Managing tax risk when bundling communications services
Bundling goods or services, usually with a discount, is a common practice in many industries. Whether it’s a fast-food combo or a cable company “triple play,” bundles appeal to the market because consumers believe they are getting a better value compared to à la carte pricing. Bundles also appeal to sellers because the discounted packages encourage increased total sales. Communications service providers use bundling as a key strategy for establishing and maintaining a competitive edge, particularly given the fast pace of innovation and the frequent introduction of new voice, video and other technology offerings.
Bundling is one of the more complicated issues in communications taxation, with implications throughout the calculation and filing lifecycle. While it’s almost always a competitive necessity, it’s important for those new to the space or even just unfamiliar with communications tax intricacies to recognize that there can be significant risk associated with offering and managing these bundles. Failing to address this complexity can quickly lead to unexpected tax liabilities with potentially significant financial, or even brand image, implications.
This article explains the history and nuances of bundling communications services. It provides some ready-to-use tips to help both tax pros and their customers who provide communications services navigate this tricky landscape.
A snapshot of bundling history and complexity
Bundling is not a new concept. The communications industry started offering bundles decades ago when local and long-distance services were offered for a single price. However, the first general bundling tax precedent was noted around the beginning of the 20th century when a New York retailer offered a single, innovative package of goods including cheese, a cutting board and a knife. The cheese in the package was exempt from sales taxes while the other items in the package were not. Tax laws in the state evolved to keep pace. The New York taxing authority ruled that although the tax-exempt cheese was the main attraction of the package, the entire package was still subject to sales tax.
A more recent and applicable example involves Amazon Prime membership. Because one of the services bundled with an Amazon Prime membership, Prime Video, is communications taxable, the Iowa Department of Revenue ruled that the Amazon Prime membership itself is taxable.
Many states are more flexible when it comes to taxing bundles. Some allow CSPs to “unbundle the bundle” for tax purposes, which means they can apply taxes only to the taxable items, not the entire bundle — as long as they have properly supported their calculations. Still, these cases illustrate the tax complexity associated with bundling communication services. The New York case also established a precedent that an entire bundle may be taxed if a customer cannot see the prices for the individual goods or services in the bundle; at least in some circumstances.
The top challenges of communications bundling
Communications taxation in general is not easy to manage; bundling adds an additional layer of difficulty. When assessing the potential tax consequences of bundling, always consider the following:
- Disparate services often mean different tax treatments. Different types of voice services can have different rules and rates, as can different types of text and data services. And the rules are much more complicated than those applied to tangible personal property.
- Complex calculations. Voice, text and data services also have different sets of complex calculations. When including multiple services in a single bundle, each service may need to be billed according to its own specific rules, even if the bundle is marketed as a single package.
- Frequently changing rates due to promotions, competitive pricing. Consumer demand and other competitive forces are driving continual innovation and frequent price changes. This compounds the complexity of managing bundled pricing.
- Books and records requirements. CSPs can potentially avoid taxing an entire service bundle at the rate of the highest item if they have proper documentation showing the value of the components. This can usually be best documented through the à la carte price for each component of the bundle. The standards for what is acceptable as a methodology for establishing the bundle valuation can vary from jurisdiction to jurisdiction. This often requires a collaborative effort involving the tax department, IT, marketing and external vendors to ensure thoroughness and accuracy.
Reduce bundling risk with solid business processes
While the complexity of creating communications service bundles may at first seem daunting, they are an effective marketing tool, and your clients can proceed with confidence if you help them put in place the following foundational processes that will help maintain compliance:
- Ensure the tax and marketing teams are collaborating on all promotions, bundle name changes and pricing changes to avoid the possibility of applying the wrong tax to a bundle.
- Maintain accurate records on all pricing changes, both for the complete bundle and for the individual items comprising the bundle. If a taxing authority asks for this documentation, you will likely need to be able to produce it.
- Create and automate quality assurance processes to ensure the tax team is keeping track of all relevant regulatory and tax rate changes and then applying these changes both to individual SKUs and within each bundle.
- Perform a capabilities assessment of the ERP and tax systems to ensure they can handle the speed and scale at which changes will need to be implemented.
Ensuring tax compliance is essential for avoiding unexpected or unknown tax liabilities that can put your client at a significant financial or competitive disadvantage. If building and maintaining the expertise to do this in-house is impractical, be sure to reach out to an organization that specializes in communications tax, in order to help your client best understand requirements and automate processes.
For more on communications tax challenges, check out the other articles in this series: