Concentric Network Corp. v. Com.

• Decision Date: 13 April 2006
• Citation: 897 A.2d 6
• Court: Pennsylvania Commonwealth Court
• Parties: CONCENTRIC NETWORK CORPORATION, (Now merged into and known as XO Communications, Inc.), Petitioner v. COMMONWEALTH of Pennsylvania, Respondent.

897 A.2d 6

CONCENTRIC NETWORK CORPORATION, (Now merged into and known as XO Communications, Inc.), Petitioner v. COMMONWEALTH of Pennsylvania, Respondent.

Commonwealth Court of Pennsylvania.

Argued December 14, 2005.

Decided April 13, 2006.

COPYRIGHT MATERIAL OMITTED

Anthony Charles Gulotta, Jr., Harrisburg, for petitioner.

Karen M. Gard, Sr. Deputy Attorney General, Harrisburg, for respondent.

BEFORE: COLINS, President Judge, and McGINLEY, Judge, SMITHRIBNER, Judge, PELLEGRINI, Judge, FRIEDMAN, Judge, LEADBETTER, Judge, and SIMPSON, Judge.

OPINION BY Judge SIMPSON.

This appeal involves sales and use tax on purchases by an Internet service provider of equipment and of access to wirelines. In particular, Concentric Network Corporation (now merged into and known as XO Communications, Inc.) (Taxpayer) filed exceptions to this Court's previous determination which essentially denied Taxpayer a substantial refund of sales and use taxes paid in 1999 and 2000.¹

We need not repeat at length the extensive and technical facts to which the parties stipulate. These facts were adequately recounted in our earlier decision. Concentric Network Corp. v. Commonwealth, 877 A.2d 542 (Pa.Cmwlth.2005). It is sufficient for present purposes to note how Taxpayer used the equipment and the wireline access.

Regarding the equipment at issue, Taxpayer purchased routers and associated equipment to direct or "route" its customers' data to its intended destination and to analyze incoming data for efficient delivery. Taxpayer used its servers for a variety of functions, including authentication of user status, e-mail, web caching, and web hosting. Further, Taxpayer's modems converted certain customers' analog data to digital signals. Stipulations of Fact Nos. 23, 24, 25.

As to the wireline access, Taxpayer does not own its own wirelines. Instead, Taxpayer purchased services from large telecommunications carriers such as MCI Worldcomm, Verizon and AT & T. The services provided Taxpayer with access to the telecommunication carriers' wirelines so that it could "transport its Customers' data traffic to and from the [Taxpayer's] serving office and to and from the Internet backbone." Stipulations of Fact No. 26. Taxpayer used the telecommunications carriers' wirelines rather than other technologies (such as television cable lines) to connect its customers to the Internet.

Taxpayer's refund request was denied first by the Department of Revenue Board of Appeals, and then by the Board of Finance and Revenue. On subsequent petition for review, the refund request was denied by a panel of this Court conducting de novo review.² Exceptions to that decision are currently before the Court en banc, consistent with Pa. R.A.P. 1571(i).

I. Statutory Background

The Tax Reform Code of 1971 (Tax Code)³ governs the sales and use tax issues here. Section 202 of the Tax Code, 72 P.S. § 7202, imposes upon each sale at retail of tangible personal property or services a tax on a percentage of the purchase price to be collected from the purchaser. The Tax Code defines the term "tangible personal property"⁴ as corporeal personal property including interstate telecommunications service.

The Tax Code defines certain occurrences as outside the definition of a taxable "sale at retail." Thus, the transfer of property to be used or consumed in the manufacture of tangible personal property does not qualify as a sale at retail, and therefore it is not subject to tax.⁵ Similarly, "sale at retail" does not include the transfer of tangible personal property for resale.⁶ Therefore, these occurrences are not subject to tax. Also, the delivering or rendering of a public utility service and the construction, repair and maintenance of facilities for a public utility service do not qualify as a taxable "sale at retail."⁷

Federal regulation of Internet service providers is also relevant, if not controlling. The Communications Act of 1934,⁸ was amended by the Telecommunications Act of 1996⁹ (Communications Act). The Communications Act regulates telecommunications carriers but not information service providers. Nat'l Cable and Telecomms. Ass'n v. Brand X Internet Servs., ___ U.S. ___, 125 S.Ct. 2688, 162 L.Ed.2d 820 (2005). This scheme codifies an historical regulatory distinction between "basic" service and "enhanced" service. In other words, telecommunications service is the equivalent of "basic" service, which consists largely of plain old telephone service, and it is more extensively regulated. Id.; California v. F.C.C., 905 F.2d 1217 (9th Cir.1990). In contrast, "information service" is the equivalent of "enhanced" service, which combines basic service with a capability to generate, acquire, transform, store, transform, process or make available information via telecommunications. Nat'l Cable. "Non-facilities based" Internet service providers — those like Taxpayer here that do not own the transmission facilities they use to connect the end-user to the Internet — are classified solely as information service providers. Id.

In 1998, Congress enacted the Internet Tax Freedom Act.¹⁰ This temporary moratorium on taxes on Internet access began on October 1, 1998 and was in effect at the time involved in this case. The Internet Tax Freedom Act also prohibited discriminatory taxes on electronic commerce, including a state tax that "establishes a classification of Internet access service providers . . . for purposes of establishing a higher tax rate to be imposed on such providers than the tax rate generally applied to providers of similar information services delivered through other means."¹¹

II. Equipment

Taxpayer raises three arguments to support its claim that its purchases of equipment should not be taxed. First, Taxpayer claims the purchases are not taxable because the equipment is used in manufacturing. Second, Taxpayer contends application of the tax to its purchases of equipment violates the Uniformity Clause of the Pennsylvania Constitution,¹² because such purchases by cable companies and facilities based Internet service providers are not taxed. Third, Taxpayer argues the purchased equipment is used to provide public utility service, and it is therefore not within the definition of a taxable "sale at retail." None of these contentions is meritorious.

Manufacturing

In our earlier decision, we decided that the operations performed by the equipment did not fall within the Tax Code's definition of manufacturing.¹³ We relied on the recent holding in Bell Atlantic Mobile Systems, Inc. v. Commonwealth, 799 A.2d 902 (Pa.Cmwlth.2002), aff'd per curiam, 577 Pa. 328, 845 A.2d 762 (2004) (taxpayer that provided cellular telecommunications service was not entitled to manufacturing exemption from sales and use tax). Having reexamined our determination, we discern no error.

Taxpayer raises a new argument based on a 2003 amendment to the Tax Code.¹⁴ Taxpayer contends this amendment essentially overrules Bell Atlantic because it adds mobile telecommunications service to the Tax Code's definition of "processing" activities that do not qualify as a taxable "sale at retail." This addition to the "processing" definition, Taxpayer contends, changes a crucial underpinning of Bell Atlantic.

We reject this argument for two reasons. First, the amendment to the Tax Code occurred several years after the taxable periods in question. There is no reason to believe the amendment was intended to receive retroactive effect. Second, Bell Atlantic was based on several rationales, not all of which are implicated by the subsequent statutory amendment. For these reasons, Taxpayer is not entitled to relief on this theory.

Uniformity of Taxation

In our earlier decision, we held that application of the sales and use tax to Taxpayer did not offend the constitutional requirement for uniform taxation even though cable operators and facilities-based telecommunications carriers received exemptions as public utilities. There is no error in this conclusion.

To be uniform, a tax must operate alike on the classes of things or property subject to it. Devlin v. City of Philadelphia, 580 Pa. 564, 862 A.2d 1234 (2004). The legislature has wide discretion in matters of taxation, and a taxpayer pursuing a Uniformity Clause challenge has the burden of demonstrating that a classification made for purposes of taxation is unreasonable and "clearly, palpably and plainly violates the Constitution." Id. at 588, 862 A.2d at 1249 (quoting Leonard v. Thornburgh, 507 Pa. 317, 321, 489 A.2d 1349, 1351-52 (1985)). If there is "some legitimate distinction between the classes that provides a non-arbitrary and `reasonable and just' basis for the difference in treatment," the tax legislation is to be upheld. Id. at 588-89, 862 A.2d 1234, 862 A.2d at 1249 (quoting Leonard, 507 Pa. at 321, 489 A.2d at 1352). On the other hand, when there exists no legitimate distinction between the classes, and, thus, the tax schemes impose substantially unequal burdens upon persons otherwise similarly situated, the tax is unconstitutional. Id. The analysis under the Uniformity Clause is "generally the same as that under the equal protection clause of the United States Constitution." Id. at 589, 862 A.2d at 1249 (quoting Wilson Partners, L.P. v. Bd. of Fin. & Revenue, 558 Pa. 462, 471, 737 A.2d 1215, 1220 n. 11 (1999) (citing Leonard, 507 Pa. at 320, 489 A.2d at 1351)).

The United States Supreme Court recently faced a similar argument in National Cable. Among other things, the Court addressed historically different regulatory treatment by the Federal Communications Commission (FCC) of Internet service provided by operators that utilize television cable lines and of similar service provided by operators that utilize telephone wirelines. Nat'l Cable, 125 S.Ct. at 2710-11. The Court concluded that different regulatory treatment was justified based on the history of regulation and policy considerations, which were described in detail in its opinion.

We...