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Regulatory Change to Telecommunications Resale Exclusion Conformed to Statutes and Was Valid

By Erica Horn and Stephen Sherman

In an opinion rendered May 22, 2014, the Kentucky Board of Tax Appeals (the “Board”) found the sale for resale of switch access services in 2005 subject to sales and use tax. Sprint Communications Co., LP v. Dept. of Revenue, Ky. Bd. Tax App. File No. K13-R-03 (May 22, 2014). In general, “switch access” is the provision of telecommunications service by a local exchange carrier to a 3rd party for resale. Telecommunication carriers maintained that the sale of switch access service should be excluded from sales tax as a sale for resale. In 2005, Sprint Communications Co., LP (“Sprint”) sold switch access services to 3rd parties for resale to their customers and accepted completed resale certificates.

Kentucky has a long history of sales taxation of telecommunications services. In the mid- to late-1990’s a dispute arose as to the authority of the Kentucky Department of Revenue (the “Department”) to assess sales and use tax on the sale of switch access services. During the time of the dispute, the Department did not require payment of sales tax on the sales. But, in 2000, effective January 1, 2001, the General Assembly amended Kentucky’s sales tax statutes to broaden the types of communications services subject to tax. Accordingly, the Department promulgated an emergency regulation that later became 103 KAR § 28:140. The regulation stated that beginning January 1, 2001, switch access services would be subject to tax; that is, the sales would not be exempt as being for resale. Pursuant to the regulation, the Department assessed Sprint sales tax for its sale of switch access services for 2005.

In 2005, the General Assembly again amended Kentucky’s sales tax statutes, but this time to expressly exempt from sales tax the sale for resale of switch access services. The amendment was effective January 1, 2006. In protesting the Department’s assessment Sprint claimed the 2005 legislation merely clarified existing law and, therefore, the intervening regulation should be disregarded because it was a change in the Department’s pre-2001 position. Sprint maintained that prior to amendment, the statutes were ambiguous and the Department should be bound by its pre-2001 construction of the statutes. Sprint argued that the doctrine of contemporaneous construction should bind the Department to its prior interpretation of the statutes.

The Board ruled that Sprint’s sales of switch access services were subject tax because the Department’s regulation was in effect at that time and clearly and unambiguously stated that access services were taxable. The Board held that even assuming that the Department did change its position when it promulgated the regulation; the doctrine of contemporaneous construction would not prohibit such a change going forward. Relying on Revenue Cabinet v. Lazarus, Inc., 49 S.W.3d 172 (Ky. 2001), the Board stated that contemporaneous construction cannot be founded upon an administrative agency’s failure to correctly apply the law; an agency

is always free to correct a misapplication of the law. Therefore, the Board stated that such a change was permissible so long as the regulation was in conformity with the statutes.

Sprint did not argue that the statutes in 2005 did not support Department’s position set forth in the regulation. The Board stated that without evidence that that the Department improperly added to or detracted from the statutes, the Board was bound by the clear and plain meaning of the regulation. Consequently, the Board found the regulation was controlling and the taxpayer’s access services sold in 2005 were subject to sales tax.

Sprint argued that, even if the sales were subject to tax, Sprint accepted resale certificates in good faith and therefore should not be liable for the tax. The Board held that no taxpayer could accept a resale certificate in good faith after the issuance of the unambiguous regulation. Therefore, the acceptance of the resale certificates did not shield Sprint from sales tax liability. The Department’s assessment and final ruling was upheld.