Did Virginia communications tax apply to subscription-priced mobile apps, and were penalties waived for separate billing errors?

Plain-English summary

Virginia removed communications tax from downloaded mobile-app subscription charges but upheld penalties tied to separate unremitted tax. The provider sold mobile applications such as ring tones, games, wallpaper, GPS navigation tools, and sports or weather information. Customers could receive them free, pay a recurring monthly charge, or pay a one-time unlimited charge.

The Department treated the applications as electronically delivered digital products excluded from the communications tax. It also said the content could qualify as an exempt information service. The customer's payment method did not change that result.

The ruling expressly overturned the part of P.D. 08-64 that distinguished monthly recurring charges from one-time charges for electronically downloaded digital products. On these facts, recurring subscription pricing did not turn the apps into taxable communications services.

A separate billing-system issue came out differently. Manual account adjustments caused collected communications tax to be underreported and not remitted. The provider disclosed the errors during audit, signed limitations waivers, and paid the liability before the audit closed, but Virginia still upheld the compliance and 20% amnesty penalties. The errors did not qualify as “providential or other good cause,” and voluntary correction did not erase the statutory penalties.

What this means for you

• Classify what the customer receives, not merely whether the customer pays monthly or once.
• Electronically downloaded apps can fall outside Virginia communications tax as digital products or information services.
• Keep billing and tax-software adjustments reconciled so collected tax reaches the return.
• Voluntary disclosure during an audit may help resolve liability but does not automatically waive compliance or amnesty penalties.

Common questions

Q: Were monthly mobile-app subscriptions taxable communications services?
A: No. The payment method did not change the apps' excluded digital-product treatment.

Q: Did the ruling change earlier guidance?
A: Yes. It overturned the part of P.D. 08-64 that distinguished recurring charges from one-time fees for downloaded digital products.

Q: Why were the penalties upheld after voluntary disclosure?
A: The provider had collected tax without remitting it, and the billing errors were not providential or other good cause under the statute.

Q: What audit adjustment followed?
A: Tax on the subscription charges was removed, while penalties on the separately unreported liability remained.

Citations and references

• Va. Code §§ 58.1-630 through 58.1-637, 58.1-635 A, 58.1-647, 58.1-648 A and C, 58.1-661, and 58.1-1840.1 A and F 1.
• Virginia Public Document 08-64 (May 19, 2008), partially overturned for recurring-charge treatment.

Subject

Wireless telecommunications services; subscription charges; Penalties

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 13-16

Original ruling text

February 5, 2013

Re: § 58.1-1821 Application: Communications Sales and Use Tax

Dear *:

This is in response to your letter submitted on behalf of * (the "Taxpayer") in which you seek correction of the communications sales and use tax assessment issued for the period January 2007 through March 2010.

FACTS

The Taxpayer is located outside of Virginia and provides wireless telecommunications services to customers located inside and outside Virginia. The Taxpayer contests the tax assessment and related penalties upon the * subscription charges. The Taxpayer also contests the assessment of compliance penalty and amnesty penalty imposed on the Billing Account Number (BANTAX) errors. Each issue is addressed separately below.

DETERMINATION

* Subscription Charges

The Taxpayer sells * applications (the "applications") to its customers. The applications are for use on mobile devices and are made available to the customers via electronic download. The applications include items such as ring tones, games, wallpaper, GPS navigation tools and access to sport and weather information. The applications are offered at a variety of price points including: free of charge, monthly recurring ( i.e. , subscription based), or one-time unlimited charge.

Pursuant to Public Document (P.D.) 08-64 (5/19/08), the Taxpayer was assessed tax on the subscription based charges in the audit. The Taxpayer contests the assessment and contends that the ruling in P.D. 08-64 is an erroneous interpretation of the statute because it creates a distinction between digital products that are downloaded electronically and charged to the customer on a monthly recurring basis and those digital products downloaded and charged a one-time fee. The Taxpayer maintains that the applications sold on a subscription basis are exempt digital products and/or exempt information services, in accordance with Va. Code §§ 58.1-647 and 58.1-648 C.

Virginia Code § 58.1-648 A imposes the 5 percent communications sales and use tax on the customers of communications services providers.

Virginia Code § 58.1-648 C provides, in pertinent part, that the communications services on which the communications tax is levied shall not include "digital products delivered electronically, such as software, downloaded music, ring tones and reading materials."

Virginia Code § 58.1-647 defines communications services, in pertinent part, as:

The electronic transmission, conveyance, or routing of voice, data, audio, video, or any other information or signals, including cable services, to a point or between or among points, by or through any electronic, radio, satellite, cable, optical, microwave, or other medium or method now in existence or hereafter devised, regardless of the protocol used for the transmission or conveyance.

Virginia Code 58.1-647 defines information service as "the offering of a capability for generating, acquiring, storing, transforming, processing, retrieving, using, or making available information via communications services for purposes other than electronic transmission, conveyance, or routing."

In P.D. 08-64, the taxpayer requested a ruling regarding the application of the communications sales tax to sales of audio-visual content ("content services") transferred to its customers via cellular telephones. The content services included news, songs, ring tones, sports live video, sports scores, astrology, stock information, recipes, travelogue, short stories, exam results, reality shows and humorous content. The customer would be charged on a per minute basis for listening to or viewing the content services. There would also be an additional fixed fee charge to download the content services for future use and reuse. The content services would be paid for on either a prepaid or post paid basis. It was ruled that digital products delivered electronically do not include any products that require continued payments from the purchaser or products that are without the right of permanent use granted by the seller. It was further ruled that content services downloaded by a consumer for future use and reuse constitute digital property delivered electronically and would not be subject to the communications sales tax.

Based upon the information provided, the applications at issue are digital products that are downloaded electronically to the Taxpayer's customers' mobile devices. In accordance with Va. Code §§ 58.1-647 and 58.1-648, the communications sales tax does not apply to the sale of the applications provided by the Taxpayer to its customers. The payment method used by the customers does not affect the application of the tax to the purchases of the applications. Additionally, based upon the content being provided, the content can also be deemed an exempt information service that is not subject to the tax.

For the purpose of applying the communications sales and use tax , this determination serves to overturn the portion of P.D. 08-64 that makes a distinction between digital products that are downloaded electronically and charged to customers on a monthly recurring basis and those digital products that are downloaded electronically and customers are charged a one-time fee.

BANTAX Penalties

The Taxpayer states that it is a subsidiary of a holding company (the "Parent"), which administers the sales and use tax reporting for each of its affiliates. The Taxpayer states that the Parent discovered errors that related to the interface between its tax software and its billing system. These errors occurred when manual adjustments were made to customer billings that required a reduction in the amount invoiced to customers for telecommunications services. These errors resulted in underpayments of taxes by the Parent's operating affiliates, including the Taxpayer. The Taxpayer maintains that the Parent began using the tax software at issue in 2002. However, the errors were not discovered until September 2004, when the procedure for making manual adjustments to customers' accounts was instituted.

The Taxpayer requests a full waiver of the compliance and amnesty penalties assessed on the unreported liability. The Taxpayer maintains that its error in remitting the tax was not the result of gross negligence. The Taxpayer states the Parent discovered the errors while the Taxpayer was being audited by the Department with respect to its communications sales tax compliance. The Taxpayer states the Department's auditor had not detected the errors during the performance of the audit. Immediately upon discovering the errors, the Taxpayer voluntarily approached the Department's auditor to disclose the outstanding liability. The Taxpayer also willingly signed statute waivers to ensure the liability was included in the audit period at issue. Prior to the closing of the audit, the Taxpayer issued a payment to the Department that represents the unreported liability that was voluntarily disclosed.

Virginia Code § 58.1-661 provides:

The provisions in §§ 58.1-630 through 58.1-637 of this title shall apply to this chapter, mutatis mutandis, except as herein provided and except that whenever the term "dealer" is used in these sections, the term "communications services provider" shall be substituted. The Tax Commissioner shall promulgate regulations to interpret and clarify the applicability of §§ 58.1-630 through 58.1-637 to this chapter.

Virginia Code § 58.1-635 A provides, in pertinent part:

When any dealer fails to make any return and pay the full amount of the tax required by this chapter, there shall be imposed, in addition to other penalties provided herein, a specific penalty to be added to the tax in the amount of six percent if the failure is for not more than one month, with an additional six percent for each additional month, or fraction thereof, during which the failure continues, not to exceed thirty percent in the aggregate. In no case, however, shall the penalty be less than ten dollars and such minimum penalty shall apply whether or not any tax is due for the period for which such return was required. If such failure is due to providential or other good cause shown to the satisfaction of the Tax Commissioner, such return with or without remittance may be accepted exclusive of penalties.

Virginia Code § 58.1-1840.1 A establishes the Virginia Tax Amnesty Program. Virginia Code § 58.1-1840.1 F 1:

If any taxpayer eligible for amnesty under this section and under the rules and guidelines established by the Tax Commissioner retains any outstanding balance after the close of the Virginia Tax Amnesty Program because of the nonpayment, underpayment, nonreporting or underreporting of any tax liability eligible for relief under the Virginia Tax Amnesty Program, then such balance shall be subject to a 20 percent penalty on the unpaid tax. This penalty is in addition to all other penalties that may apply to the taxpayer.

Based upon the aforementioned authorities and the information provided, the compliance and amnesty penalties are correct as assessed. While the Taxpayer's diligence in correcting the error and remitting the tax due to the Department are appreciated, the fact remains that the tax was collected and not remitted to the Department as provided by the statute. Additionally, the errors are not due to providential or other good cause as required in Va. Code § 58.1-635. Accordingly, the Taxpayer's request that the compliance and amnesty penalty assessments be waived is denied.

CONCLUSION

Based upon this determination and in accordance with the applicable statutes,the tax assessed with respect to the subscription charges will be removed from the audit. Additionally, the penalties assessed with respect to the unreported liability are upheld. The uncontested portion of the bill at issue has been paid in full. The audit will be returned to the audit staff to make the revisions as required by this determination. A revised bill, with interest accrued to date, will be mailed to the Taxpayer once the revisions have been completed. No further interest will accrue provided the outstanding assessment is paid within 30 days from the date of the bill. The Taxpayer should remit payment to: Virginia Department of Taxation, 600 E. Main Street, 23 rd Floor, Richmond, Virginia 23219, Attn: *. If you have any questions concerning payment of the assessment, you may contact at **.

The Code of Virginia sections and public document cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions about this response, you may contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4942070054.P