NEW YORK-Ever been whipsawed?
A whipsaw is a double-handled saw designed for use by two people. The dictionary also says the word “whipsaw” means “to defeat or get the best of a person two ways at once.”
For telecommunications carriers, getting whipsawed means paying taxes in more than one state for the same new capital equipment, said John Graham, senior manager of KPMG Peat Marwick’s Telecom Group State and Local Tax Practice, Atlanta.
“There’s nothing new in the tax law, but what’s made it come to light now is that companies are doing major build-outs,” said Graham, who formerly was tax director at SkyTel Communications Inc.
The growing recognition of this double whammy of state taxation has brought the term “whipsaw” into the telecommunications taxation lexicon in recent months, he added.
It happens this way. A manufacturer sells and delivers network elements to a service provider. If the vendor has a physical presence or a license to do business in the state where it delivers the equipment, it must charge the going sales tax, which it then pays to that state.
“Often, carriers have warehouses where they do staging of equipment, customization to fit their networks,” Graham said.
“Then they bring it to the (deployment) site. If that is in a different state, the crossing of state borders (often) triggers a usage tax in the state of first use.”
Some states will rebate at least part of their use tax to carriers that document they already paid sales tax to a different state on the purchase price of the same equipment.
Quite often, however, the use tax in the state of equipment deployment is higher than the sales tax in the state of purchase. Furthermore, states charging use taxes typically do not offer a rebate or credit for similar levies that municipalities and counties within their borders also impose.
Even if the carrier does break even, proving compliance imposes a heavy administrative burden, Graham said.
In taxation as in physics, every action seems to elicit an equal and opposite reaction. There is a viable option that allows carriers in many instances to do an end-run around this double-taxation obstacle.
“Establish an internal purchasing company as a separate legal entity-a corporation, partnership or limited liability corporation,” Graham said.
The IPC fulfills the role of a wholesale buyer. As such, its equipment purchases are deemed inventory, a category not subject to sales taxes, which apply to items that retail customers buy. State sales tax criteria consider telecommunications providers to be end-user, or retail, purchasers.
In this set-up, the internal purchasing company would then resell and deliver the equipment to its parent at the location where the network infrastructure will first be deployed. Included in the resale price is just one kind of tax, which the IPC will then remit to the state where the infrastructure is first used.
However, Graham cautioned that an IPC must have “an economic rationale” beyond existence simply to help its parent avoid double taxation of capital equipment. Many states also have incorporated into their regulations “a longstanding [Internal Revenue Service] doctrine called `substance over form’,” he said.
“The IPC can be in business to configure and customize equipment,” Graham said. “It is preferable to have the IPC do this so it is not just a shell company without a purpose other than to save on taxes.”
Before deciding where to locate an internal purchasing company, carriers need to do their homework because the tax regime in some states may impose additional levies that negate the advantage of usage tax avoidance.
“Say you put the purchasing function in Washington (state), which has a business and occupation tax similar to a gross receipts tax,” Graham said. “The purchasing company would owe Washington the [business and occupation] tax, plus the carrier would have to pay a sales tax to the state where it takes delivery of the equipment.”
Telecommunications carriers also must do a cost-benefit analysis. They must weigh the dollar benefits of avoiding two taxes for the same new equipment against the costs of establishing and running an IPC.
In addition, they must consider whether buying the same equipment one time but paying two taxes on it-sales and use-costs more or less than being involved in separate resale transactions with its internal purchasing company.
“Before setting up an IPC, it (also) is important to know the tax both where you will take initial delivery of equipment and where you will first use it,” Graham said.
All of these considerations multiply in tandem with the number of network equipment assembly and configuration facilities a carrier has or wants to have, he added.
Establishing an internal purchasing company may not be the solution for every single situation like this, but it does work advantageously for many, Graham said.
Therefore, IPCs are worth consideration, especially since “I don’t think this problem (of double taxation) is going away anytime soon,” he added.
