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| Toby Bargar |
The trend of consumers driving this fluctuation isn't new, but it's been forced into hyperdrive over the last few months as normal patterns and behaviors have monumentally changed.
For example, the communications, media and technology industries have had to rapidly adapt to meet tremendous increase in demand. The COVID-19 pandemic has proven the importance of their ability to connect humans across the globe. From streaming more content in downtime to conducting business remotely, reliance on these services has grown exponentially in both the business and consumer sectors.
Facing the possibility of falling behind their competitors, companies are strategizing about how to provide services that meet these needs — which could mean mergers and acquisitions, forming partnerships or offering a completely new product or service.
There is a sizable opportunity to grow brands, increase customers, intensify overall loyalty and drive revenue. However, the indirect communications tax implications can't be forgotten or ignored.
Prior to the impacts of COVID-19, these shakes and shifts were already being felt. In November 2019, Aberdeen, on behalf of Avalara, surveyed 150 leaders at communications and media companies on how they planned to address growth.[1]
Research findings showed that meeting customer demand for video and digital content is a top driver for expanding service capabilities. This momentum has only surged and shows no signs of abating. The pressure is now on for legal and tax teams to effectively plan for these potential challenges because, especially now, it's critical to protect businesses from costs or harm related to noncompliance.
Converging Services and the Complexities of Bundling
As different types of communications services continue to converge, bundling is one of the more complicated communications tax issues providers must tackle. A classic example is the so-called triple play, which typically offers wireline, wireless and cable at a discounted rate. The current increased demand is often for a wireless, data and streaming content package.
Aberdeen's research emphasizes how companies are reacting to meet this increased demand. Nearly one-third of businesses (29%) plan to launch entirely new products with bundled services and nearly three-quarters (73%) plan to merge or partner to offer increased service breadth.
Regardless of the method for the shift in strategy and offerings, a convergence or introduction of new services adds tax complexity. Varied rules and rates, as well as requirements for disparate services, make tax compliance difficult to manage.
When companies are crunched for time to keep up with the industry or are simply unaware, mergers and acquisitions can shine a light on these potentially neglected tax issues. This can happen if the target company relied on aggressive policy interpretation for the taxability of their offerings.
For instance, if a communications provider offers a web collaboration service that was taxed as though it was purely an information service by their organization instead of as a product including communications, the acquisition company may inherit the liability from this interpretive classification.
The pressure is heightened when you consider newer technology companies often take on riskier positions when it comes to the indirect tax application to their services. This classification may bypass local and federal communications taxes, so without proper due diligence and an examination of policy positions, an acquisition company could unknowingly open itself to liability — something numerous organizations have already experienced.
What are indirect communications taxes? Indirect communications taxes are taxes, fees and surcharges collected by a communications service provider from a consumer.
Examples include sales tax, E911 fees, utility user tax and universal service fund surcharges. These taxes and fees come with an extremely complicated tangle of rules concerning which types of communication services are taxable.
Given the fast pace of technological advancement compared to the rather slow movement of legislation, areas of controversy and uncertainty frequently force sellers to make policy and risk tolerance decisions.
Aberdeen's research uncovered that 58% of respondents admitted they've failed a previous audit. On top of that, 75% admitted to fears related to taxes.
Preparing for M&A Communications Tax Implications
These fears can be quelled with proper awareness of indirect tax trends and thorough due diligence. With convergence likely only to increase as consumers shift patterns, complications will also grow. Even prior to COVID-19, of the survey respondents who admitted to failing a previous audit, 19% of them didn't realize they were subject to communications tax in the first place.
Effective due diligence and an understanding of indirect tax liability is crucial. Public enterprises tend to be more conservative about indirect tax and regulatory compliance, erring toward passing more taxes on to the buyer.
Conversely, companies that haven't yet reached maturity and are in more aggressive growth phases may take a position of minimizing tax to customers to maintain a competitive posture despite the increased risk. This strategy appeals when companies are in periods of rapid growth, perhaps seeking to be acquired.
It's imperative that companies looking to be acquired start proactively reviewing their service classifications for indirect taxes. This allows services to be reclassified and any previous required returns filed prior to acquisition. As a result, a merger can go smoothly instead of being delayed or even abandoned due to uncollected tax liability uncovered during due diligence. If faced with this scenario in advance, the acquisition company could negotiate a concession on terms.
Looking to the Future
For companies that are noncompliant, it will take time to begin establishing a tax and regulatory footprint that's free from liability. Facing the growing complexity, 49% of respondents to Aberdeen's survey are looking to change their tax management process in the next two years.
Those ignoring the volume and desirability for subscription services from consumers face being left behind if they don't act now. Communications providers know that the demand for data-driven video and other content along with 5G and internet-of-things services are of utmost importance to their business.
As tax jurisdictions see less revenue derived from taxing voice services, new and emerging technologies are being examined with closer scrutiny by policymakers looking to determine how to tax new infrastructure and services.
If today's realities are any indication of what's to come quickly down the road, this convergence of communications services will become a greater share of product offerings from communications providers. Aberdeen's research showed 82% of respondents believe they'll be required to collect or file communications taxes in the next two years.
But as more new technologies emerge, new policies may as well.
Competition will also remain a constant as streaming consumption increases. Those without a technology-forward business strategy may feel less prepared than those that have implemented changes in their business model.
At the rate technology advances, tax policymakers will certainly attempt to keep up by implementing new rules and regulations with which businesses must comply. As the market continues to shift and settle, effective planning and preparation for tax challenges that may arise is crucial to ensure business success.
Toby Bargar is a senior tax consultant at Avalara Inc.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] https://www.avalara.com/simplify/en/communication/video-5g-and-iot-are-driving-business-change.html.
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