United States: New York Sales Tax on Hot And Cold Water? "Not Cool!" Says N.Y. Tax Appeals Tribunal — A Lesson in Science

The New York Tax Appeals Tribunal (the "Tribunal") recently ruled that purchases of hot water and chilled water used to heat and cool airport passenger terminals were not subject to New York sales tax.¹ The Division of Taxation (the "Division") had argued that such purchases were subject to sales tax as "refrigeration and steam services" under N.Y. TAX LAW § 1105(b). British Airways, PLC ("British Airways") and Terminal One Group Associates, LLP ("Terminal One") (collectively referred to as "Taxpayers") persuaded both the Administrative Law Judge (the "ALJ") and the Tribunal that such services were in fact distinct from and not encompassed by "refrigeration or steam services", and therefore not subject to New York sales tax.

Taxpayers each operated airport terminals at John F. Kennedy International Airport ("JFK"), leased from the Port Authority of New York and New Jersey ("Port Authority"). As part of their leases with the Port Authority, Taxpayers obtained hot water and chilled water to heat and cool the terminal facilities. The Port Authority in turn, contracted with a third party, KIAC Partners ("KIAC"), to provide the hot water and chilled water. The Port Authority separately stated charges for the chilled water and the hot water based on the thermal energy used by Taxpayers, as calculated by the difference in temperature in the chilled water and hot water upon delivery to Taxpayers compared to when Taxpayers returned the water to KIAC.

Taxpayers filed refund claims with the Division for sales tax paid to the Port Authority on the purchases of chilled water and hot water. The Division denied the Taxpayers’ refund claims. In responding to British Airways’s claim, the Division noted, that the claim was for tax paid on "HVAC (heating, ventilation and cooling)" services as part of British Airways’s "monthly rental charges." Similarly, the Division denied Terminal One’s refund claim by asserting that N.Y. TAX LAW § 1105(b) "imposes a tax on receipts from every sale, other than sale for resale, of gas, electricity, refrigeration and steam service of whatever nature. The words ‘of whatever nature’ indicate that a broad construction is to be given the terms describing the items to be taxed...".

Ultimately, this case turned on an analysis of what happened to the hot water and the chilled water purchased by the Taxpayers, and how that water was used to affect the temperatures in the terminals at JFK, in the context of § 1105(b), which taxes sales of "refrigeration and steam services."

Taxpayers use the hot water to heat the terminals through heat transference. KIAC delivers hot water through its own pipes, under pressure and at a temperature above 240 degrees Fahrenheit, to heat exchangers in each terminal, whereupon the KIAC water flows through compartments and transfers heat to water belonging to each of the Taxpayers. KIAC water is not commingled with Taxpayers’ water, and is returned to KIAC at a lower temperature after the heat transferral. Taxpayers’ now-heated water is then circulated around the terminal to heat the facility and returns to the heat exchanger at lowered temperature.

Because the hot water delivered to the Taxpayers is under pressure, it does not boil, and thus does not produce steam. Steam systems, in contrast, function by delivering steam through underground pipes into buildings, where it then goes through radiators, becomes condensate, and is then discarded - not returned to the company that produced it. The pipes in a steam system also must be slanted or pitched so then condensate does not build up. Hot water systems, in contrast, do not require slanted or pitched pipes.

Taxpayers use the chilled water to cool the terminals by cooling air, which is filtered and distributed throughout the terminals. More specifically, the chilled water flows through pipes into the heat exchanger, where the water draws air through a filter and a fan. The air exits as chilled air and is then distributed to "air handling" equipment throughout the terminal to cool the facility. The water is returned, at a raised temperature, to KIAC through KIAC’s pipes. This kind of ventilation is an essential part of an "air-conditioning" system, as it relies upon fans to move the air and filters to clean the air, particularly important in airport terminals to remove ever-present airplane exhaust.

The Tribunal contrasted this process with refrigeration, which involves no fans, and because it is used primarily to preserve food and drugs, aims for temperatures between 20 and 40 degrees Fahrenheit. The medium used for refrigeration apparently must be approximately twenty degrees below the temperature sought, and for this reason cannot be water for refrigeration below 45 degrees -- as water freezes at 32 degrees. Similarly, the Tribunal noted that ventilation is not important for refrigeration as "people do not reside inside the refrigerating unit." Similarly, de-icing is important in refrigeration, but it is not important in air conditioning.

The Division claimed that "refrigeration is simply the provision of the means to cool air or other substances and, as such, refrigeration is provided by the Port Authority" to Taxpayers. The purpose of the refrigeration, the Division claimed, "whether to cool perishables or people, as well as the liquid utilized" is irrelevant to taxability. Citing to Microsoft’s Encarta Encyclopedia, the Division argued that "refrigeration" encompassed lowering temperature to produce "bodily comfort," and thus necessarily included air conditioning of the type used by the Taxpayers. The Division also cited to Encarta to define "air conditioning" as a centralized system providing controlled temperature, humidity and purity, but as a term that is often applied "improperly applied" to mere blower-equipped refrigeration units that provide "a flow of cool, filtered air."

The Division argued the hot water service furnished to the Taxpayers should be considered taxable as a steam service because "hot water and steam have an identical molecular and chemical composition."

The Tribunal rejected the Division’s arguments, and made clear that among utility services, steam service is considered distinct from hot water service. The Tribunal noted that in 1983 the New York State Public Service Commission ruled that it did not have jurisdiction over a hot water heating system proposed for construction in Rochester, because the hot water heating system was not considered a "steam plant."

Similarly, the Tribunal noted that the Taxpayers were not purchasing refrigeration from the Port Authority. It noted that inside the terminals, restaurants and other food services require refrigeration, yet provide it from standalone compressors. If Taxpayers were purchasing refrigeration from the Port Authority, they could supply it directly to these subtenants.

More importantly, the Tribunal emphasized that refrigeration is physically distinct from air conditioning. Refrigeration is a "thermodynamic process to reduce or reject heat through a mechanical process," and typically involves a range of temperatures from 20 degrees below zero up to freezing (32 degrees), and that the medium to reduce the temperature must be at least 20 degrees below the desired temperature, and therefore is usually not water. "Refrigeration" is also distinct from "air conditioning" in industrial usage, as the former term is used to refer to the process of dealing with colder temperatures such as with food storage and industrial activities," while the latter has come to refer to temperature control of air (both heating and cooling), humidification, dehumidification and filtering of the air.

In light of these considerations, the Tribunal upheld the ALJ’s opinion, which set forth that the relevant law in this controversy, N.Y. TAX LAW § 1105(b), imposes a sales tax upon receipts from every sale "other than a sale for resale, of ...refrigeration and steam service of whatever nature" — not upon on the sale of hot water or chilled water. The ALJ noted this to be so despite the efforts of the Division of Taxation to construe § 1105(b) so broadly as to include the provision of chilled water within the definition of "refrigeration," and to include the provision hot water within the scope of "steam services." The Tribunal noted that the ALJ had carefully reviewed the testimony of Taxpayers’ expert witnesses, and had noted the differences between refrigeration and chilled water services and between steam and hot water services, and held the Taxpayer’s purchases of the hot water and chilled water services were not subject to New York sales tax under § 1105(b). The Tribunal noted that it found the ALJ had "completely and adequately addressed the this issue and correctly applied the relevant law to the case."

Taxpayers reportedly found that the Tribunal’s decision was "cool."

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