               IN THE SUPREME COURT OF IOWA
                               No. 07–1792

                          Filed August 21, 2009


AOL LLC,

      Appellee,

vs.

IOWA DEPARTMENT OF REVENUE,

      Appellant.


      On review from the Iowa Court of Appeals.



      Appeal from the Iowa District Court for Polk County, Robert B.

Hanson, Judge.



      Department     seeks   further   review   of    the   reversal   of   its

determination that AOL is subject to state sales tax.         DECISION OF

COURT OF APPEALS VACATED; DISTRICT COURT JUDGMENT

AFFIRMED.


      Thomas J. Miller, Attorney General, Marcia Mason and James D.

Miller, Assistant Attorneys General, for appellant.



      Bruce W. Baker of Nyemaster, Goode, West, Hansell & O’Brien,

P.C., Des Moines, and Peter J. Brann, Martin I. Eisenstein and David

Swetnam-Burland of Brann & Isaacson, Lewiston, Maine, for appellee.
                                    2

APPEL, Justice.

      This case involves the question of whether the State of Iowa may

impose sales tax on internet services provided by America Online, LLC

(AOL) to its Iowa customers.     The parties disagree as to whether the

applicable administrative rule requires the origin and terminus of the

communication to occur in Iowa in order for AOL’s gross receipts to be

taxable and whether AOL’s service met this requirement.         While the

department found AOL subject to state sales tax, the district court and

the court of appeals disagreed.      For the reasons stated below, the

decision of the court of appeals is vacated and the district court

judgment is affirmed.

      I. Background Facts and Proceedings.

      AOL is a communication service provider that offered its Iowa

members internet access, e-mail, instant messaging, and a variety of

original content features.   The essential operational features of AOL’s

internet service are not materially disputed. In order to obtain content, a

member residing in Iowa must first place a call to a local telephone

number through a modem-equipped computer.           One of the cluster of

modems at the local exchange (modem hotel) would answer the call and

then forward a digital signal routed to one of AOL’s data centers in

Virginia through a private system controlled by AOL.

      Before the customer in Iowa could receive any content from AOL,

“authentication” of the customer’s information must occur in Virginia.

Once authentication is verified, the service commences through the

connection of the Iowa customer’s personal computer to the data centers

in Virginia.   AOL refers to this as the client/server connection.     Any

information that an AOL subscriber posted on AOL servers, the internet,

or sent by e-mail would be routed through Virginia before it could be
                                        3

accessed by any other user, including AOL members and any non-AOL

members in Iowa.          Additionally, any information sent to an AOL

customer in Iowa must first be routed through Virginia before that

information reached Iowa, even if that information originated in Iowa.

Thus, without a connection between the user’s computer in Iowa via

AOL’s local exchange to the AOL data center in Virginia, no services

could be provided even for communications between two AOL members

who both resided within the state.

      At the time of this dispute, Iowa Code section 422.43(1) (1999)

imposed a state sales tax on “the gross receipts from the sales,

furnishing, or service of . . . communication service . . . when sold at

retail in the state to consumers or users . . . .”       The department

promulgated Iowa Administrative Code rule 701—18.20 to enforce this

statutory provision. The introduction to rule 18.20 and the definitions in

section 18.20(1) provide:

      701—18.20 . . . Communications services. The gross
      receipts from the sale of all communication services provided
      in this state are subject to tax. . . .

                18.20(1) Definitions.

            a. Communication services shall mean the act of
      providing, for a consideration, any medium or method for, or
      the act of transmission and receipt of, information between
      two or more points. Each point must be capable of both
      transmitting and receiving information if “communication” is
      to occur. . . .

             b. Communication service is provided “in this state”
      only if both the points of origination and termination of the
      communication       are  within    the    borders  of   Iowa.
      Communication service between any other points is
      “interstate” in nature and not subject to tax.

      The rule goes on to further address the taxation of internet services

specifically:
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           18.20(5) Prior to July 1, 1999, charges for access to
     or use of what is commonly referred to as the “Internet” or
     charges for other contracted on-line services are the gross
     receipts from the performance of a taxable service if access is
     by way of a local or in-state long distance telephone number
     and if the predominant service offered is two-way
     transmission and receipt of information from one site to
     another as described in paragraph “a” of subrule 18.20(1). If
     a user’s billing address is located in Iowa, a service provider
     should assume that Internet access or contracted on-line
     service is provided to that user in Iowa unless the user
     presents suitable evidence that the site or sites at which
     these services are furnished are located outside this state.

     On June 14, 2001, the department issued an assessment on AOL’s

Iowa sales of communication services during the period from July 1,

1995 to December 31, 2000.     In August, AOL filed a protest, but the

matter was held in abeyance pending the outcome of a similar dispute

involving AOL and Tennessee tax authorities. The Tennessee matter was

settled after the Tennessee Court of Appeals ruled in favor of another

company on similar issues.    See generally Prodigy Servs. Corp., Inc. v.

Johnson, 125 S.W.3d 413 (Tenn. Ct. App. 2003). The matter eventually

came to an evidentiary hearing before an administrative law judge (ALJ)

of the Iowa Department of Inspections and Appeals in late October 2005.

     The ALJ issued a proposed decision concluding that the services
provided by AOL were not subject to state sales tax. The ALJ analyzed

the statutory and administrative framework surrounding the issue and

concluded that under the department’s own rules, AOL services

amounted to an untaxable interstate service. The ALJ noted that while

an Iowa resident might use his Iowa-based computer to initiate service

and that the signal is transferred through the Iowa-based modem hotel

to AOL, one could not conclude that the communication originated and

terminated in Iowa. Simply put, the ALJ concluded that no service or

communication    was    provided   at   the   modem     hotel   in     Iowa.
                                      5

Communication occurred between the data center in Virginia and the

user in Iowa.

      The department appealed the ALJ’s decision to its director, who

reversed the ALJ’s proposed decision. The director largely adopted the

findings of fact made by the ALJ. The director concluded, however, that

AOL’s services were the result of a local call, regardless of the manner in

which AOL connected the local call to its network.            In addition, the

director noted that the legislature amended the governing statute to

exempt from sales tax “gross receipts from charges paid to a provider for

access to on-line computer services.”      The director reasoned that this

legislative change would be unnecessary if such services were not subject

to tax in prior years. Finally, the director concluded that AOL charged

an access fee, which was not dependent on the user actually utilizing the

service, making it subject to state sales tax.

      AOL filed a petition for judicial review.             The district court

overturned the agency’s decision, finding it an irrational, illogical, and

wholly unjustifiable application of law to fact.            The district court

concluded that only one point of communication occurred in Iowa, the

other occurred at the AOL data center in Virginia.               Because the

department’s    administrative    rule    required   that    both   points   of

communication occur within the state in order for sales tax to be

assessed, the district court concluded that AOL services were not subject

to the tax.

      The department appealed. We transferred the case to the court of

appeals. On appeal, the department argued that the definitions provided

in section 18.20(1) did not apply to section 18.20(5) which specifically

dealt with the taxation of internet services.         Thus, there was no

requirement that AOL services be provided “in this state” in order for it to
                                     6

be subject to state sales tax. In the alternative, the department asserted

that if the definitional section did apply, both points of communication

occurred within the state.    The court of appeals affirmed the district

court, concluding that both the origin and the termination of the

communication must occur within the state and that the communication

at issue here “terminates” out of state.    As such, AOL’s services were

interstate and not subject to state sales tax.    The department sought

further review.

      II. Standard of Review.

      Our review of the two issues presented in this appeal is governed

by the Iowa Administrative Procedure Act. The first inquiry involves the

proper interpretation of the department’s rule, specifically, what is meant

by communication service provided “in this state” in Iowa Administrative

Code rule 18.20 and whether this term, as properly interpreted, applies

to limit taxation of internet access services described under section

18.20(5).   The second inquiry is whether AOL, under the undisputed

facts, provided taxable communication services in this state within the

scope of the department’s administrative rules.

      An agency’s interpretation of law is given deference if authority to

interpret the law has “clearly been vested by a provision of law in the

discretion of the agency.” Iowa Code § 17A.19(10)(l) (Supp. 1999). If the

interpretation is so vested in the agency, then the court may reverse an

agency’s interpretation only if it is “irrational, illogical, or wholly

unjustifiable.” Id. If, however, the interpretation of a provision of law is

not vested in the discretion of the agency, our review is for correction of

errors at law and we are free to substitute our interpretation of the

statute de novo.   Id. § 17A.19(10)(c); Auen v. Alcoholic Beverages Div.,

679 N.W.2d 586, 589–90 (Iowa 2004).
                                       7

      The legislature has provided that the Director of the Iowa

Department of Revenue shall have the power to promulgate “rules not

inconsistent with the provisions of this chapter, necessary and advisable

for its detailed administration and to effectuate its purposes.” Iowa Code

§ 422.68(1) (1999). In light of this language, we have concluded that the

agency’s interpretation of the statute as reflected in its administrative

rules is a power that has “clearly been vested” in the agency. Ranniger v.

Iowa Dep’t of Revenue & Fin., 746 N.W.2d 267, 268 (Iowa 2008). As a

result, rules promulgated by the department will be found invalid only if

they are “irrational, illogical or wholly unjustifiable.” Id.

      AOL does not challenge the general proposition that the director

has broad authority to promulgate rules that the director finds

consistent with the governing statute. Indeed, AOL does not make any

claim that the applicable rules in this case are invalid.       Instead, AOL

argues that broad authority to promulgate rules consistent with the

statute is not the same as the issue presented in this case, namely,

whether the director is vested with authority to interpret the rules. As a

result, AOL argues that the director’s interpretation of the rules is not

entitled to deference under Iowa Code section 17A.19(10)(c) (Supp. 1999).

      In this case, it is not necessary to decide the question of whether

the director’s interpretation of the department’s rules is entitled to

deference.    As will be seen below, we conclude that the director’s

interpretation fails to meet even the most deferential standard of review.

      Once we have resolved proper interpretation of the applicable

administrative rules, we must next consider the application of law to the

established facts. Factual determinations of the agency must be affirmed

by a reviewing court if they are supported by substantial evidence. Iowa

Code § 17A.19(10)(f). The application of law to the established facts can
                                         8

be reversed only if the application is “irrational, illogical, or wholly

unjustifiable . . . .” Id. § 17A.19(10)(m).

      III. Discussion.1
      A.    Proper Interpretation of Administrative Regulations.               The

parties disagree as to whether the definition of a communications service

provided “in this state” in Iowa Administrative Code rule 18.20(1)(b)

applies to the taxation of internet services as described under rule

18.20(5).   The department argues that rule 18.20(5) is a stand-alone

provision and that the definitions do not apply to this subsection. Thus,

according to the department, the question of the taxation of AOL’s

services may be made without considering whether AOL provided a

“[c]ommunications service . . . ‘in this state’ ” as defined by rule

18.20(1)(b).     AOL urges us to apply the plain meaning of the

administrative rule without engaging in the legal jujitsu employed by the

department to escape it.

      We agree with AOL.        Definitions are a common part of the legal

landscape. Ranniger, 746 N.W.2d at 270 (noting that the legislature may

be its own lexicographer). The very purpose of putting the definitions at

the beginning of a statute, contract, or rule is to establish the framework

for the proper interpretation of subsequent provisions. When an agency

elects to be its own lexicographer, persons are entitled to rely upon the

established definitions.     An agency simply cannot assert a “King’s X”

defense when unambiguous definitions prove too tight or too loose. If the

department did not intend the definitions of rule 18.20(1)(b) to apply to a

subsequent subsection in the same rule regarding internet sales, the


      1On    appeal AOL raises a number of other arguments, including federal
preemption, in support of its claim to be immune from state sales tax. Due to our
disposition on the proper interpretation of the department’s rule, we do not address
these additional arguments.
                                        9

department should have either removed the internet access provision

from the rule to escape its definitional tentacles or expressly severed

them by stating that the generally applicable definitions did not apply to

internet services. The department did neither.

      We further note that the phrase “in this state” in rule 18.20(1)(b),

which the department now seeks to escape, is also found in the preface

to rule 18.20, which broadly states, “The gross receipts from the sale of

all communication services provided in this state are subject to tax.” The

use of the phrase “in this state” in the general introduction to rule 18.20

further   demonstrates    that   the    concept   has   general   applicability

throughout the subsequent provisions of the rule.

      The department suggests that the enactment of Iowa Code section

422.45(56) (2001) by the legislature, which specifically exempted internet

access charges from state sales tax, demonstrates that internet services

were previously subject to tax.        Under AOL’s interpretation, therefore,

this legislative action would be meaningless.

      We do not agree. The subsequent legislation exempted all receipts

from the sale of access to online services largely after the period relevant

to this dispute.   Thus, our holding in this case does not render the

legislative action redundant.     Further, to the extent the subsequent

legislation does have a bearing on the issues in this case, it does not offer

much support for the department’s position. It is not unusual for the

legislature to enact clarifying legislation in response to an ongoing

dispute with an agency.      1A Norman J. Singer, Statutes & Statutory

Construction § 22:31, at 379–80 (6th ed. 2002).

      In conclusion, we hold it is “illogical, irrational, and wholly

unjustifiable” for the department to determine that the definitions in rule

18.20(1)(b) do not apply to subrule (5). There is simply no “play in the
                                     10

joints” of the rule sufficient to allow the department to escape the rule’s

plain meaning and overall structure.      Cf. Marovec v. PMX Indus., 693

N.W.2d 779, 785 (Iowa 2005) (discussing a situation where agency rules

and statutory law granted the agency enforcement discretion). Thus, we

hold that the definition of “in this state” found in rule 18.20(1)(b) is fully

applicable in determining whether AOL services are subject to state sales

tax.

       B.   Application of Administrative Rules to AOL.          The parties

adopt fundamentally different approaches to the application of rule 18.20

to the facts of this case. The department stresses that access to AOL is

triggered by a local call to the switch or modem hotel also located within

Iowa. The department then reasons that gaining access to AOL through

its access fee is an intrastate transaction subject to sales tax.        AOL

counters that regardless of the point of access, no communication service

is provided as a result of the Iowa access. Without the Virginia computer

system, no communication service is provided at all.

       In order for AOL to prevail, it must show that the department’s

application of law to the facts of this case is “an irrational, illogical, or

wholly unjustifiable application of law to fact . . . .”          Iowa Code

§ 17A.19(10)(m) (Supp. 1999).      We conclude that AOL has met this

demanding burden.

       In this case, the access points located in Iowa do not amount to

the provision of an intrastate “communication service” subject to tax. A

“[c]ommunication service . . . ‘in this state,’ ” according to rule

18.20(1)(b), involves both the transmission and receipt of information.

The record in this case demonstrates that for AOL members, the

transmission and receipt of information does not occur wholly within

Iowa. No information is transmitted to Iowa until a member’s account
                                    11

has been authenticated in Virginia. It is undisputed that if the plug is

pulled on the Virginia computer, Iowa AOL customers access no

information of any kind.    Under these undisputed facts, it cannot be

maintained that AOL’s communication service is intrastate when,

without the Virginia connection, the user gets nothing. As a result, there

is no rational, logical or justifiable basis for imposing state sales tax on

AOL under the applicable rule.

        We note that our conclusion is consistent with the case law in

other jurisdictions. For example, in Qwest Corp. v. State ex rel. Wyoming

Department of Revenue, 130 P.3d 507, 515 (Wyo. 2006), the Wyoming

Supreme Court characterized the issue as whether the “complete end-to-

end” communication occurs within the taxing state, prior to finding the

disputed service an interstate communication service.        Although the

regulatory framework in Iowa is not identical to that in Wyoming, the

similarities are sufficient to provide support for our conclusion in this

case.

        IV. Conclusion.

        For the reasons expressed above, the decision of the court of

appeals is vacated and the district court judgment is affirmed.

        DECISION OF COURT OF APPEALS VACATED; DISTRICT

COURT JUDGMENT AFFIRMED.
