements are not taxable transactions. However, when maintenance services or parts are
provided under the maintenance agreements, the service or repair companies will be acting as
service providers under provisions of the Service Occupation Tax Act that provide that when service
providers enter into agreements to provide maintenance services for particular pieces of equipment
for stated periods of time at predetermined fees, the service providers incur Use Tax based on their
cost price of tangible personal property transferred to customers incident to the completion of the
maintenance service. See 86 Ill. Adm. Code Sec. 140.301(b)(3). The gross receipts received from
the customer are not subject to tax. This would include any deductible amount under the
maintenance agreement. Further, since service providers incur Use Tax liability on the tangible
personal property transferred to their customers incident to the completion of the maintenance
agreements, they may not give their suppliers resale certificates for such tangible personal property.
We note that your letter states in several places that the replacement program is listed on the
customer’s bill as a feature of the wireless service plan and is not part of the purchase price of the
phone. Based on the description of the program and plan in your letter, it appears the replacement
program is sold separately from tangible personal property.
I hope this information is helpful. If you require additional information, please visit our website
at www.tax.illinois.gov or contact the Department’s Taxpayer Information Division at (217) 782-3336.

Very truly yours,

Richard S. Wolters
Associate Counsel
RSW:msk
i

COMPANY is the trade name for a group of affiliated companies that provide service contracts and/or insurance contracts.
Depending on the state in which a customer resides, the service contract is provided by ABC Service Corporation, XYZ, or 123, Inc.,
and the insurance policy is provided by INSURANCE COMPANIES.
ii
Please note that CORPORATION is submitting concurrently herewith a separate ruling request with respect to the taxation of a new
customer program, which will be offered along with the PROGRAM. The PROGRAM is available only with respect to certain
premium plans, not all plans for which the program is offered. The two programs otherwise operate independently of one another and
thus separate rulings are being requested.
iii
As explained in the ruling request submitted concurrently herewith regarding the program, the 18-month period can be shortened by
redeeming points. In such a case, the time period for exchanges would also reset at that time. If a customer subscribes or migrates to
a service plan with Phone Replacement five months after purchasing his new phone, Phone Replacement coverage will begin when the
customer makes an outbound call and ends 13 months later when the customer is eligible for a new phone.