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Cash-starved cities test new approach to taxing streaming services: franchise fees

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As state and local tax forecasts continue to paint a very ugly budget picture, there is little reason to doubt that officials are casting about in search of new sources of revenue. An attractive target presents itself in the form of the explosively growing streaming media market, represented by such heavyweights as Netflix, Hulu and Disney+. These services have already been deemed subject to sales tax across a wide swath of the country and even special communication taxes in a few notable places. A handful of lawsuits launched by local municipalities points towards what may become the next level: franchise fees.

What is a municipal franchise fee, you might ask? Utility services such as water, electricity, phone, natural gas and importantly cable television usually require a physical connection through the public “rights of way” to reach customers. Decades ago, cities started imposing conditions on the companies using these public spaces in order to ensure safety and protect other public interests. To fund the management and enforcement of these conditions, the utilities in question typically will be required to pay a percentage of their local receipts in compensation: the franchise fee. In the case of cable television, these fees are usually 5 percent and are almost always passed on to the consumer as a surcharge on the bill.

How does this relate to streaming video services? At first blush, utility franchise fees would appear to be completely unrelated to streaming video services. These services are typically transmitted over the customer’s internet connection, not through tangible utility connections controlled by the likes of Netflix, Hulu or Disney. However, logic runs into the cold, hard reality of municipal finances. Municipal revenues from cable franchise fees are under the dual threat of recession coupled with the effects of cord cutting. The fast-rising popularity of streaming video platforms has led to a nearly equal collapse in subscriptions to traditional cable and satellite television, the revenue base for the franchise fees.

How does this hole get filled? Municipalities in a trio of states have recently filed lawsuits to enforce collection of franchise fees against major streaming brands. The first of these cases was filed by the city of Creve Coeur as a class-action claim on behalf of all cities in Missouri. After an attempt to remove this case to federal court, it recently returned to state district court. Even more recently, a similar class-action case was filed on behalf of all cities in the state of Texas and another action was filed on behalf of four cities in Indiana, including Indianapolis and Evansville. The targets of these suits are all the biggest names in streaming video: Netflix, Hulu, Disney+, DirecTV and Dish.

The cities bringing these claims are leaning heavily on existing language in their utility franchise laws defining pay TV services subject to the fee. Broad definitions open the door to interpretations that streaming services are included. The likely crux of these disputes will be over whether the transmission of streaming video through physical internet connections owned and operated by other companies provides sufficient justification for imposition of the associated fees. The streaming video providers will likely argue they have no actual connection to the transmission lines in the public rights of way and no control over the activities that are regulated by the underlying franchise rules. If the intent of the franchise requirements is to ensure physical utility networks are operated consistent with safety and public interest in mind, how is that policy interest addressed by assessing fees on companies that don’t actually own or operate the physical networks?

Time will tell whether these franchise fees on streaming video services are legally viable. The implications are vast, as similar fees exist across most of the country. To date, the taxes imposed on streaming video services have largely focused on interpreting them into existing tax law definitions: sales taxes, amusement taxes, utility taxes and now franchise fees. Given current revenue stresses, it is likely inevitable that we will eventually see more taxation of these services coming through legislation, and perhaps through completely new taxes.

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