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By Jeff Thalachelloor, Transaction Tax | June 24, 2020

The Internet Tax Freedom Act (ITFAof 1998 levied a moratorium on states’ abilities to tax internet access charges, and when the Trade Enforcement and Trade Facilitation Act of 2015 was signed into law in February of 2016, the moratorium became permanent. “Internet access” means a service that enables users to connect to the Internet to access: (1) content, (2) information, or (3) other services offered over the Internet; See Section 1105(5)(A) of the ITFA. If state and local governments imposed a tax on internet services prior to October 1, 1998, Section 1104 of the ITFA allowed for a “grandfather clause” provision so that those governments could continue to impose and collect tax until an end date was established. Both Texas and Ohio continued to tax internet access services after the imposition of the ITFA, but the grandfather clause, which allows these states to do this is set to expire June 30, 2020. Effective July 1 of this year, service providers should not collect taxes on amounts allocated to internet access as it is now an exempt service.  

In Texas, telecommunications services and cable television services are still fully taxable, and charges for data processing services are taxable at 80%. If a service provider bundles the internet access service with one of these taxable services, they will have to establish through their books and records a reasonable allocation for the taxable service and the nontaxable internet access. If the service provider cannot separately state these charges, the entire charge for the bundled services is taxable. See Texas Tax Code Section 151.025(d) and Rule 3.313(b)(2), Cable Television Service, and Bundle Cable Service. Businesses in Texas will need to be able to differentiate between these types of services to apply the tax correctly. 

Ohio will continue to tax data processing services, electronic information services and computer services, as these services do not fall under the definition of internet access services. However, any automatic data processing or electronic information services that are accompanying but not a significant part of the Internet access service will no longer be subject to sales tax. This is different from the bundled transaction language that Texas uses, but if it can be determined that these taxable services are merely incidental to the internet access services, they are not subject to tax. The onus will be on On-Line Service Providers (OSPs) in Ohio to differentiate these types of services and apply the tax correctly, while Internet Access Providers (IAPs) are now, starting July 1, providing an electronic information service that will no longer be subject to Ohio’s sales and use tax. See Section 1105 of the ITFA 

Altus Group’s Transaction Tax Team will be closely monitoring the effects and potential ramifications of the changes to the taxation of Internet Access Charges in Texas, Ohio, and other states as they respond to the expiration of the Internet Tax Freedom Act’s grandfather clause provision. 

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