November 1999 
 

Lack of sales tax exemption is hurting state's economy
Telephone company's capital equipment is no longer exempt

Several years ago when MCI WorldCom was close to a decision on where to locate its new platform development center and the 1,200+ jobs that would be required for operations, its Board had to decide between the Twin Cities or St. Louis, Missouri. After reviewing all of the economic incentives and criteria, MCI WorldCom decided the costs of running such a facility would be less in St. Louis. The reason? If they located in Minnesota they would have had to pay sales and use taxes on the capital equipment they use to provide their services - a sum totaling millions of dollars each year. "The bottom line difference between the two locations was the cost of the sales taxes we'd have to pay on equipment in Minnesota," said Dave Berger, MCI WorldCom.

Telecommunications companies, like MCI WorldCom and the 90+ local telephone service providers in the state, used to be included in the state's sales/use tax exemption until 1992. That's when the State of Minnesota's Department of Revenue repealed the sales/use tax exemption rule for the telecommunications industry. The rule had previously exempted telecommunications companies from sales/use taxes on transactions involving equipment used in furnishing telephone service. Equipment such as computers, transformers, cable, fiber, radio transmitters and receivers, satellite and microwave equipment, testing equipment and towers is no longer covered by the rule. Because of that, companies now look elsewhere to locate their businesses and the economic benefits they provide.

The Fairness Issue

Telecommunications companies see the whole matter as a simple issue of fairness. Some in the rapidly converging telecommunications market - satellite broadcasting companies (i.e., cable television) - receive a sales tax exemption, even for furniture and fixtures. Other services, such as the generation of electricity, are also exempt as NSP successfully proved in court.

By paying taxes on equipment that is used to provide a service that is also taxed, the telecom industry and others, according to the Sales Tax Advisory Council's 1997 report to the Legislature, are subject to a "double sales tax." The Council recommended that telecommunications and other providers of taxable services be exempted from what it called "tax pyramiding." The state already recognizes the sales/use tax exemption as good tax policy, exempting tangible property that's consumed in the production of tangible personal property sold at retail.

Exemption Should Be Restored

In addition to the fact that the economic climate has changed dramatically since the state began collecting taxes on telecoms' capital equipment purchases, Doug Hurst, Director of Research and Planning for State and Local Taxes for U S WEST, offers another reason why the industry's exemption should be restored. "When we were a monopoly and could pass sales taxes through to customers as part of our rates, not having the exemption was not as big a problem for us. But now, we're like manufacturers. We face competition and are motivated to cut costs. So it makes sense that we're treated the same way other manufacturers and service providers are."

Hurst adds, "I think a lot of legislators don't see that competition is already here for local phone companies since they are not hearing from alternative residential providers. Our competitors don't have to serve residential customers. They can concentrate on business customers, whose rates still subsidize residential rates. We're not asking for special breaks. We just don't want to be penalized. We're asking to be treated the same as other competitive businesses. Many legislators agree it's the right thing to do, but we've heard 'come back next year' at the Legislature three years in a row."

Staying "Cutting Edge"

Granting the exemption to telecoms (and service providers in other businesses) could reduce state revenues between $20 million and $25 million per year, according to Department of Revenue estimates. But not acting might lead to greater losses for the state. "Minnesota wants to be a technologically-advanced state, but companies that can spend elsewhere will go to states trying harder to attract telecommunications investments. One of the factors in U S WEST choosing Omaha as the location for its preferred customer center (for its entire 14-state area) was Nebraska's favorable tax environment. New projects are eligible for sales tax refunds on telecommunications equipment, investment credits and job credits in that state," Hurst said.

Victor Dobras, Director of Governmental and Public Affairs for Sprint-Minnesota, Inc., says that paying the tax "discourages capital investment in new technology. Since you can't pass the tax through and only have so much to spend on capital equipment, what you pay in taxes is not spent on new equipment." That's why, he adds, "If you can spend in two jurisdictions and one doesn't tax, the incentive to spend elsewhere is obvious."

"This is a highly volatile, competitive business and telecoms are investing billions of dollars annually. All companies are sensitive to costs. To generate $1 million in taxes paid on capital equipment, we must do at least $20 million in sales. In fact, that number is probably a lot higher," said Berger.

"It's in Minnesota's interest to create an environment where companies want to invest in the state," said Hurst. Jerry Knickerbocker of the Minnesota Telephone Association agrees. "It's a rapidly changing industry. The tax exemption would encourage more rapid technology investment that would keep the state on the cutting edge. It's an investment in Minnesota's future," said Knickerbocker.

Another Option?

There's one additional, and potentially costly, complication when it comes to the sales tax exemption for capital expenditures. If the state were taken to court, it's likely, as happened with NSP, to lose. The resulting costs could easily top $100 million if the state was ordered to return the taxes it collected since '92.

The threat of losing in court hangs over the state. Industry representatives hope this helps the state restore a policy universally acknowledged as fair by giving the industry its exemption back. "We're working to change the situation on a going-forward basis," notes Hurst, "but if the Legislature and the governor don't act, relief through the courts might be the only other option."

The industry will go back to the Legislature next year to try again to have its sales/use tax exemption restored. "We have no choice," said Knickerbocker. "In our view, it's a win-win situation for the industry and the state."

PROFILE: East Otter Tail Telephone Company

In 1950, when the late Royale Arvig and his wife Eleanor bought Perham's phone company there were 830 customers. Eventually renamed East Otter Tail Telephone, the company now serves 17,000 customers in a 1,600-square mile area of west central Minnesota's lake country. But that's just the starting point these days. East Otter Tail's parent, Arvig Communications Systems (ACS), also operates two smaller phone companies; provides long distance, cable and Internet; is Rural Cellular Corp.'s largest agent; provides wiring, phone security and more through Royale Comtronics; and employs more than 300 from its new headquarters building in Perham.

Of its many community-minded activities, East Otter Tail contributed $66,000 to match a $330,000 USDA loan for the Perham Community Technology Center. It will provide up-to-date high-tech services for existing and startup businesses, and its high-tech workforce training center will also be available for community education, distance learning and more. The Center will house the Perham-Dent School District's "Together for the Future" classes as well. ACS provided another $66,000 match to get an RUS loan for the Perham Area Emergency Services Center.

As an incentive to young people to stay in the area, ACS has started an apprenticeship program at Northwest Technical College in Fergus Fall. Students start the program as high school seniors and are paid for 40 hours, though eight are spent attending classes. Students who complete the program earn an A.A. degree, Apprenticeship Certification from the MN Department of Labor - and a starting salary in the $25,000-$30,000 range.

Allen Arvig, ACS president, is optimistic about his company. "We will celebrate our 50th anniversary soon and we're planning to deliver state-of-the-art telecommunications services and products to our customers for generations to come."