A case that defines “open to interpretation”:
From mid-1999 through December 2002, wireless carrier Sprint Spectrum LP (“Sprint”) offered free phones to induce new Washington subscribers to commit to using its telecom service. The handsets functioned only over Sprint’s network, requiring users to contract with the telco, which sells both tangible personal property (phones) and services (calling plans) in its ordinary course of business.
Washington’s Revenue Department (the “Department”) assessed Sprint “$85,946 of unreported use tax on fully discounted wireless phones Sprint ‘sold’ to customers for $0.00 … on the grounds that Sprint ‘provided free cell phones to customers for the primary purpose of promoting the sale of its wireless services.’” (Quotations are from Department of Revenue, Appellant, v. Sprint Spectrum, LP, Respondent, Case No. 42304-9-II, Court of Appeals of Washington, Division Two, 2013 Wash. App. LEXIS 1001.)
Procedurally: Sprint paid the assessment (which enabled it to challenge it), then appealed the levy to the Department’s Appeals Division, which affirmed. Sprint then appealed that decision to the Tax Appeals Board, which overturned the imposition entirely. Next came the Department’s turn to appeal, to State Superior Court for Thurston County, which reversed the Board and reinstated the full amount of the use tax as due and payable. Sprint again appealed, to the Washington Court of Appeals, which proceeding we report here. (On November 6, 2013, the Washington Supreme Court denied Sprint’s requested review, rendering this verdict final.)
“Sprint successfully appealed the use tax assessment to the Board of Tax Appeals, arguing that it recovers the cost of the free phones through sales of wireless phone service (on which it collects retail sales tax every month). Sprint also successfully argued that it was not a consumer of the free phones it provided to customers but, instead, was a retailer who resold the phones in conjunction with wireless service plans.”
The Department urged the trial court, “Sprint is liable for use tax because it does not ‘resell’ fully discounted phones but, instead, acts as a consumer distributing the fully discounted wireless phones primarily for the purpose of promoting the sale of its wireless telephone services.”
Both parties agreed:
- New Sprint phones were delivered to a Kentucky warehouse, whence they were transferred to Sprint’s national retail outlets for distribution
- Sprint paid no sales tax upon purchase
- Some of the phones sold for full price, some at partial discount, with appropriate sales tax collected (these sales are not at issue here)
- When Sprint “fully-discounted” phones (to nothing), it collected zero sales tax, providing customer receipts showing the $0.00 purchase price
- Costs of Sprint’s service did not change, whether a free phone were part of the package or not
Sprint’s expert testified before the Board that “Sprint loses almost $100 on every phone it sells [for $0] and that Sprint’s business model is designed to recoup the almost ‘two billion dollars a year’ that Sprint loses in phone sales through sales of wireless service plans. [He] further stated that Sprint sold most wireless phones at prices below their fair market value, because ‘consumers in the U.S. aren’t willing to pay a big upfront fee for [wireless phones], but they’re more than willing to pay it over the life of a contract. So it’s just more of a forced financing arrangement.’ [He] testified that, despite losing money on nearly every phone Sprint sells, he does not ‘consider a cell phone to be a promotional item. The cell phone is integral to the business’” (citations omitted). That’s Sprint’s interpretation.
The Department disagreed: “[C]ontrary to Sprint’s position, Sprint ‘distributed these cell phones without charge for a price of zero dollars and zero cents in order to promote the sale of its wireless service’ and, in result, Sprint owed use taxes on the fully discounted phones. DOR also explained that, because of the way Washington’s tax statutes are written, it has a bright line rule: ‘[i]f you charge over zero dollars and zero cents, even if it’s one dollar or one cent, then there’s been a retail sale, and it’s not use by the retailer. If you charge zero dollars and zero cents, it’s use” if considered promotional.
The Appellate Court overturned numerous Appeals Board holdings. “[C]ontrary to the Board’s assertions, (1) Sprint did not receive money directly from retail consumers for fully discounted phones via customers’ monthly service contract payments and, accordingly, Sprint did not sell fully discounted phones in installment sales with a ‘zero down’ payment, and (2) Sprint customers do not purchase wireless phones and wireless services as a single purchase,” as Sprint contended. The Court deemed ERROR “the Board’s conclusions that ‘[c]ell phones are “not used to promote the business,”’ and ‘Sprint is not a consumer of the “free phones,” it is a retailer.’”
Such interpretations eviscerated Sprint’s arguments. Because “customers’ monthly wireless service fees do not vary depending on whether a customer received a fully or partially discounted phone or paid the full retail price of the phone” – which they would in a cost-equalized installment arrangement – the transaction cannot be considered one, as a matter of law. “None of the evidence in the record supports a finding that Sprint conducted installment sales for the fully discounted phones it gave to customers. The record also does not support the Board’s finding that customers purchase wireless phones and wireless service as a single purchase,” although the parties plainly thought so! However, “These contracts do not … contain any specific information about the wireless phone a customer owns or has purchased.”
The Appellate Court emphasized differences in the sales: “[U]nlike the one-time sale of the wireless phone, Sprint sells wireless services on a monthly basis. Thus, a customer’s wireless service contract with Sprint is actually a contract for a series of transactions (with each transaction producing a taxable event) … selling wireless phones and selling monthly wireless services involve separate areas of taxation. Wireless service customers owe retail sales tax every month when purchasing telecommunications services from Sprint ... At the point of sale, however, consumers owe a separate tax on tangible personal property (the wireless phone).”
The subtle truth, apparent to any observer, is that Sprint makes sufficient profit on its telecommunication services to easily absorb the expense of “comping” phones. Lucrative long-term agreements propel this business model: handset costs are recovered early in the service contract, recompensing any temporary shortfall from full-discounting. Sprint further guards its investment by adding hefty early-cancellation fees to its boilerplate – another “invisible” element in the transaction. The Court took notice of some of this:
“To be clear, the record does reflect that Sprint priced its monthly wireless services at a rate intended to recoup the money it nearly always lost on selling partially or fully discounted wireless phones: [Sprint] testified that discounted phones represent ‘two billion dollars a year that we need to make up for in our service plans.’ Nevertheless, selling wireless phones and selling monthly wireless services involve separate areas of taxation. … Although Sprint’s business model is designed to treat the purchases together (i.e., Sprint prices its monthly services in a way to recoup losses from the sale of wireless phones), these purchases are separate for purposes of taxation.”
The Appeals Court delivered a parting “dissing,” clothed in courtesy: “We conclude that the record does not contain substantial evidence supporting the Board’s final decision, and that the decision involves erroneous interpretations of the law.” (Interpretations “erroneous” because not theirs.)
The Court explained, “we settled this issue on almost identical facts in Activate, Inc. v. Department of Revenue, 150 Wn. App. 807, 209 P.3d 524 (2009)” (“Activate”), on which this verdict strongly relies. In that matter, also exploring use tax consequences of offering wireless phones as inducements to buy service plans, this Court ruled that when Activate (also “a company that sold cellular telephone equipment and wireless service plans”) “distributed articles of tangible personal property (phones), the purpose of which was to promote the sale of products or services, it was a ‘consumer’ under Wash. Rev. Code § 82.12.010(9)” and consequently use tax susceptible. “Sprint acted as a consumer when it gave some customers fully discounted phones because, as in Activate, the fully discounted phones were being given to customers primarily to promote the sale of wireless services.”
Such singular interpretation renders Sprint a consumer of its own “freebie” phones, because “RCW 82.12.010(6) provides, ‘Consumer,’ in addition to the meaning ascribed to it in chapters 82.04 and 82.08 RCW insofar as applicable, shall also mean any person who distributes or displays, or causes to be distributed or displayed, any article of tangible personal property, except newspapers, the primary purpose of which is to promote the sale of products or services” and “Sprint sells all of its phones primarily to promote wireless service sales” (producing this highly absurd result: Telecom providers who sell phones are, in fact, “consumers”).
One last possible game-changer: Use tax doesn’t attach if the seller is eligible for the “sale for resale” exemption, as Sprint is upon receiving “valuable consideration” – the benefit of holding long-term service commitments. HOWEVER, this exemption is nullified if the seller makes “intervening use” of the TPP. “‘Activate made intervening use of these phones by using them as part of the marketing promotion to attract consumer business.’ … Here, Sprint made intervening use of the phones it ultimately ‘sold’ for no money (but valuable consideration) because the phones served the marketing purpose of convincing customers to purchase wireless service contracts. Accordingly, Activate is indistinguishable on this point and Sprint is liable.” (Isn’t this circular reasoning? Telephone acquisition –whatever the terms – promotes telephone usage; how can such “intervening” purpose ever be averted?)
Regardless, “this court’s decision in Activate dictates the result here: as in Activate, Sprint gave away phones primarily to promote the sale of its wireless services or, alternatively, Sprint made intervening [promotional] use of the phones. In either case, Sprint is liable for use tax.” There’s no way out.
The Court’s own endnote – and surprising admission – says volumes about this subjective, interpretational outcome: “We are aware that, on the surface, this result defies common sense: had Sprint charged a penny for the phones it provided customers in exchange for signing long-term service agreements, no use tax would apply. But … [i]f the legislature desired a different result, it could structure the tax code differently.”
Other recent “Telecom Taxation” posts by Marc Palmer Kram:
- DirecTV Seeks "Unfair Tax Treatment" Verdicts - and Is Disappointed
- GPSPS Penalized $9 Million For Cramming, Slamming … & Chutzpah!
- Kentucky’s Telecommunications Tax: Hanging in Limbo
- D.C. TV Station Is Not “High-Tech Company,” So No Tax Break
- Florida: America's Foremost Purveyor of Tax Nonsense?