Internet Access Charges Not Subject to Sales Tax

August 26, 2009 | Roger McEowen

The Iowa Supreme Court has determined that America Online (AOL) does not offer telecommunication services in Iowa because members could only access the services through AOL's out-of-state call centers.  Thus, AOL's services were not subject to sales tax because the tax can only be imposed on services that originate and terminate within Iowa. Iowa law taxes the gross receipts from the sale, furnishing or service of communication services when they are sold at retail in Iowa to consumers or users. The Iowa Department of Revenue (IDOR) developed a rule providing that communication service is provided in Iowa only if both the points of origination and termination are in Iowa.  AOL's Iowa members access AOL's services through AOL's local exchange which routes calls to call centers in Virginia.  Nevertheless, IDOR issued a sales tax assessment on AOL’s sales of communication services to Iowa members. IDOR ‘s position was that AOL's Internet service constituted a taxable communication service. AOL appealed and an administrative law judge sided with AOL. But, IDOR’s Director overruled the administrative law judge, concluding that AOL’s services were the result of a local call to its network.

AOL then appealed to the district court, which reversed the tax assessment.  IDOR appealed, arguing that Iowa Adm. Code 701-18.20(5) subjected AOL's Internet access charges to sales tax because its service is provided by local or in-state long distance telephone numbers and that the primary service offered is two-way transmission and receipt of information.  But, the appellate court disagreed with IDOR.  AOL's services did not occur in Iowa.  The court determined that to be taxable, AOL's communication services must both originate and terminate in Iowa.  Because it was undisputed that AOL's members could only access its services through a connection with AOL's Virginia call centers, the test wasn't met.  In addition, the court noted that when a member requested a termination from an AOL session, the Virginia call center made the actual disconnection.  That clearly made the services interstate in nature. IDOR pushed the case on to the Iowa Supreme Court, which affirmed on all points.   America Online, L.L.C. v. Iowa Department of Revenue, 771 N.W.2d 404 (Iowa Sup. Ct. 2009), aff’g, No. 8-258/07-1792, 2008 Iowa App. LEXIS 1128 (Iowa Ct. App. Oct. 1, 2008).