California's approach to taxing cellphones provides a view into the issues and intricacies faced by taxing entities in today's world, as a recent case over a bundle of hardware and services, some of which are taxable and some are not, shows.
The case, Bekkerman v. California Department of Tax and Fee Administration, held that California may tax a bundled cellphone at the full price as an unbundled cellphone, rather than the discounted price that's typically offered as part of a product plus service bundle.
California's approach is unusual due to how California law applies to a bundled cellphone/service transaction. In the case of sales tax, bundled transactions are complicated because retailers get creative with marketing bundled transactions, according to Scott Peterson, vice president of U.S. tax policy and government relations at Avalara, and the former executive director of the Streamlined Sales Tax Governing Board.
"It's hard to put a value on taxability when multiple items are in a bundle — selling two distinct things for one price," he said. "When some of the products in a bundle are tax-exempt, you have to figure out how to tax the total bundle. This is what's happening with cellphone sales — non-taxable service and taxable cellphones. California doesn't tax cellphone service. Accordingly, the new cellphone approach says that cellphone companies selling at less than full retail price must charge sales tax on the full price of the phone."
In this case, the retailer remitted the tax to the state based on the wholesale value of the phone — what was paid for it — instead of charging tax on the retail value of the cellphone.
Of course, cellphones have presented taxing issues for decades.
"In the early cellphone days, states didn't have legal authority to tax all cell calls. In the 1990s you would get a cellphone and the bill would go to your address," explained Peterson. "Legal authority to tax cellphones was very regulated by the Supreme Court, limiting states' ability to tax phone service — that goes back to the early days of phones. Phone companies would be audited by various states both trying to tax a call based either on where it started or where it ended. There was only one retailer — Bell Telephone. The Supreme Court said that if one caller is in one state and one is out of state, you get to choose whom to tax, but not both. Most states taxed calls originating in their state. The only calls ever taxed in those days were calls that originated and ended in the same state. Many states still won't tax interstate calls due to interstate commerce regulations."
The portability of cellphones changed everything, and states had to change taxability, not knowing where calls would originate from a specific phone. States had a very difficult time in the 1990s trying to figure out taxability, according to Peterson.
"I experienced this as tax commissioner in South Dakota," he said. "We couldn't tax interstate calls, but a call starting and ending in South Dakota could be taxed. This matched state sales tax guidelines, but not city guidelines. How would they know which city could tax cellphone service?"
"Thus, someone living in Rapid City but working in Sioux Falls making cell calls — in which city should they be taxed? Or if they're in a car traversing the state and making calls, where to tax? It was a mess. South Dakota was leading the charge to make things complicated, trying to tax something that's moveable."
"The only way a cellphone company could know where someone was, was to track calls via pings on cellphone towers," explained Peterson. "Therefore, South Dakota looked to get phone companies to help with determining when cellphones switched towers."
The Mobile Communications Sourcing Act was Peterson's first entry into federal legislation. "Cellphone companies looked to us to be onboard, and that legislation was the result," he said. "Cellphones were taxed by the place of primary use — the billing address, whether home or business. This was 30 years ago, and it was a radical move at the time. We worked with Senator Tom Daschle [D-South Dakota] on this legislation, which made things simpler for phone companies, and gave states the right to tax interstate cellphone calls. This legislation also made South Dakota lose sales tax collections on folks in the state making cellphone calls in state but not residing in South Dakota."
