By Larry Jones
November 12, 2007

Surrounded by key congressional leaders in the Oval Office on October 31, President George W. Bush signed into law the Internet Tax Freedom Act Amendments Act of 2007, a law that will extend tax-free-Internet access through October 31, 2014. Originally enacted in 1998, the law imposes a moratorium on state and local taxes on Internet access fees, multiple and discriminatory taxes. This is the third time Congress has temporarily extended the law. And while the Conference and other state and local groups urged support for a four-year extension, they are pleased Congress decided against making the law permanent, and in favor of making a number of changes that will protect state and local revenues.

Senate leaders decided to take action on a House passed bill (H.R. 3678) after Senator John Sununu (N.H.) offered an amendment on the Amtrak reauthorization bill (S.294) during Senate floor debate to make the moratorium permanent. The House bill, which would have extended the moratorium for four years, was sponsored by House Judiciary Committee Chairman John Conyers (MI) and supported by state and local governments. Senator Thomas Carper (DE), who sponsored a four-year extension bill in the Senate (S. 1453) on behalf of state and local governments, offered a counter amendment to make the moratorium in Sununu’s amendment a four-year extension.

In the end Senators agreed on a compromise that canceled action on the Amtrak reauthorization bill and moved the House passed bill with several changes. The moratorium was extended to seven instead of four years; certain states that have been taxing the transport of the Internet or the so called “backbone” would be given until June 8, 2008 instead of November 1 2007 to phase out such taxes; and a provision was added to make certain that incidental services such as a home page, electronic mail and instant messaging are not taxed regardless of whether they are offered as a part of a package with Internet access or independently. The Senate approved the final measure by voice vote on October 25 and the House approved it on October 30.

The new law extends the moratorium on state and local Internet access fees through October 31, 2014. Since the passage of the original legislation in 1998, the law has been extended three times—for two years in 2001, for 3 years in 2004 and for 7 years this time. The Conference and other state and local groups are concerned about the impact a permanent moratorium will have on government revenues in light of the enormous changes taking place in telecommunications technology, particularly as more service providers turn to the Internet to deliver goods and services. Congress needs to continue to reassess these changes, the Internet and electronic commerce and make needed changes as necessary.

In a significant victory for state and local governments, Congress approved changes in the definition of “Internet access” that will clear up a number of ambiguities. Under previous legislation, services bundled with Internet access and offered to customers as part of a package were at risk of having to be offered tax-free. The previous definition stated that Internet access “may also include access to propriety content, information, and other services as part of a package offered to users.” The fear was this language could have been interpreted to mean any time taxable services such as movies, games, music and magazines are packaged with Internet access, they should be offered tax-free. The changes adopted in the new law clarifies that the moratorium on state and local taxes only applies to the service that connects a user to the Internet and not to goods and services sold over the Internet.

It also clarifies that all technologies used to provide access to the Internet such as telephone, cable, wireless, satellite and DSL, to the extent they are used to provide Internet access, are subject to the moratorium. It also states that incidental services such as a home page, electronic mail and instant messaging when offered as part of a package with Internet access or when offered independently are subject to the moratorium. It does not include voice, audio or video programming, or other products or services sold over the Internet which remain subject to state and local taxes.

State and local governments collecting taxes on Internet access before the original moratorium was enacted in 1998, are allowed to continue to collect such taxes. It is estimated that these taxes amount to between $80 million and $120 million annually. Also, the new law states that if a state eliminated its tax on Internet access more than two years ago, it is prohibited from re-imposing such a tax.

Because of ambiguities surrounding two grandfather clauses that had different termination dates in the previous law, several states claimed they had authority to tax the transport of the Internet or the so called “backbone.” In addressing this concern, the new law gives these states until June 30, 2008 to phase out such taxes.

Several states including Michigan, Texas, Ohio and Washington recently enacted gross receipt tax laws that apply to all large businesses, including Internet access service providers. In these states, the gross receipt tax and the business and occupation tax serve as a general business tax and either substitute for or supplement the corporate income tax. The problem is there was explicit language in the previous law that allowed corporate income taxes to be imposed on Internet access service providers, but not gross receipt or the business and occupation tax. Without an adjustment in the legislation, states that use this approach to general business taxation could suffer a disproportionate loss in revenues. The new law made an exception for these states to continue to collect these taxes, particularly those that enacted gross receipt laws between June 20, 2005 and November 1, 2007; and those that enacted a business activity tax between January 1, 1932 and January 1, 1936.