The New York City Tax Appeals Tribunal, reversing an Administrative Law Judge decision, has held that McGraw-Hill does not have a First Amendment right to source its credit ratings receipts for New York City general corporation tax purposes using an “audience-based” methodology similar to that available to publishers and broadcasters. The City Tribunal also rejected McGraw-Hill’s claim that the receipts in question were “other business receipts,” sourced to where the receipts are “earned,” rather than arising from the performance of services and sourced to where the services were performed. Matter of The McGraw-Hill Companies, Inc., TAT(E) 10-19 (GC) et al., (N.Y.C. Tax App. Trib., Oct. 28, 2015).

Facts. McGraw-Hill, through its Standard & Poor’s (“S&P”) division, operates a credit rating agency to provide ratings, risk evaluations, and investment research. Debt issuers hire S&P to prepare credit ratings for use by investors, intermediaries, and the issuers themselves. S&P employs approximately 1,200 analysts who prepare the ratings. Upon approval by an S&P ratings committee, the ratings are communicated to the issuer, and then usually made public on the S&P website to registered users free of charge. The issuers, rather than the website users or investors, pay S&P for providing the credit ratings, usually based on a percentage of the offering amount, and also pay for follow- up monitoring.

For the tax years 2003 through 2007, McGraw-Hill filed general corporation tax (“GCT”) returns, and in its receipts factor treated the credit rating fees of its S&P division as from the performance of services, sourced based on a place-of-performance method. In 2009, McGraw-Hill filed amended GCT returns, requesting refunds for those years totaling approximately $35 million. The refund claims were based on sourcing the credit rating receipts, which McGraw-Hill now reported as “other business receipts,” to “customer” locations. The Department of Finance (“Department”) disallowed the refund claims on the grounds that the credit rating fees were from the performance of services, sourced based on where the services were performed. McGraw-Hill filed its 2008 GCT return consistent with the receipts factor reported in its amended returns and, following an audit, the Department issued a Notice of Determination for $3.2 million, also sourcing the credit rating fees based on place of performance.

ALJ decision. After an administrative hearing, in February 2014 the Chief ALJ held that, on First Amendment grounds (pertaining to freedom of the press), McGraw-Hill was entitled to a discretionary adjustment to source its credit rating receipts using an audience-based allocation methodology. The Chief ALJ held that as a financial information publisher, McGraw-Hill’s S&P division “was entitled to the same [First Amendment] protections afforded other members of the press.” She cited McGraw-Hill, Inc. v. State Tax Commission, 75 N.Y.2d 852 (1990), where the Court of Appeals affirmed a decision of the Third Department, holding that the State of New York could not for Article 9-A purposes source McGraw-Hill’s revenues from advertisements in its magazines based on place of performance because this represented differential treatment between the print media and the broadcast media, in violation of the First Amendment. She also concluded that S&P’s credit rating fees constituted “other business receipts” under Admin. Code §11-604(3)(a)(2).

Tribunal decision. The City Tribunal reversed the Chief ALJ’s decision, and in doing so rejected each of McGraw- Hill’s three principal arguments. First, the Tribunal held that the denial of use of an audience method did not violate McGraw-Hill’s First Amendment rights. It addressed the First Amendment implications of the U.S. Supreme Court decision in Leathers v. Medlock, 499 US 439 (1991), which rejected a First Amendment challenge to application of an Arkansas gross receipts tax on a cable television provider’s sales and services, even though receipts from subscriptions and over-the-counter sales of newspapers and magazines were exempt. The Tribunal concluded that, under Leathers v. Medlock, the First Amendment only bars disparate taxation based on the content of a taxpayer’s speech. According to the Tribunal, McGraw-Hill did not show that it was similarly situated to broadcasters and publishers such that the denial of use of the audience method resulted in unconstitutional discrimination based on content. The Tribunal also distinguished the 1990 Article 9-A McGraw-Hill decision, decided on First Amendment grounds, finding that it was limited to advertising receipts and has no application to the sourcing of credit rating receipts.

McGraw-Hill also argued that S&P’s credit rating receipts constituted “other business receipts,” and not receipts from the performance of services, contending that they were “generated through the creation and communication of financial commentary to an audience.” The City Tribunal disagreed, concluding that McGraw-Hill was compensated for its work in generating the ratings— which involved substantial investigation and analysis —and made its credit ratings available to users free of charge. Thus, the receipts in question were found to be from the performance of services.

Finally, McGraw-Hill asserted that sourcing based on a place of performance method resulted in an improper reflection of McGraw-Hill’s activities in New York City, and claimed that the City Tribunal should exercise discretionary authority and apply an audience- based method to more fairly allocate the credit rating fees. According to the Tribunal, McGraw-Hill did not establish that the sourcing of credit rating receipts based on the location of the S&P analysts who worked on the ratings did not properly reflect McGraw-Hill’s activities in the City. Moreover, the Tribunal concluded that there was insufficient evidence to support a conclusion that the location of visitors to the S&P free website—the “customers” that McGraw-Hill used for its audience-based methodology—was a more reasonable means of sourcing those receipts.

Additional Insights

To a large extent, the City Tribunal’s reversal is predicated on its conclusion that McGraw-Hill is not similarly situated to broadcasters and publishers with respect to its S&P credit rating services, and therefore the First Amendment was not implicated in this case. The Tribunal’s decision may be appealed to the New York courts, as McGraw-Hill successfully did previously in pursuing its First Amendment constitutional challenge under Article 9-A with respect to its advertising receipts. If the decision stands, its impact under the new Article 3-A tax—which generally provides for the sourcing of receipts based on where the customer “derives the benefit”—is not entirely clear since S&P’s paying “customer” is the issuer or intermediary, not the party viewing the ratings on the S&P web site.

One interesting question presented is whether the City Tribunal has the authority to exercise the discretionary authority to adjust the receipts factor. Because it did not agree with the substance of McGraw-Hill’s position urging the exercise of the Department’s discretionary authority to apply the audience-based method, the Tribunal declined to address the claim that McGraw- Hill could not request such an exercise for the first time “on exception.” While it is subject to dispute whether McGraw-Hill first sought such relief “on exception” —McGraw-Hill appears to have made such a request through an earlier aborted letter ruling request—the decision is a reminder that taxpayers should claim discretionary relief either during the audit process or at conciliation to avoid such a potential impediment.