In June 2012 a New York State Division of Tax Appeals administrative law judge (ALJ) ruled in favor of a movie theatre operator represented by McDermott Will & Emery on the question of whether non-taxable licenses to exhibit digital movies become taxable if the movies are delivered to the theatre on hard drives, which are physical media.  In Matter of American Multi-Cinema, Inc., DTA Nos. 823589, 823590, 823646 (N.Y. Div. Tax App. June 21, 2012), the ALJ determined that the delivery of digital movies on hard drives would not cause the transaction to be taxable under the New York sales tax law primarily because the use of the hard drives was not necessary for the display of the movies.  (View Digital Movies Delivered by Physical Media Deemed Not Taxable in New York to learn more.)

The New York State Department of Taxation and Finance did not take exception (i.e., appeal), therefore the ALJ’s determination is final and binding.  While ALJ determinations are only binding on the particular refund claim or assessment at issue, the determination provides guidance for similar refund claims, should other theatre operators file them for prior periods.  It is not known whether the Department of Taxation and Finance will apply the determination to all theatre operators prospectively or whether other operators will have to seek redress through refund claims and litigation of denial of those claims.

In addition, the determination reiterates the vitality of the “primary purpose” or “true object” test, which has long been applied by the Tax Appeals Tribunal, but is often disregarded by the Department of Taxation and Finance in its audit positions and advisory opinions.  Here, the parties’ primary purpose was demonstrated through contract language, testimony and the mechanics of how payments were computed. 

Moreover, because digital motion pictures are not “software,” the determination did not apply to software delivered or accessed via tangible media, such as in a “load and leave” transaction or software accessed remotely.  Still, the determination provides additional ammunition for taxpayers challenging an assertion of sales tax in the ever-evolving digital world.  For a complete framework for challenging a Department of Taxation and Finance assertion of sales tax in an application service provider or cloud computing context, see States’ Extra-Statutory Attempts to Impose Sales Tax on Online Services Raise Questions of Fairness, Flouting of Legal Authority , published in Tax Management Multistate Tax Report