Recent Tax Updates from the Commonwealth of Pennsylvania 

Tax Alert

February 2, 2017

Connect Modem Service Not Taxable

The Pennsylvania Commonwealth Court en banc affirmed a panel decision that service provided by Level 3 Communications to America Online, Inc. constituted internet access service and was, therefore, exempt from sales and use tax and protected by the Internet Tax Freedom Act, 47 U.S.C. § 151. Level 3 Communications, LLC v. Commonwealth, No. 166 F.R. 2007 (Pa. Commw. Dec. 8, 2016). Level 3 received analog telephone calls from AOL subscribers, converted the calls to digital format, and transmitted them to an AOL data center that then transmitted the call to the recipient. The dispute evidently hinged on whether the services provided by Level 3 constituted providing access to the internet. The commonwealth contended that they did not; rather, the commonwealth contended that in order to constitute providing access to the internet, the access must be to what the commonwealth described as the public internet, not the private internet. Level 3’s communications were provided to AOL over private lines. The court rejected the distinction between public and private internet, on the grounds that there was no accepted demarcation between the two. Level 3 provided a service that used an arrangement of physical transmission, routing and switching facilities utilizing the Transmission Control Protocol/Internet Protocol to connect end-users to the internet. Therefore, Level 3 was a point of presence, which is an access point, location, or facility that connects and helps other devices establish a connection with the internet. As such, it was an enhanced telecommunications service and excluded from taxable telecommunication transmissions. The court affirmed the distinction from the services held taxable in America Online, Inc. v. Commonwealth 932 A. 2d 332 (2007), exceptions denied, 942 A. 2d 236 (Pa. Commw.), aff’d per curiam 963 A. 2d 903 (Pa. 2008), which was based on the technical method by which the digital signal was transmitted to AOL.

No Exemption for Road Signs

The Pennsylvania Commonwealth Court en banc affirmed a prior panel decision that denied an exemption from sales and use tax for road signs erected by a contractor for the Pennsylvania Turnpike Commission and various municipalities. Strongstown B&K Enterprises, Inc. v. Commonwealth, No. 400 F.R. 2013 (Pa. Commw. Dec. 21, 2016). The court held that the road signs were not entitled to an exemption as building machinery and equipment (BME) because there was no evidence in the record that the signs were part of a system of traffic control. The statute excludes BME from tax when transferred pursuant to a construction contract with certain exempt entities, whether the BME becomes part of real estate or remains personal property. 72 P.S. § 7201(pp). BME is defined in detail and includes a control system related to traffic and traffic signals. Id. The court held, citing prior decisions, that even if the road signs were considered tangible personal property, the sale of tangible personal property to an exempt entity pursuant to a construction contract is not exempt. Only BME is exempt. The court added that removing a traffic control system from the tax base is not an exclusion, which must be construed against the government, but an exemption, which is construed against the taxpayer. While the exemption/exclusion issue may not have affected the outcome in the appeal, the court’s discussion of the issue is unsatisfying. The exception for BME along with many other exceptions is plainly labeled an exclusion in the statute, not an exemption. 72 P.S. § 7204. Nonetheless, the court discusses whether the exception for BME removes from the tax base an item that would otherwise be covered by the general language, which the court believes means that the exception is an exemption even though it is listed as an exclusion. However, the terms exclusion and exemption, are technical terms in tax statutes. If the General Assembly uses a technical term, probably it should be given its accepted meaning. There is no constitutional dimension to whether an exception is classified an exclusion or exemption. If the General Assembly stated that an item is being removed from the tax base and that the removal should be construed against the government that should be an end to the discussion. There should be no need to go further and discuss whether the item otherwise would or would not be considered part of the tax base. In addition, the court dismissed the argument that it was bad public policy to impose a sales tax on a construction contractor contracting with the commonwealth or its municipalities. The public policy issue is one for the General Assembly to decide. Since the statute appears to require non-exempt treatment, any relief must be obtained from the legislature.

Producing Purified or Distilled Water Is Not Manufacturing

A panel of the Commonwealth Court held that the production of purified or distilled water does not constitute manufacturing for sales and use tax purposes. DS Waters of America, Inc. v. Commonwealth, No. 370 F.R. 2013 (Pa. Commw, Nov. 30, 2016). The court held, relying on prior cases, that the production of purified or distilled water did not constitute putting water in a form, composition, or character different from what the process started with and, therefore, the process did not constitute manufacturing. The fact that purified or distilled water had a different market than ordinary water did not meet the test. It is the process, not the end product, that determines whether the activity is manufacturing. The court further held that a 1995 determination by the Revenue Department’s Board of Appeals that a predecessor taxpayer, was engaged in manufacturing in producing purified or distilled water did not mean that the commonwealth was estopped from changing its position. The court stated that estoppel does not run against the government, but the court did not cite or discuss several cases to the contrary. In Abbotts Dairies, Inc. v. City of Philadelphia, 258 A.2d 634 (Pa. 1969), the city was estopped from retroactively imposing its mercantile license tax on various companies that had relied on their exempt status granted pursuant to a court injunction for 13 years. In King Crown, 415 A.2d 927 (Pa. Commw. 1980), the Pennsylvania Department of Revenue was estopped from attempting to collect additional taxes that were subject to a compromise agreement to the extent the taxpayer complied with it. In Transcontinental Gas Pipeline Corp. v. Commonwealth, 620 A.2d 614 (Pa Commw. 1993), the court held that the taxpayer could not be assessed utilities gross receipts tax for tax periods before it had been notified by the Department of Revenue that it was subject to the tax, citing Abbotts Dairies. In Estate of Margaret E. Leitham, 726 A. 2d 1116 (Pa. Commw. 1999), the court stated: “It is now firmly settled that when all the traditional elements of estoppel have otherwise been established, its application should not be denied merely because it is being asserted against the government.” In Borough of Wilkinsburg v. WIMCO Metals Inc., GD 97-11304 (C.P. Allegheny Co. Mar. 16, 2001), the borough was estopped from attempting to collect additional business privilege taxes for prior tax years based on a recent change in the interpretation of its ordinance by the borough’s new tax collector, where the taxpayer had relied on the borough’s long-standing interpretation of the ordinance.


Joseph C. Bright


(215) 665-2053

Related Practices

To discuss any questions you may have regarding the opinion discussed in this Alert, or how it may apply to your particular circumstances, please contact: Joseph C. Bright at or 215.665.2053, Dan A. Schulder at or 717.703.5905, Cheryl A. Upham at or 215.665.4193 or Robert M. Careless at or 215.665.4798.