The New York State Tax Appeals Tribunal held that a taxpayer was required, for years before 2015, to apportion its receipts based on the location of the work that generated its receipts, and not based on the location of its customers.1
Catalyst Repository Systems, Inc. is a Colorado-based electronic data and document-repository corporation that provides litigation support to its clients. Through access to its proprietary software, Catalyst allows its customers to store, filter, organize, find, and retrieve documents, typically in response to discovery requests. The receipts at issue were from two of Catalyst’s monthly charges—one based on the number of users accessing the software, and the other based on the volume of documents uploaded.
On its New York franchise tax returns for 2008 through 2010, Catalyst characterized its sales factor receipts as arising from the performance of services, and determined that it performed the services entirely in Colorado, where all of its servers and nearly all of its employees were located. Catalyst did not assign any of its receipts to its New York sales factor numerator. The New York State Department of Taxation and Finance audited Catalyst and determined that it should have instead characterized its receipts as “other business receipts” and apportioned them based on the location of its customers.
The Division of Tax Appeals “Trifecta”
At the Division of Tax Appeals below, the administrative law judge determined that Catalyst properly characterized its receipts as service receipts, and properly apportioned the receipts based on the location of its own activities rather than on customer location.2 The administrative law judge’s decision was the third in a series of decisions reaching the same result, following In re CheckFree Services Corp.3 and In re Expedia, Inc.4
The Tribunal’s Decision
On appeal, the Tax Appeals Tribunal disagreed with the administrative law judge’s—and Catalyst’s—classification of the receipts as service receipts. The Tribunal looked to Catalyst’s customer agreement, noting that the fees at issue were paid in exchange for a “non-exclusive, non-transferable limited right and license” to access Catalyst’s proprietary software.5 The Tribunal characterized this arrangement as a fee for an intangible, falling outside the ordinary meaning of the term “service.” Because the fees were not for services, the Tribunal agreed with the Department that the receipts should be reclassified as other business receipts.
The Tribunal’s agreement with the Department ended there. It determined that other business receipts are not apportioned based on customer location, but based on where they are “earned”—i.e., where the taxpayer performs the work that derives the receipts. Because Catalyst performed its activities almost entirely in Colorado, the Tribunal concluded that the receipts at issue were not earned in New York. Thus, even though the Tribunal disagreed with Catalyst’s characterization of its receipts, it upheld Catalyst’s position that none of its receipts should be apportioned to New York.
Advisory Opinions Rejected
In reaching that decision, the Tribunal relied on a 1997 case, In re Siemens Corp. v. Tax Appeals Tribunal, in which New York’s highest court held that interest income was earned in New York to the extent that the income “result[ed] from work performed in New York.”6 The Department issued several advisory opinions in later years, in direct conflict with Siemens, advising taxpayers that their other business receipts must be apportioned based on customer location. The Department relied on those non-precedential opinions again here, but the Tribunal rejected them outright:
We find, however, that the cited advisory opinions are not persuasive because they offer no statutory or regulatory justification for the conclusion that receipts for digital transactions as described in the opinions are properly sourced to the customer’s location; they simply assert it.7
Market-Based Sourcing—Not Until 2015
The Tribunal also pointed to the legislative amendment to market- or customer-based sourcing as part of New York’s 2015 tax reform as support for its conclusion that other business receipts were not apportioned to customer location. In doing so, the Tribunal rejected the Department’s argument that customer-based sourcing fulfilled “the long-standing purpose of the receipts factor.”8 To the contrary, the Tribunal noted, the memorandum in support of New York’s corporate tax reform legislation stated, “This reform proposal would source a business’s receipts based on the location of its customers,” indicating that a customer-based method was not required before the legislation’s enactment.9
A Distinction Without a Difference
Although the Tribunal reclassified the taxpayer’s receipts as other business receipts, the decision puts to rest the importance of the Department’s asserted distinction between services and other business receipts. Contrary to the Department’s claims over the last several years, the decision makes clear that both service receipts and other business receipts were properly apportioned based on the taxpayer’s activities, and not on customer location, for tax years before 2015. The decision harmonizes the treatment of services and other business receipts, ensuring that both are apportioned using the same methodology.
The Department has no right to further appeal the Tribunal’s decision.