PART A VOICE OVER INTERNET PROTOCOL PART B INTERNET ACCESS AND ORST PART C 800 SERVICE PART D TELECOMMUNICATIONS FOR RESALE

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1 Application of GST/PST to Voice Over Internet Protocol (VOIP) By: Ali Sheikh Rogers Communications Inc The author would like to thank Audrey Diamant of PricewaterhouseCoopers LLP for her valuable input and Rob Dhindsa of Rogers Communications Inc. for his valuable input and review. BACKGROUND In this constantly changing world of telecommunications, determining the correct tax status of a particular service is the biggest challenge, among others, facing the telecom industry and the government tax authorities. Telecommunications companies are developing and offering leading-edge technologies and services. Carriers are expanding into new jurisdictions across Canada, into the United States and overseas. Customers are also on the move. An Ontario resident may use his cell phone in Toronto or Vancouver or New York or London. Tax authorities lag many steps behind new technologies and services. As a result, the entities providing the services are faced with the difficult task of determining, at least in part, which sales tax provisions to apply to these new services. In the United States, tax rules relating to the telecom industry were simplified by introducing a new set of place of use rules. The Mobile Telecommunications Sourcing Act ( MTSA ) was signed into law on July 28, 2000 (effective August 2, 2002) 1. It provides for a uniform method of sourcing tax revenues from the sales of mobile transactions. Tax revenues from sales of wireless telecommunications services are sourced to the customer s place of primary use. This is defined as the residential or business street address of the customer, regardless of the state where the customer s calls originate, terminate, or pass through. In Canada, federal and provincial sales tax ( PST ) rules were developed with the basic local and long-distance service in mind. Government tax authorities have been unable to keep pace with the development of new technologies and services. The telecommunication rules for GST, HST and QST are similar but are not identical in all respects. Provincial sales tax rules are also not the same across the taxing provinces. The so called 2 out of 3 rule (discussed later in the paper) used to determine the place of supply is not the same across the applicable provinces. This paper focuses on the taxability of VOIP. However, it is only prudent to discuss the tax rules in place for the telecom industry in general, Internet related services in particular, and the status of service-offerings such as when provided as part of VOIP. Keeping that in mind, the discussion topics are presented in the following order: PART A VOICE OVER INTERNET PROTOCOL PART B INTERNET ACCESS AND ORST PART C 800 SERVICE PART D TELECOMMUNICATIONS FOR RESALE

2 PART E TWO OUT OF THREE RULE PART F - SUMMARY PART A VOICE OVER INTERNET PROTOCOL (VOIP) Introduction The recent years have seen great advances in technologies that offer new options and choices that include broadband Internet access, Wireless Fidelity (Wi-Fi), and now Voice-over Internet Protocol (VOIP). This technology (VOIP) is expected to have as great an impact on telecommunications as the switch from analog to digital did in the past three decades. VOIP specifies both a technology and a service. The technology is Internet Protocol (IP). The service is voice transmission. This technology (VOIP) allows the user to make and receive phone calls using a broadband Internet connection instead of a public switched telephone network (PSTN). The basic steps involved in originating an Internet telephone call are conversion of the analog voice signal to digital format, and compression/translation of the signal into Internet protocol packets for transmission over the Internet. The process is reversed at the receiving end to make it possible for the user to speak to anyone with a regular phone number. VOIP is a borderless technology; unlike the circuit-switched network, the IP network is connectionless. Traffic is global and no longer defined within the limited jurisdiction of states. The main advantage VOIP offers consumers is the cost savings. This technology allows for long distance-calls without incremental costs to the service provider. As a result, a long-distance call to Europe through the Internet should be treated as a local call covered by the monthly fixed fee charged by the service provider. In addition, with a broadband Internet connection, there is no need to maintain and pay the additional cost for a line simply to make telephone calls. Also, since Internet voice is digital, it may offer features and services that are not available with a traditional phone. A disadvantage of VOIP is that some services will not work during power outages if the provider does not offer back-up power. Also, some voice services have difficulty connecting with a 911-dispatch centre. Is VOIP Internet access and therefore exempt from ORST? Prior to determining if VOIP is Internet access, it is important to describe the Internet and access to Internet. This will provide us a guide line to determine 2

3 whether VOIP is Internet access or whether it is a service provided by means of Internet access. Internet 2 The Internet or the World Wide Web is a decentralized, global, public network of computers over which digital information and products can be distributed. A person who is connected to the Internet can communicate quickly, cheaply, and efficiently with other people such as employees, suppliers and customers, can access data such as credit and market information and can buy and sell products and services electronically. Another way to describe the Internet is that it is made up of telecommunications, broadcasting and computer networks which are interconnected to provide high capacity and interactive means of sending and receiving information. The Internet is an information highway that spreads around the globe with links to various clusters of information (web sites) available to be accessed by the users (subscribers) of this service. Internet Access Internet Service Providers (ISPs) supply the necessary access to the Internet. The ISPs have also become part of the Internet by providing necessary hardware, software and telecommunication services to allow its customers to connect to the Internet. Internet access, provided by ISPs, is a gateway to the information highway. VOIP and Internet Access VOIP is an Internet application. For it to work, a broadband (high speed Internet) connection is required. This can be through a cable modem, or high speed services such as digital subscriber line or a local area network. Conversations are converted to digital data that is distributed by way of the broadband connections. Standard, simple Internet wiring also piggybacks your phone calls. Every phone is a mini-computer including a digital display with menus that change depending on what the user is doing; for example, prompting the user through the setup of a 12-person conference call. A VOIP phone, like a computer, is personalized to users needs. The VOIP phone can be plugged in wherever Internet access is available; whether in a conference room across the hall or a hotel room across the continent; it sends and receives calls as if at your desk, retains your power-dial settings, and lets you browse the company phone book. In fact, with the right software and an inexpensive headset, your computer itself can entirely eliminate a traditional phone and make calls by selecting names right off your contact database, i.e., no need to punch in numbers. The Internet generally provides customers with access to information and a number of services, including the ability to send and receive s and, in the case of VOIP, make 3

4 and receive phone calls. For VOIP, the Internet is the medium being used to conduct voice conversation. It involves taking a telephone call and breaking it down into discreet digital packets that can be sent flying across the Internet just like data from e- mails and web sites. The voice call may be the only place where IP is involved, with people at either end using traditional analog or digital telephones. VOIP is therefore a form of information transmission (i.e., the transmission of voice in a packet form using Internet Protocol) and Internet access is the service of providing access to the information. VOIP is an infrastructure technology that can be incorporated in products using voice. Moving files containing voice isn t much different than moving files containing a report even if it is done using IP. Would that make VOIP Internet access? If VOIP is not Internet access what is it? Should it be taxed as a telecommunication service? A distinction must be made between a telecommunication service and a service, other than a telecommunication service, provided by means of telecommunication. Indeed, a service should not qualify as a telecommunication service solely by reason of the fact that its provision requires the use of telecommunications. In order to make this distinction, the nature of the service that the supplier provides to the recipient of the service must be analyzed. We will now look at the definition of telecommunication, under federal and provincial statutes, to see how it applies to VOIP. TELECOMMUNICATION For GST/HST/QST purposes, the definition of telecommunication falls under the following headings: (1) Telecommunications (2) Telecommunications facility, and (3) Telecommunication service (1) Subsection 35(1) of the Federal Interpretation Act defines telecommunications as the emission, transmission or reception of signs, signals, writing, images, sounds or intelligence of any nature by wire, cable, radio, optical or other electromagnetic system, or by any similar technical system. (2) Subsection 123(1) of the Excise Tax Act (the Act ) defines a telecommunications facility to be - any facility, apparatus or other thing (including any wire, cable, radio, optical or other electromagnetic system, or any similar technical system, or any part thereof) that is used or is capable of being used for telecommunications. 4

5 (3) A telecommunication service is defined in subsection 123(1) of the Act as follows: (a) the service of emitting, transmitting or receiving signs, signals, writing, images or sounds or intelligence of any nature by wire, cable, radio, optical or other electromagnetic system, or any similar technical system, or (b) making available for such emission, transmission or reception telecommunications facilities of a person who carries on the business of supplying services referred to in paragraph (a). For PST purposes, telecommunications is defined as follows: ONTARIO As per section 1 of the Ontario Retail Sales Tax Act (ORSTA), telecommunication means any transmission, emission or reception of signs, signals, writing, images or sound or intelligence of any nature by wire, radio, visual or other electromagnetic or laser-based system, but does not include any transmission, emission or reception or class thereof that is prescribed by the Minister to be excluded for the purpose of this paragraph. MANITOBA As per the Manitoba Retail Sales Tax Act (MRSTA), paragraph 4(3), telecommunication means a message transmitted by means of electro-magnetic waves or otherwise in the form of words, writing, images, symbols, or other indications. SASKATCHEWAN As per the Provincial Sales Tax Act (PSTA), paragraph 3(1)(l), telecommunication service means any transmission, reception or distribution of signs, signals, words, images, symbols, sounds or intelligence of any nature by means of electromagnetic waves and includes the provision of facilities required for such transmission, reception or distribution. BRITISH COLUMBIA As per the Social Service Tax Act (SSTA), section 1, telecommunication includes any transmission, emission or reception of signs, signals, writing, images, sound or intelligence of any nature by wire, fiber optic cable, radio, satellite or other electromagnetic or laser based system, but does not include any prescribed transmission, emission or reception or any prescribed class of transmission, emission or reception; 5

6 telecommunication service means the right, whether exercised or not, to send or receive one or more telecommunications by means of a transmitter that is ordinarily situated in British Columbia, and includes (a) the sending or receiving of a telecommunication by means of a transmitter that is ordinarily situated in British Columbia, and (b) a dedicated telecommunication service. PRINCE EDWARD ISLAND The Revenue Tax Act imposes sales tax on goods consumed within the province. Goods are defined under subsection 1(e) to include telecommunication services. Under paragraph 1(1)(x) of the Revenue Tax Act Regulations, telecommunication services are defined as the charge billed to subscribers for any transmission, emission or reception of signs, signals, writing images, sound or intelligence of any nature by wire, fiber optic cable, radio, satellite or other electromagnetic or laser based system and includes such services as telephone, cable television, telex and telegraph. It is clear based on the definitions noted above that telecommunication services are very broadly defined. Exclusions would therefore presumably have to focus on the objective of the service, whether the transmission is a means rather than an end and, notwithstanding the evolving technology, whether the method of delivery is less important than what is being delivered. VOIP is a service that is available through the Internet. If we look at VOIP from the e- commerce perspective, VOIP has no borders and it is a supply of an information service made over the Internet. If the service purchased is that of information, and it simply uses telecommunication technology to deliver the service to the customer, akin to security alarm services or providing access to, but not the ability to manipulate, a database, then it is not a purchase of a telecommunication service. The one province we are aware of that has issued an opinion 3 on VOIP is that of B.C. The legislation branch of the Ministry of Provincial Revenue of British Columbia is of the opinion that VOIP services fall within the Social Service Tax Act s (SSTA) definition of telecommunication service and are, therefore, generally subject to SST, and do not qualify for the residential rate exemption under section 56(a) of the SSTA. VOIP may be shaking the foundations of telecommunications, but it s hardly mature and its regulatory future remains uncertain. The VOIP revolution is not about replacing voice with voice. It is about delivery of integrated multimedia services voice, video, text, data, web pages and teleconferencing via one simple network based on IP technology. This is part of the convergence. Internet providers can offer telephone service and VOIP service can be offered by software providers. In my opinion, VOIP is made up of three 6

7 interwoven components internet, telecommunication and information. Its taxability would depend on how these components are bundled for the end consumer. The difficulty in disconnecting the components of the service, as well as the fundamental premise of convergence that underlies the service-offering, makes the analysis as telecom or other complex. Given the dearth of analysis at the Canadian provincial level, it may be worth looking to other jurisdictions for guidance. As discussed in the section that follows regarding U.S. sales taxes, not all jurisdictions automatically characterize the service as that of telecommunication, either based on their analysis of its true nature, or a desire not to overburden a fledgling service offering in its initial stages of growth. Is VOIP subject to U.S. state sales tax as a telecommunication service? As mentioned, it is often useful to examine the analysis and developments in other jurisdictions, in order to better understand both the areas of convergence and, sometimes more importantly, to examine any differing viewpoints and the justification therefore. In this part of the paper, we first look at the definition of telecommunications service followed by a review of a court case related to VOIP and, finally, the current developments relating to the taxation of VOIP. Telecommunications Defined Following are some of the terms as defined in the Telecommunications Act (U.S.) of 1996: Telecommunications is defined as the transmission, between or among points specified by the user, of information of the user s choosing, without change in the form or content of the information as sent and received. Telecommunications Service is defined as the offering of telecommunications for a fee directly to the public, or to such classes of users as to be effectively available to the public, regardless of facilities used. Information Service is defined as the offering of a capability for generating, acquiring, storing, transforming, processing, retrieving, utilizing, or making available information via telecommunications. Court Case on VOIP 4 In a court opinion released on October 16, 2003, Judge Michael J. Davis of the district of Minnesota wrote that VOIP service provided by Vonage is an information service rather than a telecommunications service and therefore exempt from state regulation. In the opinion, Davis relied heavily on interpretations of information services developed by the FCC in light of anti-internet regulation policies put forward by Congress. 7

8 Drawing on a FCC policy paper known as the Universal Service Report, Davis spelled out a four-part test for determining whether a phone service should be classified as a telecommunications service, rather than an information service. The four part test refers to services in which the provider meets the following conditions: (1) it holds itself out as providing a voice telephony or facsimile transmission service; (2) it does not require the customer to use customer premises equipment ( CPE ) different from that CPE necessary to place an ordinary touch-tone call (or facsimile transmission) over the public switched telephone network; (3) it allows the customer to call telephone numbers assigned in accordance with the North American Numbering Plan, and associated international agreements; and (4) it transmits customer information without net change in form or content. The FCC s four part test sets out the conditions that characterize a traditional telephone service as a telecommunication service. Davis concluded that Vonage s Digital Voice service does not match all of the FCC s criteria and that it is therefore an information service. Namely, he said, Vonage uses a digital converter that translates data between an IP format and an analog phone signal to complete computer-to-phone and phone-tocomputer calls. Vonage s VOIP service failed the second and fourth tests. A VOIP service requires the use of additional equipment (digital voice converter) that converts the analog voice signal to digital format, and translation of the signal into internet protocol packets for transmission over the Internet. Further, a net change in form and content occurs when Vonage s customers place a call. If the end user is connected to the public switched telephone network ( PSTN ), the information transmitted over the Internet is converted from IP into a format compatible with the PSTN. Vonage s service is not a telecommunications service because from the user s standpoint the form of a transmission undergoes a net change. Legal experts said that the decision offers an early win for VOIP in what s sure to be a drawn-out legal battle with state regulators and local phone carriers worried about losing market share to a new brand of competitor. Current Developments In the U.S., the federal government has emerged as the body that has authority over regulating VOIP services. On April 2, 2004, 5 Sen. John Sununu announced the longawaited internet phone legislation that would effectively eliminate state and local authorities ability to tax and regulate broadband phone calls. The bill says all authority over regulating VOIP services is reserved solely to the federal government. The measure, VOIP Regulatory Freedom Act, also imposes some curbs on the Federal Communications Commission s ability to extend to VOIP much of the thick quilt of rules and requirements that govern the traditional phone network. For instance, it bans imposing certain access charge taxes, but does require the FCC to levy VOIP universal service fees that will be redirected to provide discounted analog phone service to low income and rural Americans. The legislation is another attempt by federal policymakers 8

9 to claim lone responsibility for regulating VOIP calls. The FCC wants a light hand to foster the young industry, while states and cities fear that as more calls make their way onto the unregulated Internet, they ll have fewer taxes to collect to support 911 and other public services. Yahoo, America Online and Microsoft were, technically, the biggest winners recently (early 2004), when federal regulators balked at imposing taxes and rules on free voice calls that flow completely over the Internet. On July 6, , two key members of Congress announced legislation that could create a sweeping federal regulatory framework for Internet phone calls. Reps. Rick Boucher, D-Va., and Cliff Steams, R-Fla., asserted that the Federal Communications Commission not state government or regulators should oversee rules regarding phone calls made over the internet. Their bill would beat back attempts by regulators in states such as New York, California and Minnesota to extend their jurisdiction to the fledgling technology known as VOIP. Under this bill the FCC would have the option to regulate three key areas for VOIP companies that link with traditional phone networks. The three areas are enhanced 911, universal service, and access charges. A white paper released in June 2004 by the VON Coalition which includes Microsoft, MCI, Intel and Pulver.com argues that because VOIP providers already pay universal service taxes and access charges directly or indirectly when they link to the traditional phone network, no changes to existing rules are necessary. The third bill 7, called the Advanced Internet Communications Services Act, is the only one with bipartisan support. It is also the most regulatory, saying that the FCC shall by regulation require VOIP companies to offer E911 service and disabled access, in addition to paying universal service and related taxes. Universal service taxes and access fee regulations apply to traditional phone lines. They subsidize Americans who live in rural areas by charging urban subscribers more for phone service. So far, each of the three bills in Congress that address VOIP prohibits state governments from taxing and regulating companies that provide Internet telephone service. However, on July 22, , the Senate Commerce Committee approved an amendment to the VOIP Regulatory Freedom Act that would allow states to levy taxes on VOIP services to pay for universal service and to compensate traditional telephone companies for the use of their phone lines by imposing access charges. A separate amendment would give states the power to force VOIP providers to pay for 911 services. Before the above mentioned amendments, the bill would have exempted VOIP services from state and local taxation. California, New York, and Minnesota have all asserted jurisdiction over VOIP providers that connect to the public switched telephone network, and other states are considering similar actions. It is felt that many of these measures have been adopted not so much in recognition of the differences in nature as between VOIP and traditional telecom services but rather, to encourage the development of the Internet and therefore leave it unregulated. 9

10 PART B INTERNET ACCESS AND ORST Internet access is a service provided by the Internet service provider. The service provider is supplying access to a vast telecommunication network enabling the subscriber to take advantage of various services (e.g., send and receive , download files, etc.) All provinces, except Ontario, consider Internet access to be a service that allows the user to transmit and receive signals and thus treat it as a telecommunication service. Accordingly, all provinces but Ontario tax Internet access fees. If Internet access really is a telecommunication service, then Ontario Sales Tax Guide #651 is an administrative exemption that applies to Internet related services provided by ISPs. What is Internet access for ORST purposes? Internet access is not defined in the Ontario Retail Sales Tax Act. Instead, Guide # 651 cites Internet related services as follows: Membership or subscription fees to access the Internet and/or World Wide Web Internet services Arranging for live chat or conferencing sessions directly on the Internet Technical assistance and support (not hands-on) Web hosting and/or domain name registration Advertising fees charged to place ads within a web page Real-time streaming video and/or audio. Many services provided by carriers and other businesses involve the use of the Internet, does this make the service Internet access? Internet access is a gateway to all the services provided by means of the Internet. For example, VOIP is a service provided by the carriers and it involves use of the Internet. Does this make the service Internet access? Perhaps it is a bundled service which includes the Internet access provided by the ISP and the voice packets are the information that is sent or received over the Internet? In accordance with one of the rulings issued under the British Columbia SSTA, Internet access meets the definition of a telecommunication service because it provides the right to send or receive telecommunications. Pursuant to the SSTA, VOIP is also a telecommunication service. Could the service of VOIP be considered Internet access? 10

11 When is a business selling Internet access as opposed to a telecommunication service? The line between telecommunication services and other on-line services is becoming increasingly blurred. Businesses are now offering bundled services which makes it even harder to determine whether a business is selling Internet access or a telecommunication service. However, we can use two simple examples to assist with this determination: Wireless Fidelity (Wi-Fi) is a new service offered by telecommunications carriers. In simple terms, Wi-Fi is wireless Internet access. Special equipment is installed at various locations (hot-spots) where users access this service. Clearly here, the business is selling wireless Internet access to the users of this service. A service provider supplies access to a vast telecommunications network enabling the subscriber to take advantage of a plethora of services. The service provider does not directly supply the various services which, when considered separately, do not necessarily constitute a telecom service. Rather, he supplies access to the network through which the subscriber can, among other things, send and receive s, download files, etc. In this respect, the amount that the subscriber pays to his service provider represents consideration for the supply of a telecommunication service. Are Internet service providers purchasing telecommunication services from carriers for own use, or are they purchasing Internet access from carriers? One of the main uses of the Internet is to access information. In the above example (Wi- Fi), the business is offering wireless Internet access to the hot-spot users. So, the business is acquiring Internet access for resale purposes. Fundamentally, an ISP provides a gateway to information, as opposed to the conduit through which the information flows, similar to the provision of a library card. ISPs actually consume telecom services in the provision of their services, but this does not mean that they are re-supplying a telecom service. PART C 800 SERVICE service enables the caller to call long distance with the charge being fully absorbed by the receiver. An 800 telephone service is effectively a service which allows people to call the subscriber on a collect call basis without having to go through the trouble of making an operator assisted or software assisted collect call. By subscribing to the 800 service, the subscriber agrees to pay all toll charges with respect to calls it will receive on its 800 number. 11

12 What types of services are exempt 800 services for PST purposes? In general, PST applies to 800 services in accordance with the 2 out of 3 rule. However, some provinces, in an effort to attract telemarketing centres, have specifically exempted 800 telephone services. Further to legislation and / or administrative policy, the exemption may apply to usage only or may extend, depending on the jurisdiction, to some or all services ancillary to the 800 service such as: Installation of, and minimum monthly charges for the 800 service Installation of, and minimum monthly charges for 800 features such as: - area code routing, - time of day / day of week routing, - overflow routing, - dialed number identification - call prompter - area code restrictions - courtesy response What are the requirements of the various PST statutes in order that a service may be characterized as an exempt 800 service? British Columbia Section 10 of the SSTA Regulations exempts 1-800, 1-888, telephone and facsimile services purchased for commercial use. Such services purchased for noncommercial purposes, e.g., family or domestic use, are taxable. Manitoba No tax is payable for a telephone service. This provision was amended, effective May 17, 1999, to clarify that the exemption includes other equivalent toll free telephone service. Pursuant to subsection 4(6) of the MRSTA, no tax is payable for a or other equivalent toll free telephone service. Based on the above provision, it is understood that usage charges, installation charges for the service and features integral to it are all eligible for exemption. Ontario Pursuant to paragraph 7(1)(2.2) of the ORSTA, 1-800, 1-855, 1-877, and other toll free numbers are exempt from tax. All charges for services provided exclusively with the 12

13 toll-free services are exempt from RST. Charges for additional services or options that are not provided exclusively with these services are taxable, such as the monthly charge for a basic telephone service. Subsection 14(7) of Regulation 1012 to the ORSTA excludes or equivalent telephone services that are acquired for domestic or family use. Prince Edward Island Pursuant to the Revenue Tax Act of P.E.I., paragraph 12(1)(y.2), contains an exemption for 800 telephone service. The regulations define 800 telephone services as long distance telephone communication terminating in the province the charges for which are billed to subscribers in the province. Quebec Through the application of the two-out-of-three rule, when the recipient of the call is in Quebec, QST applies to the supply of the telephone service. However, Input Tax Refund restrictions have long been removed on the following: telephone service and other related telecommunications services (effective May 10, 1995); telephone service and other related telecommunications services (effective March 1, 1996); telephone service having an identity code that is the extension of a telephone service (e.g., 1-877), and other related telecommunications services (effective April 5, 1998). Saskatchewan Paragraph 5(1)(x.2) of the Regulations to the PSTA define a toll-free telephone service to mean a toll-free telephone service using one of the following dialing prefixes: (i) 1-800; (ii) 1-888; (iii) 1-877; (iv) Any similar dialing prefix for which there is no long distance charge payable by the person using that dialing prefix. As per Paragraph 8(1)(mm.1) of the PSTA, telephone services using or telephone lines are exempt from sales tax when purchased by retail sale in the province. Effective March 30, 2000, exemption also applies to service, as well as to any similar dialing prefix where there is no long distance charges payable by the caller. 13

14 Does the service have to involve the use of a telephone and carriage of voice, or can a computer and data be used? Internet telephony refers to communications services voice, facsimile, and/or voicemessaging applications that are transported via the Internet, rather than the public switched telephone network. Equipment needed for VOIP includes a broadband, or high speed Internet connection, a cable modem, and a telephone adaptor. Internet telephony within an intranet enables companies to transmit their (digitized) voice and data traffic together over the intranet in support of shared applications. They can make point-to-point calls via gateway servers attached to the local-area network (LAN). No PC-based telephony software or Internet account is required. The PC-to-PC Internet telephony works if both parties are using Internet Phone software. The software is designed to run on a personal computer equipped with a sound card, speakers, microphone, and modem. The software compresses the voice signal and translates it into IP packets for transmission over the Internet. Another way is to utilize a microphone headset plugged into your computer. The number is placed using the keyboard and is routed through your cable modem. This technology is being further developed to allow text communication. In the U.S., Trace Center is working with Cisco on a technique which would allow every phone in an organization to be instantly capable of text communication (with and without voice carryover) by simply installing a software program in the call manager. Although the technology is therefore evolving, the available exemptions should apply regardless of the technology used, as the policy decision to exempt is based on the nature of the service rather than the means of achieving that service. PART D TELECOMMUNICATIONS FOR RESALE Resellers are those persons selling telecom services. Resellers rent dedicated lines from telecommunications carriers to provide long distance phone services. Their principal business is to offer alternative phone and data communications services to customers at rates below those charged by carriers. What criteria or characteristics must be present in order that a telecommunication service can be said to be purchased for resale exempt of PST? Following are requirements, for the purchase of telecommunication service, of the various PST statutes: 14

15 British Columbia Businesses are not required to pay tax on telecommunication services that are acquired solely for resale. For example, businesses that provide specialized long distance calling services may purchase bulk telecommunication lines from the major telecommunication companies without paying tax. Such businesses are, however, required to collect and remit tax on their sales of telecommunication services. Saskatchewan If purchasing telephone services for resale to customers, the line charges may be purchased exempt from tax by providing the vendor s license number to the supplier. Ontario Resellers may purchase telecommunication services for resale exempt from Ontario Retail Sales Tax (ORST) by giving carriers a properly completed Purchase Exemption Certificate. Equipment purchased to provide the service is taxable. For ORST purposes, resellers also include businesses not primarily in the business of selling telecommunications services (e.g., banks, utility companies, and other large corporations) that may sell their excess telecommunications capacity to the public. These businesses must also charge, collect, and remit tax on these sales. The tax paid to suppliers on the excess telecommunications capacity they sell may be deducted by internal adjustment from the tax they must remit. Certain businesses and institutions providing telecom services are not considered resellers. For example, hotels/motels, apartments/condominiums, hospitals, taxi company dispatchers, and providers of facsimile services. These businesses must pay ORST on telecommunication services purchased from carriers or resellers and are not required to charge, collect or remit ORST on their sales. Quebec As a general rule 9, every person who is a registrant and who acquires property or a service for consumption, use or supply in the course of his commercial activities may claim an ITR on the QST paid in respect of such property or service. A business that operates a cellular mobile telephone service, for example, may pay amounts to a business that operates a traditional telephone service in order to be connected with the latter s network. This service constitutes an inter-connection service. Interconnect charges related to an inter-connection service provided by a third party to the telecommunications service provider, are taxable. However, the telecommunication 15

16 service provider will be entitled to an ITR in respect of QST payable on the supply of an inter-connection service. If the telecommunication purchased is different than the service or telecommunication service ultimately sold by the purchaser, can the purchaser still purchase the telecommunication for resale? Little written guidance has been provided by the provinces on this matter, with the relatively few comments/examples summarized below, by province. Ontario Telecommunications may be purchased by vendors to provide services such as teleconferencing. This service is considered to be one of providing personnel and bringing equipment (equipment owned and operated by the vendor) to converge various participants into a common conversation. The vendor of such a service may or may not rent dedicated lines from a telecommunication service provider (Bell). The consideration paid by participants includes charges for arranging and conducting the call and the reimbursement of any long distance or other charges incurred by the vendor. The company providing a teleconferencing service is basically a provider of communications via a telephone network and, as such, is a vendor of a telecommunication service, regardless if dedicated lines are rented or not within the provision of such service. Hence, the vendor must charge tax on such services and may purchase telecommunication services exempt of ORST to provide such teleconferencing services. Quebec 10 A supplier of telecommunication services cannot claim an ITR in respect of all the telecommunication services he acquires in the course of his business. Only the telecommunication services acquired for the purpose of being used directly and solely to make a taxable supply of another telecommunication service by that person can give entitlement to an ITR. Hence, the telecommunication services that such a supplier acquires for his own use, in other words for internal use, do not give entitlement to an ITR in respect of such services. PART E TWO OUT OF THREE RULE The 2 out of 3 rule is the basic rule used to determine where a telecommunication service is provided and, hence, which tax will apply. For PST purposes, charges for individual telecommunications provided as part of a telecom service are typically taxed in a particular jurisdiction if the telecommunication meets at least 2 of the following criteria: 16

17 1. The telecommunication originates in the province; 2. The telecommunication terminates in the province; 3. The charge for the telecommunication is invoiced with respect to a transmitter that is ordinarily situated in the province (billing location). The first two rules are the same across the PST charging provinces (except for PEI ) and for GST and QST purposes. In some provinces, such as Saskatchewan, the third condition differs and will refer to an acquirer who either resides in the province or is engaged in commercial activities in the province. There are also default or origin rules that are discussed in greater detail later in the paper. Prince Edward Island Prince Edward Island does not have a 2 out of 3 rule. P.E.I taxes telecommunication services based on the location of the subscriber. GST/HST/QST For GST, HST and QST purposes, a two step test is used to determine the taxability of the telecommunication services. First, you have to determine if the service provided is one of making telecommunication facilities available. If it is, the place of supply rules 11 (described in the next section) are applied to determine whether the GST,HST or QST applies. If not, then we revert to the 2 out of 3 rule and the service will be considered to be supplied where the telecommunication is both emitted and received, or where the transmission is emitted or received and the customer is billed 12. The administrative position of the CRA and Revenue Quebec is that the supply of residential phone and cable service constitutes making telecommunication facilities available and the place of supply rules should be used to determine if these telecommunication services are made in Canada or in Quebec. Many businesses have intra-nets and other networks connecting their different office locations. In many cases the telecommunication networks are not dedicated and the networks span a number of provinces. Intranet is similar to Internet, except that, it is more private. Intranet is like a virtual private network ( VPN ). Businesses use leased lines from ISPs to create a private tunnel on the Internet for point to point communication between offices at different locations. Where businesses have intra-nets and networks expanding to other provinces, the billing location, rather than the 2 out of 3 rule, will be used to determine which taxes will apply. 17

18 To use the so called 2 out of 3 rule, the initiation and/or termination point of each transaction must be known. The collection of this type of information will be a challenge in situations where the Internet is being used to perform the required services. With transmitters located in a number of different provinces, how does the 2 out of 3 rule apply? In addition to the 2 out of 3 rules, and the slight variations by province, there are a number of additional rules that apply, specific to the GST/HST/QST and the PST, as follows:. (a) Place of Supply (b) Billing Location (c) The Origin Rule (a) Place of Supply The Place of Supply rules are relevant for GST/HST and QST and determine the nexus to a particular jurisdiction and the ability of that jurisdiction to tax a supply. For HST purposes, the telecom place of supply rule is found in section 2 of Part VIII of Schedule IX to the Excise Tax Act (ETA) and states, if a telecommunication service consists of making telecommunications facilities available (other than a service of granting sole access to a telecommunications channel, e.g., to a telecommunications circuit, line, frequency, channel or partial channel, excluding a satellite channel), the supply of the service is made in a particular province if: all of the facilities are ordinarily located in that province; or not all of the facilities are ordinarily located in the province, but the invoice for the supply is sent to an address in that province. In any other case (except a service of granting sole access to a telecommunications channel, e.g., dedicated line ), the supply is considered to be made in a particular province if the telecommunication: is both emitted and received in that province; is either emitted or received in that province, and the billing location for the service is in that province; or is emitted in the province and received outside the province, and the billing location for the service is not in a province in which the telecommunication is emitted or received. In Quebec, the basic rules for place of supply are relatively similar to those for the GST. The 2 out of 3 rule refers, similarly as for the GST or other provinces, to the origin and 18

19 the destination of the telecommunication. However, in Quebec, the third condition refers to the billing location 13. In addition, when the origin, the destination and the location of the billing are in three different provinces, the QSTA stipulates that the supply will be located in Quebec if the point of origin of the telecommunication is in Quebec. (b) Billing Location Pursuant to section 1 of Part VIII of Schedule IX to the ETA, the billing location for a telecommunication service is considered to be in a particular province if the telecommunication supplier charges the fee for the service to the recipient s account relating to telecommunications facilities that are used or are ordinarily located in that province. If the telecommunications company does not charge or apply the fee for the service to the recipient s account, the billing location is considered to be in a particular province if the telecommunications facility used to initiate the service is located in that province. (c)the Origin Rule Under the Origin rule, telecommunication services will be subject to Retail Sales Tax in the province where the services are originating and for which the purchaser is not liable to pay tax in another tax jurisdiction. This rule only applies when the three elements are in different provinces and at least two elements are in Canada. The Origin rule will not be triggered if the second and third elements (terminating point and billing location of transmission facilities) are both situated in Alberta, Quebec or an HST province even though no tax may be payable in Alberta, and the HST and QST are recoverable as an input tax credit or an input tax refund. It is the administrative position of Ontario that other PST (for Quebec, HST provinces and Alberta) is still payable under these circumstances. British Columbia, Prince Edward Island, and Saskatchewan do not have the Origin rule. When transmitters are located in different provinces, in addition to the application of the 2 out of 3 rule, consideration should also be given to the application of the place of supply, billing location, and the origin rules. For example, access to the Internet is treated as making telecommunication facilities available. This refers to the location of the transmitter that is being used to provide the access to the Internet or the telecommunication service. The billing location is considered to be in the province where the transmitter used to initiate the service is located. The application of the above rules in British Columbia and Ontario is as follows: 19

20 British Columbia The B.C. Ministry has written that under the two-out-of-three rule 14, charges for telecommunications between two locations in British Columbia are always subject to the tax. This applies regardless of whether the charge for the service is billed with respect to a transmitter normally located inside or outside the province. For example, an Ontario resident visiting British Columbia places a long distance call between Kamloops and Prince George, and bills the call to an Ontario home phone number. The charge for the call is subject to British Columbia tax because it meets two of the three criteria the call both originates and terminates in British Columbia. Telecommunications between a location in BC and a location outside the province will always meet one of the criteria of the two-out-of-three rule. That is, the telecommunication either originates or terminates in BC. The application of tax to such telecom therefore depends upon whether the charge is billed with respect to a transmitter that is normally located in BC. This principle is best illustrated through the following examples: A long distance collect call is placed from a BC transmitter to a location in Newfoundland. BC tax does not apply because only one of the three criteria is met. The call originates in BC but it terminates outside of the province and is billed with respect to a transmitter ordinarily situated in Newfoundland. A BC resident subscribes to a cellular telephone service in BC, travels to Calgary, and uses the cellular phone to place a call to Vancouver. The call is subject to tax because it meets two out of the three criteria. That is, the call terminates in BC and is billed with respect to a cellular phone that is ordinarily located in the province. A long distance call is placed from a BC transmitter to a location in Ontario. The call is charged to the BC telephone. The charge is taxable because the call originates in BC and is invoiced with respect to a transmitter situated in BC. Ontario For telecommunication services, ORST would apply where at least two of the following criteria are found to be in Ontario 15 : 1. Telecommunication originates in Ontario; 2. Telecommunication terminates in Ontario; 3. The instrument or facility for the emission, transmission, or reception of the service in respect of which the charge for the provision of the telecommunication service is, or is to be, billed is ordinarily situated in the province. 20

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