The Commonwealth Court of Pennsylvania held that network infrastructure services (including local dial networks, telephone numbers and modems, i.e., Internet “backbone”) sold to Internet service providers (ISPs) to provide Internet access to end users were not subject to Pennsylvania sales and use tax. The commonwealth court found that the taxpayer, a facilities-based provider of backbone services, was not subject to Pennsylvania sales and use tax on its sales because such transactions were charges for access to the Internet excluded from the definition of taxable “telecommunications service.” Under Pennsylvania sales tax law, “[c]harges for access to the Internet” includes access to the Internet but does not include “telecommunication services purchased by an [ISP] to deliver access to the Internet to its customers.” 72 P.S. § 7201(rr)(3)(B).
On audit, the Pennsylvania Department of Revenue (Department) assessed sales tax for the tax periods January 1, 2000, through April 30, 2003, on the grounds that the taxpayer’s sales of Internet backbone services were taxable sales of telecommunications service. Specifically, at issue was the taxpayer’s sale of services to America Online, Inc. (AOL), a retail ISP. The commonwealth court distinguished the America Online, Inc. v. Commonwealth, 932 A.2d 332 (Pa. Cmwlth. 2007), case in which it previously held that port management services offered by a third-party service provider were taxable telecommunications services. Here, the commonwealth court found that there were fundamental technological differences between the taxpayer’s service and the service at issue in the AOL case. In AOL, among other relevant facts, the third-party service provider controlled and managed the analog calls that traveled along its network to the taxpayer’s modems. In this case, however, the analog calls traveled from end users through the taxpayer’s modems and over the taxpayer’s network, which then converted the analog calls to digital signals via Internet protocol. The commonwealth court next found that because the taxpayer’s facility was an access point that established an end user’s connection with the Internet (a “Point of Presence” or “PoP”), the taxpayer’s Internet backbone service constituted “Internet access service” per se. Thus, unlike the service at issue in AOL, which in the court’s view was telecommunications service purchased by ISPs to provide Internet access service, the taxpayer’s service in this case provided end users with a connection to the Internet at the taxpayer’s PoP facility. Accordingly, the commonwealth court determined that the taxpayer’s backbone services fell squarely within the Pennsylvania statutory exclusion for “[c]harges for access to the Internet.”
Of note, the taxpayer in Level 3 also argued that the Department’s assessment of sales tax on its Internet backbone services violated the Internet Tax Freedom Act, 46 U.S.C. § 151 (ITFA). However, because the commonwealth court resolved the case under Pennsylvania sales tax law, it did not address the taxpayer’s ITFA preemption argument. Level 3 Communications, LLC v. Commonwealth of Pennsylvania, 166 F.R. 2007 (Commw. Ct. Oct. 15, 2015).