The Conservative Approach of Over-Collection of Sales Tax Is Perilous

Many companies (and their advisors) believe there is no harm in “over-collecting” sales tax and, therefore, erring on the side of collection of tax in gray areas.  But that is a very risky course of action, as AT&T recently found out.

It seems that AT&T was collecting sales and use tax on Internet service it provided to customers.  It did so, despite the federal Internet Tax Freedom Act, 47 U.S.C. § 151 n. (1998), as extended and amended by the Internet Tax Nondiscrimination Act, P.L. 108-435 (2004) and the Internet Tax Freedom Act Amendments Act of 2007, P.L. 110-108 (2007), which prohibits states from imposing taxes on Internet access, with the exception of certain grandfathered states.  Even a company of the size of AT&T apparently got it wrong, since it continued to collect tax on Internet access in all states.  Its customers reacted, and commenced a class action law suit against AT&T.

AT&T recently settled the lawsuit with the class action plaintiffs at significant expense to AT&T.  See In re AT&T Mobility Wireless Data Services Sales Litigation, MDL No. 2147, Case No. 10 C 2278 (N.D. Ill. Aug.11, 2010).  While AT&T is not obligated to refund to the plaintiffs any amounts not refunded to AT&T by a state, it is required to seek such refunds.  If it obtains a refund, AT&T, of course, must distribute the amounts it receives to its customers, but it doesn’t have to dip into its own pocket to do so.

So, you say, what is the harm to AT&T?  As part of the settlement, AT&T is required to pay the cost of notice to each member of the class.  Given the size of the class, this likely will be a substantial cost.  In addition, AT&T must pay a contingency fee to the lawyers for the class action plaintiffs, which is generally based on the value of the settlement, and can be millions of dollars.  Thus, far from being an income neutral proposition for AT&T, AT&T’s decision to collect tax created a large expense to it.

The conclusion to be drawn is that retailers need to be very careful to make sure they get it right.  To simply err on the side of over-collection may prove to create substantial exposure.  Rather, the true amount due must be collected.  If a retailer gets in a bind by over-collecting, the state will not compensate the retailer for its additional expenses.