Concentric Network Corp. v. Com.

• Citation: 922 A.2d 883
• Decision Date: 31 May 2007
• Docket Number: No. 65 MAP 2006.,65 MAP 2006.
• Parties: CONCENTRIC NETWORK CORPORATION (Now Merged into and Known as XO Communications, Inc.), Appellant, v. COMMONWEALTH of Pennsylvania, Appellee.
• Court: United States State Supreme Court of Pennsylvania

922 A.2d 883

CONCENTRIC NETWORK CORPORATION (Now Merged into and Known as XO Communications, Inc.), Appellant, v. COMMONWEALTH of Pennsylvania, Appellee.

No. 65 MAP 2006.

Supreme Court of Pennsylvania.

May 31, 2007.

Appeal No. 65 MAP 2006 from the Order of the Commonwealth Court dated April 13, 2006 at No. 290 FR 2003.

ORDER

PER CURIAM.

The Order of the Commonwealth Court is hereby AFFIRMED.

Justice SAYLOR files a dissenting statement.

Justice SAYLOR, dissenting.

Appellant, an Internet service provider ("ISP") for residential and business customers, appeals from the Commonwealth Court's determination that it is not entitled to relief from sales and/or use tax assessments related to its purchases of data transport services and related equipment for use in its business. For the following reasons, I agree with Appellant that it is entitled to relief under the manufacturing exclusion for the equipment it purchased for the purpose of converting electronic signals from one form into another. See 72 P.S. § 7201(k)(8)(ii)(A), (o)(4)(B)(i).

By way of statutory background, the Tax Reform Code of 1971 (the "Code")¹ provides that purchases of "tangible personal property" are subject to sales and use tax assessments. See 72 P.S. § 7202. The General Assembly has defined the term "tangible personal property" in a broad manner to include, inter alia, telecommunications services:

"Tangible personal property." Corporeal personal property including, but not limited to, goods, wares, merchandise, steam and natural and manufactured and bottled gas for non-residential use, electricity for non-residential use, prepaid telecommunications, premium cable or premium video programming service, spirituous or vinous liquor and malt or brewed beverages and soft drinks, interstate telecommunications service originating or terminating in the Commonwealth and charged to a service address in this Commonwealth, intrastate telecommunications service....

72 P.S. § 7201(m).² The Code defines the term "telecommunications service" as "all types of telecommunications transmissions" but excludes from its definition "charges for access to the Internet." 72 P.S. § 7201(rr)(3). The Code further provides that "access to the Internet" does not include "telecommunication services purchased by an Internet service provider to deliver access to the Internet to its customers." 72 P.S. § 7201(rr)(3)(B). As a result, telecommunications services purchased by an ISP are included within the general definition of "telecommunications service" and are subject to sales and/or use tax, unless they are excluded from tax under a separate provision.

The Code contains an exclusion from tax for tangible personal property that is used or consumed by the purchaser directly in the manufacture of tangible personal property. See 72 P.S. § 7201(k)(8)(ii)(A), (o)(4)(B)(i). The Code defines the term "manufacture" in the following manner:

"Manufacture." The performance of manufacturing, fabricating, compounding, processing or other operations, engaged in as a business, which place any tangible personal property in a form, composition or character different from that in which it is acquired whether for sale or use by the manufacturer.

72 P.S. § 7201(c). As telecommunications services are included within the definition of "tangible personal property," the manufacturing definition thus facially encompasses activities that place telecommunications services, including the components thereof, namely, electronic signals, into different forms from that in which they were acquired.

Consistent with the parties' stipulation of facts, an ISP is a vendor that provides its customers with access to the Internet, along with other secondary functions, such as electronic mail services, web hosting, and other services. An ISP, such as Appellant, functions as an intermediary between its own customers and larger ISPs that comprise the Internet backbone, which is composed of large bandwidth networks that meet at certain points in various metropolitan areas around the world. Customers can access the services of an ISP on a dial-up basis using an ordinary analog voice-grade local telephone line that they lease from a telecommunications carrier. If the customer accesses the Internet through such method, the customer must use a modem to convert the computer's digital signals into analog signals in order for the information to travel over the analog telephone lines. Once the signal reaches the ISP's digital transport network, the customer's information is converted back to digital format to travel across the ISP's network. This conversion is performed by a modem at the ISP's point of presence ("POP"), which is the physical place where the ISP operates and maintains the routers, servers, and other facilities necessary to perform its various service functions. As an alternative to dial-up service, a customer may purchase a dedicated data transport service to connect with the ISP, which provides the customer with "full-time" Internet access at higher speeds than the customer would experience using a dial-up access line.

In order to provide Internet access to its customers, Appellant made two categories of purchases during the period beginning January 1999 and ending December 2000. First, Appellant purchased various services from several large telecommunication carriers, including MCI Worldcomm, Verizon, and AT & T. Specifically, Appellant purchased ISDN-PRI, T-1, ATM, and Frame Relay Services (collectively referred to hereinafter as "data transport systems"), which enabled Appellant to transport its customers' information along the carriers' lines and to connect to the Internet backbone. The second group of items purchased by Appellant included routers, servers, modems, and other equipment. Appellant utilized these items to route its customers' data and to perform some processing functions, which ensured accurate and efficient delivery of the data to the intended destination. In addition, Appellant used this equipment to provide its customers with secondary services such as e-mail and web hosting.

In April 2002, Appellant filed a petition for relief from sales and/or use tax assessments with the Pennsylvania Department of Revenue's Board of Appeals for both groups of purchases.³ The Board of Appeals denied Appellant's petition, and Appellant appealed to the Board of Finance and Revenue, which similarly denied Appellant's claim. Appellant thereafter filed a petition for review with the Commonwealth Court, asserting, inter alia, that it was entitled to relief under the manufacturing exclusion applicable to sales and use taxation. See 72 P.S. § 7201(k)(8)(ii)(A), (o)(4)(B)(i).

The Commonwealth Court, in a published opinion, held that Appellant was not engaged in manufacturing and was thus not entitled to relief. See Concentric Network Corp. v. Commonwealth, 877 A.2d 542 (Pa.Cmwlth.2005) ("Concentric I"). The court concluded that the data transport services purchased by Appellant met the definition of telecommunications service, and thus constituted "tangible personal property" as defined by the statute. See Concentric I, 877 A.2d at 546. While recognizing that Appellant's purchases constituted "tangible personal property," the court declined to find that Appellant was engaged in "manufacturing." In this regard, the court observed that the "manufacture" definition does not encompass the transformation of electronic impulses and signals. See Concentric I, 877 A.2d at 548. In support of this proposition, the Commonwealth Court relied upon its previous decision in Bell Atlantic Mobile Sys., Inc v. Commonwealth, 799 A.2d 902 (Pa. Cmwlth.2002), aff'd per curiam, 577 Pa. 328, 845 A.2d 762 (2004).

In Bell Atlantic, Bell Atlantic Mobile Systems, Inc. ("Bell Atlantic"), a provider of cellular telecommunications service ("CTS"), argued that it was entitled to the manufacturing exclusion for its purchase of various items that it utilized to transform tangible personal property, namely, electricity and various signals, into different signals. See Bell Atlantic, 799 A.2d at 906. The Commonwealth Court rejected Bell Atlantic's argument on the ground that the manufacturing exclusion does not apply to dealings with electrical or electronic impulses, but rather only applies to the production of tangible matter. See id. at 906-07. In reaching this conclusion, the court relied upon the discussion of the term "manufacturing" by the Commonwealth Court in Suburban Cable TV Co. v. Commonwealth, 131 Pa.Cmwlth. 368, 570 A.2d 601 (1990) ("Suburban Cable I"), aff'd per curiam, 527 Pa. 364, 591 A.2d 1054 (1991).

In Suburban Cable I, a group of cable television operators, contended that "the transformation of an electronic signal through the use of equipment and personnel, from a form that may not be viewed on a television set to one that may be viewed on a television set, constitute[s] manufacturing" under, inter alia, the sales and use tax. See Suburban Cable I, 131 Pa.Cmwlth. at 374, 570 A.2d at 603. In considering the taxpayers' argument, the Suburban Cable I court relied in large part upon this Court's discussion of the common law definition of manufacturing in Golden Triangle Broadcasting, Inc. v. City of Pittsburgh, 483 Pa. 525, 397 A.2d 1147 (1979). In Golden Triangle, this Court explained that the term has been given its "ordinary and general meaning" as "the application of labor or skill to material whereby the original article is changed into a new, different and useful article." See Golden Triangle, 483 Pa. at 529, 397 A.2d at 1149 (citation omitted). On this basis, the Suburban Cable I court concluded that the manufacturing exclusion has been confined to dealings with "tangible matter," and does not apply to dealings with intangible matter, such as electrical or electronic impulses. See Suburban Cable I, 131 Pa.Cmwlth. at 380, 570 A.2d at 607.⁴

Based upon these prior cases, the Bell Atlantic court held that...