Legal Alert: FCC Imposes Additional USF Contribution Obligations on Interconnected VoIP Providers, Increases Wireless Safe Harbor

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1 Legal Alert: FCC Imposes Additional USF Contribution Obligations on Interconnected VoIP Providers, Increases Wireless Safe Harbor July 7, 2006 On June 27, 2006, the Federal Communications Commission ( FCC ) issued Report and Order and Notice of Proposed Rulemaking No. FCC (the Order ). The 151-page Order sets forth new requirements for wireless telecommunications providers and interconnected voice over internet protocol ( VoIP ) service providers regarding Federal Universal Service Fund ( USF or the Fund ) contributions. Background The USF was established to ensure the delivery of affordable telecommunications services to all Americans. 1 Telecommunications service providers are required to contribute to the Fund a percentage of their interstate and international revenue. The percentage is adjusted quarterly and is currently 10.5%. The Fund is overseen by the FCC and administered by the Universal Service Administrative Company ( USAC ). Although the USF contribution obligation applies to all telecommunications service providers, the FCC previously established special rules for wireless telecommunications service providers. Wireless telecommunications service providers are often unable to determine their actual interstate telecommunications service revenue for purposes of USF reporting. As a result, the FCC permits wireless telecommunications service providers to report their telecommunications revenue using one of three methods: actual interstate and international revenue; a traffic study estimating the percentage of interstate and international revenue; or a safe harbor percentage (formerly 28.5%) of telecommunications service revenue. With respect to IP-enabled services like VoIP, the FCC has reviewed the nature of VoIP service to determine whether VoIP service providers should be required to contribute to the Fund. 2 Many VoIP service providers have argued that VoIP service is inherently interstate. In 1 47 U.S.C. 254(d). 2 In the Matter of IP-Enabled Services, WC Docket No , Notice of Proposed Rulemaking, 19 FCC Rcd 4863, 4905, 63 (2004) (IP-Enabled Services Notice). This article is for informational purposes and is not intended to constitute legal advice. 1

2 Order No. FCC (the Vonage Order ), the FCC reviewed Vonage s Digital Phone Service and determined that while it was predominately interstate, the service was in fact jurisdictionally mixed. Consequently, the FCC concluded that Vonage s service offering was preempted from state regulation. The FCC further suggested that VoIP services similar to those offered by Vonage may also be preempted. The Minnesota Public Service Commission subsequently challenged the Vonage Order and that challenge is currently pending before the U.S. Court of Appeals for the Eighth Circuit. 3 Because of several factors including the growing use of bundled wireless service plans and the adoption of VoIP technologies the viability and fairness of the Fund has come under scrutiny. The percentage of interstate telecommunications service revenue reported to the FCC has decreased substantially. Moreover, the FCC ruled last August that providers that discontinue providing DSL transmission service as a common carrier service are not required to contribute to the Fund on that revenue after the expiration of a 270-day contribution freeze period. 4 The Fund will lose an estimated $350 million a year because of that decision. 5 The FCC also expresses concern in the Order that wireless providers (and perhaps others) may be underreporting (or not reporting) interstate and international revenue. As a result of these perceived revenue pressures, the FCC indicated the Order represents its interim response to maintain the stability and sustainability of the Fund. New Contribution Requirements for Wireless Telecommunications Providers Increased Safe Harbor Percentage for Interstate and International Revenue Commencing with the projected revenue for the fourth quarter of 2006 (reported on the August 1, 2006 FCC Form 499-Q), the Order increases the safe harbor contribution rate for wireless providers from 28.5% to 37.1%. Wireless providers may continue to report revenue using one of the three reporting options (actual, traffic study, or safe harbor) discussed above. 3 Several parties have filed amicus curiae briefs with the Eighth Circuit in this case. Notably, New York State has filed a brief arguing that notwithstanding the nature of Vonage s Digital Phone Service, interconnected VoIP service providers should be subject to state regulation. 4 See Appropriate Framework for Broadband Access to the Internet Over Wireline Facilities; Universal Service Obligations of Broadband Providers; Review of Regulatory Requirements for Incumbent LEC Broadband Telecommunications Services; Computer III Further Remand Proceedings, CC Docket Nos , , 95-20, 98-10, Report and Order, 20 FCC Rcd 14853, , para. 113 (2005). 5 See Order at p. 146, Statement of Comm r Michael J. Copps. This article is for informational purposes and is not intended to constitute legal advice. 2

3 Traffic Studies Must Be Provided to the FCC and USAC for Review Wireless providers that utilize a traffic study to determine contributable revenue for USF purposes must submit the traffic study to the FCC and to USAC for review. The traffic study must be submitted no later than the deadline for submitting Form 499-Q for the same period. 6 Traffic studies may rely on statistical sampling to estimate the proportion of minutes that are interstate and international. Traffic studies should include, at a minimum: (1) an explanation of the sampling and estimation methods employed and (2) an explanation of why the study results are an accurate, unbiased estimate. Wireless providers should retain all data underlying their traffic studies, as well as all documentation necessary to facilitate an audit of the study data, and should be prepared to make this data and documentation available to the FCC. Sutherland Observation: The FCC devoted several paragraphs of the Order to its concerns with underreporting of contributable revenue. The FCC indicated it would not hesitate to use our enforcement authority to investigate and remedy... discrepancies in USF contributions. The Order further reminds carriers that they are obligated to refile any forms containing errors and notes that corporate officers certifying the accuracy of USF filings are subject to prosecution for inaccurate or untruthful filings. Based on the FCC s perception of non-compliance with regard to Fund contributions, we anticipate an increase in USF audits and FCC enforcement actions. Wireless carriers and interconnected VoIP providers (discussed below) using traffic studies to contribute to the Fund should review the studies to ensure that they comply with the methodology set forth in the Order, prior to submitting the studies to the FCC and USAC. Affiliated Legal Entities Must Use Same Safe Harbor Category The FCC also reminded wireless carriers that, while they are permitted to continue to report revenue at either the legal-entity level or on a consolidated basis, they are required to report either actual or safe harbor revenue for all of their affiliated legal entities within the same safe harbor category. 7 6 For example, if a wireless provider uses a traffic study to determine its projected interstate revenue for its August 1, 2006, FCC Form 499-Q submission, the provider must submit the study to the Commission and to USAC no later than August 1, See Federal-State Joint Board on Universal Service, 1998 Biennial Regulatory Review Streamlined Contributor Reporting Requirements Associated with Administration of Telecommunications Relay Service, North American Numbering Plan, Local Number Portability, and Universal Service Support Mechanisms, Telecommunications Services for Individuals with Hearing and Speech Disabilities, and the Americans with Disabilities Act of 1990, Administration of the North American Numbering Plan and North American Numbering Plan Cost Recovery Contribution Factor and Fund Size, Number Resource Optimization, Telephone Number Portability, Truth-in- This article is for informational purposes and is not intended to constitute legal advice. 3

4 New Contribution Requirements for Interconnected VoIP Service Providers Interconnected VoIP Service Providers Are Required to Contribute to the Fund on an Interim Basis Commencing August 1, 2006, providers of interconnected VoIP services 8 are required to contribute to the Fund on an interim basis, using the existing contribution methodology. The FCC found that this action was necessary to respond to growing pressures on the stability and sustainability of the Fund. The FCC was careful to note that it was not yet classifying interconnected VoIP services as telecommunications services or information services under the definitions of the Telecommunication Act of The Order broadly applies to several types of interconnected VoIP services. The FCC emphasized that interconnected VoIP service offers the capability for users to receive calls from, and terminate calls to, the public switched telephone network ( PSTN ). Therefore, the new contribution requirements apply to all VoIP communications made using an interconnected VoIP service, even those that do not involve the PSTN. The FCC further indicated the new obligations apply regardless of how interconnected VoIP providers facilitate access to and from the PSTN, whether directly or by making arrangements with a third party. Additionally, the FCC noted that the definition of interconnected VoIP services may need to expand as new VoIP services increasingly replace traditional phone service. Sutherland Observation: Notwithstanding the Order s broad application, the new contribution requirements only apply to interconnected VoIP providers. Therefore, not all VoIP service providers may be subject to such contribution requirements. Billing and Billing Format, CC Docket Nos , , , , , , , Report and Order and Second Further Notice of Proposed Rulemaking, 17 FCC Rcd 24952, 24967, 25 (2002) (Second Wireless Safe Harbor Order) C.F.R See E911 Requirements for IP-Enabled Service Providers, WC Docket No , First Report and Order and Notice of Proposed Rulemaking, 20 FCC Rcd 10245, , 24 (2005), petitions for review pending; see also Communications Assistance for Law Enforcement Act and Broadband Access and Services, ET Docket No , RM-10865, First Report and Order and Further Notice of Proposed Rulemaking, 20 FCC Rcd 14989, 15008, 39 (2005), aff d, American Council on Education v. FCC, No (D.C. Cir. June 9, 2006). 9 See IP-Enabled Services Notice, 19 FCC Rcd at , This article is for informational purposes and is not intended to constitute legal advice. 4

5 Reporting Methodologies To fulfill contribution requirements, interconnected VoIP providers have three options: (1) report based on the interim safe harbor established in the Order; (2) report based on their actual interstate and international telecommunications revenue; or (3) report based on a traffic study, subject to the conditions described below. Interim Safe Harbor The interim safe harbor for interconnected VoIP service providers is established at 64.9% of telecommunications revenue. The safe harbor is based upon actual interstate revenue reported by wireline toll providers. Additionally, the Order encourages interconnected VoIP providers to explore more precise avenues for determining the jurisdictional nature of their revenue. Actual Interstate Revenue VoIP providers with the capability to report actual interstate and international revenue may do so. However, the FCC noted that interconnected VoIP providers with the capability to track the jurisdictional confines of customer calls will no longer qualify for the preemptive effects of the Vonage Order and would be subject to state regulation. In the opinion of the FCC, the ability to track actual usage would render inapplicable the central rationale justifying federal preemption set forth in the Vonage Order with respect to such an interconnected VoIP provider. Report Based on Traffic Study The Order permits interconnected VoIP providers to use a traffic study to determine the jurisdictional nature of its revenue. Presumably, the traffic studies must meet the same requirements as those permitted for wireless carriers and are required to have a sound basis. However, interconnected VoIP providers must submit proposed traffic studies in advance of their 499 filings to the FCC and USAC for approval. Sutherland Observation: Many parties that submitted commentary to the FCC in advance of the Order s release indicated that a contribution rate of 64.9% may not reflect actual interstate and international revenue. Although USF is often passed-on to the end user of the service, given the competitive nature of the telecommunications industry, interconnected VoIP providers may consider contributing to the Fund using either actual receipts (if determinable and to the extent state preemption is not a concern) or a traffic study. This article is for informational purposes and is not intended to constitute legal advice. 5

6 Bundled Service Offerings The FCC noted that many interconnected VoIP providers offer packages of services to consumers for a single price that include telecommunications, customer premise equipment and/or information services. To the extent that an interconnected VoIP provider bundles its offerings in this manner, it may use the safe harbors established in the CPE Bundling Order to determine the appropriate amount of telecommunications revenue to be reported (as distinguished from revenue derived from non-telecommunications). 10 Interconnected VoIP providers are not required to use either of the safe harbors in the CPE Bundling Order, but other allocation methods may not be considered reasonable and will be evaluated on a case-by-case basis in an audit context. 11 This may once again be indicative of the FCC s intent to increase enforcement efforts. Wholesale Revenue Finally, the Order requires carriers supplying telecommunications services to interconnected VoIP providers who are not carriers to continue to include the revenue derived therefrom in their own contribution bases for two full quarters after the effective date of the Order. Wholesale carriers may not exclude these revenue by invoking the carrier s carrier rule during this interim period. While this may result in some double counting of USF revenue, the FCC indicated the rule was necessary to preserve Fund revenue as interconnected VoIP providers transition to the reporting requirements set forth in the Order. Sutherland Observation: Interconnected VoIP providers who currently pay into the fund directly may still be able to avail themselves of the carriers carrier exemption. Notice of Proposed Rulemaking The Order is accompanied by a Notice of Proposed Rulemaking, inviting comments by interested parties with regard to the rules set forth in the Order. Specifically, the FCC invited comments on the following issues with regard to wireless providers: Whether to eliminate or raise the interim wireless safe harbor; 10 Policy and Rules Concerning Interstate, Interexchange Marketplace, Implementation of Section 254(g) of the Communications Act of 1934, as amended, 1998 Biennial Regulatory Review Review of Customer Premises Equipment and Enhanced Services Unbundling Rules In the Interexchange, Exchange Access and Local Exchange Markets, CC Docket Nos , , Report and Order, 16 FCC Rcd 7418, , (2001). 11 See id. at 7448, This article is for informational purposes and is not intended to constitute legal advice. 6

7 Whether mobile wireless providers can, or should be able to, determine their actual interstate and international end-user revenue; How mobile wireless providers would determine their actual usage if the safe harbor were eliminated and whether wireless providers should be allowed to continue to use traffic studies; Whether originating and terminating NPAs reflect whether a call is interstate or international; Whether originating and terminating cell sites could be used to determine the jurisdictional nature of a call; Whether there are other methods of determining jurisdiction; Associated difficulties and costs of implementation; Whether there are unique difficulties associated with analyzing either outgoing or incoming calls, and whether it is necessary to analyze both types of calls or would, for example, out-bound calls reasonably approximate all interstate and international usage; How to determine the safe harbor percentage to better reflect market conditions on an ongoing basis. For example, should the interim safe harbor percentage be adjusted periodically (e.g., annually, quarterly) to reflect wireless interstate end-user revenue trends? If so, how would these trends be established? The FCC also invited comments on the following issues with regard to interconnected VoIP providers: Describe possible ways in which our new requirements for interconnected VoIP providers could be improved; Provide suggestions for a permanent approach to USF contributions from interconnected VoIP providers; Address whether to eliminate or change the interim safe harbor for providers of interconnected VoIP service; This article is for informational purposes and is not intended to constitute legal advice. 7

8 Address whether a safe harbor continues to be appropriate for providers of interconnected VoIP service; Discuss whether providers of interconnected VoIP service can identify the amount of actual interstate and international, as opposed to intrastate, telecommunications they provide? If so, should we require that these providers report based on actual data? If advocating a change to the safe harbor, explain the basis of their proposed revised safe harbor and how the safe harbor should be calculated. Sutherland Observation: Parties seeking to provide comments may file using (1) the Commission s Electronic Comment Filing System ( ECFS ), (2) the Federal Government s erulemaking Portal, or (3) paper copies. 12 The Order takes note of numerous comments previously submitted by wireless and VoIP service providers. It appears that the FCC remains receptive to industry comments concerning the fairness and administration of the Fund. If you have questions about the above information, please feel free to contact one of the following members of our State Tax Practice Group: Eric S. Tresh eric.tresh@sablaw.com Jeffrey A. Friedman jeff.friedman@sablaw.com Kendall L. Houghton kendall.houghton@sablaw.com Todd A. Lard todd.lard@sablaw.com Jolie A. Sims jolie.sims@sablaw.com 12 See Electronic Filing of Documents in Rulemaking Proceedings, 63 Fed. Reg (1998). This article is for informational purposes and is not intended to constitute legal advice. 8