California Court of Appeals Upholds Regulation 1585 Standard That Sales Tax is Due on Full Price of Cell Phone

The California Court of Appeals Third Appellate District has released their judgment in the case Bekkerman et al., v. California Department of Tax and Fee Administration (CDTFA) (Case Number C093763), which challenged Regulation 1585 on both actual and procedural grounds. Regulation 1585 defines “bundled transactions” and requires California cell phone retailers who are also wireless providers to collect sales tax on the full retail price of a phone rather than the discounted price customers receive when they bundle a phone with ongoing telecommunication services through a provider.

The plaintiffs’ first arguments against Regulation 1585 were that it contravened three basic rules of sales tax in California, namely: services are nontaxable, discounts should be excluded from gross sales price, and tax should be charged on the agreed upon price, which plaintiffs argued was the discounted price. While the Appeals Court agreed regarding the services and discount exclusion, the judges disagreed with the plaintiffs on what was the agreed upon price. The agreed upon price, according to the Court of Appeals and Regulation 1585, was the initial payment for the phone plus subsequent monthly payments and the carrier- retailers were not offering a true discount. Rather, retailers can recoup the discount through the customers’ monthly payments. The Court went on to detail that under the California Revenue and Tax Code, “gross receipts” is the total sale price represented in money, whether actual payment was received in money or through some other form of payment. Since the carrier-retailers can allocate monthly payments from customers to the cell phone cost, CDTFA can also levy sales tax on the full cost. A bundled transaction is created because the discount on the phone is not offered unless customers also agree to the service. Under Regulation 1585, the portion of the contract reflecting the unbundled price of the phone is subject to sales tax, and the rest is wireless services, which are not taxable. While plaintiffs argued the agreed price was the bundled price, the Court found that interpretation ignores the fact that the discount is only available to customers who agree to the contract, thus comingling the two and creating the bundled transaction.

The Court next turned to the plaintiffs’ arguments regarding the technical issues with Regulation 1585, which it also rejected. Plaintiffs claimed the Regulation was adopted without evidence as to adverse effect on economic impact for businesses or consumers and without public notice and hearings which are required under the California Administrative Procedures Act (APA). The Court first declared that CDTFA could reasonably determine there would be no adverse impact on businesses because retailers would transfer the impact to consumers, upholding the assessment as evidence of the economic impact or lack thereof.  Finally, the Court turned to the argument related to public notice and hearings, where they also rejected the plaintiffs’ contentions. There was a public hearing where participants objected to the original text, thus creating both the hearing and notice.

This ruling should remind taxpayers of the importance of non-monetary consideration. Though the actual money exchanging hands in this case for the cell phone reflects a discount, the transaction as a whole is a bundled transaction, and clients would not have access to the discount without the non-monetary contract considerations. The question comes down to what the full payment or consideration is, and that full payment is not always cash. Similar to considering what is actually being paid for, taxpayers need to be mindful of what is actually involved in a transaction, from beginning to end, especially in cases where there may be a non-financial form of compensation. Bekkerman et al., v. California Department of Tax and Fee Administration, California Third Appellate District Case Number C093763, ruling filed 2/27/2024 and signed by J. Mesiwala)

Posted on June 12, 2024