IoT and 5G are exploding, with use cases spanning from consumer goods to connected health to manufacturing. While the benefits are widely understood, there is a continued lack of clarity about what is and is not communications taxable. Should IoT connectivity really be classified as Internet or is it LAN/WAN data networking? Due to the unstoppable growth of these technologies, this is fertile ground for taxing authorities, and businesses are increasingly concerned about the obscurity around risk.
Alexa, Where’s the Money
Communications taxable revenues are declining and thanks to the Permanent Internet Tax Freedom Act (PITFA), state and local taxation of ISP service is banned. Federal, state and local jurisdictions need to find ways to fund their initiatives and taxing IoT is a tempting avenue to do so.
This is by no means definitive, as IoT taxability is not black and white. Changes in laws and regulations to facilitate this will not happen overnight. However, in the interim, we are left to navigate a complex web of laws, regulations and tax liabilities associated with IoT.
World Wide Web of Questions
As you seek to understand your tax risk as it relates to IoT, it is helpful to begin with two simple questions:
1) Am I really selling Internet access? It is important to understand the difference between private network connectivity and what is considered Internet access. In broad terms, Internet access is tax-free in the United States. However, there are potentially restrictive definitions of what qualifies as Internet service and who can be an Internet Service Provider (ISP). If you are supplying a service to subscribers that meets the statutory definitions of ISP service, per federal law there is a moratorium against state and local taxes.
But, private network connections have a different set of rules. If you are connecting the IOT device via a local area network or a wide area network (LAN/WAN) then most states will treat this as a taxable communications service. Further, you may also be subject to Federal Universal Service Fees (FUSF) as well. And even here, questions remain. If you sell a device that offers connectivity but does not enable a WWW experience, then it may not meet the federal definitions of ISP service. If a sensor or other device transmits data using Internet protocols but does not allow access to the web, there is reasonable question about whether that connection qualifies as Internet or whether it is WAN/LAN networking
2) How do you provide connectivity? Is your connectivity embedded or over-the-top? If you offer a device that comes with its own data connection as part of the sale or service plan, e.g. a drone with its own wireless SIM for navigation and transmission, then the connection is embedded. There are variable structures between device providers and network operators, but providers may need to account for any taxes that need to be collected as it relates to their device connections.
Over-the-top connectivity is networked over a user-supplied connection. This connectivity can be wired, Wi-Fi or even purchased separately from a wireless service. Good examples are consumer devices such as printers, smart doorbells or exercise machines. The taxes on these connections are between the user and their ISP. The IoT device maker likely does not have responsibility for its customers’ Internet connections.
Saddle up for uncertainty
In 2021, while we anticipate IoT taxation to remain the wild west, you’re well advised to increase your tax risk awareness. Monitor tax rules at the federal and state levels. Be vigilant about monitoring for upcoming Internet taxation changes so that you can be prepared.
It is also helpful to have a corporate conversation around risk tolerance and IoT taxation. This approach can help you avoid being caught off guard and taking a big hit to your bottom line. Most importantly, consult tax and legal providers who can help you navigate the changing landscape.
The wild west of IoT classification may not be settled in the near term, but with the right advice and a good strategy you can survive.