A New York State Administrative Law Judge has upheld the position of Expedia, Inc. that its receipts from travel reservations arise from the performance of services and are properly sourced outside of New York to where the services are performed. Matters of Expedia, Inc. and Expedia, Inc. (Delaware Company), DTA Nos. 825025 & 825026 (N.Y.S. Div. of Tax App., Feb. 5, 2015). The ALJ also agreed with the claims by Expedia’s parent, Expedia, Inc. (Delaware Company) (“Expedia Del”), that the advertising receipts earned by its subsidiary TripAdvisor Business Trust (“TripAdvisor”) similarly arose from the performance of services and were sourced to where those services were performed.

Facts. Expedia, based in Bellevue, Washington, operated the well-known travel reservation facilitation business, directly and through subsidiaries and affiliates. It collected information from airlines and cruise ships, hotels and resorts, and car rental companies (referred to as “Travel Service Providers”), provided that information to customers, and negotiated with the Travel Service Providers to obtain special rates and availability. It operated under two business models. Under the merchant model, which, for example, was used with hotels, Expedia acted as the merchant of record, charged the customer’s credit card for the reservation and its fee, and conveyed the information to the hotel. After the accommodations were provided, the hotel invoiced Expedia, which remitted payment. Under the agency model, customers directly paid the Travel Service Providers, typically airlines, rental car companies, and cruise lines, which then paid a commission to Expedia. Expedia maintained customer service call centers, all outside New York, and all of its administrative and corporate functions related to the operation of the business occurred outside New York.

TripAdvisor operated an online travel search engine and directory that compiled user reviews, opinions, photos, and articles regarding various travel destinations, hotels, and activities. It derived revenue from advertisers and other third parties who placed ads on TripAdvisor’s website. All procurement and management of the advertisements was done by employees located in Massachusetts, and all administrative activities were done in Washington and Massachusetts.

Issue. For 2005 and 2006, Expedia treated its travel reservation facilitation receipts as arising from the performance of services and, since no services were performed in New York, reported a New York State receipts factor of zero. Similarly, for 2007, TripAdvisor reported no receipts in New York and a New York State receipts factor of zero. On audit, the Department determined that Expedia’s receipts were not from services, but rather were “other business receipts” under Tax Law § 210(3)(a)(2)(D), sourced to where they were “earned,” which the Department contended was the location of the customers, some of whom were in New York. It similarly determined that receipts from advertising on TripAdvisor were “other business receipts” and should be sourced to the customer’s modem, apparently arguing that TripAdvisor’s “customers” were the individuals who accessed the site rather than the advertisers. Since information was not provided on audit regarding travel reservations generated by consumers on computers located in New York, the Department allocated TripAdvisor’s receipts to New York based on an estimate derived from information on Expedia Del’s Form 10-K and U.S. census population data.

ALJ Decision. The ALJ agreed with Expedia that it was providing services, and indeed found the conclusion “inexorable.” He found that all of Expedia’s activities, including providing information to its customers, compiling summaries facilitating travel arrangements, providing support and customer assistance, and maintaining the reservation information, were the performance of services.

Relying on a regulation, 20 NYCRR 4-4.3[a], that provided that receipts from services are allocated to New York whether performed by employees, agents, or subcontractors, the Department was arguing that there must be human involvement by an employee, agent, or subcontractor at the precise moment the transaction occurred. The ALJ rejected this position as an “impermissible expansion” of Tax Law § 210(3)(a)(2) (B), and found that the statute by its plain meaning did not require human interaction at the moment of sale. The ALJ also found that the Department’s interpretation of the regulation—which he said was merely intended to make it clear that services performed by agents or subcontractors were covered, as well as those performed by employees—ignored the substantial human involvement of approximately 6,600 employees, which even under “the [Department’s] stretched reading of the regulation” qualified as human involvement.

The ALJ also rejected the Department’s attempt to rely on several of its advisory opinions, in which it claimed to have consistently found that services performed over the Internet or by electronic transmission should be classified as other business receipts, finding that advisory opinions are not precedential or binding, and also that the cited opinions involved significantly different business models.

Once having found that the receipts arose from the performance of services, the ALJ readily concluded that those services, including the provision of information, booking of arrangements, compilation of information, and programming and maintenance of servers, all occurred outside New York. He found “instructive” the decision in Siemens Corp. v. Tax Appeals Tribunal, 89 N.Y.2d 1020 (N.Y. 1997), in which the Court of Appeals held that, to the extent interest income from loans arose from work performed in New York, such receipts were sourced to New York. While noting that the court in Siemens decided that the interest income was “other business receipts” under N.Y. Tax Law § 210(3)(a)(2)(D), rather than receipts from services under § 210(3)(a)(2)(B), the ALJ followed the Siemens court direction that the loan receipts were sourced to New York “to the extent that the work done to establish and maintain such loans is done in New York, without regard to the situs of the obligor.” The ALJ also observed that last year the New York Legislature amended the Tax Law to change the sourcing of service receipts from the place of performance to the location of customers, effective for years beginning after January 1, 2015, which would have been unnecessary if the Department’s interpretation of the former statute were correct.

Similarly, the ALJ found that TripAdvisor’s advertising receipts were from the performance of services, and that there was no basis for the Department’s position that Tax Law § 210(3)(a)(2)(B)(i) applies to Trip Advisor. This statute provides a special rule to source advertising receipts earned by taxpayers in the business of publishing newspapers or periodicals to where the newspapers and periodicals were delivered, but TripAdvisor did not publish newspapers or periodicals or perform any similar activity. Again, the ALJ rejected the Department’s reliance on one of its advisory opinions, WTAS LLCTSB-A-09(5)C (N.Y.S. Dep’t of Taxation & Fin. Mar. 9, 2009), which had found that advertising receipts earned by a business that operated a social networking site for subscribers should be sourced based on the location of its subscribers, as being unrelated to TripAdvisor’s business.

Finally, the ALJ also rejected the Department’s argument that Expedia and Expedia Del had failed to meet their burden of proof because no witnesses testified, holding that the affidavits that had been introduced provided sufficient evidence, even when the affiants were not employed during the years in issue, since they detailed review of records to demonstrate familiarity with the facts. Also, the relevant statements had not been materially contradicted by the Department, which offered only “anecdotal statements” based on personal use of the website.

Additional Insights

The position taken by the Department in this case has frequently been raised on audit, particularly when a business involves use of the Internet or computer access. While some years ago the Department agreed that services performed electronically were sourced where performed, see, e.g., Peach Tree Bancard Corp., Advisory Opinion TSB-A-95(13)C (N.Y.S. Dep’t of Taxation & Fin., Aug. 4, 1995) (finding that credit card processing fees were receipts from services allocated to the place where the services were performed), the Department has since changed its position and, in Advisory Opinion, TSB-A-11(1)C (N.Y.S. Dep’t of Taxation & Fin., Dec. 28, 2010), expressly revoked the Peach Tree Advisory Opinion. Without any modification to the statute or regulations, the Department now regularly takes the position on audit, and has found in several advisory opinions, that services provided electronically are “other business receipts” that are sourced to the location of the customers. This sourcing determination is inconsistent with the holding in Siemens, in which the Court of Appeals held that other business receipts arising from loans were sourced to where the work was done on the loans, and not to the location of the borrowers, which the Department has ignored on audit, concluding that Siemens did not apply to electronically delivered products, and citing for support only the Department’s own advisory opinions.

Since the Expedia ALJ decision is not precedential, it may not have yet resolved this battle. However, given how often and how strenuously the Department has taken a position on audit similar to the one it took in Expedia, the Department will very likely appeal the ALJ decision to the Tax Appeals Tribunal.