The New York State Division of Taxation (“Division”) has taken inconsistent positions on when a business activity constitutes “entertainment” for corporation franchise tax (“CFT”) purposes. In Matter of Celebrity Cruises, Inc. and NewChannels Corp. v. Tax Appeals Tribunal, the Division attempted to tax cruise line operators and a cable operator as entertainment businesses.1 By contrast, in Matter of Capitol Cablevision Systems, Inc., the Division argued that a provider of cable television programming was a transmission business instead of an entertainment business.2 The taxpayers prevailed in all three cases. In the following sections we analyze when a business activity constitutes entertainment for CFT purposes as illustrated by Celebrity Cruises, NewChannels and Capitol Cablevision and conclude that the proper classification of a business for CFT purposes requires examining the business as a whole and not just one aspect of the business.
Applicable Case Law
In Celebrity Cruises, the Administrative Law Judge (“ALJ”) overruled a deficiency determination by the Division asserting tax against two cruise line operators, Celebrity Cruises, Inc. and Royal Caribbean Cruises, Ltd.3 The issue was whether the companies were principally engaged in the conduct of a transportation business within the meaning of New York Tax Law Sections 183 and 184, which impose tax on transportation and transmission corporations. The Division argued that the companies should file returns under Article 9-A rather than Article 9 because the companies’ transportation of passengers was purportedly ancillary to the primary function of delivering entertainment. 4 Article 9-A imposes tax on general business corporations while Article 9 imposes tax on certain specialized businesses, including transportation and transmission companies.
The ALJ rejected the Division’s assertions and concluded that, under the plain meaning of the statute, the companies were “without question” principally engaged in transportation and not entertainment.5 The companies’ ships transported passengers to various ports on the itinerary. Their largest capital investments were the vessels and other equipment necessary for the operation of the vessels. Most of the companies’ incomes were derived from passenger ticket revenue. The companies incurred the majority of their expenses from operating and maintaining the vessels. While entertainment, accommodation, dining, and shopping were arguably integral to the companies’ cruises, they were merely incidental to the main purpose of transporting passengers.
Similarly, in NewChannels the issue was whether two providers of cable television access were principally engaged in the conduct of a transmission business within the meaning of New York Tax Law Sections 183 and 184.6 The companies were cable operators that obtained television signals from cable programmers such as HBO and the Disney Channel and transmitted the signals to customers. The Division argued that the companies were taxable as general corporations under Article 9-A instead of transmission companies under Article 9 because the focus of the companies’ business was allegedly to provide entertainment.7
The court stated that the Division’s assertions were “entirely irrational” and “completely unsupported by the record.”8 Under the plain meaning of the statute, the court found that providing entertainment was merely incidental to the companies’ function of transmitting signals. 9 The companies were extremely limited in their capacity to manipulate the signals they obtained from cable programmers and the companies offered limited original programming. The companies’ largest capital investments were in their cable plants and transmission equipment. Most of the companies’ incomes were derived from subscriber fees and most of the companies’ expenses came from maintenance costs.
By contrast, the Division in Capitol Cablevision argued that a company that provided cable television programming should be subject to tax under Article 9 as a transmission business instead of under Article 9-A as a general business selling entertainment.10 Like the cable operators in NewChannels, the company in Capitol Cablevision transmitted television signals by cable and initiated programming at its offices. However, unlike in NewChannels, the Division asserted that the company was subject to tax under Article 9 as a transmission business.11 The Tax Appeals Tribunal rejected the Division’s argument and held that the company was principally engaged in providing entertainment.12 The company sold a monthly program package of television signals to its subscribers that, in the company’s judgment, represented “the best blend of channels and subject matter to achieve its goal of attracting and keeping subscribers.”13 Furthermore, the company originated programming towards the same goal. The Tax Appeals Tribunal concluded that the transmission of television signals was merely the means by which the company conveyed its product to its customers and not its business.14
Determining Primary Purpose Requires Examining the Business As a Whole
The Division erred in Celebrity Cruises, NewChannels and Capitol Cablevision by asserting that a component of the companies’ businesses constituted the primary purposes of those businesses. When determining how to classify a business for tax purposes, the nature of a taxpayer’s business controls and not simply one aspect of the business’ operations. Just because a business has an entertainment component does not mean that entertainment is the primary purpose of that business. The business must be viewed in its entirety considering all of the facts. Whether a business is primarily engaged in entertainment or something other than entertainment depends upon what the business is doing as a whole.
Moreover, the business must be viewed from the perspective of its customers on what they buy and pay for, in addition to the perspective of the sellers. As an example, most people would not view a long-distance flight on a plane as entertainment no matter how many in-flight movies, cocktails, meals and other entertainment services were offered. Under the Division’s approach, taking a flight across the country in the middle seat in the back of the plane near the restroom would constitute entertainment and not transportation merely because the passenger receives a bag of peanuts while watching a movie. Entertainment is certainly an aspect of the experience of taking a flight (and a larger or smaller aspect, depending on the flight). However, the primary purpose for taking a flight for most passengers is to get from one place to another.
When determining how to classify a business for tax purposes, the nature of a taxpayer’s business controls and not simply one aspect of the business’ operations. This requires examining the actual business under the facts as well as how the customers and sellers perceive the business. States should not assume that an aspect of a business constitutes the entire business just because the applicable statute did not expressly enumerate that particular business. Even though the statute may not address a particular set of facts, the statute must be strictly construed. 15 Moreover, any ambiguities must be resolved in favor of the taxpayer.16
Whether a business activity is entertainment or something else depends on the nature of the business as a whole and not simply one aspect of the business’ operations, and the classification should not be based merely on how the state wants to tax that particular business.