Tollbooths on the information highway State taxman may seek to cash in on communications revolution _________________________________________________________________ By Josh Hyatt ___________________________GLOBE STAFF___________________________ CAMBRIDGE - It is easy to explain the constant hum that rises from the purple one-story house where Channel 1 resides: There are almost 100 modems stuffed inside. But lately, the sound of seething is nearly as audible. That comes from Brian Miller and Tess Heder, co- owners of the computer bulletin-board service, which has 15,000 subscribers. Armed with personal computers and modems, users tap into Channel 1 to try out software programs, check up on stock prices, play games and trade messages on any of 3,500 topics. But of late Miller and Heder themselves have been receiving unwanted messages - from the Massachusetts Department of Revenue which, starting in March, dispatched an auditor to comb through Channel 1's invoices. Although the company has yet to be assessed, the couple has calculated that Channel 1 may owe as much as $150,000 in uncollected sales taxes and interest on memberships dating back to September 1990. "It's enough to wipe us out," says Miller bluntly. The debate between the state and Channel 1 centers on the relatively narrow issue of just what constitutes a taxable "telecommunications service." But the definition that emerges will have lmplications that extend far beyond Channel 1 or any of the state's more than l,OOO bulletin boards. As communications technology advances, old categories blur and new services are born, state and local tax authorities across the country see in them a potentially rich source of new revenue. Indeed, with the so-called information superhighway - the nation- wide computer network the Clinton administration has been promising on the horizon, many states are eyeing the possibility of imposing a "road tax" that would help replenish state coffers. But critics such as Miller and Heder argue that such taxes could end up tarnishing one of high-technology's brightest spots, and ultimately impede the flow of information, which ought to trade freely. The Channel 1 dispute grows out of a 1990 Massachusetts statute that imposed a 5 percent sales tax on telecommunications services, defined as those that provide for the "transmission of messages" through microwave,wire or fiber-optic cable. The statute - part of a sweeping effort by the state to broaden sales taxes, most of which were repealed - clearly exempted "the sale or use of information" from the tax. Miller and Heder argue that Channel 1 does not provide any transmission services - users access it via telephone lines, upon which they already pay a sales tax through their monthly bills - but instead offers tax-exempt information. The Department of Revenue cannot discuss specific audits because of confidentiality laws protecting taxpayers, according to Karl Frieden, deputy general counsel. But Robert Hurst, a Chestnut Hill accountant who has worked with Channel 1 since March 1992, says the state's auditor has suggested that at least one of Channel 1's services - specifically, the one enabling subscribers to leave messages - qualifies as a taxable telecommunications service as defined by law. According to Frieden, companies that don't break out the taxable services from nontaxable services - in this case, "transmission" from "information" - are obligated to pay a 5 percent sales tax on all revenues. In his more generous moments, Miller characterizes the state's interpretation of the statute as a "tortuous twist of imagination." Adds Daniel M. Saroff, a Channel 1 subscriber from Somerville: "This is not reasonable. The state has picked on the wrong crowd." But if, as Miller believes, Massachusetts is "trying to set a precedent so that it will have access to taxing the information superhighway," the state is hardly alone. "Many states are looking for what they hope is a whole new pot of revenue from a growing area" says David Peyton, vice president of processing and network services at the Information Technology Association of America, a trade group representing computer software and service companies, based in Arlington, Va. In Florida, Peyton says, bulletin boards have received similar letters from municipalities. Tennessee recently repealed a 1989 statute that taxed "value-added network -services," Peyton says, and in Pennsylvania "there's a substantial effort" to repeal a 6 percent tax on computer services. Given this state's longstanding, feud with the business community over taxation - earning it the -nickname "Taxachusetts" decades ago, - the issue of taxing cyberspace is likely to provoke passion on both sides. "There are struggles being waged all over, and there should be," says Peyton, who was part of a group that met with officials at the Massachusetts Department of Revenue in May. "This is effectively tax on modernization." Once states move beyond taxing what the Federal Communications Commission defines as basic regulated services - like phone companies and into competitive unregulated services,"there is no clear dividing line," Peyton warns. In addition to bulletin boards, he says, states could impose a sales tax on such enhanced telecommunications services as creditcard verification, or on companies that crunch payroll numbers over phone lines, or even on electronic mail. "There's the potential here of impact on all kinds of companies that consider themselves to be software companies," says Joyce Plotkin, executive director of the Massachusetts Computer Software Council Inc. "The state hasn't realized how many companies there are that could be effected depending on how they define a 'telecommunications provider.' And as statutes stand now, there is plenty of room for interpretation. In most states "the statutory structure has a lot of ambiguity inherent in it," observes Paull Mines, counsel for the Multistate Tax Commission. "It represents quite an issue for the states and for taxpayers to sort out." Based in Washington, the agency works with states to come up with guidelines to create uniform tax codes. Its members, which number 33 states, have recently asked it to study the whole issue of taxing enhanced telecommunications services. "We have looked extensively at what other states have done for ideas and approaches," says Frieden of the Department of Revenue. "But the whole area is so new that everybody is grappling with it." And Channel 1 isn't the only business in the state to have felt the effects of that grappling. Richard Gorgen, chairman and chief executive of Framingham- based Microsystems Software inc.,says his Company was audited last year because of the bulletin board it runs for customers. "We explained that it is tax exempt because it is just information we're allowing people to download," says Gorgen, whose company makes scheduling software and software for the physically challenged. "They ruled it was exempt." The state has also ventured beyond bulletin boards. Elaine K. Hoiska, an accountant who runs the Boston-based State and Local Tax Institute, reports that a couple of Boston law firms have been audited - but not yet assessed - stemming from their use of online database services. She says the state is exploring whether such firms must pay a "use tax," owed when a Massachusetts customer buys services from an out-of-state vendor that does not collect sales taxes. (In fact, in July Channel 1 was assessed as owing about $16,000 in use tax for out-of-state equipment purchases between April 1990 and December 1992. Although Miller says this tax is "selectively enforced" he allows that "at least it is on the books.") Hoiska also says a manufacturing company has also been audited for its use of Prodigy Services Co., the online service owned by IBM Corp., and Sears, Roebuck & Co. "This is becoming a standard part of an audit," she says. "They ask, 'Are you paying all the taxes on your electricity? What about your telecommunications?' " According to Frieden, the state is working on revising its regulation on telecommunications, and expects to release a proposed regulation in the fall. As earlier proposed revision, which was offered for public comment in December, would have defined companies like Channel 1 in such a way as to require them to break out on bills their taxable transmission services from their nontaxable information services. "Just the administrative burden alone would cost a tremendous amount of money," Plotkin says of the software council. Frieden as- sures that the department "has heard the concerns" of the industry. "Any time we work in a new area, we try to be sensitive," he adds. But at least one national online service, Compuserve lnc., isn't assuming that sensitivity will govern policy. Earlier this summer the Columbus, Ohio-based service sent notices to its 27,000 Massachusetts subscribers that said it would begin collecting a 5 percent sales tax as of this month. Spokesman David Kisbler said that CompuServe "received a bulletin from the state taxing authority. After seeking legal opinion it's our understanding that this is something we are required to do." He noted, though, that CompuServe differs from Channel 1 in that it offers subscribers access to a "private network" - that is, its own telephone lines - so that it does provide some transmission services. Persuading the state of that distinction has so fair cost Miller and Heder $35,000 in accounting and legal fees. "If we hadn't done this we'd probably be paying the $150,000 and going out of business," Heder says. Both have much at stake personally. Each abandoned earlier careers- he still sees some clients as a psychologist, but she gave up architecture - to "catch the information wave," as Miller, who is 49, puts it. Heder declines to reveal her age for fear of alienating those subscribers, whose imaginations are fired by her messages. Their 10-year-plan calls for establishing Channel 1 as one of the biggest of the nation's estimated 55,000 bulletin boards, distinguished by its gargantuan 100,000-program library of public-domain software and shareware, which subscribers can try and buy from manufacturers. They then plan to sell the service. As likely buyers, Miller lists "the Saudis, or maybe the Japanese or maybe even AT&T." The business now grosses about $400,000 a year, with a pretax profit of $l00,000. "We are just a small mom-and-pop operation," says Heder. "But we didn't just turn over and start collecting sales taxes when the department of Revenue rapped on our door. Because we have to draw a line somewhere on this whole issue of taxing information. If we don't, next they'll be taxing people to talk in the street." A ROSS PEROT FOR THE MODEM-MINDED How many people know that the recently passed federal budget package includes a special tax on modems? Too many, according to James Leonard. The tax doesn't exist, of course, but it's an example of the kind of misinformation that gets spread over the nation's computerized bulletin boards. With a growing subscriber base of around 3 million personal computer users, various types of online services "can spread these rumors like firestorms across the electronic global community," says Leonard, a spread sheet specialist who lives in Seattle. To douse those flames - and to help ensure that modem users aren't targeted by a tax - he has set out to form a group called the International Association of Modem Users. "THIS NOT A HOAX!" shouts his invitation, which he dispatched on six bulletin board systems two weeks ago. As Leonard notes, bulletin board users are nothing: if not responsive. When the owners of Cambridge-based Channel 1 opened up a forum for discussion of their dispute with the state over telecommunications taxes - with the hyperbolic claim that the Department of Revenue is "attempting to tax the flow of information" indignant users couldn't log on fast enough. Among other things, they used the opportunity to de- clare their devotion to Libertarian politics, to warn gov- ernment "to keep its cotton-pickin' hands off the infor- mation superhighway" and to diagnose the Department of Revenue's behavior as "immoral, indecent and evil." One suggested that the state's behavior befits "the old Soviet Union, before it collapsed." Leonard, who apparently prides himself on being sleepless, in Seattle hangs out online every night from 5:30 p.m. to 2 a.m. During that time, he says he's picked Up all manner of inaccurate reports about state efforts to tax various aspects of modem usage. But he believes that the fundamental fear is based in a simple truth: "It's be- ing driven by cities and states, who are all looking for new revenue." For now, Leonard is handing out free memberships to anyone who wants to join his group 10 days after his appeal went out, he had received 175 responses, from as far away as Thailand - and he expects to spend time try- ing to verify rumors members hear about relevant legislation. As the grass-roots group gets organized, though, he will begin charging dues. He already compares his fledgling movement to United We Stand, Ross Perot's organization. "I think I am like him," he says,"but I don't have a drawl." Nevertheless, he does believe he's the first to tap into a potentially powerful constituency. "Modem use crosses all classes of people," Leonard says, "and they all strong- ly believe it's their right to communicate freely." JOSH HYATT