Does an Internet service provider owe Tennessee sales tax on the DSL lines, circuits, and other telecom services it buys wholesale to deliver Internet access to its customers?

Plain-English summary

An Internet service provider buys wholesale telecom infrastructure — DSL lines, circuits, T1 lines, DS3 lines — from telecom carriers, in order to deliver Internet access to its own retail customers. It had been paying Tennessee sales tax on those wholesale purchases and asked whether that was correct.

The ruling traces an interesting history:

• Under Tennessee's own statute, retail sales of "telecommunications services" are taxable, but Internet access services are specifically excluded from that definition. A 2003 Tennessee Court of Appeals case, Prodigy Services Corp. v. Johnson, held that a company FURNISHING Internet access to its customers wasn't taxable as a telecommunications provider — it was a "consumer of telecommunications services, not a provider." But after that decision, the Department took the position that ISPs, while not taxable on what they SOLD to customers, WERE taxable as the end-user/consumer of the wholesale telecom services they BOUGHT to build that access — i.e., tax got collected one level up the supply chain instead.
• The federal Internet Tax Freedom Act changed that. This federal law preempts state taxation not just of retail Internet access sales, but specifically of "the purchase, use or sale of telecommunications" BY a provider of Internet access, to the extent purchased to provide that access. Because the taxpayer here buys its DSL/T1/DS3 telecom inputs specifically to provide Internet access to its own customers, those purchases fall within the Act's protected definition of "Internet access" itself — meaning Tennessee's sales tax on those purchases is preempted by federal law under the Supremacy Clause, superseding the Department's post-Prodigy practice of taxing ISPs as end-users.
• A grandfather-clause wrinkle, now closed. The Act originally let states keep taxing this kind of purchase if the tax was already in place and publicly known as of November 1, 2003 — and Tennessee had been able to rely on that grandfather clause. But per the ruling, that grandfather protection expired November 1, 2005, closing off Tennessee's ability to keep taxing these ISP telecom purchases.

What this means for you

Internet service providers buying wholesale telecom capacity in Tennessee

Your purchases of telecommunications services used specifically to provide Internet access to your own customers should not be subject to Tennessee sales tax, under the federal Internet Tax Freedom Act. If you've been paying sales tax on this kind of purchase, this ruling is worth discussing with a tax professional to evaluate a possible refund claim.

Accountants and tax professionals

This ruling is a clean illustration of federal preemption overriding an otherwise-settled state administrative position (the Department's post-Prodigy end-user taxation theory). The Internet Tax Freedom Act has been renewed and amended multiple times since its 1998 enactment (as this ruling itself notes, tracking amendments through 2007) — because federal extension/permanence legislation can change after a ruling issues, confirm the Act's current status and expiration terms independently rather than relying solely on this 2008 ruling's federal-law snapshot.

Common questions

Q: Why doesn't Tennessee's own "Internet access is not a taxable telecommunications service" exclusion already cover this?
A: That exclusion addresses what an ISP SELLS to its customers. The separate issue here is what an ISP BUYS from telecom carriers to build that access — which the Department had been separately taxing at the ISP's purchase level, until the federal Internet Tax Freedom Act preempted that too.

Q: Does the federal Internet Tax Freedom Act cover all Internet-related purchases?
A: Only telecommunications purchased, used, or sold by a provider specifically to provide Internet access, or otherwise to enable users to access Internet content — plus certain incidental services (email, homepages, instant messaging, personal storage). Non-Internet-access telecom purchases aren't automatically covered.

Q: Did Tennessee ever have the ability to tax these ISP purchases despite the federal Act?
A: Yes, temporarily — a grandfather clause let Tennessee keep collecting this tax if it was already publicly imposed as of November 1, 2003. Per this ruling, that grandfather protection expired November 1, 2005.

Q: Can another ISP rely on this ruling?
A: No. A Tennessee letter ruling binds the Department only as to the specific taxpayer and facts it was issued to, and it can be revoked or modified by the Commissioner. Confirm your own purchases and the current state of federal law with a tax professional.

Citations and references

Federal law cited by the ruling:

• Internet Tax Freedom Act, 47 U.S.C. § 151 note (Pub. L. No. 105-277 (1998), amended by Pub. L. No. 107-75 (2001), Pub. L. No. 108-435 / Internet Tax Nondiscrimination Act (2004), Pub. L. No. 110-108 / Internet Tax Freedom Act Amendments Act (2007))
• Internet Tax Freedom Act § 1101(A)(1), § 1105(5) ("Internet access" definition, including provider telecom purchases)
• Internet Tax Freedom Act § 1104(b)(1)-(2) (grandfather clause; Tennessee's expired November 1, 2005)
• U.S. Const. art. VI, cl. 2 (Supremacy Clause)

Tennessee statutes (Tenn. Code Ann.):

• § 67-6-205(c)(3) (2007) (sales tax on telecommunications services)
• § 67-6-102(81)(A) (2007) ("telecommunications service" definition)
• § 67-6-102(81)(B)(vi) (2007) (Internet access services excluded from that definition)
• § 67-6-101 et seq. (Retailers' Sales Tax Act)

Cases cited by the ruling:

• Prodigy Services Corp., Inc. v. Johnson, 125 S.W.3d 413 (Tenn. Ct. App. 2003) (an Internet access provider is a consumer, not a provider, of telecommunications services -- not taxable on its retail Internet access sales)
• Cipollone v. Liggett Group, Inc., 505 U.S. 504 (1992) (federal preemption doctrine under the Supremacy Clause)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/sales/08-08.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING 08-08

WARNING
Letter rulings are binding on the Department only with respect to the individual taxpayer
being addressed in the ruling. This presentation of the ruling in a redacted form is
informational only. Rulings are made in response to particular facts presented and are not
intended necessarily as statements of Department policy.

SUBJECT
Whether the purchase of telecommunications services by an Internet service provider is subject
to the Tennessee sales and use tax.
SCOPE
This letter ruling is an interpretation and application of the tax law as it relates to a specific set of
existing facts furnished to the department by the taxpayer. The rulings herein are binding upon
the Department and are applicable only to the individual taxpayer being addressed.
This letter ruling may be revoked or modified by the Commissioner at any time.
Such revocation or modification shall be effective retroactively unless the following conditions
are met, in which case the revocation shall be prospective only:
(A) The taxpayer must not have misstated or omitted material facts involved in
the transaction;
(B) Facts that develop later must not be materially different from the facts upon
which the ruling was based;
(G) The applicable law must not have been changed or amended;
(D) The ruling must have been issued originally with respect to a prospective or
proposed transaction; and
(E) The taxpayer directly involved must have acted in good faith in relying upon
the ruling; and a retroactive revocation of the ruling must inure to the taxpayer's
detriment.

FACTS
[TAXPAYER] is an Internet service provider. The Taxpayer purchases telecommunication
services from telecommunications companies in order to provide Internet access to end-user
customers. The items purchased include digital subscriber line services (“DSL”), circuits, T1
lines, DS3 lines, etc. The Taxpayer paid sales tax on the purchase of these telecommunication
services.
QUESTION
Is the purchase of telecommunications services by the Taxpayer, an Internet service provider,
subject to the Tennessee sales and use tax?
RULING
No. Under the Federal Internet Tax Freedom Act, as amended by the Internet Tax
Nondiscrimination Act of 2004 and the Internet Tax Freedom Act Amendments Act of 2007, the
Taxpayer’s purchase of telecommunication services in conjunction with its provision of Internet
access services is not subject to Tennessee sales and use tax.1
ANALYSIS
The purchase of telecommunications services by the Taxpayer is not subject to the Tennessee
sales and use tax because of the federal Internet Tax Freedom Act, 47 U.S.C. § 151 note,2 which
prohibits the imposition of a state sales tax upon the retail sale of telecommunications services to
providers of Internet access for use in providing Internet access. The Internet Tax Freedom Act is
federal legislation that preempts any Tennessee laws relating to the taxation of Internet access or
telecommunications services purchased by Internet access providers.3
1.

Prior Law

Prior to the enactment of the Internet Tax Freedom Act, the taxability of Internet access services
was governed by the Tennessee sales and use tax laws.
Under the Retailers’ Sales Tax Act, Tenn. Code Ann. § 67-6-101 et seq., the retail sale of
tangible personal property and certain services is generally subject to sales and use tax. Tenn.
1

Currently, the Internet Tax Freedom Act is set to expire on November 1, 2014, pursuant to the amendment of the
Act by the Internet Tax Freedom Act Amendments Act of 2007. If the Internet Tax Freedom Act is not extended by
Federal legislation beyond that date, Tennessee will resume taxing telecommunications services sold to providers of
Internet access for providing Internet access after November 1, 2014.

2

Internet Tax Freedom Act (Pub. L. No. 105-277, §§ 1100-1104, 112 Stat. 2681-719 (1998) (set out at note to 47
U.S.C. § 151), amended by Pub. L. No. 107-75, § 2, 115 Stat. 703 (2001), Pub. L. No. 108-435, §§ 2-6, 6A, 118
Stat. 2615 (2004), Pub. L. No. 110-108, §§ 2-6, 121 Stat. 1024 (2007)).
3

The doctrine of preemption stems from the Supremacy Clause, U.S. CONST. art. VI, cl. 2, which gives federal law
precedence over a conflicting state law. See Cipollone v. Liggett Group, Inc., 505 U.S. 504, 516 (1992).

2

Code Ann. § 67-6-205(c)(3) (2007) imposes the sales tax on the service of furnishing “intrastate,
interstate or international telecommunications services.” The term “telecommunications service”
is defined under Tenn. Code Ann. § 67-6-102(81)(A) (2007) as the “electronic transmission,
conveyance, or routing of voice, data, audio, video, or any other information or signals to a point,
or between or among points.” The term includes transmission, conveyance, or routing “in which
computer processing applications are used to act on the form, code or protocol of the content for
purposes of transmission, conveyance or routing without regard to whether such service is
referred to as voice over Internet protocol services or is classified by the Federal
Communications Commission as enhanced or value added.” Id.
The sale of Internet access services, however, is not subject to sales and use tax. Tenn. Code
Ann. § 67-6-102(81)(B)(vi) (2007) specifically excludes Internet access services from the
definition of “telecommunications services.” Accordingly, if a taxpayer’s activity could be
characterized as the furnishing of a “telecommunications service” as defined under Tenn. Code
Ann. § 67-6-102(81)(A), its provision of such services would be subject to the Tennessee sales
and use tax. On the other hand, if a taxpayer’s activity were properly characterized as the
furnishing of Internet access services, the taxpayer would not be subject to the Tennessee sales
and use tax.
In Prodigy Services Corp., Inc. v. Johnson, 125 S.W.3d 413 (Tenn.Ct.App. 2003), the Tennessee
Court of Appeals considered whether the Internet access services furnished by the taxpayer came
within the definition of “telecommunications services” in effect at the time.4 The Tennessee
Court of Appeals ruled that Internet access services were in fact not subject to the Tennessee
sales and use tax as telecommunications. Id. at 413. The court noted that the taxpayer relied on
telecommunications to provide services to customers, and thus was a “consumer of
telecommunications services, not a provider.” Id. at 419. As such, the taxpayer’s furnishing of
Internet access services to its customers was not subject to sales and use tax as a
telecommunication service.
After the Prodigy decision, the Department took the position that an Internet access provider was
taxable as the end user and consumer of the telecommunications services it purchased in order to
provide Internet access.
2.

The Internet Tax Freedom Act

The purchase of telecommunications services by the Taxpayer is not subject to the Tennessee
sales and use tax because the Internet Tax Freedom Act, 47 U.S.C. § 151 note (the “Act”),
prohibits the imposition of a state sales tax upon the retail sale of telecommunications services to
providers of Internet access for use in providing Internet access.
Under the Act, retail sales of Internet access services are not subject to Tennessee sales and use
tax. Internet Tax Freedom Act § 1101(A)(1), 47 U.S.C. § 151, note. The Act defines that the
4

See Tenn. Code Ann. § 67-6-102(31) (2002). Following the Prodigy decision, the Tennessee General Assembly
enacted Public Chapter 782, Acts of 2004, effective July 1, 2004, which rewrote the sales and use tax provisions
pertaining to telecommunications. Public Chapter 499, Acts of 2005, effective June 22, 2005, made further
revisions to the telecommunications provisions. As discussed above, the statute now specifically excludes Internet
access from the definition of “telecommunications service.”

3

term “Internet access:”
(A) means a service that enables users to connect to the Internet to access
content, information, or other services offered over the Internet;
(B) includes the purchase, use or sale of telecommunications by a provider
of a service described in subparagraph (A) to the extent such telecommunications
are purchased, used or sold—
(i) to provide such service; or
(ii) to otherwise enable users to access content, information or other
services offered over the Internet;
(C) includes services that are incidental to the provision of the service
described in subparagraph (A) when furnished to users as part of such service,
such as a home page, electronic mail and instant messaging (including voice- and
video-capable electronic mail and instant messaging), video clips, and personal
electronic storage capacity;
(D) does not include voice, audio or video programming, or other products
and services (except services described in subparagraph (A), (B), (C), or (E)) that
utilize Internet protocol or any successor protocol and for which there is a charge,
regardless of whether such charge is separately stated or aggregated with the
charge for services described in subparagraph (A), (B), (C), or (E); and
(E) includes a homepage, electronic mail and instant messaging (including
voice- and video-capable electronic mail and instant messaging), video clips, and
personal electronic storage capacity, that are provided independently or not
packaged with Internet access.
Internet Tax Freedom Act. § 1105(5), 47 U.S.C. § 151, note.5
Based on the facts provided, the Taxpayer provides Internet access. Additionally, the Taxpayer
purchases telecommunications services in order to provide Internet access to its customers.
Because the telecommunications services are purchased by the Taxpayer in conjunction with its
provision of Internet access services to its customers, such telecommunications services are
considered nontaxable Internet access services under the Act.

5

Note that the Internet Tax Freedom Act was amended in 2004 with passage of the Internet Tax Nondiscrimination
Act, Pub. L. No. 108-435, 118 Stat. 2615, in which Congress clarified the definition of “Internet access” under the
Act to include telecommunications services, “to the extent that such services are purchased, used, or sold by a
provider of Internet access to provide Internet access.”
Note as well, that prior to the 2007 amendment to the Act, the Act contained a grandfather clause that allowed states
to tax telecommunication service purchased, used or sold by an Internet service provider in certain instances. In
general, a tax on telecommunications services that was authorized by statute and generally imposed as of November
1, 2003, was taxable if a provider of Internet access services had a reasonable opportunity to know by virtue of a
public rule or other public proclamation that such agency has interpreted and applied such tax to telecommunication
services. See Internet Tax Freedom Act § 1104(b)(1), 47 U.S.C. § 151 note. Tennessee was able to impose the sales
and use tax pursuant to the grandfather clause until its expiration on November 1, 2005. See Internet Tax Freedom
Act § 1104(b)(2), Pub. L. No. 108-435, §§ 2-6, 6A, 118 Stat. 2615 (2004).

4

Accordingly, under the Internet Tax Freedom Act, the Taxpayer’s purchase of
telecommunication services used to provide Internet access services is not subject to Tennessee
sales and use tax.6

Tony Greer
Tax Counsel

APPROVED: Reagan Farr
Commissioner of Revenue

DATE: 2/22/08

6

See footnote 1.

5