California Superior Court invalidates sales tax Regulation 1585 awarding refund on sales of bundled cellular telephones

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On Oct. 27, 2020, the Sacramento Superior Court granted a writ of prohibition barring the California Department of Tax and Fee Administration (the Department) from applying sales tax Regulation 1585 (Reg 1585) to bundled sales of cellular telephones and service by carrier-retailers.1 The prohibition is based on the ground that the regulation conflicts with statutory definitions, which require sales tax to be collected on consideration paid, not another measure of value.

Reg 1585 provides, in part, that sales tax on bundled sales of cellular telephones and service will apply to the “unbundled sales price” of the cellular telephone. Reg 1585 defines “unbundled sales price” as “the price at which the retailer has sold specific wireless telecommunication devices to customers who are not required to activate or contract for utility service with the retailer or with an independent wireless telecommunications service provider for utility service as a condition of that sale.”

Petitioners were consumers who brought a class action suit against the Department because, pursuant to Reg 1585, they were charged sales tax on the full retail price of the phone as opposed to the discounted sales price advertised by the retailer. The Department argued that application of Reg 1585 captures the true “price” of discounted cellular phones, which is represented in part by the price paid for the service agreement. The court rejected this argument, holding that the determination of the “unbundled sales price” pursuant to Reg 1585 is an attempt to capture the “value” of the cellular phone, but imposing sales tax on “value” rather than “price” is inconsistent with the sales tax statutes, which impose sales tax on actual gross receipts received by the retailer – i.e., the sales price.

Eversheds Sutherland Observation: The court’s decision, if upheld on appeal, represents a substantial win for taxpayers. In recent years, the Department has made several attempts to impute additional consideration to the stated sales price and require the collection of additional sales tax on many types of sales. For example, California has alleged that retailers selling to affiliated entities at cost must charge sales tax on cost plus an imputed mark up. Here, the court limited its decision to bundled sales made by carrier-retailers, and the decision distinguishes sales by independent retailers that involve a commission. Nevertheless, in our view the court’s reasoning extends to any application of Reg 1585 that effectively imposes sales tax on an amount greater than what is charged by a retailer for a cellular telephone.

1 See Bekkerman et al. v. California Dept. of Tax and Fee Admin., Case No. 34-2015-80002242 (Cal. Super. Ct. Oct. 27, 2020).

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