Title: In Re Tax Appeal of AT & T Technologies, Inc.
Citation: 242 Kan. 554, 749 P.2d 1033
Docket Number: 60,864
State: Kansas
Issuer: Kansas Supreme Court
Date: February 4, 1988

242 Kan. 554 (1988)
749 P.2d 1033
In The Matter Of The Appeal Of AT &amp; T TECHNOLOGIES, INC., From The Order Of The Director Of Taxation.
No. 60,864

Supreme Court of Kansas.
Opinion filed February 4, 1988.
Michael C. Cavell, of Southwestern Bell Telephone Company, of Topeka, argued the cause, and Lawrence A. Dimmitt, of the same firm, and Michael B. Andolina, of AT&amp;T Technologies, Inc., of Berkley Heights, New Jersey, were with him on the briefs for appellants and cross-appellees, AT&amp;T Technologies, Inc. and Southwestern Bell Telephone Company.
Thomas E. Hatten, of Kansas Department of Revenue, of Topeka, argued the cause, and Mark A. Burghart, general counsel, was with him on the briefs for appellee and cross-appellant, Kansas Department of Revenue.
Joseph T. Ruble, of ADAPSO, of Arlington, Virginia, and Mark Beshears, of Goodell, Stratton, Edmonds &amp; Palmer, of Topeka, were on the amicus curiae brief for ADAPSO.
Mark Beshears, of Goodell, Stratton, Edmonds &amp; Palmer, of Topeka, was on the amicus curiae brief for Kansas Society of Certified Public Accountants.
The opinion of the court was delivered by
HOLMES, J.:
This is an appeal by AT&amp;T Technologies, Inc., (AT&amp;T) from an order of the State Board of Tax Appeals (BOTA) concerning assessment of state and local sales taxes upon certain *555 of its services and a cross-appeal by the Kansas Department of Revenue from BOTA's order setting aside the assessment of retailers' compensating (use) tax on software programs transferred by AT&amp;T to Southwestern Bell Telephone Company (Bell). The case was transferred from the Court of Appeals pursuant to K.S.A. 20-3018(c).
Appellant AT&amp;T raises three issues on appeal as follows:
The Department of Revenue cross-appeals, raising the following issue:
The facts are set forth in great detail in the BOTA order and will be briefly summarized here. In early 1982, the Department of Revenue conducted a sales and use tax audit of AT&amp;T, formerly known as Western Electric Company, covering the three-year period from January 1, 1979, through December 31, 1981. The audit resulted in the assessment of additional taxes in the amount of $5,001,524. Following an informal audit review conference, the assessment was amended to reflect a total liability of $3,175,372. The matter was then the subject of a hearing before the Director of Taxation where additional adjustments resulted. AT&amp;T appealed the Director's assessment to the *556 BOTA, which essentially upheld the sales tax assessment on repair services but abated and set aside an assessment of compensating tax upon software developed by AT&amp;T out of state and furnished to Bell for use in its various telephone offices. AT&amp;T appeals from the BOTA order as to the sales tax assessment and the Department of Revenue cross-appeals from the abatement of the compensating tax assessment. Bell has joined with AT&amp;T in asserting its appeal, presumably pursuant to K.S.A. 1987 Supp. 74-2426(c)(1). Additional facts will be detailed in connection with the various issues on appeal.
Repair Services
The first issue in the AT&amp;T appeal is whether certain services furnished by AT&amp;T in repairing telephones owned by Bell were subject to sales tax under the Kansas retailers' sales tax act. AT&amp;T asserts error by the BOTA based upon K.S.A. 79-3603(q), which provides:
....
AT&amp;T and Bell contend that the telephones were "being held" by Bell "for sale in the regular course of business" and that the repairs were not subject to sales tax under the statute.
The facts relating to this issue are not disputed. During the audit period AT&amp;T furnished certain services and equipment to Bell, including the repair of telephones used by Bell in providing telephone service to its customers. Bell, during the audit period, was required under tariffs approved by the Kansas Corporation Commission to provide telephones, including maintenance of that equipment, to its telephone service customers if they so requested, although the customers could, if they wished, acquire from third-party vendors their own telephones which could in turn be connected to Bell's lines. The customer, when using telephones provided by Bell, paid an additional sum in *557 monthly telephone service rates which varied depending upon the number and type of telephones selected by the service customer. If the customer provided the telephones, an adjustment was made by Bell in the monthly cost of the telephone service. Title and ownership of telephones provided by Bell to its customers remained in Bell.
Bell purchased its telephones new from AT&amp;T, and AT&amp;T collected and remitted sales tax on those purchases. These telephones were installed in the homes and businesses of Bell telephone service customers who desired Bell provide them telephones and maintenance. When a telephone malfunctioned, Bell would repair it, if possible, on the customer's premises. If on-site repairs could not be made, Bell would replace the malfunctioning telephone with another, and ship the malfunctioning instrument to AT&amp;T's Merriam, Kansas, service center to be evaluated for possible repair. The Merriam service center processed telephones received from Bell offices in Kansas, Missouri, and Oklahoma. Upon receipt of a telephone, AT&amp;T inspected it to determine whether it could be repaired or whether it should be junked. If it could not be repaired, a nominal charge was made to Bell for the inspection. If repairable, AT&amp;T would place the telephone in an "as new condition" and then return it to Bell. Repaired telephones were returned to Bell offices in each state in proportion to the value of telephones received by AT&amp;T from each state. The telephones lost their individual identity while processed by AT&amp;T, and no claim is made that a repaired telephone was returned to the specific Bell customer who had previously used the instrument. The repaired telephones were merely placed in Bell's inventory for future use in servicing its customers. During the repair process, ownership of the telephones remained with Bell.
AT&amp;T charged Bell a standard amount for repairs based upon the particular style or type of telephone and did not collect or remit sales tax on the repair charges. In the final adjusted assessment by the Division of Taxation, a total of $1,505,463 in state and local sales tax was assessed on the amount received for repair service receipts, of which $1,109,462 was for receipts from repairs to telephones returned to Bell offices outside Kansas, and $396,001 represented tax on repairs associated with telephones returned to Bell offices in Kansas.
*558 The narrow issue before this court is whether these facts represent a situation contemplated by the statutory words, "service of repairing, servicing, altering or maintaining tangible personal property which when such services are rendered is not being held for sale in the regular course of business," contained in K.S.A. 79-3603(q). The Department of Revenue contends that the telephones repaired by AT&amp;T were "not being held for sale in the regular course of business," and therefore the repair services were subject to sales tax. AT&amp;T argues the telephones were being held for sale by Bell in the regular course of its business, emphasizing that the term "sale" is defined very broadly by K.S.A. 79-3602(c), and therefore the repair services were not subject to sales tax.
Sale is defined in the statute as:
In addressing this issue, the BOTA stated in part:
In Southwestern Bell Tel. Co. v. State Commissioner of Revenue &amp; Taxation, 168 Kan. 227, 212 P.2d 363 (1949), Bell sought to avoid the imposition of a compensating tax upon equipment, including telephones, purchased out of state and brought into Kansas for use by Bell in furnishing its telephone service to its customers. It was Bell's contention, inter alia, that,
After discussing the relationship between the sales tax and the compensating tax, the Court stated:
The court determined Bell was liable for payment of compensating tax upon its purchase of telephones, as well as other equipment, in that the property did not become a part of the sale of services to its customers, stating:
*560 The BOTA, in addition to Southwestern Bell, relied upon Nashville Mobilphone Co., Inc. v. Woods, 655 S.W.2d 934 (Tenn. 1983), stating:
*561 In concluding that AT&amp;T was liable for sales tax upon the services it rendered Bell in repairing Bell's telephones, the BOTA stated:
We think Nashville Mobilphone, when read in conjunction with our opinion in Southwestern Bell, is persuasive for its holding that repair services performed on Nashville Mobilphone, Inc., radio phones by Melrose Electronics, Inc., an independent corporation, were subject to sales tax under Tennessee's sales tax statute. Because the court there held that Nashville Mobilphone, and not its service customers, was the primary user or consumer of the equipment, it reasoned that Melrose Electronics was not furnishing repair services on equipment held for purposes of resale, and its repair service charges were therefore subject to the sales tax on services. In Southwestern Bell we held that Bell is the final user of its equipment, including telephones, necessary to provide service to its customers. It was on that basis that Nashville Mobilphone concluded that repair services to such equipment could not avoid sales tax because the equipment was not being held for resale. We think Southwestern Bell is controlling for its holding that the telephone company is the final user or consumer of telephones and other equipment necessary to enable it to provide services to its customers. An attempt was made at oral argument to distinguish Southwestern Bell from the present case based upon the extensive technical advances and changes since 1949. While it may be conceded that the entire telecommunications industry has undergone great changes, that fact does not change the basic holding of Southwestern Bell. The telephones used here in providing services to Bell's customers apparently were used in the same manner as the telephones in *562 Southwestern Bell. The telephones in question were at all times the property of Bell and we conclude that the BOTA was correct in its determination that the repaired telephones were not "being held [by Bell] for sale in the regular course of business." K.S.A. 79-3603(q). The repair of such equipment by AT&amp;T was correctly found to be subject to the Kansas retailers' sales tax.
Re-Audit of Local Sales Tax on Installation Services
The second issue raised by AT&amp;T is whether the BOTA acted within its authority in ordering a re-audit on that portion of the sales tax assessment representing local sales tax on receipts from installation services performed by AT&amp;T personnel for Bell. Whether such services were subject to sales tax is not in dispute. The Department of Revenue assessed local sales tax, however, based upon the location of AT&amp;T's service center in Merriam, Johnson County, Kansas. The services were actually conducted throughout the state by personnel stationed in Dodge City, Wichita, Salina, and Topeka.
On November 18, 1985, the Director of Taxation ordered a re-audit of the assessment to comply with this court's decision in Capital Electric Line Builders, Inc. v. Lennen, 232 Kan. 379, 386, 654 P.2d 464 (1982), modified on other grounds and reh. denied, 232 Kan. 652, 658 P.2d 365 (1983), which held that services are subject to the local sales tax of the locality in which the services are actually performed. Capital Electric was decided after the assessment by the Department of Revenue in this case.
The total amount of local tax assessed on installation labor was $377,342 based upon the local sales tax rate in Merriam, Kansas. AT&amp;T essentially argues that the BOTA should have abated the assessment in its entirety as being void, and that the BOTA had no authority to remand the assessment for a re-audit. AT&amp;T also contends that a re-audit is barred by the statute of limitations. The Department of Revenue contends that the order for a reaudit is not a final order which is appealable. None of these arguments have merit. The BOTA disposed of this issue, stating:
We conclude that the BOTA is vested with the power to order a remand to the Department of Revenue to properly determine the amount of the assessment. When the evidence is insufficient or additional evidence, findings, or conclusions are necessary to properly determine an issue, the BOTA has the implied, if not specific, authority to require additional proceedings. K.S.A. 74-2437 grants to the BOTA the authority to hear appeals from the director of taxation. Such authority includes appeals from assessments of sales tax and carries with it the authority to require proceedings sufficient for the BOTA to make a rational determination of the issues.
Based upon Capital Electric, the assessment of local sales tax should have been based upon the local tax where the services were rendered and not upon the local tax applicable in the City of Merriam. The BOTA acted properly in ordering the re-audit to comply with the requirements of Capital Electric. Appellant's arguments concerning the statute of limitations have been carefully *564 considered and we find them to lack merit. The matter must be remanded to the BOTA to carry out its directive of a re-audit of this portion of the assessment.
Sales Tax Allegedly Assessed on Out-of-State Repairs
The third and last issue raised by AT&amp;T is whether the BOTA's refusal to order abatement of sales tax allegedly assessed on repair services performed out of state, on telephones delivered to Bell in Kansas, was unreasonable, arbitrary, and capricious. AT&amp;T alleges that the December 1985 final assessment included $43,669 in sales tax on services not subject to the Kansas sales tax since the services were performed outside the state. That Kansas sales tax may not be imposed on such services is not in dispute and is conceded by the Department of Revenue.
The testimony presented by AT&amp;T before the Director of Taxation indicated that this sum had been removed in the process of amending the assessment. In testimony presented to the BOTA, however, AT&amp;T's witness testified that an amount of $43,669 originally assessed for repairs performed elsewhere had not been abated in the December 1985 amended assessment. The appellee's employee who had been responsible for performing the audit also testified. When asked on cross-examination whether the disputed amount had been included in the December 1985 final assessment, he stated that he could not remember, nor could he remember deleting the amount.
On the basis of this testimony, the BOTA disposed of this issue as follows:
While it is true that K.S.A. 77-621(a)(1) places the burden upon AT&amp;T to prove the invalidity of the assessment, it would appear to us that whether the $43,669 was erroneously assessed should be readily ascertainable in the records of the Department of *565 Revenue. If sales tax was assessed upon services performed out of state, that portion of the assessment should be abated. We have carefully reviewed the record including the documents submitted by both parties and they are not conclusive either way. In the interests of justice to the taxpayer, we are of the opinion that this portion of the assessment should be remanded to the BOTA, which in turn should remand the issue to the Department of Revenue for further proceedings sufficient to make a proper determination.
Cross-Appeal
We now turn to the cross-appeal of the Department of Revenue. As a part of the 1979-1981 audit, the Department of Revenue assessed a compensating tax pursuant to K.S.A. 79-3701 et seq. against certain computer software developed by AT&amp;T outside of Kansas for use by Bell in Kansas. As in the issues raised by AT&amp;T in its appeal, the basic facts are not seriously in dispute.
During the audit period, AT&amp;T developed software under contract for Bell to use in its offices located in Kansas. The software was specifically tailored according to the unique requirements specified by Bell to suit each of its different central switching offices that used computerized switching equipment. The computerized switching equipment (hardware) was manufactured and sold by AT&amp;T to Bell. The software to be used with the hardware was developed, or programmed, in locations outside Kansas. It was provided to Bell's Kansas offices under a nonexclusive license granting Bell the right to use the software in consideration for license fees payable by Bell to AT&amp;T. AT&amp;T retained ownership of and proprietary rights to the software and provided periodic updates of the software programs. The electronic switching system software is referred to throughout the record as ESS software but will be referred to in this opinion simply as software except when it is necessary to specifically identify the ESS software.
The programmed instructions comprising the software were physically transmitted to Bell central telephone offices by means of magnetic tape or magnetic cards. AT&amp;T collected and remitted tax on the gross receipts from the magnetic media, but did not do so on the gross receipts from the license fees for the software. *566 The Department of Revenue assessed compensating tax on the amount billed by AT&amp;T for the software license fees, resulting in a total tax of $221,562, excluding interest.
Based upon these facts, the BOTA initially determined that the software was intangible personal property. It reasoned that a distinction was drawn between operational software and application software by this court in In re Tax Protest of Strayer, 239 Kan. 136, 716 P.2d 588 (1986), and that "[t]he facts in this case are abundantly clear that the ESS software is application software." Next, the BOTA determined that the compensating tax statutes (K.S.A. 79-3701 et seq.) expressly apply only to the "use" of tangible personal property, and therefore found that the software fees were not subject to compensating tax, regardless of whether they would have been subject to Kansas sales tax.
In reaching its determination that the ESS software was not subject to the compensating tax, the BOTA stated, in part:
K.S.A. 79-3703 imposes a tax:
The word `use' is defined by K.S.A. 79-3702 as:
We concur in the conclusions reached by the BOTA. The compensating tax is also popularly known as a "use" tax upon property purchased out of state and used, stored, or consumed in this state. While the Kansas retailers' sales tax act and the Kansas compensating tax act complement each other, they are not identical K.S.A. 79-3603 provides for a sales tax on tangible personal *570 property and certain services set forth in the statute. K.S.A. 79-3703 provides for a compensating tax on tangible personal property purchased outside the state and brought into Kansas. It does not assess a compensating tax on intangible property or on services.
The Department of Revenue relies heavily on K.S.A. 79-3603(s), which purports to apply sales tax to computer software. Regardless of its effect upon software purchased in Kansas, it is not a definitional statute that defines software as tangible personal property, as the Department of Revenue contends. Nor does K.S.A. 1987 Supp. 79-3703 apply to intangible property. The statute is clear in assessing a compensating tax on tangible personal property, and the last sentence which refers to all property does not expand the tax to intangible property even if such property might be subject to sales tax under 79-3603.
Nowhere in the retailers' sales tax act is "use" defined in a manner that would be applicable to the compensating tax act. The definitions in K.S.A. 79-3602 which may be applicable to the compensating tax act by reason of K.S.A. 79-3702(b) do not define "use." Also, the definition of "tangible personal property" in K.S.A. 79-3602(f) does not purport to cover computer software. Whether K.S.A. 79-3603(s) was intended to apply the sales tax to computer software as a form of tangible personal property or as a service we need not determine here. If it had been the intent of the legislature, when it enacted K.S.A. 79-3603(s), to impose a compensating tax on computer software purchased out of state it could easily have been accomplished by amending the appropriate statutes.
We agree with the BOTA that computer software, at least to the extent that it is application software as recognized in Strayer, is intangible personal property and as such does not come within the compensating tax act which specifically applies only to tangible personal property. It is also clear that the compensating tax does not apply to services. Regardless of what the scope of K.S.A. 79-3603(s) may be in relation to the assessment of sales tax, we think it is clear that it has no application to the compensating tax. We have considered all the various arguments of the Department of Revenue and find them without merit.
In conclusion, we affirm the decision of the BOTA upholding *571 the taxability of the AT&amp;T repair services on Bell telephones; we affirm the authority of the BOTA to order a re-audit of the local sales tax included in the sales tax on repair services; we direct the BOTA to remand the issue of sales tax allegedly assessed on repair services performed outside Kansas to the Department of Revenue for a proper determination of the amount, if any, of the assessment which should be abated; and we affirm the decision of the BOTA that the ESS software purchased out of state was not subject to compensating tax.
The decision of the BOTA is affirmed in part and reversed in part, and the matter is remanded to the BOTA to proceed in accordance with the views expressed herein.