EDUCATIONAL ADVISORY UNIVERSAL SERVICE FUND: FCC s Wholesaler-Reseller Exemption Requirements A Practical Compliance Guide

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EDUCATIONAL ADVISORY UNIVERSAL SERVICE FUND: FCC s Wholesaler-Reseller Exemption Requirements A Practical Compliance Guide INTRODUCTION In 1996, Congress directed the Federal Communications

1 EDUCATIONAL ADVISORY UNIVERSAL SERVICE FUND: FCC s Wholesaler-Reseller Exemption Requirements A Practical Compliance Guide INTRODUCTION In 1996, Congress directed the Federal Communications Commission ( FCC or Commission ) to establish the Universal Service Fund ( USF or the Fund ) to extend reasonably priced telecommunications service to low-income and rural users, as well as to schools, libraries and medical facilities. 1 The FCC created the USF in To fund the initiative, the FCC required telecommunications service providers to pay a percentage of end-user revenues into the Fund. Over the years, as the telecommunications industry has evolved, the process of reporting and contributing to the Fund has become increasingly complex and burdensome. One of the most complicated aspects of the USF contribution regime is the Wholesaler- Reseller Exemption rule, otherwise known as the Carrier s Carrier Rule. Although the FCC first introduced the Wholesaler-Reseller Exemption rule in its original Order 2 establishing the Fund, the FCC has subsequently issued Orders attempting to clear up multiple uncertainties. In 2012, the FCC issued the 2012 Wholesaler-Reseller Clarification Order 3 to explain contribution requirements for wholesale providers and their resellers. Furthermore, the FCC just recently issued the Universal Service 2017 Order 4 explaining how a 499 contributor can seek a refund in the event of a double contribution to the USF. 1 Telecommunications Act of 1996, Pub. L. No , 110 Stat. 56 (codified as amended at 47 U.S.C. 254(a)). 2 Federal-State Board on Universal Service, CC Docket No , Report and Order, 12 FCC Rcd 8776, (1997) (Universal Service First Report and Order). 3 In the Matter of Universal Service Contribution Methodology, CC Docket No , Order, 27 FCC Rcd (Nov. 1, 2012) ( 2012 Wholesaler-Reseller Clarification Order ). 4 In the Matter of Universal Service Contribution Methodology Federal-State Joint Board on Universal Service, CC Docket No , Memorandum Opinion and Order, DA (Jan. 13, 2017) ( Universal Service 2017 Order )

2 Page 2 This Educational Advisory aims to provide telecommunications companies with practical tools for compliance with the USF s Wholesaler-Reseller Exemption rule, both to ensure that your company will stay in compliance with the FCC s rules, while avoiding overpayment of USF fees. THE USF EXEMPTION PROCESS 5 Under FCC rules 6, telecommunications carriers who provide interstate telecommunications services to end-user customers must contribute to the USF on interstate and international revenues from such end-user services. By limiting contributions to enduser revenues, the FCC only requires contribution to the USF once along the entire distribution chain. To avoid assessing the same revenues twice, the FCC requires filers to categorize revenues in two ways, one of which requires contributions to the USF and one of which does not. 7 The first type of revenue is carrier s carrier revenue, or revenue from sales to resellers. Resellers are telecommunications providers that: (a) incorporate the purchased services into their own offerings; and (b) can be expected to contribute to the USF based on the revenue from those offerings. Revenue from sales to resellers is exempt from contributions to the USF. 8 The second type of revenue is end-user revenue, or retail revenue from sales to endusers. This classification includes revenues from sales to consumers and revenues from services offered to other providers that do not contribute to the USF, such as de minimis carriers 9 and other exempted providers of interstate telecommunications. Because this classification includes any sales to providers who do not themselves contribute to the USF, any unverified revenues should be treated as retail, USF assessable end-user revenues. To classify revenues as wholesale, a provider must complete due diligence 10 in order to demonstrate that its customer is a reseller as defined above. The wholesale provider Wholesaler-Reseller Clarification Order at U.S.C. 254(d) ( Every telecommunications carrier that provides interstate telecommunications services shall contribute, on an equitable and nondiscriminatory basis, to the specific, predictable, and sufficient mechanisms established by the Commission to preserve and advance universal service. ) 7 Instructions to 2017 FCC Form 499-A at Wholesaler-Reseller Clarification Order at C.F.R A telecommunications provider is considered de minimis if it is required to contribute to the USF, but its contribution to the USF in any given year would be less than $10, Universal Service 2017 Order at 6.

3 Page 3 must have either (1) affirmative knowledge or (2) a reasonable expectation that a customer contributes to USF. 11 A reasonable expectation is determined either by way of compliance with the safe harbor provision or other reliable proof. 12 Additionally, any telecommunications provider determined to be a reseller has an independent obligation 13 to contribute to the USF on subject revenues. Resellers cannot contract away this obligation by relying on their wholesale providers to contribute for them by passing through USF fees on this revenue. 14 Wholesale providers may recover their USF costs (in the form of pass-through fees) to end-user customers and non-exempt carrier customers. 15 A. What is Exempt? Carrier s carrier revenue, or revenue from sales from wholesale providers to resellers is exempt from USF contributions. To qualify as a reseller, a service provider must fit under the two-part definition imposed by the FCC. A reseller (1) incorporates purchased telecommunications into its own service offerings and (2) can reasonably be expected to contribute to the USF based on revenues from those service offerings. 16 Inherent in the reseller definition is a service-by-service evaluation requirement. Previously, the USF s Wholesaler-Reseller Exemption rule was applied on an entity-wide basis. However, the 2012 Wholesaler-Reseller Clarification Order 17 adopted a servicespecific exemption process. Under this standard, the customer must contribute on the specific service offering that incorporates the purchased inputs from the wholesale service provider. Example: A customer purchases two DS1 lines from a wholesale provider. The customer (1) incorporates one line into a retail telephone service; and (2) incorporates the other line into a retail Internet access service Id. at Wholesaler-Reseller Clarification Order at Universal Service 2017 Order at Id. at Wholesaler-Reseller Clarification Order at Id. at Wholesaler-Reseller Clarification Order at Id. at 40, n.111.

4 Page 4 First, the customer will be obligated to contribute to the USF on interstate and international end-user revenues from the retail telephone service, and can certify exemption from USF fees on this service to the wholesale provider. However, the customer will not be required to contribute to the USF on the retail Internet access service revenues, and therefore cannot certify exemption to the wholesale provider relative to the DS1 line that it purchased for its Internet access service. The wholesale provider must treat revenues from the DS1 line purchased for Internet access service as end-user revenues. Therefore, the wholesale provider must contribute to the USF on interstate/international revenues from these sales, but the wholesale provider can recover these costs from the customer with pass-through fees. B. Procedures to Ensure Exemption In order to meet the reasonable expectation standard, and thus be exempt from USF contributions, a wholesaler provider has two options: (1) Following the safe harbor provision or (2) providing other reliable proof. 19 As an alternative to the reasonable expectation standard, the wholesale provider can provide affirmative knowledge that the reseller contributed to the Fund. However, the safe harbor provision is the most reliable way to prevent any contribution issues. 1. Safe Harbor Provision The safe harbor provision is embodied in the FCC Form 499-A Instructions. 20 Any deviation from these instructions will require the provider to prove with clear and convincing evidence. A wholesale provider must collect and include the following information about resellers in order to be in compliance with the safe harbor provisions: Filer 499 ID (a 6-digit number assigned to entities that register as Interstate Telecommunications Service Providers with USAC). Legal name, legal address, name of contact person, and the phone number of the contact person. 21 Annual USF Exemption Certificates regarding the reseller s status, including safe harbor language in the Form 499-A. 19 Id. at Filers that comply with the procedures specified in this section of the instructions will be afforded a safe harbor - i.e., that filer will be deemed to have demonstrated a reasonable expectation. Instructions to 2017 FCC Form 499-A at Instructions to 2017 FCC Form 499-A at 37.

5 Page 5 o The wholesale provider must collect certificates signed each calendar year by the resale customer certifying all services that are exempt. o A reseller can either certify that all services are exempt or must list the services individually by name describing which services are exempt and which aren t. If a wholesale provider complies with this procedure, it will not be responsible for additional contributions even if the customer does not in fact contribute to the revenues from its services. Example: Company 2 bought services A, B & C from Company 1. Company 2 incorporated these services into retail offerings that it resold to its end-user customers. Company 1 believes that Company 2 is a reseller because Company 2 orally informed Company 1 that it contributes directly to the USF. Company 1 reports all revenue from sales to Company 2 as wholesale (exempt from USF). However, in a USAC audit, USAC discovers that, while Company 2 contributed to the USF on Services A & B, Company 2 did NOT contribute to the USF on revenues from Service C. Because Company 1 neither followed the safe harbor exemption procedure, nor could it prove via clear and convincing evidence (it had only oral communications) that it had a reasonable expectation that Company 2 would contribute to the USF on ALL services purchased from Company 1, Company 1 is responsible for USF contributions on interstate and international revenues from sales to Company 2 of services that Company 2 incorporated into non-exempt Service C. Additionally, it is important to note that the reasonable expectation standard does not apply when a wholesale provider is attempting to prove double collection. Even if the wholesale provider does not provide a reasonable expectation by a preponderance of the evidence that its underlying customer would contribute to the Fund at the time of filing the applicable revenue data, USAC will not attempt to collect payment if the reseller customer actually contributed to the USF on the subject revenue Universal Service 2017 Order at 6.

6 Page 6 2. Other reliable proof and affirmative knowledge As an alternative to the safe harbor provision, the FCC will allow providers to provide other reliable proof to meet the reasonable expectation standard. 23 The FCC evaluates other reliable proof on a case-by-case basis, depending upon whether the filer has presented clear and convincing evidence of contribution during the Form 499 reporting year at issue. Furthermore, the wholesale provider may also show affirmative knowledge. However, the wholesale provider must prove clear and convincing evidence of affirmative knowledge. 24 C. Practical Guidance to Ensure Compliance Because the USF s Wholesaler-Reseller Exemption rule can be confusing and complicated for all parties, below are some considerations for services providers to take into account in to order to ensure compliance with all the various requirements. 1. Reseller Provide accurate and applicable information in all USF Exemption Forms from suppliers. If you are incorporating a wholesale provider s services into your own, selling them as telecom or I-VoIP and contributing to the USF on revenues from those services, certify that you are an FCC Form 499-A filer and a contributor to the USF. If you are selling services exclusively to other sellers that contribute directly to the USF (and have certified as such), certify that your customers are FCC Form 499-A filers and are also contributors to the USF. Furthermore, provide accurate information about your company, such as legal name, address and contact information, to ensure your wholesale provider has a clear record on file if contribution issues arise. Create a plan with your wholesale provider. Set up multiple accounts in order to easily separate and specify which services are exempt and which services are not exempt. Ensure FCC Forms 449-A and 499-Q are completed on time: 25 All resellers must complete FCC Form 499-A by April 1st. Forms 499-Q are due February 1st, May 1st, August 1st, and November 1st Wholesaler-Reseller Clarification Order at Id. at Instructions to 2017 FCC Form 499-A at 12.

7 Page 7 2. Wholesale Provider Obtain certificates annually from Resellers. Ensure the certificate is specifically crafted for your company s service and needs. Include applicable language according to the Form 499-A Instructions. 26 Provide certificates to customers for completion, and mandate return of such forms well before the annual Form 499- A deadline. Lastly, keep these certificates on file for 5 years (per FCC s requirements) 27 and double check all certificates because any minor errors could result in the certificate being considered invalid. Keep a file for each customer with all the applicable information: At a minimum, you should have information regarding the reseller s legal name, phone number, address, current company website, the name of an applicable contact person, and 499 Filer ID. Include a detailed log: Each wholesale provider should have a record of all the services for each customer separated by which services are exempt and which services are not. Ensure FCC Forms 449-A and 499-Q are completed on time: 28 All wholesale providers must complete FCC Form 499-A by April 1st. FCC Forms 499-Q are due by February 1st, May 1st, August 1st, and November 1st. D. Further Considerations: Secure Refunds for Duplicative USF Payments The FCC recently created a standard for allowing resellers that made duplicative USF payments, such as in the form of pass-throughs from suppliers and directly to USAC, to seek refunds directly from USAC. As long as one service provider in the distribution chain has contributed to the USF, USAC will not collect a double payment. However, the burden of proof is on the provider claiming double collection to show by a preponderance of the evidence that contributions were actually made both directly to the USF and to its supplier on the same revenue. Either the wholesale provider or the reseller can claim doublecollection. 26 Instructions to 2017 FCC Form 499-A at 37: I certify under penalty of perjury that the company is purchasing service(s) for resale, at least in part, and that the company is incorporating the purchased services into its own offerings which are, at least in part, assessable U.S. telecommunications or interconnected Voice over Internet Protocol services. I also certify under penalty of perjury that the company either directly contributes or has a reasonable expectation that another entity in the downstream chain of resellers directly contributes to the federal universal service support mechanisms on the assessable portion of revenues from offerings that incorporate the purchased services. 27 See 47 CFR (e) ( These records shall include without limitation the following: Financial statements and supporting documentation; accounting records; historical customer records; general ledgers; and any other relevant documentation ). 28 Instructions to 2017 FCC Form 499-A at 12.

8 Page 8 A reseller must show that the underlying provider contributed on its behalf and prove how much the underlying provider contributed (reported per quarter). 29 Ultimately, if the reseller offers evidence that shows by a preponderance of the evidence that (1) it paid passthroughs to its underlying provider; and (2) its underlying provider contributed to USF on the subject revenue, then USAC will provide a credit to the resale provider against the resale provider s contribution obligation in the amount the underlying provider ultimately paid. A resale provider likely can meet the evidentiary requirement by producing a sworn affidavit from the underlying provider showing the revenue received from the reseller and a record of the contributions paid to USAC based on this revenue; and certification from the reseller that it attests to the veracity of the underlying provider s statement based upon a review of its own books and records. 30 As described above, a wholesale provider must also prove by a preponderance of the evidence that the resale customer paid to the Fund. CONCLUSION The USF Wholesaler-Reseller Exemption rule is full of complicated requirements. Because the rule affects a wide range of U.S. and global communications industries, it is important to understand how to keep your company in compliance while uncertainty still remains as to how these rules will continue to be enforced and what new issues might emerge. One thing is certain, the FCC has highly stressed the importance of the safe harbor provision in the Form 499-A instructions. Following the safe harbor provision carefully, such as providing annual certificates specifying each exempt service and keeping an up-to-date information about your reseller, will help to ensure your company will be in compliance with all reporting requirements. While this advisory provides practical guidance on how your company should approach the USF Wholesaler-Reseller Exemption rule, your company should seek the advice of an attorney regarding your individual company s legal rights and obligations. If you have any questions regarding FCC/USAC Compliance, please reach out to The CommLaw Group s USAC Compliance, Audit Preparation and Defense Practice. 29 Universal Service 2017 Order, at Id. at 22.

9 Page 9 DISCLAIMERS: This Advisory has been prepared for informational purposes only. It is not for the purpose of providing legal advice and does not create an attorney-client relationship between Marashlian & Donahue, PLLC and you. You should not act upon the information set forth herein without seeking experienced counsel. This Advisory may be considered Attorney Advertising in certain jurisdictions. The determination of the need for legal services and the choice of lawyer are extremely important decisions and should not be based solely upon advertisements or self-proclaimed expertise. The CommLaw Group By: For the Firm

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