California: Provider-Retailers not Required to Collect Sales Tax based on Unbundled Value of Phone

A Sacramento Superior Court recently granted a writ of prohibition providing that California Regulation 1585 is invalid as applied to a bundled transaction in which a customer purchases a mobile device along with wireless telecommunications service, and the telecommunications service provider does not pay a commission to the retailer.  Regulation 1585 governs the calculation of sales tax on bundled sales of cellular telephones and wireless service. The petitioners in this case were consumers that made bundled purchases of mobile devices and wireless service from telecommunications service providers that operated their own retail stores. During the periods at issue, telecommunications service providers often offered mobile devices at discounted prices to induce consumers to enter into bundled contracts for wireless service.   Under Regulation 1585, a retailer must calculate and pay sales tax on the unbundled price of the mobile device – the price that the consumer would pay for purchasing the mobile device separately. The petitioners argued that under California law, sales tax is based on the price actually charged by the telecommunications service providers for the mobile devices. All of the mobile device purchases at issue were made from retail stores operated by telecommunications service providers, so there was no question as to whether a commission or cost reimbursement was paid to a third-party retailer.  In contrast, the CDTFA asserted that the discounted price did not represent the “true price” of a mobile device, and that the sales price should include some portion of the value of the wireless contract purchased.

In rejecting the CDTFA’s argument, the court concluded that Regulation 1585 was arbitrary and capricious to the extent that it based the sales tax calculation on the price of an unbundled mobile device. While Regulation 1585 attempted to tax the true “value” of a mobile device, California law mandated that sales tax be based on the consideration paid by the consumer. Where, as here, the petitioners’ purchases involved separate, agreed-upon prices for their mobile devices, there was no basis to impose tax on the unbundled price of a device. Therefore, the court held that Regulation 1585 may not be applied to a bundled sale of a mobile device and wireless service when the telecommunications service provider does not pay a commission to the retailer.

The petitioners also argued that Regulation 1585 was invalid in its entirety because the CDTFA had failed to follow rulemaking procedures under the state’s Administrative Procedures Act. Specifically, the petitioners contended that the CDTFA had failed to (1) provide an adequate statement on the Regulation’s economic impact, and (2) republish the amended Regulation and hold a public hearing on the amendments as required. The court determined that the CDTFA’s statements on the economic impact of the regulation were sufficient, and that amendments to the regulation were discussed at the public hearing on the original text. Because the amendments were sufficiently related to the original text, there was no requirement to republish the regulation or hold another public hearing. Therefore, the CDTFA did not violate the APA when it promulgated the regulation, and the court did not strike down Regulation 1585 in its entirety. The writ of prohibition requires the CDTFA to cease and desist from applying Regulation 1585 to the discounted price of a mobile device sold by a telecommunications service provider-retailer in a bundled transaction with wireless service. For questions about this case, please contact Audra Mitchell at 816-802-5456.