A second New York State Administrative Law Judge has rejected the attempt of the Department of Taxation & Finance to source the receipts of a business provided over the Internet to the location of customers, holding that receipts from the provision of electronic bill payment and presentation services should be sourced to where those services were provided, entirely outside New York. Matter of CheckFree Services Corporation, DTA Nos. 825971 & 825972 (N.Y.S. Div. of Tax App., Jan. 5, 2017).

Facts. CheckFree was based in Norcross, Georgia, and provided, in addition to other services not at issue, electronic bill payment and presentment ("EBPP") services that enabled end-user consumers to receive and pay bills electronically. CheckFree provided its services to, and was paid by, consumer service providers ("CSPs") such as large financial institutions, credit unions, and more than 15,000 community banks, as well as direct billers and health and fitness facilities (the "Service Customers"). CheckFree's services allow consumers the customers of the CSPs to log onto CheckFree's website and pay bills electronically to any merchant or vendor in the United States, with funds drawn from the consumers' accounts at the CSPs. For some of the larger merchants, consumers are also able to receive and view bills electronically. CheckFree's services allowed its Service Customers to outsource their bill payment and presentment functions, while preserving their own unique brands, since the websites are set up to look like they are the Service Customers' own websites. Service Customers are often unable or unwilling to provide these services themselves, but the services are valuable, since consumers demand the ability to pay bills electronically.

CheckFree provided these services using a proprietary transaction processing technology, and assured the transactions would comply with Federal Reserve Automated Clearing House standards for money movement. CheckFree operated primarily on a proprietary "Risk Processing" model, under which it assumed the risk for the consumers' payments once it sent the credit to the merchant, thereby providing a quicker turn-around time to consumers.

CheckFree operated primarily at facilities in Georgia, Ohio, Illinois, and Arizona, and had no employees, assets, or offices involved in generating the EBPP receipts in New York. It had between 3,050 and 4,300 employees during the years in issue, and approximately 70-80% of them performed functions connected with the EBPP business. CheckFree's implementation team manually updated consumer information, while other employees monitored payments that were not processing successfully, and its collections group worked to collect payment when debits were returned for insufficient funds. About 20% of the transactions ended up resulting in paper checks, and those checks were issued from CheckFree's facilities in Ohio and Arizona. CheckFree's activities also included monitoring transactions for potential fraud using a "Fraud Net" System, and it had over 1,000 employees in call centers in several states responding to consumers' calls in the name of the particular CSP and working directing with the consumers to solve problems.

The Issue: On its Article 9-A returns for the period July 1, 2004, through December 31, 2009 (the "years in issue"), CheckFree treated its EBPP receipts as arising from a service and, under New York's former apportionment rules, Tax Law former 210(3)(a)(2)(B), sourced the receipts to where the service was performed, entirely outside New York. On audit, the Department recharacterized the EBPP receipts as "other business receipts" under Tax Law former 210(3)(a)(2)(D), claiming that there was no "direct human involvement" in the performance of the services, and that the receipts should be sourced to the location of the consumers where, the Department contended, they were "earned." CheckFree objected to the recharacterization but argued that, even if the receipts were "other business receipts," they were earned at the locations where the activities and work were performed. The Department also raised, in its post-hearing brief, an argument that the EBPP receipts were generated by CheckFree allowing access to and use of intangible assets its website and the EBPP system.

ALJ Decision. The ALJ agreed with CheckFree that it was providing services. He found that CheckFree's Service Customers outsourced their EBPP function to third parties such as CheckFree to avoid having to incur the costs for personnel, technological resources, and expertise necessary to create and maintain their own bill-paying websites, and that the Service Customers paid CheckFree for providing this service to their own customers, the consumers. The ALJ determined that it was "of no moment that the ultimate fulfillment of the desired service is . . . accomplished electronically," and that the computers, servers, and other equipment were "simply the tools" used to perform and provide the service.

The Department argued that its regulation, 20 NYCRR 4-4.3(a), which provided that receipts from services are allocated to New York "whether . . . performed by employees, agents, or subcontractors" required that there had to be "human involvement" at the time the consumers used the website for the receipts to qualify as resulting from services. The ALJ rejected this position as an "impermissible expansion" of Tax Law former 210(3)(a)(2)(B) and found that the statute by its plain meaning did not require human interaction at the moment of sale. The ALJ also found that the regulation was aimed at the allocation of receipts and not the classification of receipts, and that the regulation presupposes that the receipts to which it pertains are service receipts. He further found that the "evident aim" of the regulation was to prevent a taxpayer from excluding receipts from being allocated to New York by using agents or subcontractors, and the fact that a corporation may employ technology in performing its services does not by itself remove the receipts from being classified as service receipts. In any case, the ALJ agreed with CheckFree that, even if human involvement were required, there was ample evidence of human involvement throughout the process of providing EBPP services, and that the services performed consisted of "much more than a simple, instantaneous, fully automated transaction" occurring solely when customers used their computers, but rather were the provision of efforts that were "highly labor-intensive . . . expensive (requiring a large platform and technology infrastructure), complicated[,] . . . risky . . . and . . . evolving."

Finally, the ALJ also rejected the Department's argument that the EBPP receipts were derived from granting licenses allowing access to and use of intangible assets, finding that, when properly viewed in its entirety, CheckFree's business was providing and performing an EBPP service, and any rights granted to access its systems were "only a necessary incident" of providing such service.

After concluding that the receipts arose from the performance of services, the ALJ found that those services all occurred outside New York, citing Siemens Corp. v. Tax Appeals Tribunal, 89 N.Y.2d 1020 (1997), in which the Court of Appeals held that, to the extent interest income from loans arose from work performed in New York, such receipts were sourced to New York. Noting that the court in Siemens decided that the interest income was other business receipts under Tax Law former 210(3)(a)(2)(D) rather than receipts from services, the ALJ found that, under either classification, the receipts were properly allocated outside New York. The ALJ also noted that the New York Legislature amended the Tax Law effective January 1, 2015, to change the sourcing of service receipts from place of performance to the location of customers, which would have been unnecessary if the Department's interpretation of the former statute were correct.

Additional Insights

The decision in this case is very similar to the one reached in Matters of Expedia, Inc. and Expedia, Inc. (Delaware Company), DTA Nos. 825025 & 825026 (N.Y.S. Div. of Tax App., Feb. 5, 2015). In both cases, the Department was arguing that there was no "human" involvement at the final moment of the provision of services and that such involvement was required under the Department's regulation an argument now rejected by two different ALJs.

The Department did not file an exception to the Expedia ALJ decision, and it is not known yet whether the Department will seek to appeal CheckFree. In light of the fact that two ALJs have definitively held that receipts from services, even if ultimately provided electronically, were sourced to where they were performed under the former New York apportionment rules, and in light of the sweeping change in New York law adopting market sourcing after 2015, perhaps the Department will reconsider its "human involvement" approach for the pre-2015 years. If not, and if an appeal is filed in CheckFree, there may yet be a precedential decision on this issue from the Tax Appeals Tribunal.