By Stephen Burroughs

The Kentucky Board of Tax Appeals (Board) has held that Netflix’s digital streaming service is not subject to the state’s telecommunications taxes.

Kentucky’s telecommunications tax regime is comprised of three distinct taxes, each imposed on the provision of “multichannel video programming service” (MVPS). The taxes consist of a gross revenues tax, an excise tax, and a utility gross receipts license tax, all amounting to a 6.7% tax on MVPS. Kentucky defines MVPS as programming that is “generally considered comparable to programming provided by a television broadcast station.” The statutory definition also includes cable service.

The Kentucky Department of Revenue (Department) argued that the similarities between the digital content Netflix offers through its streaming service and traditional television programing justified subjecting Netflix to the tax. The Department analogized Netflix’s service to cable television’s video-on-demand. Netflix distinguished its service from the array of “linear” programming options offered by cable and broadcast television providers.

The Board focused on the dictionary definitions of “programming” and “comparable” to conclude that Netflix was not similar enough to broadcast television to justify the imposition of tax on the streaming service. The Board noted that while both Netflix and broadcast television allow consumers to watch television shows and movies, Netflix does not offer live programming, sports or news. The Board determined that on-demand television, while similar to the presentation of Netflix programming, was “only an incidental part of the broadcast and cable TV services programming” and insufficient to draw a significant comparison with Netflix’s customer interface.

Two related issues will be worth watching as this case progresses through Kentucky’s appellate system (if it is appealed). First, Kentucky’s telecommunications tax regime preempts Kentucky local governments from imposing local franchise fees on certain MVPS providers. Kentucky cities, along with the Kentucky League of Cities, have challenged the constitutionality of this local tax prohibition under the Kentucky Constitution. The Department and the Kentucky Cable Television Association argued to uphold this preemption, but an unpublished decision of the Kentucky Court of Appeals struck it down. See City of Florence, Kentucky, et al v. Flanery, No. 2013-CA-001112-MR, Nov. 7, 2014, modified by No. 11-CI-01418 (Ky. Ct. App. filed March 13, 2015) (unpub). That case now awaits a hearing date before the Kentucky Supreme Court.

Second, although Kentucky’s definition of MVPS closely tracks a similar federal regulatory definition, the Board refused to consider the federal regulatory treatment of digital streaming services. For more than a year, the Federal Communications Commission (FCC) has grappled with similar issues as it seeks to determine whether digital streaming video providers are properly classified as multichannel video programming distributors for regulatory purposes. An FCC order on the issue is expected this fall. Netflix, Inc. v. Kentucky Finance & Admin. Cabinet, Order No. K-24900 (Ky. Bd. Tax App. Sept. 23, 2015).