Response
September 7, 1992
September
7, 1992
XXXXX
Dear
XXXXX:
Your
request for a ruling concerning the taxable status of telephone cooperatives
for purposes of the Utah Corporation Franchise Tax was referred to the Auditing
Division for their analysis. Such cooperatives
have been exempt for federal purposes under IRC 501(c)(12). However, recent developments within the
Internal Revenue Service have brought into question whether telephone
cooperatives continue to meet the requirements for exempt status although such
status has not been revoked to date.
The division's recommendations are as follows:
Utah
Code Annotated 59-7-105(1)(a) exempts organizations meeting the requirements of
Section 501(c) as amended of the Internal Revenue Code. An exempt ruling from the Tax Commission
under this section means that such corporation is not required to file Utah
returns as long as such exemption applies.
If a change in status occurs, the corporation is responsible to notify
the Tax Commission and would be required to file returns. If a corporation which had received such an
exemption begins filing federal returns, the state of Utah would have to assume
that the federal exempt ruling no longer applies and that the corporation is taxable. If it were to be determined later that the
federal and state filings were not required due to the fact that the federal
exempt ruling had remained in effect at all times, refunds would be issued upon
request subject to restrictions created by any statute of limitations.
Based
upon the facts presented in your letter, we are in agreement with the Auditing
Division's recommendations. Obviously,
if there are deviations from these facts, this opinion may be negated.
If
you do not agree with this determination, you may appeal to the Tax Commission
for a formal hearing. The results of
that hearing would constitute a declaratory judgment and be appealable to the
Utah State Supreme Court. A Notice of
Appeal Rights and a copy of the Utah Taxpayer Bill of Rights are attached.
For
the Commission,
Joe
B. Pacheco
Commissioner
Utah
State Tax Commission
160
East Third South
Salt
Lake City, Utah 84134
Attn:
XXXXX
Re: Taxable Status of Telephone Cooperatives
The
following is submitted pursuant to our telephone conversation of XXXXX, during
which we discussed the present situation regarding federal taxation relating to
telephone companies which are organized as non profit corporations in Utah,
operating as cooperatives, and having
been exempted from federal taxation under Section 501(c)(12) of the Internal
Revenue Code. You recommended that the
essence of our discussion be put into letter form together with a request for a
ruling in the matter.
Background:
Since
1916, the Internal Revenue Code has provided mutual or cooperative telephone
companies exemption from income taxation.
Beginning in 1924, the tax law required telephone companies claiming
this exemption to operate on a mutual or cooperative basis and to collect 85
percent or more of their income from members for the sole purpose of meeting
losses and expenses. With the exception
of several technical changes made to the law excluding certain income items
from the 85-percent income test, exemption provision for telephone cooperatives
have remained essentially unchanged.
Several
telephone companies were organized in Utah, generally during the late 1940's
and early 1950's as non-profit corporations, and have been exempt from income
taxation in Utah because of the federal income tax exemption.
The
net advertising income of nonprofit organizations has always been considered as
unrelated business income (UBI) and subject to federal taxation whether or not
the organization was exempted from taxation under some provision of the IRS
code. In 1980, an amendment in the
statute affecting exempt cooperative telephone companies provided that all
XXXXX directory "advertising" income would be excluded from the 85
percent test computation. The telephone
companies pay a federal tax on the net advertising income. This element of federal taxation has never
affected the exemption from Utah State taxation of the cooperative.
Local
telephone companies operate as "local exchange carriers", providing
the local exchange network necessary for telephone communication to its local
members. When the cooperative's members
converse with other callers on interstate or intrastate long-distance telephone
calls, they use, in addition to the cooperative's facilities of an
interexchange carrier and another local exchange carrier. All exchanges earn a return on investment
and recover their costs in providing long-distance service. The charges are paid by the "end
users". The cooperative bills the
cooperative's members for the (1) local telephone service charges, (2) end-user
charges for interexchange access, (3) interstate and intrastate long distance
charges, and (4) other miscellaneous charges.
These billed amounts include charges which are associated with the
services provided by interexchange carriers.
The interexchange carriers pay the exchange carrier a "billing and
collection" fee for billing and collecting the charges related to the
interexchange services.
During
XXXXX, the Internal Revenue Service initiated an audit of a telephone
cooperative in Iowa, focused on the calculation of the 85-percent income
text. The field agent proposed
excluding gross tolls billed from the income test, while including all billing
and collection revenues as nonmember sourced income, further proposing to treat
billing and collection margins as unrelated business income. This case was forwarded to the National
Office of the IRS for review and technical advice.
Two
years later, on XXXXX, the National Office issued a Technical Advice Memorandum
(TAM) was sustained the field agent's position. The TAM was released to the public on XXXXX, the full text of
which is attached as Enclosure 1; a summary of the TAM is included as Enclosure
2. The National Office concluded that
organizations exempt from tax under Section 501(c)(12) shall include End User
Revenue, Message Tolls, and Wide Area Toll Services as member sourced income in
the calculation of the 85-percent income test, but that Carrier Facilities
Revenue and Inter-Intrastate Access Revenues be excluded from the 85-percent
income test that billing and collection functions be considered both nonmember
income and subject to unrelated business income (UBI) taxes.
The
position taken in this Technical Advice Memorandum, if actually applied to
telephone cooperatives, would result the loss of exemption to most companies,
if not all.
Congress
acted quickly to clarify it's intent in granting exemption to local telephone
companies. On XXXXX, H.R. 1860 was
introduced to the House of Representative by Representative XXXXX of North
Dakota, to "amend the Internal Revenue Code of 1986 to clarify the
treatment of certain amounts received by a cooperative telephone company
indirectly from its members" and on XXXXX, S. 879 was introduced to the
Senate by XXXXX. The text of his
introduction and the text of the proposed amendment are included in Enclosure
3.
Legislation
resulting from these initial bills presently contains the provision that the
85-percent test be reduced to a 65-percent test. This current language has been approved by both the House and
Senate. Congress has left no doubt as
to its intention that these cooperatives be exempted from federal taxation.
Filing
status of local Cooperatives:
When
the TAM was released in March, 1991, the local telephone cooperative was in a
quandary as to how it stood in its taxable status. Section 6110(j)(3) of the IRS code provides guidance as to the
precendential status of written determinations which include letter rulings and
technical advice memoranda. It states
that "(u)nless the Secretary otherwise establishes by regulations, a
written determination may not be used or cited as precedent." However, there was a proposed regulation
under section 6662 which would allow for the assessment of accuracy-related
penalties which recognized technical advice memorandums as authority which may
be relied upon in a filing. Thus, the
TAM may not be cited as precedent, while, simultaneously, it is recognized as
filing authority.
Some
options were available to the local company:
1. Ignore the situation and continue as in the
past. This presents the risk of
assessment of tax by the IRS under the conclusions of the TAM and the
subsequent effort in defending against the assessment. Also, in the event that a tax assessment
should be collected, the company would likely not be able to recover the tax
through cost settlement procedures.
2. File a corporate tax return and pay a
federal tax using the conclusions of the TAM as guidance. This course eliminates the risk of any
assessment of penalty (since, although the TAM cannot be cited as precedent, it
has some authority as to penalty assessment) and a refund of the tax could be
effected upon satisfactory clarification of the issue either by the courts or
through legislation. The amount of such
tax could then be recovered through the settlement process.
Many
local cooperatives elected to follow the second course while clarification of
the situation is being obtained, and file a federal tax report for 1990 and
1991. Also, some have filed Utah state
tax reports.
Present
question: has an event transpired which
triggers Utah state taxability:
It
has long been the position of the Utah State Tax Commission that state
exemption would be extended to those organizations which are exempt from federal
taxation.
Nothing
has transpired to affect the federally exempt status of local telephone
cooperatives. The technical advice
memorandum which was issued states only the position of the Internal Revenue
Service. Nothing has been changed in
the statute, regulations, or the exemption certificate of the local
company. *It should be noted that the
IRS, as of April, 1992, has made no assessment against the company for which
the TAM was requested.)
It
is apparent that, until an event takes place which actually removes the federal
exemption from the local cooperative, the local cooperative is not subject to
Utah income taxes.
A
clarification ruling on this matter is respectfully requested.
Yours
truly,
XXXXX