New York taxpayers received additional guidance on the important issue of whether online services constitute “service” receipts, and how those receipts should be sourced, for New York corporate franchise tax purposes.
On January 5, 2017, a New York State Division of Tax Appeals (DTA) administrative law judge (ALJ) determined that a taxpayer’s electronic bill payment and presentation (EBPP) receipts constitute “service” receipts and not “other business receipts,” and are properly sourced where the service is performed. In the Matter of the Petitions of Checkfree Services Corp., DTA Nos. 825971 & 825972 (N.Y. Div. Tax. App. Jan. 5, 2017).
An ALJ found for a taxpayer on this same issue previously. In Expedia, another ALJ confirmed the taxpayer’s position that travel reservation facilitation receipts, and online advertising receipts, constitute “service” receipts that are sourced to the location of performance. In the Matter of the Petition of Expedia, Inc., DTA Nos. 825025 & 825026 (N.Y. Div. Tax. App. Feb. 5, 2015)
Sutherland Observation: The ALJ’s analysis in Checkfree largely mirrors the sound analysis in Expedia. Both determinations concluded that the taxpayer performed a “service” under the term’s plain meaning; that a “service” does not require human involvement; that the taxpayer did have some human involvement even though the service had an automated component; and that “service” receipts are properly sourced where performed, which is the taxpayer’s location, not the customer’s location.
“Service” Receipt or “Other Business Receipt”
In Checkfree, the taxpayer was headquartered in Georgia and provided EBPP services to its customers (Clients), which allowed the Clients’ customers to pay bills through various methods and receive them electronically. Specifically, the taxpayer’s services enabled the Clients’ customers to log onto the taxpayer’s website and make payments to any merchant/vendor, and funds would get withdrawn from the customers’ accounts. The taxpayer provided these services using its proprietary software, and performed these services and other related functions (e.g., technology programming and maintenance, anti-fraud services, creditworthiness services, and customer service call centers) from various locations, all outside of New York.
The ALJ first addressed whether EBPP receipts constitute “service” receipts or “other business” receipts. “Services” are not expressly defined in the statute, so the ALJ looked to the plain meaning of “services” and concluded, “‘services’ may be properly defined…as ‘useful labor that does not produce a tangible commodity’…or ‘performance of labor for benefit of another, or at another’s command.’”
The ALJ dismissed the Department’s argument that “service” requires “human involvement at the moment of sale in order for services to have been performed,” concluding that the Department’s interpretation of the regulation impermissibly expands or limits the tax law. Further, the ALJ determined that the taxpayer actually did have significant human involvement, even though that is not a legal requirement to constitute a service. The taxpayer employed technology to perform its services, but that did not overtake the “highly labor-intensive” services that the taxpayer’s employees performed daily. The ALJ also stated that the Clients’ customers achieved the same end result whether they log into the taxpayer’s online system or speak with a person at the taxpayer’s customer service center. Therefore, the taxpayer’s online system was merely a tool the taxpayer used to provide its service.
In the alternative, the Department argued that the taxpayer’s receipts are “other business receipts” because the taxpayer derives them from the sale of intangible assets (i.e., a license to access the technology). The ALJ rejected this argument, concluding that the primary purpose of the taxpayer’s business was not an intangible asset license, but providing an outsourced, electronic bill payment service for its Clients.
Service Receipt Sourcing
The ALJ determined that service receipts must be sourced to the “location of the activities performed.” The ALJ rejected the Department’s position that the service was a “simple, instantaneous, fully automated transaction” that is “performed” where the customer clicked on his or her computer (i.e., modem location). The ALJ determined that the taxpayer’s service was labor-intensive and required constant monitoring and human support, so the service was performed where the taxpayer’s facilities and employees were located.
The ALJ went further and stated that even if the receipts were “other business receipts,” the taxpayer should still source its receipts to the location of performance, because that is where the receipts are “earned.” Citing Matter of Siemens Corp., 89 N.Y.2d 1020 (N.Y. Sup. Ct. App. Div. 1997).
Sutherland Observation: The ALJ in Expedia did not address the proper sourcing methodology for “other business receipts.” The Department’s long-standing position had been that “other business receipts” should be sourced on a market approach rather than an origination approach, which Checkfree appears to reject.
This determination provides additional guidance on the contentious issue of online service receipt sourcing. Although neither Expedia nor Checkfree is currently precedential, they both provide a consistent and sound basis for taxpayers to source online service receipts. The Department may appeal the Checkfree determination to the DTA’s Tax Appeals Tribunal, which would result in a precedential decision.