United States: New York State Division of Tax Appeals Issues Determination Rejecting Department's "Other Business Receipts" Position for Electronic Service Receipts

The New York State Division of Tax Appeals has issued a determination regarding the proper methodology for sourcing electronic service receipts under Article 9-A of the pre-reform Tax Law. The taxpayer prevailed in overcoming the Department's attempt to impose market-based sourcing and was vindicated in sourcing its service receipts to the location where the services were performed.

On January 5, 2017, the New York State Division of Tax Appeals ("DTA") issued a determination regarding the proper classification and sourcing of electronic service receipts for apportionment purposes under Article 9-A of New York's legacy corporate franchise tax regime.1 In a taxpayer win, the DTA rejected the "other business receipts" market-based sourcing approach of the New York State Department of Taxation and Finance (the "Department"), and found that place of performance was the proper sourcing methodology.2

A. Facts

The taxpayer, CheckFree Services Corporation (hereinafter "CheckFree"), is a provider of electronic bill payment and presentment services. CheckFree's services allow financial institutions, credit unions, and community banks across the United States to outsource the service of providing electronic bill payment and presentment, allowing customers to initiate payments electronically, and allowing merchants and vendors to present bills electronically. CheckFree's core business functions, including its data center, call center, and other support facilities, were located entirely outside of New York.

CheckFree timely reported and paid tax for the period July 1, 2004 through December 31, 2009 (the "Audit Period"). On its returns, CheckFree applied a cost of performance methodology to source its electronic bill payment and presentment service receipts. The Department conducted an audit and assessed additional tax against CheckFree for the Audit Period, based on the position that CheckFree's electronic bill payment and presentment receipts should be reclassified as other business receipts and sourced to New York based on customer location.

B. Department's Position

The Department sought to source CheckFree's bill payment and presentment receipts based on the location of CheckFree's customers. The Department's primary argument was that CheckFree's receipts were not from the performance of services because there was no direct human involvement in the performance of the services. The Department also argued that the receipts were generated as the result of the sale of access to and use of an intangible asset. Under both theories, the Department sought to classify CheckFree's receipts as "other business receipts" and, therefore, source them based on customer location. The Department also argued that, even if the receipts were properly classified as service receipts, they should still be sourced based on customer location.

C. Taxpayer's Position

CheckFree asserted that its bill payment and presentment receipts were properly classified as service receipts. CheckFree argued that the Tax Law and corresponding regulations contain no requirement for human involvement in order to properly classify receipts as service receipts and that, even if such a requirement existed, the performance of CheckFree's services included significant human involvement. CheckFree also asserted that, even if the receipts were properly classified as "other business receipts," the receipts were "earned" at the location where the work that generated the receipts was performed by CheckFree and, therefore, would still be sourced outside of New York. Lastly, CheckFree asserted that the Tax Law does not permit service receipts to be sourced based on customer location, which is evidenced by the Legislature's recent adoption of a market-based sourcing regime that applies only on a prospective basis.

D. Determination of the Division of Tax Appeals

On appeal to the DTA, the Administrative Law Judge ("ALJ") found for CheckFree with respect to all of the issues discussed above.

1. Need for Human Involvement

The ALJ determined that the term "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 determined that there is no requirement – in the statute or regulations – for human involvement in an activity in order to properly classify receipts from the activity as service receipts.

In regard to the Department's attempt to classify receipts from electronically delivered services as "other business receipts," the ALJ stated:

It is of no moment that the ultimate fulfillment of the desired service is... accomplished electronically. In this respect, and due to the advance of technology, the computers, services, data centers and secure electronic connections (i.e. the portions of the overall service petitioner provides that have been automated) are simply the tools used by petitioner (and its employees) to perform and provide its... services.

Thus, the ALJ recognized that the Department's attempt to treat electronic services as other business receipts would serve to eliminate any consideration of technological advances, and the practical expansion of the means by which service activities may be performed. In sum, the ALJ determined that the use of electronic means as a tool to perform a service cannot be said to reclassify the service itself.

Moreover, the ALJ found that even if there was a requirement for human involvement, the work performed by CheckFree's approximately 3,000 to 4,000 employees during the Audit Period undoubtedly fulfilled that requirement.

2. Sale of Access to and Use of an Intangible Asset

The ALJ rejected the Department's attempt to classify the receipts as derived from the sale of granting access to or use of an intangible asset. The determination reinforced the rule that, in classifying receipts for corporate income tax purposes, a taxpayer is required to ascertain the primary purpose, or true nature of the business activities that generate the receipts. While CheckFree's service contracts may have involved access to and use of CheckFree's online platform, such access was merely a component part of the means by which CheckFree performed its overall services.

The ALJ found that when looked at in its entirety and from the perspective of its customers, CheckFree's business was providing customers with electronic bill payment and presentment services. Any rights granted to access and use its systems represented a necessary incident or aspect of the means by which CheckFree provides such service. Notably, the existence of "right to access and use" terms in CheckFree's service contracts – language the Department often points to on audit for support of its position – did not reclassify the service.

3. Sourcing of "Services"

The ALJ rejected the notion that, even if classified as service receipts, CheckFree's receipts must be sourced based on customer location. The statute requires service receipts to be allocated to the location where the services are performed. As the ALJ recognized, the services performed consisted of much more than an instantaneous, fully automated transaction rendered at the moment a customer clicked on his or her keyboard. Rather, the services were performed over a period of time (payments were sometimes scheduled for up to a year in advance) by hundreds of CheckFree employees working at facilities and locations entirely outside of New York.

The determination also noted that New York's recently enacted corporate tax reform3 supports the fact that the Department's attempt to use a market-based sourcing approach contradicts the statutory scheme in place during the years at issue. The ALJ determined that the rules of statutory construction make clear that it is presumed that changes to law are made to affect some purpose and to make some change in the existing law. Accordingly, if a market-based sourcing regime had been contemplated by the prior statute, portions of the new law would have been unnecessary.

4. Sourcing of an "Other Business Receipt"

Finally, the determination concluded that even if the receipts at issue were other business receipts, the receipts were "earned" at the location where the work that generated the receipts was performed. Contrary to the Department's view, the location where a receipt is earned is not necessarily the same as customer location. In this case, the work done to complete the bill payment and presentment services was rendered at CheckFree's data center and facilities located entirely outside of New York.

The Department has until February 5, 2017, to appeal the ALJ's determination.4

E. Conclusion

To a large degree, these sourcing issues are fact-specific. However, taxpayers in electronic service industries should pay particular attention to the CheckFree determination. Reed Smith LLP will be hosting a teleseminar in the near future which will include a further discussion of the determination and its impact on your business. In the meantime, if you have questions about New York's rules for sourcing receipts for corporate franchise tax purposes, and how the CheckFree determination could impact your business, please contact one of the Reed Smith attorneys who worked on this matter, or the Reed Smith attorney with whom you usually work.

This case was litigated by Reed Smith attorneys Aaron M. Young, Jack Trachtenberg, and Jennifer S. White. Reed Smith's State Tax practice has seven lawyers licensed to practice in New York. Our team also includes accountants and paralegals to assist in tax matters of all types, such as audit defense and appeals, refund reviews, and transactional tax issues.

About Reed Smith State Tax

Reed Smith's state and local tax practice is composed of lawyers across seven offices nationwide. The practice focuses on state and local audit defense and refund appeals (from the administrative level through the appellate courts), as well as planning and transactional matters involving income, franchise, unclaimed property, sales and use, and property tax issues. Click  here to view our State Tax team.


  1. Prior to 2015, New York Tax Law distinguished between "service" receipts and "other business receipts." The law generally required sourcing for "service" receipts based on the location of performance and sourcing of "other business receipts" based on where the receipts were earned.
  2. In the Matter of CheckFree Services Corporation, DTA Nos. 825971 & 825972 (January 5, 2017).
  3. Tax Law § 210-A; L 2014, ch 59 eff. January 1, 2015.
  4. This may be extended an additional 30 days for cause. Tax Law § 3000.17.

This article is presented for informational purposes only and is not intended to constitute legal advice.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.