During the past year, a number of small cities in states like Indiana have sought to sue streaming giants like Netflix and Hulu for franchise fees related to use of local internet infrastructure. These cities are looking to recoup tax revenue that was lost when residents cut their cable cords and switched to streaming services.
Last month, some Indiana cities clinched a victory in their plight to recoup unpaid franchise fees from Netflix et al, as a judge rejected the tech giants’ motion to dismiss a lawsuit brought by the likes of tiny Fishers, Indiana, and a host of other municipalities.
Toby Bargar, senior tax consultant at Avalara, had predicted that cities across multiple states would keep trying new strategies until they got traction in the courts, and that appears to be what’s happening.
Procedurally, the initial suit was filed in state district court, according to Bargar. “The streamers moved to get the case removed to federal court,” he said. “It’s a common strategy. But the cities appealed, and it wound up at the circuit level. Here, the circuit court judge tossed it back to the state courts. It was an entirely procedural decision, that states should have the first right of jurisdiction on the case.”
“The streamers said that applying tax to these services is preempted by federal law, but the federal judge agreed that the local jurisdictions can have the first crack at it,” he added.
The argument at the heart of this is of a public policy nature, according to Bargar: “Small cities are trying to assert that franchise fees should be paid by the streaming giants. There are a lot of procedural issues in these cases as well as substantive issues. Is applying these fees to streamers in tune with why the fees were originally in place?”
The history of utility franchising may play a part in deciding these issues, Bargar suggested.
It started in the early days of electricity, gas and phone installations, he explained. “Initially, it was a free-for-all across the country. But there had to be a physical connection to the premises of the customer, and there were safety issues involved. That’s why franchise fees came into existence, and that’s why there was normally only one franchise granted to a locality. The franchise fees paid for the jurisdiction to monitor the compliance of the utility with safety and other regulations.”
Likewise, cable TV created exposed multiwire connections into people’s homes, and associated electrical hazards. Franchise agreements meant abiding by safety requirements. Cable companies were compelled to comply with utility franchise rules and regulations.
“These franchise fee agreements are everywhere in the U.S.," Bargar said. “Now, cities want to extend these fees to streaming companies to make up for lost revenue due to consumers cutting the cable cord. They want Hulu, Netflix, Disney+ and others to pay these fees or taxes. The issue is why these franchise fees were imposed in the first place. Streaming giants aren’t causing safety issues with digging and multiwire configurations.”
“The cities are saying that streamers should not be selling their services into a local jurisdiction without fees for accessing [the] internet right of way. The counterargument is that the streamers don’t have responsibility or control over the people using their services — Netflix is riding over the top of local ISP data connections. They don’t have the level of control via service trucks and equipment that cable companies do.”
The local jurisdictions are suing for the notion that the streamers should be collecting about 5% in franchise fees, according to Bargar: “People still using cable are paying this fee — cities want to make it binding across the board,whether someone is accessing content via cable or streaming.”
Most of these suits are class actions, according to Bargar. “Class-action attorneys went out and enlisted various jurisdictions to get the process started. My instinct is that these suits are a reach — how can streamers be responsible for fees designed around physical infrastructure? Cities are driven to this argument because they miss the cable revenue.”
Bargar believes a better strategy would be a more straightforward approach.
“Cities could pass new ordinances with new taxes, rather than trying to utilize existing statutes,” he said. “This would be the next obvious course of action, but it would take political will to push through.”
