Appeal of AT & T Technologies, Inc.

• Decision Date: 04 February 1988
• Docket Number: No. 60864,60864
• Parties: In the Matter of the Appeal of AT & T TECHNOLOGIES, INC., from the Order of the Director of Taxation.
• Court: Kansas Supreme Court

Page 1033

749 P.2d 1033

242 Kan. 554

In the Matter of the Appeal of AT & T TECHNOLOGIES, INC. from the Order of the Director of Taxation.

No. 60864.

Supreme Court of Kansas.

Feb. 4, 1988.

Syllabus by the Court

In an appeal by the taxpayer, AT & T Technologies, Inc., and a cross-appeal by the Kansas Department of Revenue from an order of the State Board of Tax Appeals affirming the assessment of sales tax and abating the assessment of compensating tax levied against the taxpayer, the record is examined and it is held: (1) The Board of Tax Appeals was correct in upholding the assessment of sales tax on repair services performed by the taxpayer; (2) the Board of Tax Appeals acted within its authority in ordering a re-audit of certain local sales tax assessed against the taxpayer; (3) the assessment of certain sales tax on services allegedly performed outside Kansas is remanded with directions that the Board of Tax Appeals order a proper determination by the Department of Revenue of the amount which should be abated, if any; and (4) the Board of Tax Appeals was correct in its determination that certain computer software programs prepared by the taxpayer outside the state were not subject to an assessment of compensating tax.

Michael C. Cavell of Southwestern Bell Telephone Co., Topeka, argued the cause, and Lawrence A. Dimmitt, of the same firm, and Michael B. Andolina, of AT & T Technologies, Inc., Berkley Heights, N.J., were with him on the briefs for appellants and cross-appellees, AT & T Technologies, Inc. and Southwestern Bell Telephone Co.

Thomas E. Hatten of Kansas Dept. of Revenue, Topeka, argued the cause, and Mark A. Burghart, Gen. Counsel, was with him on the briefs for appellee and cross-appellant, Kansas Dept. of Revenue.

Joseph T. Ruble of ADAPSO, Arlington, Va., and Mark Beshears of Goodell, Stratton, Edmonds & Palmer, Topeka, were on the amicus curiae brief for ADAPSO.

Mark Beshears of Goodell, Stratton, Edmonds & Palmer, Topeka, was on the amicus curiae brief for Kansas Soc. of Certified Public Accountants.

HOLMES, Justice:

This is an appeal by AT & T Technologies, Inc., (AT & T) from an order of the State Board of Tax Appeals (BOTA) concerning assessment of state and local sales taxes upon certain of its services and a cross-appeal by the Kansas Department of Revenue from BOTA's order setting aside the assessment of retailers' compensating (use) tax on software programs transferred by AT & T to Southwestern Bell Telephone Company (Bell). The case was transferred from the Court of Appeals pursuant to K.S.A. 20-3018(c).

Appellant AT & T raises three issues on appeal as follows:

1) Whether state and local taxes pursuant to the Kansas retailers' sales tax act (K.S.A. 79-3601 et seq.) are payable on gross receipts from repair services performed by appellant during calendar years 1979, 1980, and 1981, on telephones which had been provided by Bell to its telephone service customers;

2) Whether the BOTA has the authority to order a re-audit of the local sales tax assessed against appellant on gross receipts for installation services which were performed in various Kansas localities; and

3) Whether the BOTA acted unreasonably, arbitrarily, or capriciously in refusing to order abatement of sales tax allegedly assessed on repair services performed outside Kansas.

The Department of Revenue cross-appeals, raising the following issue:

1) Whether the transfer by AT & T of computer software to Bell, for purposes of operating computerized electronic switching system (ESS) equipment located in various central telephone offices, is a taxable transaction under the Kansas compensating tax act (K.S.A. 79-3701 et seq.).

The facts are set forth in great detail in the BOTA order and will be briefly summarized here. In early 1982, the Department of Revenue conducted a sales and use tax audit of AT & T, formerly known as Western Electric Company, covering the three- year period from January 1, 1979, through December 31, 1981. The audit resulted in the assessment of additional taxes in the amount of $5,001,524. Following an informal audit review conference, the assessment was amended to reflect a total liability of $3,175,372. The matter was then the subject of a hearing before the Director of Taxation where additional adjustments resulted. AT & T appealed the Director's assessment to the BOTA, which essentially upheld the sales tax assessment on repair services but abated and set aside an assessment of compensating tax upon software developed by AT & T out of state and furnished to Bell for use in its various telephone offices. AT & T appeals from the BOTA order as to the sales tax assessment and the Department of Revenue cross-appeals from the abatement of the compensating tax assessment. Bell has joined with AT & T in asserting its appeal, presumably pursuant to K.S.A. 1987 Supp. 74-2426(c)(1). Additional facts will be detailed in connection with the various issues on appeal.

Repair Services

The first issue in the AT & T appeal is whether certain services furnished by AT & T in repairing telephones owned by Bell were subject to sales tax under the Kansas retailers' sales tax act. AT & T asserts error by the BOTA based upon K.S.A. 79-3603(q), which provides:

"For the privilege of engaging in the business of selling tangible personal property at retail in this state or rendering or furnishing any of the services taxable under this act, there is hereby levied and there shall be collected and paid a tax as follows:

....

"(q) a tax at the rate of 3% upon the gross receipts received for the service of repairing, servicing, altering or maintaining tangible personal property which when such services are rendered is not being held for sale in the regular course of business, and whether or not any tangible personal property is transferred in connection therewith." (Emphasis added.)

AT & T and Bell contend that the telephones were "being held" by Bell "for sale in the regular course of business" and that the repairs were not subject to sales tax under the statute.

The facts relating to this issue are not disputed. During the audit period AT & T furnished certain services and equipment to Bell, including the repair of telephones used by Bell in providing telephone service to its customers. Bell, during the audit period, was required under tariffs approved by the Kansas Corporation Commission to provide telephones, including maintenance of that equipment, to its telephone service customers if they so requested, although the customers could, if they wished, acquire from third-party vendors their own telephones which could in turn be connected to Bell's lines. The customer, when using telephones provided by Bell, paid an additional sum in monthly telephone service rates which varied depending upon the number and type of telephones selected by the service customer. If the customer provided the telephones, an adjustment was made by Bell in the monthly cost of the telephone service. Title and ownership of telephones provided by Bell to its customers remained in Bell.

Bell purchased its telephones new from AT & T, and AT & T collected and remitted sales tax on those purchases. These telephones were installed in the homes and businesses of Bell telephone service customers who desired Bell provide them telephones and maintenance. When a telephone malfunctioned, Bell would repair it, if possible, on the customer's premises. If on-site repairs could not be made, Bell would replace the malfunctioning telephone with another, and ship the malfunctioning instrument to AT & T's Merriam, Kansas, service center to be evaluated for possible repair. The Merriam service center processed telephones received from Bell offices in Kansas, Missouri, and Oklahoma. Upon receipt of a telephone, AT & T inspected it to determine whether it could be repaired or whether it should be junked. If it could not be repaired, a nominal charge was made to Bell for the inspection. If repairable, AT & T would place the telephone in an "as new condition" and then return it to Bell. Repaired telephones were returned to Bell offices in each state in proportion to the value of telephones received by AT & T from each state. The telephones lost their individual identity while processed by AT & T, and no claim is made that a repaired telephone was returned to the specific Bell customer who had previously used the instrument. The repaired telephones were merely placed in Bell's inventory for future use in servicing its customers. During the repair process, ownership of the telephones remained with Bell.

AT & T charged Bell a standard amount for repairs based upon the particular style or type of telephone and did not collect or remit sales tax on the repair charges. In the final adjusted assessment by the Division of Taxation, a total of $1,505,463 in state and local sales tax was assessed on the amount received for repair service receipts, of which $1,109,462 was for receipts from repairs to telephones returned to Bell offices outside Kansas, and $396,001 represented tax on repairs associated with telephones returned to Bell offices in Kansas.

The narrow issue before this court is whether these facts represent a situation contemplated by the statutory words, "service of repairing, servicing, altering or maintaining tangible personal property which when such services are rendered is not being held for sale in the regular course of business," contained in K.S.A. 79-3603(q). The Department of Revenue contends that the telephones repaired by AT & T were "not being held for sale in the regular course of business," and therefore the repair services were subject to sales tax. AT & T argues the telephones were being held for sale by Bell in the regular course of its business, emphasizing that the term "sale" is defined very broadly by K.S.A. 79-3602(c), and therefore the repair services were not subject to sales tax.

Sale is defined in the statute as:...