In the recent IRS vs. Worldcom decision, the Court of Appeals Second Circuit reversed the denial of a $38 Million communications excise tax the IRS previously collected. In Worldcom’s bankruptcy proceeding, the IRS had been ordered to refund the excise tax to Worldcom’s bankruptcy estate. The issue for the Court of Appeals: Whether Worldcom’s purchase of central office based remote access “COBRA,” a service that gave customers the ability to connect to the Internet through a regular telephone line, was “local telephone service” subject to the 3% excise tax required by the Tax Code.
The Court easily found that COBRA provided access to a local telephone system pursuant to 26 U.S.C. § 4252(a). Therefore, its decision turned on whether the local telephone line had the capacity to provide voice quality transmission. If the technological capacity to transmit voice signals existed, irrespective of whether or not the line was actually used for voice, then the line was subject to the tax. The COBRA service did provide a voice quality line though it was used for Internet access via computer modem. Based on this, the Court concluded that “data communication transmitted by a modem” falls under the telephonic quality communication definition in the Tax Code.
Interestingly enough, the IRS had formerly issued a Revenue Ruling determining that computer-to-computer communications over telephone wires were not “telephonic quality communication.” If the Court had followed the precedent set forth in this ruling, no excise taxes. However, the Court ruled that deference was not required as the Revenue Ruling was not persuasive in this instance. Therefore, the IRS bests the “Law of Unintended Consequences” and collects an excise tax in spite of its prior position.