San Francisco
--------------------------------------------------
Thomas H. Steele 415.268.7039
tsteele@mofo.com
Andres Vallejo 415.268.6793
avallejo@mofo.com
Peter B. Kanter 415.268.6005
pkanter@mofo.com
James P. Kratochvill 212.336.4007
jkratochvill@mofo.com
Scott M. Reiber 415.269.7630
sreiber@mofo.com
Jason M. Satterfield 415.268.7074
jsatterfield@mofo.com
Kirsten D. Wolff 415.268.6638
kwolff@mofo.com
Denver
--------------------------------------------------
Thomas H. Steele 303.592.2243
tsteele@mofo.com
Los Angeles
--------------------------------------------------
Gary W. Maeder 213.892.5846
gmaeder@mofo.com
New York
--------------------------------------------------
Paul H. Frankel 212.468.8034
pfrankel@mofo.com
Hollis L. Hyans 212.468.8050
hhyans@mofo.com
Craig B. Fields 212.468.8193
cfields@mofo.com
Irwin M. Slomka 212.468.8048
islomka@mofo.com
Michael A. Pearl 212.468.8135
mpearl@mofo.com
Amy F. Nogid 212.468.8226
anogid@mofo.com
Roberta Moseley Nero 212.506.7214
rnero@mofo.com
Mitchell A. Newmark 212.468.8103
mnewmark@mofo.com
Michael W. McLoughlin 212.468.8240
mmcloughlin@mofo.com
Michael J. Duffy 212.336.4261
mduffy@mofo.com
R. Gregory Roberts 212.336.8486
rroberts@mofo.com
Sacramento
--------------------------------------------------
Eric J. Coffill 916.325.1324
ecoffill@mofo.com
Carley A. Roberts 916.325.1316
croberts@mofo.com
David A. Ziring 916.325.1336
dziring@mofo.com
Timothy A. Gustafson 916.325.1312
tgustafson@mofo.com
Washington, D.C.
--------------------------------------------------
Linda A. Arnsbarger 202.887.1598
arnsbarger@mofo.com
State & Local Tax Group
State & Local Tax
Insights
Mitchell A. Newmark and Pilar M. Sansone, Co-Editors Winter 2008
Inside
--------------------------
3
Upcoming Conferences
--------------------------
7
The Manifest Justice of
the Manifest Injustice
Doctrine
By Paul H. Frankel and
Amy F. Nogid
--------------------------
9
California’s New 20%
Underpayment Penalty
--------------------------
Limiting a Taxpayer’s Right
to Recover Tax Costs Through
Line Item Surcharges
By James P. Kratochvill1
Continued on Page 2
Two recent federal Court of Appeals decisions,
BellSouth Telecommunications, Inc. v. Farris
(“BellSouth”)2 and Peck v. Cingular Wireless,
LLC (“Peck”),3 provide guidance regarding the
restrictions imposed upon states to prevent or limit
vendors from recovering their gross receipts tax costs
through the use of line item surcharges on customer
bills. Cumulatively, these decisions appear to signify
that states cannot prohibit vendors from disclosing or
recovering tax costs from their customers by line item
charges, but that states do have leeway to prescribe when
and how such line item customer charges can be applied.
In addition to examining the above-referenced decisions,
this article summarizes the history and development
of line item surcharges and addresses several of the
legal and practical questions facing taxpayers and states
regarding the implementation and enforcement of
possible government limitations upon vendors seeking
to recover their tax costs.
BACKGROUND
Public utilities, including telecommunications service
providers (“TSPs”), have for decades borne the
principal liability for state and local gross receipts taxes
nationwide. Relying upon authority granted by the
Federal Communications Commission (“FCC”), TSPs
have included on their monthly billing statements a
separate line item charge to recover these gross receipts
taxes from customers located in the respective state or
local jurisdictions imposing the applicable taxes or fees.4
is line item charge serves two important purposes.
First, because gross receipts taxes generally are imposed
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Page 2
upon the vendor or service provider,
vendors are not permitted to collect
the tax directly from their customers
(like a sales tax). Instead, providers
who do not wish to simply increase
the base price of the service (or TSPs
that do not wish to raise their national
rates) can recover their costs incurred
for the tax from their customers by
adding a separate surcharge for the tax
recovery on customer invoices. Second,
providers use line item surcharges to
inform customers about the existence
and degree of a state’s gross receipts tax
and to protect customers outside the
taxing state from bearing the burden of
an exported tax.
Employment of the surcharge by TSPs
contributed to the reduced number of
states imposing telecommunications
gross receipts taxes, from almost
thirty states in 1986 to only about ten
states by 2004. But since then, several
states have either expanded or enacted
new gross receipts tax impositions
on general businesses, as well as on
TSPs and utilities.5 ese impositions
have included the adoption of such
taxes in Ohio,6 Texas,7 Michigan,8
Pennsylvania,9 and Kentucky.10
Like TSPs, general business vendors
naturally will seek to recover their
tax expenses in some manner from
their customers. However, a few of
the states that have enacted such taxes
have also sought to restrict or prohibit
the recovery of such tax costs through
the use of line item surcharges or
similar entries on customer bills.
BellSouth and Peck each arose out of
litigation initiated to test the limits
of a state’s power to control whether
or how vendor taxpayers can recover
their tax costs from customers by
using line item charges.
BELLSOUTH
TELECOMMUNICATIONS, INC.
V. FARRIS
In BellSouth Telecommunications, Inc.
v. Farris, the United States Court of
Appeals for the Sixth Circuit held that
a Kentucky statutory provision that
prohibited TSPs subject to a gross
receipts tax from both collecting the tax
directly from customers and stating the
tax as a line item charge on customer
bills violated the First Amendment of
the United States Constitution.11
In 2005, Kentucky enacted a new gross
revenues tax on communications and
video service providers.12 Included in
the measure was a provision that sought
to prohibit the service providers from
stating the tax charge on customer bills,
and effectively, to prohibit recovery
of the tax from customers through
the use of separate line item charges
on customer invoices. e provision,
Kentucky Revised Statues Annotated
(“KRS”) section 136.616(3) (“Section
3”) stated:
“e provider shall not collect the
tax directly from the purchaser or
separately state the tax on the bill
to the purchaser.”13
e court first addressed the “not
stating the tax” portion of the statute.
Applying the constitutional test
applicable to commercial speech,
the court concluded that the statute
regulates speech, not conduct, as it
prohibits providers from stating the tax
on the bill. While the court accepted
that Kentucky has a substantial interest
in avoiding potential consumer
confusion about whether consumers,
rather than providers, bear legal
responsibility for the tax, the court
concluded that the statute did not
directly advance the Commonwealth’s
interest because the Commonwealth
allowed providers to tell their
customers anything about the tax, no
matter how confusing, in all settings
(e.g., in advertisements or on billing
inserts) except on a customer invoice.
Finally, the court concluded that
the statutory prohibition was over-
inclusive in that such a ban was more
extensive than necessary to serve the
Commonwealth’s interest in preventing
customer confusion over legal liability
for the tax. e court stressed that
regulating speech must be a last—not
first—resort, and noted that Kentucky
Line Item
Surcharges
Continued from Page 1
To ensure compliance with requirements
imposed by the IRS, Morrison & Foerster LLP
informs you that, if any advice concerning one
or more U.S. federal tax issues is contained in
this publication, such advice is not intended
or written to be used, and cannot be used, for
the purpose of (i) avoiding penalties under
the Internal Revenue Code or (ii) promoting,
marketing, or recommending to another party
any transaction or matter addressed herein.
For information about this legend, go to
www.mofo.com/Circular230.html.
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