The New York State Department of Taxation and Finance has issued an Advisory Opinion addressing how receipts from the sale and processing of prepaid debit cards should be sourced under Article 9-A. Advisory Opinion, TSB-A-11(1) C (N.Y.S. Dept. of Taxation & Fin., Dec. 28, 2010). The Advisory Opinion signals the Department’s increased propensity to apply customer-based sourcing of receipts under Article 9-A, and its willingness to look to Article 32 (the bank tax) for guidance in sourcing certain types of income in the absence of direct authority under Article 9-A.

Prepaid Credit Card Program. The petitioner markets and processes prepaid debit cards throughout the U.S. It contracts with issuing banks to manage the prepaid debit cards connected with the banks’ customer accounts, using its own proprietary software and account and customer service representatives. It facilitates the sale, activation, loading and re-loading of the cards. The petitioner distributes the cards through third-party “distributors,” typically retail stores, and provides the stores with the card inventory, marketing materials and IT functionality at the point of sale. It also manages the entire prepaid debit card program. The prepaid debit cards (including gift cards) can be purchased by customers from retailers that accept payments through credits cards such as MasterCard, VISA and Discover, or can be purchased online through the petitioner’s website.

The petitioner derives several types of revenues from these activities. First, it charges a flat fulfillment fee upon the issuance and subsequent use of the cards, which is paid by the cardholder and split between the petitioner and the retailer. Once the money is loaded onto a card, the petitioner charges various transactional fees, which include “interchange fees” (fees usually charged by a card-issuing bank to the merchant bank for processing the cardholder’s purchases, but charged by petitioner because it handles the processing), and various service fees (such as fees charged each time the card is used by the customer). The petitioner’s account managers are located in various states, and solicit business and maintain relationships with existing retailers, including assisting in marketing the cards.

The petitioner, from its out-of-state offices, processes the transactions and manages the cardholder’s account data, including activating the card, processing, clearing and settlement and a host of other services. For example, the petitioner receives electronic notification from the retailer when the cardholder makes a purchase over a designated amount. It then verifies that the cardholder has sufficient funds on account with the issuing bank, and notifies the cardholder’s bank to release the funds to the merchant.

Advisory Opinion. At issue was how the petitioner should source the various types of fees it receives for purposes of the receipts factor under Article 9-A. The petitioner is able to track its fulfillment fees on a state-by-state basis based on where the underlying card sale takes place, but cannot track the location of transactional fees.

The Department first ruled that fulfillment fees generated from the sale of prepaid debit cards to customers should be treated as “other business receipts” under Tax Law section 210.3(a)(2)(D), and sourced based on where they are “earned.” For cards sold at a retailer’s establishment, the fee is considered “earned” based on where the card is purchased—i.e., at the retail store. Where the customer purchases the card through the petitioner’s website, the fees should be allocated to New York if the location where the customer accesses the website is in New York. If that information is unavailable, then the Department will allow it to be sourced based on the customer’s billing address. The Department noted that this was consistent with an earlier Advisory Opinion (Deloitte & Touche, TSB-A-02(3)C (N.Y.S. Dept. of Taxation & Fin., Apr. 18, 2002)), which concluded that merchant certificates and gift checks sold to customers over a website should be sourced based on where the customer accessed the website and, if that wasn’t known, it was presumed that access was from the customer’s mailing address.

The Department then addressed the sourcing of the interchange fees charged for petitioner’s various processing activities, such as card activation and maintenance, transaction authorization, processing and clearing. The Department first concluded that the interchange fees should also be classified as “other business receipts.” It acknowledged that neither the tax law nor the Article 9-A regulations provided specific guidance for where those fees were “earned.” In the absence of guidance under Article 9-A, however, the Department looked to how income from bank and credit card receivables are sourced under Article 32. There, interest and similar fees on credit cards are sourced in the receipts factor based on the cardholder’s mailing address. Also, merchant discounts by the issuing bank for processing the credit card sales are sourced under Article 32 based on the location of the merchant. Here, analogizing to merchant discounts, the Department ruled that it was appropriate for the petitioner to source its interchange fees for processing transactions using a method similar to the sourcing method used under Article 32—based on the location of the retailer or, if that location cannot be determined, based on the cardholder’s mailing address.

In reaching this conclusion for sourcing interchange fees, the Department stated that an earlier Advisory Opinion (Peach Tree Bancard Corp. (Advisory Opinion), TSB‑A‑95(13)C (N.Y.S. Dept. of Taxation & Fin., Aug. 4, 1995)), which held that credit card processing fees should be sourced based on where the processing services are performed, was no longer valid. (“Neither the conclusion in Peach Tree nor the rationale remains valid.”)

The Department went on to rule that the petitioner’s maintenance and use fees charged when a customer initiated a transaction, like the interchange processing fees, should be sourced either where the cardholder initiated the transaction (e.g., where the customer re-loads the prepaid credit card) or, if the location cannot be determined, then based on the cardholder’s mailing address.

Additional Insights

While Article 9-A does contain special customer-based sourcing rules for certain industries and types of income, questions regarding sourcing continue to persist. The Advisory Opinion appears to reflect recognition by the Department that various types of income should properly be treated as “other business receipts,” and thus sourced based on where they are “earned,” and that certain types of income are “earned” based on where the underlying customer transaction which generated the income took place. It is noteworthy that the Department expressly overruled an earlier Advisory Opinion treating certain credit card processing fees as services income based on where the services are performed. In that regard, the Advisory Opinion is a reasonable attempt by the Department to avoid vastly different sourcing rules for essentially similar transactions based on whether the taxpayer is subject to Article 9-A or Article 32.