“Buy One and Get One Free” is normally a good deal, but in
Washington, it’s “Buy One and Get the Second One Double
Taxed”.
By Garry G. Fujita, Eisenhower Carlson PLLC
www.eisenhowerlaw.com
(253) 620-2513
On April 30, 2013, the Court of Appeals decided Sprint Spectrum, LP v. State of Washington,
Department of Revenue, No. 42304-9-II. The holding in this case is alarming for three reasons,
one is that a retailer that markets a product “Buy one, get one free” may be required to pay use
tax on the free item. Second, if the retailer is required to pay use tax under the court’s theory,
then logically, that seller must collect use tax from the consumer as well. Third, carried to its
logical extreme, some wholesalers could be facing this multiple tax too.
Background
In this case, Sprint Spectrum, LP (“Sprint”), sold wireless telephone services. As a means to
induce subscribers to do business with Sprint, it would underwrite the cost of cellular phones,
often giving the telephone away for “free” if the customer agreed to a two-year service plan. It
appears that Sprint determined a two-year contract would allow it to recover the cost of the
telephone. Sprint bought the telephones at wholesale, because it believed that it was reselling the
telephone to the customer who would pay sales tax on the bundle of the telephone and the twoyear service contract. Through cost recovery in the two-year service agreement, Sprint did not
really “give away” the telephone. However, whether or not the customer took the free telephone,
that decision did not affect the price of the wireless service. Thus, on its surface, the service
price was static, so the court concluded that wireless telephone service was unrelated to the
telephone sale.
So, did Sprint sell wireless telephone service and give the telephone away, or
did Sprint sell the wireless service and telephone in one transaction?
The court decided that Sprint gave away the telephone. By refusing to bundle the telephone with
the wireless service, the court’s decision leads to two different taxable events. The first taxable
event was “intervening use,” a term of art used in sales and use tax administration. When a
retailer buys inventory for resale, the retailer is exempt from the sales or use tax. However, if the
retailer withdraws an item from inventory and uses it, then “intervening use” has occurred even
if the retailer eventually sells the item. If present, then the “intervening use” triggers the use tax.
An office supply store provides a perfect example of this principle. When it pulls a ream of copy
paper from the shelf and uses the paper in its printers for its own consumption, then it has put
that paper to intervening use. It owes use tax on the ream of paper.
According to the court, when Sprint advertised the “free” telephone to induce the sale of the twoyear service contract, it put the telephone to intervening use.1 Sprint now had a use tax liability
on the value of the telephone (presumptively, Sprint’s cost and not the suggested retail value),
because, like the office supply store, the court viewed the use of the telephone as comparable to
the use of the ream of copy paper.
The state took the position that the telephones cannot be exempt as inventory because Sprint
used the telephones by giving them away for free. In other words, the telephones were never
inventory; they were promotional items like a free pen, coaster or calendar. The state relied
heavily on Activate, Inc. v. Dep’t of Revenue, 150 Wn.App. 807, 2099 P.3d 524 (2009)
(“Activate”). The court opined that Activate was different2 because in Sprint’s case, it used the
free telephone inducement resulted in the buyer’s promise to buy a two-year service contract and
Sprint would also honor and fulfill the service contract. However, in Activate, a third-party,
AT&T honored and fulfilled the service agreement, not Activate. By contrast, in Sprint’s case, it
… not a third-party … honored and fulfilled the service agreement. The court reasoned that the
buyer’s promise to buy Sprint’s two-year service agreement constituted valuable consideration
1
“Here, Sprint made intervening use of the phones it ultimately "sold" for no money (but valuable consideration)
because the phones served the marketing purpose of convincing customers to purchase wireless service contracts.”
Sprint, slip opinion, page 17.
2
In Activate, the taxpayer’s business model was different from Sprint. The taxpayer bought telephones used on the
AT&T network. AT&T agreed to pay the taxpayer a commission on the two-year service plans the taxpayers could
sell from mall kiosks. The taxpayer used the telephones to induce customers to purchase AT&T’s two-year service
agreements. Unlike Sprint, the taxpayer did not actually provide wireless telephone service. Apparently, the
commission was large enough to offset the cost of the telephones that the taxpayer gave away for free. Here, it was
not possible to argue that that the free telephones were part of the two-year service agreement because the taxpayer
did not sell its own wireless subscription; it sold the subscription that AT&T would honor and fulfill.
for the telephone.3 This meant that Sprint made a retail sale of the telephones. Thus, the sale for
resale exemption applied to the telephones.
This case, taken to its logical extreme, could result in several taxes on the same item. The key
will be whether there has been “intervening use”.
THE FIRST TAX
Although Sprint made a retail sale, the court went on to say that conclusion did not end the
analysis. It added that Activate still controlled the use tax issue. Just like the taxpayer in
Activate, Sprint put the telephones to intervening use. When Sprint used the telephones to
induce the sale of the service contract, it put the telephones to intervening use prior to the retail
sale. It is at that moment that Sprint triggered the use tax, reaching the same tax result as
Activate.
THE SECOND TAX
This is when the second taxable event occurs. Letting the court’s analysis stand for the moment,
here is the problem. According to the use tax statutes, the customer owes use tax in the
following situation:
(1) There is levied and collected from every person in this state a
tax or excise for the privilege of using within this state as a
consumer any: (a) Article of tangible personal property
acquired by the user in any manner, …
RCW 82.12.050. In Sprint’s case, the customer owes use tax on the telephone if the customer
used the telephone in Washington that it acquired “in any manner.” Well, in this case “free” is
the “any manner,” and the customer will use the telephone in Washington. So, the customer has
a use tax burden too.
The statute goes on to explain that a retailer must collect the use tax from the customer under the
following situation:
(1) Every person who maintains in this state a place of business or
a stock of goods, or engages in business activities within this
3
“Here, the undisputed material facts reflect that Sprint provided fully-discounted [sic] phones only to customers
who were willing to sign long - term service agreements. …this meant that in exchange for a fully-discounted [sic]
wireless phone, a customer would agree to contractual obligations involving monthly service fees and
potential termination fees amounting to "$1,400 worth of stuff.” [citations omitted.] Accordingly, Sprint
received valuable consideration in exchange for these fully-discounted [sic] phones.” Sprint, slip opinion,
page 16-17. This fact was missing in Activate.
state … and shall, at the time of making sales of tangible
personal property ... collect from the purchasers or transferees
the tax imposed under this chapter.
RCW 82.12.040. WAC 458-20-221 (“Rule 221”) implements this use tax provision, it says:
Obligation of sellers to collect use tax. Persons who obtain a
certificate of registration, maintain a place of business in this state,
maintain a stock of goods in this state, or engage in business
activities within this state are required to collect use tax from
persons in this state to whom they sell tangible personal property
at retail and from whom they have not collected sales tax. Use tax
collected by sellers shall be deemed to be held in trust until paid to
the department. Any seller failing to collect the tax or, if collected,
failing to remit the tax is personally liable to the state for the
amount of tax…
Rule 221(4) (italics supplied)
Thus, because Sprint has a Washington certificate of registration, maintains a place of business
in Washington, maintains a stock of goods in Washington and engages in business in
Washington, it must collect the use tax from the purchasers if it has not collected sales tax.
According to the court, Sprint sold the telephones for $0, so Sprint has collected no sales tax.
This means that Sprint must collect use tax from the customers.
Let’s count up the taxes. Sprint pays use tax because it put the telephones to intervening use
when it used them to induce the purchase of the two-year subscription. Customers must pay use
tax on the telephones, because they acquired the telephones without paying sales tax. Thus, that
free telephone bears two use taxes.
To make matters worse for retailers who have induced sales by giving away free goods or
services, there is a viable risk that the Department of Revenue could retroactively assess this
uncollected use tax against the seller personally under Rule 221(4), meaning Sprint and
similar retailers will bear the two use taxes on a retroactive basis, unless they are willing to
trash their customer relationships and chase their customers for the tax.
The credit in RCW 82.12.035 for taxes previously paid does not help, because the credit only
applies if there is a donor or bailor who has previously paid sales or use tax. That is not the case
here; the court found that Sprint made a retail sale. Thus, Sprint can be neither a donor nor
bailor if it is a seller, and thus, the credit will not apply. (Candidly, it would be a stretch to say
that Sprint donor or bailor in any event.)
Aside from the wireless situation, to what other transactions could this apply? Here is a short
list:
1. A tire store advertises “Buy three tires and get one for free.”
2. A mattress store advertises “Buy a deluxe mattress set and get the bed frame,
delivery, set up and haul away for free.”
3. A pizza parlor advertises “Buy an extra-large pizza and get one for free.”
4. An online vendor advertises “Buy more than $25.00 in one order, and the shipping
is free.”
5. A car dealer advertises “Buy model XYZ, and receive a 24 month maintenance
agreement for free.”
6. A clothing store advertises “Buy one pair of pants, and get a second one for free.”
7. A tour boat operator advertises “Buy one Puget Sound cruise and get a free
dessert.”
8. A hotel advertises “Pay for two nights at regular price and get one night free.”
The examples are endless when a vendor is using goods or services to induce the purchase of
another good or service. The seller in each situation thinks that it is selling 1) four tires for the
price of three, 2) a mattress set, frame and related services for the price of the mattress set, 3) two
extra-large pizzas for the price of one, 4) a $25 or greater item and shipping for one price, 5) a
car and maintenance agreement for one price, 6) two pairs of pants for the price of one, 7) a
cruise and dessert for the price of a cruise and 8) three nights for the price of two.
And in every situation, if the court’s opinion is upheld, then the “free” item is subject to use tax
by the seller and again by the customer. The “free” tire, bed frame and related services, pizza,
delivery charges, maintenance agreement, pair of pants, dessert or hotel room will each have two
use tax impositions. There is one tax on the seller who used the goods or services to induce the
initial sale and the second tax on the consumer who actually consumed the goods or services.
The court added an interesting footnote. In footnote 14, according to the court, had Sprint sold
the telephone for one cent instead of selling the telephone for free, then there would have been a
different result. The court observed:
We are aware that on the surface, this result defies common sense:
had Sprint charged a penny for the phones it provided customers in
exchange for signing long - term service agreements, no use tax
would apply. But the specifics of the taxation process are a
legislative concern. If the legislature desired a different result, it
could structure the tax code differently.
Sprint, slip opinion, page 18.
The court concludes that a one cent charge would be enough to avoid Sprint’s use tax liability on
the intervening use, because it would have resold the telephone. That seems like the simple
solution to the problem. However, that rationale is a non-sequitur; the statement is inconsistent
with the court’s rationale for asserting the use tax on intervening use in the first place.
Let’s begin with the basis for the use tax on Sprint. The court states that using the discounted
telephones to induce the customer’s purchase of a two-year service contract is intervening use.4
If using discounted telephones to induce the purchase of a two-year service contract is
intervening use, and then what difference does it make whether the telephone was eventually
given away for free or the customer paid one cent, one dollar or one hundred dollars? As long as
the products were used to induce a sale, intervening use occurred. Was there any less
“intervening use” because the telephone was charged an affirmative amount instead of given
away for free? No. Thus, not only are the “free” telephones problematic under the court’s
reasoning, but so are any discounted telephones; the subsidized discounted telephone is
presumptively intended to induce the customer to buy a two-year service plan.
Moving away from discounted telephones into other ways a retailer might use inventory to
induce sales, more problems are lurking. For example, at one time, only AT&T was authorized
as a third-party seller of iPhones, and AT&T advertised to potential wireless customers that they
could only get an iPhone if they bought AT&T wireless telephone services. Did AT&T put the
iPhones to intervening use because iPhones were marketed to induce customers to buy AT&T
wireless telephone service? It would appear that the answer is yes.
Software is another example. Let’s say that a software company granted a computer maker the
licensing rights to install trial software on its new computers. The computer maker the induced a
retail vendor to buy and resell its computers by marketing its computers as preloaded with “free
trial” software. The retail vendor, in turn, induces retail buyers to buy the computers by
marketing these computers as pre-loaded with “free trial software”. In this case, the computer
maker used the “free trial software” to induce the retail vendor to buy and resell its computers.
The retail vendor used the “free trial” software to induce the retail buyers to buy the computers.
The software company used its “free trial” software to induce the retail consumers to buy a key
code to access the full license from the software company. Wouldn’t all three be liable for use
tax on the “free trial” software? They all used the “free trial” software to induce sales of the
computer and software.
Taking this premise yet another step further, when a store displays sweaters on a display rack,
toys on a store shelf, plants at a nursery, or cars on a car lot, do they do so to induce a consumer
to buy a sweater, toy, plant or car? If not, then why wouldn’t the sellers show examples of item
for sale by taking pictures of the items and showing the pictures to the consumers?5
ARE WHOLESALERS SAFE?
4
See footnote 1.
Ironically, if this case is upheld, then online sellers would once again have an advantage if the current version of
the Market Place Fairness Act pending in the U.S. House of Representatives passed. As drafted, it would not allow
Washington to require an out-of-state online seller to remit use tax under an intervening use theory. They would
collect one tax and products sold by Washington retailers would potentially bear two taxes. Even more absurd is the
possibility that if a Washington online retailer promoted sales using the “buy one, get one free” model from
Washington-based inventory, that Washington online retailer could be liable for the Washington use tax because the
intervening use would have occurred in Washington even though the retail sale occurs out of state.
5
A final problem exists. Though rarely thought to present a problem, wholesalers are vulnerable
too if they use their product to induce sales. For example, when seasons change, a wholesaler
may not want winter sweaters in the warehouse with spring approaching. There appears to be
nothing in the court’s opinion that would prevent the “intervening use” analysis from applying to
a transaction when the wholesaler “gives” away 25 “free” sweaters if the retailer agrees to buy
75. Thus, not even wholesalers are safe from “intervening use” if it uses “free” to induce a sale.
However, if the wholesaler sells 100 sweaters for the price of 75, then the court would not likely
find intervening use to have occurred.
The point is that most vendors use their inventory to induce sales every day of the year. If the
court is correct that inducing a sale constitutes intervening use, then every vendor that uses
inventory for that purpose would be liable for use tax.
PLANNING AROUND THE COURT’S DECISION6
The planning to avoid the consequence is facially simple for most promotions, because the
problem is a matter of semantics as suggested by footnote 14. So, rather than selling a two-year
service plan and giving the telephone for free, the tax problem is likely solved by selling the
wireless service and the telephone for a bundled price that is subject to sales tax. However, this
planning only helps with future sales. For past periods, any marketing done on “Sprint model”
could have the same outcome as Sprint, plus the additional problem of failing to collect the use
tax from customers as required by Rule 221.
UPDATE: On November 5, 2013, the Washington Supreme Court denied Sprint’s petition for
discretionary review.
6
This article does not constitute legal advice and is provided as a general discussion of the court’s opinion. The
actual tax result can depend upon the facts and circumstances and other applicable law. You should consult legal
counsel or other tax professional before taking action on the issues presented in this discussion.