On December 16, 2008, New York Governor David A. Paterson released his 2009 - 2010 budget proposal, Senate Bill 60/Assembly Bill 160, including 137 new or increased taxes and fees. The proposal attempts to close a $15.4 billion two-year budget gap — the largest in state history — reflecting a current-year shortfall of $1.7 billion and a 2009-2010 deficit of $13.7 billion. The biggest revenue raisers are: (i) elimination of the state's sales tax exemption for certain clothing items; (ii) increasing the liabilities of electric, gas, water, and telephone utilities ($651 million); and (iii) scaling back the tax breaks offered through the state's Empire Zone economic development program ($272 million).
The following revenue increases, if adopted, will have substantial and wide-spread implications for New York business taxpayers.
1. Franchise Tax Proposals
a. Electricity and gas companies’ capital tax cap increase: Certain utility companies would be excluded from the definition of “manufacturer.” The result is that such companies, if paying franchise tax based on the capital base, would no longer enjoy the lower $350,000 cap and would instead be subject to the standard cap — currently $10 million. Projected to raise $17 million, effective immediately for tax years beginning on or after June 1, 2009.
b. Overcapitalized captive insurance companies: Certain captive insurance companies defined as “overcapitalized captive insurance companies” would be required to file a combined report with affiliates. An overcapitalized captive insurance company is defined as any captive insurance company that earns 50% or less of its gross receipts from premiums. Mere qualification as an overcapitalized captive insurance company requires inclusion in the combined return of its parent company or closest controlling stockholder that is a taxpayer. If the parent or closest controlling stockholder is not a New York taxpayer, the overcapitalized captive insurance company may be combined with a related company with which it has substantial intercorporate transactions or distortion. Projected to raise $31 million (2009-10)/ $25 million (2010-11), effective immediately for tax years beginning on or after January 1, 2009.
Sutherland Observation: This is a significant shift in New York’s tax treatment of captive insurance companies, which historically prohibited the combination of captive insurance companies with non-insurance companies. The provision is targeted at captive insurance companies that have presumably, from New York’s point of view, earned too much income from non-insurance activities. It is interesting – but confusing — that the targeted entity is called an “overcapitalized captive insurance company” but it is not over capitalization itself that triggers combination. Instead, combination is triggered based on the level of non-premium income earned by the company. Presumably a captive insurance company could have the same capitalization from year to year but exceed the income threshold one year and not the next depending on the return on the same capital investment — resulting in fluctuations in the members of a combined group.
c. Insurance Tax Simplification: Currently, life insurance companies are subject to a franchise tax based on the higher of four alternative tax bases, including a capital base and an income base, plus a 0.7% tax on premiums. The proposal would eliminate the franchise tax entirely, and instead impose a 2% tax on premiums. Insurance companies other than life insurance companies are currently subject to premium taxes subject to varying rates. The proposal would impose a standard 2% premium tax on these insurance companies as well. Projected to raise $62 million (2009-10)/$50 million (2010-11), effective immediately for taxable years beginning on or after January 1, 2009.
2. Sales Tax Proposals
a. Affiliate Nexus Rule: Remote sellers of tangible personal property would be subject to sales/use tax collection responsibility if either (a) the seller has affiliates qualified as vendors for New York sales tax purposes that use the same trademark, trade names, or service marks as the remote seller, or (b) the seller’s affiliate makes or maintains a market for the seller in New York sufficient for nexus under the U.S. Constitution. Projected to raise $9 million (2009-10)/$12 million (2010-11), effective for sales made on or after June 1, 2009.
Sutherland Observation: The first part of the proposal essentially adopts the MTC’s proposed (but never adopted) sales tax affiliate nexus rule. Several other states have adopted this rule, which could produce unconstitutional nexus results.
b. Expansion of Intangible Property and Enumerated Services Subject to Sales Tax
i. Digital Products: Would impose a new tax on a broadly defined set of digital products. Projected to raise $15 million (2009-10)/$20 million (2010-11), effective for sales made on or after June 1, 2009.
Sales tax would be imposed on “any property or service . . . delivered to the purchaser through the use of wire, cable, fiber optic, laser, microwave, radio wave, satellite or similar or successor media, or any combination thereof. Digital product includes, but is not limited to, an audio work, audiovisual work, visual work, book or literary work, graphic work, game, information or entertainment service, storage of digital products and computer software.”
Sutherland Observation: This proposal reverses New York’s historically favorable tax treatment of most digital products. The digital tax proposal fails to follow the definitions of digital products that have been developed jointly by states and industry-members as part of the Streamlined Sales Tax (SST) Agreement. Notably, New York would not limit tax to purchases made by end users with the right of permanent use. While the budget proposal does limit imposition to products that are sold in a “retail sale,” it is not clear that this limitation would serve to eliminate tax on sales for resale when the digital products purchased for resale do not perfectly match the products being resold. Additionally, because the definition is so broad, the proposal goes well beyond capturing downloaded music, books and movies as is the focus of the SST digital products definition. The proposal would impose tax on downloaded and online games, ringtones, digital photographs and graphics, as well as information and entertainment services. Even worse, the bill’s broad definition provides that the list of taxed items is not exhaustive but is simply demonstrative of the type of things subject to tax.
The digital tax proposal includes a provision that would require sales of digital products to be sourced on a destination basis. Destination is defined to occur where the digital product is transmitted to the purchaser or its agent, or from which the purchaser or its agent accesses the digital product. For sales of prewritten computer software not in tangible form, the proposal would source the sale using a “multiple points of use” (MPU) approach if the sales price of software is greater than $1,000 or the license covers ten or more sites. This approach would permit the vendor to collect tax on the portion of the receipt allocable to the various jurisdictions in the state in which the software will be used. Such MPU sourcing requires that the vendor obtain a completed MPU form within 90 days of delivering the software and operates to shift to the purchaser the burden of proving the jurisdictions to which the software was delivered.
Sutherland Observations: MPU sourcing was repealed from the SST Agreement as businesses were unable to agree on a satisfactory approach to sourcing transactions that involve products capable of being used in more than one jurisdiction at a time. The bill would also add a new, specific category for the sourcing sales of digital property for purposes of calculating the apportionment percentage for the franchise tax. Currently, New York has five different sourcing categories for receipts: tangible personal property (delivery); services (where performed); rentals of real and tangible property (location of property); royalties (where underlying patents and copyrighted material are used); and "other business receipts" (where earned). It was never clear under these categories how sales of digital products should be sourced. The new category provides a hierarchy of sourcing rules with the primary sourcing rule being where the purchaser accesses or uses the digital product.
ii. Cable, Direct Broadcast Satellite (DBS), and Satellite Radio Service: Would impose sales tax on cable, direct-to-home satellite, and satellite radio service. Projected to raise $136 million (2009-10)/$180 million (2010-11), effective June 1, 2009 for sales made on or after that date.
Cable service would be subject to the regular state sales tax and local sales taxes. Taxable “cable service” would also include “any tangible personal property and any service or other content provided with the cable service.”
The proposed tax on DBS differs from that of cable service as a result of the federal preemption against any local tax or fee on DBS. The proposal would enact a new statute imposing a state-only tax on DBS with a rate equal to the state rate plus the sum of various applicable local rates. The amounts collected under the proposed state sales tax would then be distributed to localities in the same manner that the state-administered local sales taxes are redistributed to the localities.
Sutherland Observation: Interestingly, the proposed budget seemingly anticipates a judicial challenge based on Section 602 preemption by providing that if the initial rate structure is invalidated or reduced, the rate on DBS would equal 8.75% statewide. Indeed, similar issues have been litigated in other states. See, e.g., DirecTV v. Treesh, Dkt. No. 2006-CA-001983-MR (Ky. Ct. App. Sept. 7, 2007).
iii. Credit Rating & Reporting Services: The bill would impose sales/use tax on credit rating and reporting services. Specifically, the provisions define credit rating and reporting services to include: mercantile and consumer credit ratings or reporting agencies, and credit adjustment or collection agencies. Projected to raise $78 million (2009-10)/ $104 million (2010-11), effective June 1, 2009.
iv. Transportation Services: Transportation services performed in the state would be a new category of specifically enumerated taxable services. Taxable “transportation services” include the transportation of a person by almost any standard means, including: taxicab, charter, intrastate buses, planes, trains, and vessels, as well as sightseeing services. The new tax is imposed regardless of whether the charge is paid in New York. Projected to raise $45 million (2009-10)/$60 million (2010-11), effective June 1, 2009.
v. Entertainment: A variety of additional forms of entertainment would be taxable under the “amusements” category. The existing definitions would be expanded to encompass a broader range of activities. For example “admission charges” (which previously was defined as the amount paid for admission, and included charges for service, entertainment or the use of any facilities) would now include membership fees, participation fees, and usage fees. It would also include charges for sports, and for the use of devices, rides, games or equipment. Finally, the new law also makes it clear that the charge for an amusement or dues for a taxable membership will be subject to tax even if the charge is paid outside of the state if the club or place of amusement is in the state. Projected to raise $53 million (2009-10)/ $70 million (2010-11), effective June 1, 2009.
c. Several Popular Sales/Use Tax Exemptions Eliminated
i. Clothing: New York currently exempts clothing and footwear sold for $110 or less from its sales/use tax. The Budget proposal eliminates the exemption as well as all local exemptions. It adds a sales tax holiday for clothing and footwear sold for $500 or less. Projected to raise $462 million (2009-10)/$660 million (2010-11), effective June 1, 2009.
ii. Coupon Discount Changes: The definition of “receipt” for sales tax purposes has been amended to include all discounts given for a “coupon”, which is defined broadly as any instrument that reduces the sales price. Currently, the amount of a discount given for a coupon is a taxable receipt only if the vendor is reimbursed for the value of the coupon. Going forward, the sales tax base will include the value of any type of coupon that reduces the sales price to the customer, regardless of whether the vendor is reimbursed by a third-party for any portion of the price reduction. Projected to raise $3 million, effective for sales made on or after June 1, 2009.
iii. Corporate aircraft exemption eliminated: Currently, New York exempts the purchase or lease or use of commercial aircraft primarily engaged in intrastate, interstate, or foreign commerce from sales/use tax. The proposed amendment eliminates this exemption by altering the definition of “commercial aircraft” providing that “transporting person for hire does not include transporting agents, employees, officers, members, partner, managers, or directors of affiliated persons.” Persons are considered “affiliated” where one of the persons has an ownership interest of more than 5%, whether direct or indirect. The existing exemption for the use of property or services purchased by a nonresident for use in trade or business would not apply to the use of aircraft, vessels and motor vehicles where the property is purchased “primarily to carry individuals, whether or not for hire, who are agents, employees, officers, shareholders, members, managers, partners, or directors of the purchaser, where any of those individuals or an affiliated person were a resident of the state when the property was purchased. Proposed to raise $4 million (2009-10)/$6.3 million (2010-11), effective June 1, 2009.
i. Sampling: The Commissioner would be given new, specific authority to use generally accepted sampling techniques to determine the amount of sales tax due. This change would take effect immediately.
ii. Bank Information Returns on Registered Vendors: Banks would be required to provide the Department with annual information returns about all account holders who are registered vendors for sales tax purposes. The information return would disclose the gross amount of each account holder’s cash, checks, and other funds deposited; and the gross amount of each account holder’s reportable settlements. A $50 penalty per account holder would be imposed for failure to file a return that is capped at $250,000 per year. Effective immediately and applies to deposits or settlements made on or after January 1, 2009.
3. Additional Taxes
a. Soft Drink Tax: The proposal imposes an additional 18% tax on fruit drinks and soft drinks and beverages ordinarily dispensed at soda fountains. The tax would not apply to coffee, tea, cocoa, fruit drinks having 70% or more natural fruit juice, diet soda or water products. Many of the current exemptions for beverages in the regular sales tax law will not apply to this new tax (such as an exemption for drinks sold to students at school). Projected to raise $404 million (‘09-10)/ $539 million (2010-11) that would be earmarked solely for certain health care programs, effective for sales on or after June 1, 2009.
b. Luxury Products Tax: The proposed budget adopts an additional luxury tax of 5% on the following items: Automobiles (priced over $60,000); private boats (priced over $200,000); private aircraft (priced over $500,000); and jewelry, fur clothing and footwear (priced over $20,000). Sellers must separately state the charge from the sales price of the good and from any other taxes. Projected to raise $12 million (2009-10)/$15 million (2010-11), effective June 1, 2009.
4. All Taxes
a. Whistleblower Rewards: Authorizes the Commissioner to award whistleblower funds to individuals providing information that leads to the determination of substantial underpayment or that leads to the prosecution or conviction of individuals who violate, attempt to violate, or conspire to violate tax. Awards will be either percentage awards based on the amount of tax (excluding interest and penalties) collected or a lump sum not to exceed one thousand dollars. The budget authorizes percentage awards only when the tax evaded exceeds $5,000 for personal income taxes or $30,000 for all other taxes. The Department may not disclose the identity of the whistleblower. Effective immediately.
b. Federal and State Offsets: Gives the Commissioner authority to enter into agreements with the U.S. Treasury and other states to use New York taxpayer overpayments to satisfy debts of the taxpayer to the other jurisdictions. Effective immediately.
Spending: The Executive Budget includes a spending increase of $14.5 million for the Department of Taxation and Finance. This increase would allow the hiring of 300 new employees for the Department's Audit, Collection, and Enforcement programs.