Comcast of South Jersey Inc. v. Director, Division of Taxation, No. 001153-2004; Tax Court; opinion by Brennan, J.T.C.; decided and approved for publication February 20, 2013. DDS No. 35-5-xxxx [23 pp.]

Comcast, which provides cable television service in New Jersey, has filed a summary judgment motion in these consolidated matters challenging the July 2003 use tax assessment of defendant, the director of the Division of Taxation, with regard to converters and remotes and the assessment of underpayment penalties. Comcast contends that the converters and remotes were exempt from taxation pursuant to N.J.S.A. 54:32B-8.13(e), which provides an exemption from the Sales and Use Tax Act for machinery, apparatus or equipment which has a useful life of more than one year and is used directly and primarily in the production or transmission of radio or television information, and that it should not be responsible for any underpayment penalties because of confusion and ambiguity regarding the tax liabilities at issue.

The director has filed a cross-motion for summary judgment claiming that Comcast is not entitled to an exemption because the primary purpose of the converters was security, not transmission, and the remotes did not transmit television information. He also requests late and underpayment penalties because Comcast lacked good cause in its failure to pay the taxes at the time they were due.

Held: The exemption from taxation in N.J.S.A. 54:32B-8.13(e) is available to devices with multiple functions so long as the primary purpose and function of the device is the transmission of television information. Because the nontransmission functions of Comcast’s converters were secondary and incidental to their transmission function, they were exempt from taxation. Because the remotes were not used directly and primarily in the transmission of television information, they were not entitled to the statutory exemption and the director’s assessment of late fees and underpayment penalties in connection with the taxes on these devices was reasonable and within his discretion.

Comcast’s cable network is comprised of a head end (receives and processes a signal from satellites and other sources), a transportation system (transports the signal from the head end to the community), a distribution system (carries the signal within the community on cables on utility poles or buried underground to a location outside a customer’s building, known as the "tap") and a drop system (transports the signal into a customer’s location). The drop system starts at the tap and ends at the customer’s terminal device, i.e., a converter, television, VCR or computer.

To reach the customer, the cable signal travels along the coax cable to the customer’s location, then through the wiring inside the customer’s location to the converter, which converts the signal from the transmission frequencies to the frequencies for the channel to which the customer’s television is tuned for transmission to the television.

Comcast’s converters also perform other functions, such as providing a cable television guide, parental controls and near video on demand.

Typically, the conversion process is initiated by the reception of an infrared signal from a remote. The remotes do not transmit television information — they simply communicate commands to the converter, serving the same function as the control buttons on the front of the converter. They also enable the customer to access the cable television guide, order near video on demand and access Comcast’s parental controls.

When this complaint was filed, similar complaints by another cable television company and its various entities were pending. Determining that the legislative history provides limited guidance as to the proper interpretation of 54:32B-8.13(e), RCN of New Jersey Inc. v. Dir., Div. of Taxation, 23 N.J. Tax 22 (Tax 2006) (RCN I) applied general principles of statutory construction and held that a cable provider’s purchase of cable wiring was exempt under the Sales and Use Tax Act. RCN Telecom Services Inc. v. Dir., Div. of Taxation, 23 N.J. Tax 520 (Tax 2007) (RCN II) interpreted 54:32B-8.13(e) as limiting the exemption to purchases of apparatus or equipment used only for receiving or transmitting interactive telecommunications service or for the transmission of television information and held that RCN’s purchase of converters was exempt from tax under 54:32B-8.13(e) because they were directly and primarily used in transmitting television information.

Here, the director asserts that, unlike in the RCN cases, credible evidence shows that the converters had other functions in addition to the transmission of television information. He argues that the security function, not transmission, was the primary function of a converter.

The Tax Court accepts the statutory analysis in RCN I and RCN II, but rejects any notion that to be exempt a converter must have only the singular function of transmission. It says the exemption is available to devices with multiple functions as long as the primary purpose and function of the device is the transmission of television information.

Although Comcast did use converters to gate-keep against the pirating of their cable service, process pay-per-view billing, and provide access to parental controls and cable channel guides, the argument that these other functions were primary is illogical. The transmission function must be the primary function of the converter as it was the basis for the need and use of the other functions. When in use, the converters’ primary purpose was transmission. Accordingly, they were exempt from sales and use tax under 8.13(e).

As for the remotes, Comcast’s own witnesses testified that, while used for operation of the converter, remotes were not required to receive the television information because customers could operate a converter manually. Remotes were therefore not part of the transmission process and did not meet the statutory exemption under 8.13(e). Comcast was not exempt from taxation on remotes purchased during the relevant periods at issue.

As to late payment penalties, 54:49-11(a) allows the director to waive late payment penalties where the taxpayer’s failure to pay taxes timely can be explained to the director’s satisfaction.

The court concludes that the director acted reasonably in refusing to waive late payment penalties with respect to the taxes due on the remotes. That the remotes did not by definition meet the eligibility requirements of 54:32B-8.13(e) was within Comcast’s knowledge. Its misjudgment is not good cause for its failure to pay taxes on these devices.

The court denies Comcast’s request for reasonable litigation costs pursuant to 54:51A-22 because it does not find that the director’s position was without reasonable basis in law or fact.

Finally, the court finds that because the customer contracts were leases of equipment and not rentals, the director is barred from asserting an alternative sales tax assessment.

For plaintiffs — David J. Shipley (McCarter & English; Shipley and Aliza Sherman on the briefs). For defendant — Marlene G. Brown, Senior Deputy Attorney General (Jeffrey S. Chiesa, Attorney General).