Reflecting the increased tendency of the Department of Taxation and Finance toward market-based sourcing of business receipts under Article 9-A, the Department has issued an Advisory Opinion regarding the sourcing of receipts generated by a group of affiliated entities that operate an internet-based exchange platform for global futures and over-the-counter markets. Alvarez & Marsal (Advisory Opinion), TSB-A-11(8)C (N.Y.S. Dep’t of Taxation & Fin., July 12, 2011). In that Advisory Opinion, the Department analyzed the receipts generated by a variety of business activities, finding that some were receipts from services properly sourced to where the services were performed, and others were “other business receipts” properly sourced to where the receipts were “earned.”
Parent, a corporation headquartered outside New York State, owned and operated an internet-based exchange platform (“Exchange”), which functioned as a marketplace where member buyers and sellers of contracts involving commodities, futures, and other derivatives could execute transactions via the Internet. Parent owned, directly or indirectly, several subsidiaries, all of which were involved in some aspect of the global futures or over-the-counter markets, but only one of which was a registered securities broker-dealer. At issue in the Advisory Opinion was the proper sourcing of commissions and other fees charged by members of the affiliated group.
Since 2007, the receipts factor alone has been used to determine what portion of a taxpayer’s business income is allocated to New York State under Article 9-A. New York law provides several different sourcing rules for determining which receipts are sourced to New York State and which are sourced outside of the State, depending upon the category of the receipts. For instance, receipts from the furnishing of a service are sourced to where the service is performed. Receipts that do not fall into an enumerated category are classified as “other business receipts,” and are sourced to where they are “earned.” A separate set of receipts factor sourcing rules, based on customer location, apply to the various types of receipts generated by a registered securities or commodities broker-dealer.
The Advisory Opinion dealt with how the various types of receipts earned by the Exchange platform provider and its affiliates should be sourced. While an analysis of the many fees discussed in the 13-page opinion is beyond the scope of this article, the Department’s analysis of several categories of receipts is instructive.
Parent, which was not a registered broker-dealer, charged a minimum fee to each member of the Exchange to access the data on the Exchange, and charged commission, transaction, and confirmation fees for each successful execution of a trade. Citing several earlier Advisory Opinions, the Department found that all of these receipts were essentially derived from the activity of a customer who accessed the Internet to obtain information from Parent, confirm a transaction, or complete a transaction, and as such, constituted “other business receipts.” The Department found that under these circumstances “other business receipts” were properly sourced to the location of the customer who accesses or conducts a trade through the Exchange. Receipts earned by an affiliate that was also not a registered broker-dealer, and that operated a global futures exchange similar to Parent’s, were treated by the Department in the same manner. The only difference in the treatment of the affiliate and Parent was that the Department treated commissions earned by the affiliate from “open outcry” trading on the affiliate’s trading floor as fees for services, and sourced the fees to where the service was performed, in this case the location of the physical trading floor.
Another affiliate, also not a registered broker-dealer, operated an automated digital auction business for the global OTC financial markets. It earned commissions from each counterparty to an executed trade. The Department ruled that fees generated through interdealer broker-assisted trades were receipts from services, and were sourced to the location of the interdealer broker involved in the transaction. However, commissions earned by the affiliate from electronic trading were found to constitute “other business receipts,” and sourced based on customer location. The Department differentiated between purely electronic trades and trades facilitated by interdealer brokers, noting that the interdealer brokers provided the services of expertise and advice to the customers.
The one affiliate that was a registered broker-dealer earned revenue through trade commissions, as well as from its digital auction business in which customers paid fees to execute purchase and sale orders digitally. Applying the sourcing rules applicable to registered securities broker-dealers, the Department found that the trade commissions and digital auction fees were brokerage commissions and should be sourced to the mailing address of the customer based on the broker-dealer’s records.
Additional Insights. This Advisory Opinion offers important insight into how the Department is inclined to characterize and source various types of receipts earned in the financial services industry, but that are not earned by a registered securities broker-dealer. Based on the Advisory Opinion, receipts from wholly electronic trading activities and transactions will be viewed by the Department as “other business receipts,” rather than as service fees, and sourced to the location of the customer. However, where the charges are made for the involvement of interdealer broker or other real persons in facilitating the transaction, or for transactions taking place on an actual physical trading floor, the transaction is more likely to be viewed as a service and sourced to where the service is being provided. The Advisory Opinion goes further than the earlier opinions, cited as being “substantially similar,” which involved the provision of access to databases and sales of gift certificates.
The receipts generated from electronic trades and related transactions technically are sourced under different rules for registered broker-dealers (considered for services and sourced based on customer mailing address) and for others (considered “other business receipts” sourced where earned). Ultimately, under the Advisory Opinion the receipts are both sourced to the same place, the location of the customer. The Advisory Opinion reflects the Department’s increased tendency to classify receipts from financial services as “other business receipts,” rather than as service income, and therefore as earned where the payor customer is located. This tendency is likely to continue now that Article 9-A utilizes single-factor apportionment for business income, possibly since customer-based sourcing provides the State of New York with a more predictable taxable income base.