The nature of the services performed by a corporation, and how that corporation should source its receipts from those services for New York City general corporation tax purposes, are the subjects of an interesting recent decision of a New York City Administrative Law Judge. The ALJ held in favor of the taxpayer that it was engaged in the performance of consulting services, and could source receipts from those services based in part on the location of independent contractor consultants who performed the services. Matter of Gerson Lehrman Group, Inc., TAT(H) 08-79(GC), et al. (N.Y.C. Tax App. Trib., Admin. Law Judge Div., Oct. 4, 2016).
Services Provided by the Taxpayer. Gerson Lehrman Group, Inc. ("GLG"), headquartered in New York City and with offices throughout the world, provides consulting services to clients. It engages expert "consultants"-- typically, medical doctors, research scientists, engineers, and attorneys -- as independent contractors who provide the expertise sought by GLG's clients. Those clients worked with GLG's employee "research managers" to identify the appropriate consultants, focus on research questions, and obtain expert views. GLG's employee "consultant managers" recruited and managed the independent consultants, who were selected from GLG's computer database of as many as 283,000 potential experts.
GLG entered into subscription agreements with clients, generally for periods of up to one year. Clients made non-refundable lump sum payments to GLG in exchange for access to its industry knowledge and expertise. GLG paid the independent contractor consultants. GLG obtained clients through the efforts of its salaried salespeople, the vast majority of whom worked in New York City. The agreements stated that GLG "helps clients find, engage, and manage experts . . . through [its] network of industry [consultants]." The agreements also provided that GLG was "not responsible for the content of Projects or the quality of [consultant] services." GLG's clients obtained expert information either through telephone conference calls, written research reports or seminars and expert round tables. In most cases, conference calls were made and written reports were prepared at the consultants' homes or offices.
GCT Filings and Audit. The case spanned a sevenyear period during which GLG changed the manner in which it sourced its lump sum business receipts. In its originally filed general corporation tax ("GCT") returns for 2003 and 2004, GLG sourced those receipts in its receipts factor based on the office locations of its salespeople. This resulted in New York City receipts factors of 96% (in 2003) and 77% (in 2004). GLG later filed amended GCT returns using a different methodology, this time based on a blend of (i) the locations of its independent contractor consultants and (ii) the locations of its employee research and consultant managers, but not its salespeople. This reduced its reported receipts factor to approximately 40% in each year, resulting in refund claims.
For the years 2005 through 2010, GLG filed its GCT returns using the same receipts factor methodology as it did in its amended GCT returns for 2003 and 2004. Following an audit, the Department issued Notices of Determination asserting additional tax by applying GLG's original sourcing methodology, sourcing receipts based on the location of its salespeoples' offices, and not based on where the work was performed.
The Department maintained that under GCT Regulation 11-65(b)(1), the efforts of independent contractors may only be considered where they generate receipts for the taxpayer. According to the Department, GLG generated receipts not from the independent contractors, but rather from the efforts of its salaried salespeople who sold subscriptions to clients.
Under the GCT, receipts from the performance of services are generally sourced based on where the service is performed. Admin. Code 11-604(3)(a)(2). The parties disagreed about what service GLG was actually providing to its clients. GLG contended that it was providing a consulting service through its employee research managers and the independent expert consultants. The Department argued that GLG's service was simply to locate the appropriate expert, and that it was GLG's salespeople who were responsible for generating GLG's business receipts.
Refund Claims. GLG also raised alternative refund claims for the years 2005 through 2010, based on a receipts factor that considered either (i) the location of its employee research managers and independent consultants, or (ii) only its independent consultants. No formal refund claims were actually filed, only refund claim summary schedules.
Holding. The ALJ held that GLG was engaged in the service of providing "expert knowledge, analysis and views," which it rendered through independent consultants with the assistance of its employee research managers. Under GCT Regulation 11-65(b)(3)(i), lump sum payments for services are sourced based on "the relative values of, or amounts of time spent in the performance of, such services . . . ." Thus, it was appropriate to source the receipts in question based on the locations of both the independent consultants and the employee research managers, the individuals who performed the services.
The ALJ rejected the Department's reliance on several Article 9-A Advisory Opinions, finding that they were either irrelevant or were based on a "generation of income" analysis that the ALJ found unsupported by the statute or regulations. The ALJ also found unpersuasive the Department's claim that since GLG received a lump sum payment from clients at the outset of the subscription period, the receipts were generated without regard to the amount of expert services actually used. The ALJ reasoned that since the regulations provide that the location of payment of receipts is immaterial with regard to sourcing, the timing of the payment is also irrelevant. The ALJ also held that there was no authority to source receipts based on the location of GLG's salespeople, noting that under the GCT regulations only the activities of commissioned sales agents are relevant, and here GLG's salespeople were salaried employees. Thus, the ALJ held that the Notices of Determination should be cancelled.
However, the ALJ rejected the taxpayer's alternative refund claims. One such refund claim (totaling $2 million) was held to be incorrect since it only took into account the location of the independent consultants, without considering the location of the GLG's employee research managers who also provided the services. As for the alternative refund claims that were purportedly based on the location of both, the ALJ concluded that the taxpayer failed to substantiate the claims, despite being given the opportunity to do so after both the hearing and briefing were completed.
It is somewhat surprising that there is little New York City precedent on the sourcing of receipts from services that are performed in part by a taxpayer's independent contractors. The decision reaches a reasonable result since it was clear that GLG was performing services for its clients, in part by utilizing the services of its independent consultants, and was not merely acting as a "middleman" to procure expert consultants for clients as the Department had argued. Interestingly, the decision rejects the approach taken by the New York State Department of Taxation and Finance in certain Advisory Opinions (see, e.g., Petition of Alan Langer, TSB-A-92(9)C (N.Y.S. Dep't of Taxation & Fin., May 20, 1992), which in sourcing receipts considered only those activities by the taxpayer that actually "generated" the receipts in question. The decision does not discuss how GLG actually sourced the receipts in its Article 9-A returns in light of those Advisory Opinions, possibly because it was not in the evidentiary record. An exception has been filed with the New York City Tax Appeals Tribunal seeking review of the decision.
The sourcing issue in Matter of Gerson Lehrman is no longer a continuing issue for most corporations in New York City. For tax years beginning after 2014, under New York City corporate tax reform -- applicable except with respect to S corporations, which remain subject to the GCT-- receipts of the type in question are sourced based on customer location and not where the services are performed.