State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP New York ALJ Finds Receipts from Electronic Bill Payment and Presentment Transactions Constitute Service Receipts An administrative law judge (ALJ) in the New York State Division of Tax Appeals determined that a taxpayer s receipts from its electronic bill payment and presentment transactions constituted receipts derived from the performance of services, sourced to the location where the service was performed, in this case outside New York. 1 In reaching its determination, the ALJ rejected efforts by the Division of Taxation to classify the receipts as other business receipts sourced to New York where, according to the Division, the receipts were earned. Background The taxpayer, CheckFree Services Corporation, provided electronic bill payment and presentment (EBPP) services that allow consumers to pay bills through a variety of methods and to receive bills electronically. The taxpayer s direct EBPP customers included consumer service providers (CSPs), 2 direct billers, and health and fitness facilities. These customers, in turn, sold the services to end-user consumers. The taxpayer used a proprietary transaction processing technology platform to process online bill payment transactions. The taxpayer s EBPP business operated at facilities outside New York and, during the audit period at issue, employed between 3,050 and 4,300 full-time employees. Employees assigned to the EBPP business handled a variety of duties including managing merchant relationships, evaluating the level of credit risk associated with transactions, collecting defaulted payments from consumers and monitoring transactions for potential fraud. None of the employees, assets or offices generating the EBPP receipts in dispute were located in New York. On its New York State general business corporation franchise tax returns, in computing its business allocation percentage, the taxpayer treated its EBPP receipts as arising from services performed, all of which were performed outside New York. 3 The Division audited the taxpayer s tax returns and issued notices of deficiency for the tax years Release date February 9, 2017 States New York Issue/Topic Corporation Franchise Tax Contact details Matthew DiDonato New York - Manhattan T 212.542.9960 E matthew.didonato@us.gt.com Art Burkard New York - Manhattan T 212.542.9600 E art.burkard@us.gt.com Spiro Dorizas New York - Melville T 631.577.1844 E spiro.dorizas@us.gt.com Jamie C. Yesnowitz Washington, DC T 202.521.1504 E jamie.yesnowitz@us.gt.com Chuck Jones Chicago T 312.602.8517 E chuck.jones@us.gt.com Lori Stolly Cincinnati T 513.345.4540 E lori.stolly@us.gt.com Priya D. Nair Washington, DC T 202.521.1546 E priya.nair@us.gt.com www.grantthornton.com/salt 1 Matter of CheckFree Services Corp., New York Division of Tax Appeals, Administrative Law Judge Unit, DTA Nos. 825971, 825972, Jan. 5, 2017. 2 CSPs consist of large financial institutions, credit unions and community banks. 3 The taxpayer s reporting position for the EBPP receipts was based on studies performed by two independent accounting firms..
Grant Thornton LLP - 2 between July 1, 2004 and December 31, 2008 and January 1, 2009 through December 31, 2009. The Division argued at the ALJ hearing that the taxpayer s EBPP receipts did not constitute receipts derived from the performance of services because there was no human involvement in the transactions that generated the receipts. Therefore, the EBPP receipts must be classified as other business receipts sourced to the location where they are earned. As an alternative argument proposed following the ALJ hearing in a brief, the Division claimed that the taxpayer was not providing services but instead was licensing access to and use of its Web site and systems. Under this argument, EBPP receipts resulting from the granting of a license or contractual right constituted other business receipts. According to the Division, the other business receipts were earned at the locations of the taxpayer s end-user consumers computers where they gained access to the taxpayer s Web site and EBPP systems, a portion of which were located in New York. The Division indicated that, even if the receipts were classified as service receipts and as such, required to be sourced to the location where the services were performed, a portion of the taxpayer s receipts would be sourced to New York. The Division argued that the services were performed at the location of the consumers computers, requiring some level of sourcing to New York. The Division conceded that it was unable to obtain information on the location of the various individual consumers computers, and allocated the taxpayer s receipts to New York based on the New York addresses of the taxpayer s customers. The taxpayer argued that its EBPP receipts were properly classified as service receipts under former N.Y. Tax Law Sec. 210(3)(a)(2)(B), and the location where the services were performed was located entirely outside New York, as none of its employees worked in New York. The taxpayer also argued that even if the EBPP receipts were classified as other business receipts, they nevertheless should have been sourced outside New York because they were earned at out-of-state locations where the activities and work that generated the receipts were performed. Performance of Services The core controversy at hand centered on the calculation of the receipts factor for purposes of determining the taxpayer s business allocation percentage. For the tax years at issue, the receipts factor consisted of an in-state to everywhere ratio of: (i) sales of tangible personal property; (ii) services performed; (iii) rentals from properties and royalties from the use of patents or copyrights; and (iv) all other business receipts. 4 For purposes of the receipts factor, determining whether the taxpayer s EBPP receipts should be classified as receipts from services performed within the state required an examination of the word services. Noting that the term services was not defined in Article 9-A of the New York Tax Law during the tax years at issue, the ALJ employed a statutory interpretation analysis and explained that, in the absence of ambiguity in the statutory language, words of ordinary import are to be given their ordinary and usual 4 Former N.Y. TAX LAW 210(3)(a)(2)(A-D).
Grant Thornton LLP - 3 meaning. The ALJ explained that, based on the ordinary meaning of the word, 5 the taxpayer s EBPP receipts resulted from services performed by the taxpayer. A large portion of the taxpayer s EBPP customers consisted of CSPs, such as banks. Consumers expect EBPP services from their banking institutions, and, in turn, banks see tangible benefits, such as customer retention, from providing such services. However, providing EBPP capabilities comes at significant costs that are beyond the means of most banks. Thus, these banks outsource their EBPP functions to third parties, such as the taxpayer. As a result, the ALJ explained that, by providing these EBPP services, the taxpayer is performing a service to its customers, and to its customers customers (consumers), as contemplated by the use of that word. The Division relied primarily upon a regulation to support its position that the receipts did not arise from service transactions. The regulation in effect for the tax years at issue provided that [t]he receipts from services performed in New York State are allocable to New York State. All receipts from such services are allocated to New York State, whether the services were performed by employees, agents or subcontractors of the taxpayer, or by any other persons. 6 The Division argued the taxpayer s receipts could not qualify as receipts from services performed because no employees, agents, subcontractors or other persons on behalf of the taxpayer were involved in performing the transactions giving rise to the revenue. According to the Division, the regulation requires that there must be human involvement for the receipts to have resulted from services performed. The ALJ rejected the Division s interpretation of the regulation, finding that it was an impermissible expansion of the regulation. The ALJ explained that the language whether the services were performed by employees, agents or subcontractors of the taxpayer, or by any other persons was meant to ensure that allocation would not be avoided if the services were performed by an individual tangentially related to a corporate taxpayer, rather than the taxpayer itself. By reading the regulation to require human involvement, the Division would improperly restrict the meaning of the word services and ignore the technological advances that have expanded the means by which service activities can be provided. The ALJ explained that, even if the Division s reading of the regulation were correct, human involvement exists throughout the process of providing EBPP services, through the taxpayer s employee base tasked with obtaining agreements with customers, and creating and maintaining the Web site interfaces. The ALJ concluded that this human involvement met what would be required under the Division s proposed reading of the regulation for the activity to be considered a service. Licensing of Intangible Assets The Division also argued that, based on language contained in the EBPP contracts, the taxpayer merely licensed access to and use of its Web site and systems, and was not a 5 Service is defined as useful labor that does not produce a tangible commodity, Webster s Ninth New Collegiate Dictionary, 1076, or performance of labor for benefit of another, or at another s command, Black s Law Dictionary, 1227 (5th edition, 1979). 6 N.Y. COMP. CODES R. & REGS. tit. 20, 4-4.3(a).
Grant Thornton LLP - 4 service provider. Under this argument, the taxpayer s receipts would result from the licensing of intangible assets, and thus constitute other business receipts. The ALJ conceded that a portion of the contracts may have, taken in isolation, supported the Division s position. However, an examination of the contracts in their entirety did not support the Division s argument. Citing to prior rulings by the Tax Appeals Tribunal, the ALJ explained that the determination of whether the taxpayer s EBPP receipts arose from the licensing of intangible assets requires ascertaining the primary purpose and true nature of... [the taxpayer s] EBPP business as viewed in its entirety, so as to determine what is being purchased and paid for from the perspective of the purchasing customers. Applying this test, the primary purpose and true aim of the taxpayer s business was to provide an outsourced, turn-key electronic bill presentment (distribution) and payment service. The ALJ explained that the rights granted to access and use the systems are only a necessary incident or aspect of the means by which the taxpayer provided its services. Turning to the issue of the allocation of the EBPP receipts, the ALJ held that Siemens Corp. v. Tax Appeals Tribunal 7 requires a consideration of where the activities giving rise to the income were performed. Here, the services performed were more than a simple, instantaneous, fully automated transaction only taking place when a consumer clicked on his or her computer. Instead, the services encompassed all of the steps in the bill presentment and payment process, none of which occurred in New York. Furthermore, under the Siemens rationale, the result would be the same even if the receipts were classified as other business receipts. Commentary The decision is notable in highlighting the difficulties that arose under the former New York Tax Law when trying to determine whether sales should be classified as services or as other business receipts, and following that determination, trying to appropriately source such amounts in calculating the sales factor. In many cases, the location of a taxpayer s costs of performance, which is relevant for sales of services, is substantially different than the location of where other business receipts are earned. New York s adoption of market-based sourcing of service revenue, effective for tax years beginning on and after January 1, 2015, 8 changes the composition of the sales factor for many companies by providing a different set of classification and sourcing rules. However, in its decision, the ALJ pointed to this recent adoption of market-based sourcing of service revenue as support for its holding using the location of a taxpayer s costs rather than the location of its ultimate customer base. According to the ALJ, the new legislation would not have been necessary if the amendment did not effect some purpose and make some change in the existing law. The ALJ explained that the Division applied a 7 679 N.E.2d 1072 (N.Y. 1997). 8 Ch. 59 (A.B. 8559 / S.B. 6359), Laws 2014. For a discussion of this legislation, see GT SALT Alert: New York State Enacts FY 14-15 Budget Legislation Providing Extensive Tax Reform. The new legislation is effective for tax years beginning on and after January 1, 2015 and generally applies a market-based sourcing approach for sales of services as well as other business receipts.
Grant Thornton LLP - 5 customer-sourcing approach that was not effective until January 1, 2015 and ran against existing law during the periods at issue. By employing an interpretation of services that accounts for the new and emerging technology used in today s markets, the decision hews to the analysis contained in Matter of Expedia Inc. 9 In Expedia, a taxpayer s receipts for facilitation of online travel reservations were from the provision of a service, sourced to the location of the taxpayer s costs of performance. With this consideration in mind, taxpayers should carefully review their sourcing methodology on New York State corporation franchise tax (and potentially New York City general corporation tax) returns that are still open under the statute of limitations to determine whether the ALJ s guidance could result in potential tax exposure, or support refund opportunities based on different sales classification and sourcing positions. The information contained herein is general in nature and based on authorities that are subject to change. It is not intended and should not be construed as legal, accounting or tax advice or opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to or suitable for specific circumstances or needs and may require consideration of nontax and other tax factors. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Grant Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, re-keying or using any information storage and retrieval system without written permission from Grant Thornton LLP. This document supports the marketing of professional services by Grant Thornton LLP. It is not written tax advice directed at the particular facts and circumstances of any person. Persons interested in the subject of this document should contact Grant Thornton or their tax advisor to discuss the potential application of this subject matter to their particular facts and circumstances. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed. 9 New York Division of Tax Appeals, Administrative Law Judge Unit, DTA Nos. 825025, 825026, Feb. 5, 2015. For a discussion of this decision, see GT SALT Alert: New York ALJ Rejects Attempt to Apply Sourcing Rules for Other Business Receipts to Online Travel Reservation Services.