The New York State Department of Taxation and Finance has determined that a financial services firm is not subject to the New York State sales and use tax because the product being sold by the taxpayer constitutes a single, integrated, nontaxable service.  The taxpayer provides its clients with investment management and risk management services and sells a product that consists of a comprehensive enterprise portfolio management support service for financial institutions and investment managers.  The product includes numerous components, including a customized platform to manage information, customized investment analysis services, data control and operations services, customized trade management workflow services, compliance evaluation and reporting services, daily support, and a desktop analytical calculator.  In determining the taxability of the product, the Department considered whether it represents a transaction that bundles taxable and nontaxable components for a single price or a “single integrated product.”  The Department noted that, when considered separately, some components of the taxpayer’s product seem to qualify as taxable (e.g., the web interface for the product is built on taxable prewritten software).  Ultimately, however, the Department determined that the product was a single integrated product—specifically a nontaxable operations and management contract service for portfolio investment managers—because: (i) the product does not come in multiple variants; (ii) customers may use different components of the product in different proportions without incurring extra charges; and (iii) the different components of the product are highly synergistic.  Although nuanced, the Department’s opinion follows prior guidance and case law that distinguishes between bundled transactions and single integrated products.  The opinion also provides a good analysis of the factors that taxpayers may want to consider in determining whether a particular transaction is subject to sales and use tax.  N.Y. Advisory Opinion TSB-A-13(12)S (Apr. 23, 2013).

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• Double-Dipping in Delaware: Delaware Assesses Unclaimed Property Liability for Years Covered by Voluntary Disclosure Agreement
• Truckin' It in Florida: Delivery in Company-Owned Vehicles Creates Sales Tax Nexus in Florida
• Class Dismissed! Georgia Court of Appeals Dismisses Sales Tax Refund Action Against Utility Company
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• Brr! Bundle Up to Collect Sales Tax on Entire Transaction in Massachusetts
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• "Inspirational Shopping" Does Not Create Income Tax Nexus in New York
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The New York State Division of Tax Appeals (DTA) ruled that the dividend income received by a taxpayer holding company from its minority ownership in a publicly traded corporation constituted “investment income” for purposes of New York’s Article 9-A franchise tax on business corporations. The holding company held stock in American International Group, Inc. (AIG), which functioned as an equity compensation plan by using the return on the stock to compensate its shareholders, all of whom were AIG senior executives. The State argued that the AIG dividends were not investment income because the holding company’s intent in acquiring the AIG stock was to benefit the AIG executives, not to “invest in” the stock “for its own account.” Using a common dictionary definition of the term “investment,” the DTA held that the dividends were investment income derived from investment capital because the holding company acquired the AIG stock in exchange for its own capital, held the stock for some 35 years, and during its period of ownership stood to gain or lose on the acquisition based upon the performance of the issuer of the stock. The DTA rejected the State’s attempt to read a “motive” requirement into the statutory and regulatory provisions, stating that “[n]either the motive for making an acquisition of a given type of item otherwise qualifying as investment capital, nor the investor’s subsequent use of the returns gained from that acquired item (i.e., dividends and capital appreciation over time) serve to negate that fact that such acquisition was an investment.” Matter of C.V. Starr & Co., Inc., Division of Tax Appeals, DTA No. 824121 (April 18, 2013).

The New York State Department of Taxation and Finance determined that a women’s apparel company’s “inspirational shopping” trips were not sufficient to be considered “doing business” in the state for corporate franchise tax purposes. Petitioner was a traditional remote seller headquartered outside of New York. Petitioner’s employees occasionally traveled to New York for two to three days to meet with potential merchandise vendors and to go on “inspirational shopping” trips, but Petitioner did not have any sales representatives promoting or soliciting sales in the state. As of May 31, 2008, Petitioner had also terminated its online web affiliate linking program with New York-based web affiliates. Although a “close question,” the Department concluded that, pursuant to Section 1-3.2 of the Business Corporation Franchise Tax Regulations, Petitioner’s occasional trips did not rise to the level of “doing business” in the state. However, the Department noted that if Petitioner was engaged in solicitation activity protected by Public Law 86-272, as well as the occasional trips, then Petitioner would be considered to be “doing business” in New York. N.Y. Adv. Op. TSB-A-13(6)C (Apr. 11, 2013).

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Read the April 1, 2013 SALT Shaker newsletter.

• SALT Pet of the Month: Cooper
• Delivered by Independent Contractors, Undelivered by P.L. 86-272: Order Fulfillment Activities Subject Out-of-State Seller to New York Corporation Franchise Tax
• Everything's Bigger in Texas, Even the Burden of Proof  
• Publish This: Unpublished Michigan Case Rejects Department's Estimated Assessment in Favor of Statutory COP Sourcing Method
• Oregon's Definition of Business Income Still Less Than Crystal Clear
• U.S. Bankruptcy Court Puts the W[H]AM-O on Oregon's Joint and Several Liability Claim for Corporate Excise Taxes on Bankrupt WAMU Parent
• Division Imposes Penalties on UPS, New Jersey Appellate Court Returns to Sender
• Pass the Kleenex: Massachusetts Appeals Court Affirms Appellate Tax Board's Decision in Kimberly-Clark Case
• More News is Bad News for Publisher in Vermont: Newspaper Coupon Books Not Exempt from Sales and Use Tax
• A "Wynne" for Maryland Taxpayers: Double Taxation of Pass-Through Income Ruled Unconstitutional
• In Virginia, Arm's-Length Still Leads to Overreach
• Cracking the Code: No Nexus in Utah for Internet Gift Code Seller
• "Shell" Game? Taxpayer Operating Multi-Service Internet Data Center Entitled to New York State Sales and Use Tax Exemption for Purchases of Tangible Personal Property
• A Federal Contractor, the Missouri DOR and a Rabbi Trust Walk Into a Bar: Taxpayer Has Last Laugh in Missouri Nonbusiness Income Ruling

For additional details, read our legal alert, "A Royal Opportunity: Amendments to New York’s Royalty Expense Add-back Statute Leave the Income Exclusion Intact for Prior Years."

The New York State Department of Taxation and Finance ruled in an Advisory Opinion that a Virginia corporation was subject to New York corporation franchise tax because it hired independent contractors to store its consigned inventory and to solicit orders from and deliver products to New York customers. In this case, the taxpayer consigned inventory to approximately 16 independent contractors located in New York, who maintained the taxpayer’s inventory at in-state locations and delivered the products sold to New York customers. The taxpayer neither owned physical sales locations in New York nor paid rent to such independent contractors for storing inventory at their locations. The taxpayer did, however, retain title to its products until they were sold. The Department ruled that the taxpayer was “doing business,” as defined under N.Y. Tax Law § 209(1), because the taxpayer owned the products that it consigned to its independent contractors until sold to New York customers. The Department further determined that the statutory “order fulfillment” exemption under N.Y. Tax Law § 209(2)(f) did not apply because the independent contractors did “more than just accept or just ship orders in New York State.” The Department likewise took the position that P.L. 86-272 did not protect the taxpayer’s activities because the independent contractors both solicited orders from New York customers and delivered the products to them. TSB-A-13(4)C, New York Dept. of Tax. & Fin. (March 4, 2013).

In an Advisory Opinion, the New York State Department of Taxation and Finance held that a taxpayer developing a data center for Internet services is eligible for the State’s sales and use tax exemption pertaining to Internet data centers. In order to qualify for the exemption, the tangible personal property must be located or installed in a facility or structure which is an Internet data center and required for and directly related to the provision of Internet website services for sale by the operator of the center. In this case, the taxpayer planned to provide three primary types of services to its customers: (1) “powered shell” space, which will be partially furnished by the taxpayer for data center operations and partially furnished by customers with equipment designed to meet the customer’s individual data center needs; (2) “turn-key” data center operations, which will be fully furnished by the taxpayer; and (3) carrier and network space, which will house network provider equipment and support uninterrupted Internet access. The Department determined that upon completion of the facility, the taxpayer will be an operator of an Internet data center because the taxpayer will operate the center in a high security environment and will provide uninterrupted Internet access relative to the services to be offered to the taxpayer’s customers. Therefore, the Department held that the taxpayer is entitled to claim the sales and use tax exemption for purchases of machinery, equipment and other tangible personal property that will be used in the center. TSB-A-12(30)S, New York Dept. of Tax & Fin. (Dec. 3, 2012).

One month later, on September 27, 2012, the Department released another advisory opinion, TSB-A-12(24)S, dealing with a similar transaction, and concluded that a customer’s limited use of the Petitioner’s specialized software did not cause its otherwise exempt information services to become taxable. The Petitioner gathered, mapped, and stored the customer’s data, and created customized reports through its proprietary software based on that data. The customer was able to customize the report using the Petitioner’s software; however, that use was limited to parameters set by the Petitioner. Under these facts, the Department determined the access to the software and directories was not subject to sales tax because the access was integrally related to the overall services provided by the Petitioners, which were not subject to sales tax.

These advisory opinions are important because they establish that the use of software bundled with other services will not automatically cause a transaction to become taxable. While this is generally a business-friendly position, taxpayers still must be careful when evaluating transactions involving the use of, or access to, software. They must engage in a fact-intensive inquiry into whether the object of the transaction is truly the sale of taxable software or whether the transaction remains nontaxable because the software is merely incidental to the transaction, or the transaction qualifies for another statutory exemption.

While the Department’s new comment submission process offers some clear benefits, it could have some downside. It is unclear from a procedural standpoint whether a taxpayer who requests an Advisory Opinion will be notified of comment submissions from interested parties. Likewise, it is unclear whether a taxpayer who requests an Advisory Opinion will have an opportunity to respond to adverse comments from interested parties. In any event, it appears that the new comment submission process could increase the amount of time it takes for the Department to issue Advisory Opinions.

For more information, please visit the Department’s website.

Jack's arrival comes just weeks after we announced that Carley Roberts and Prentiss Willson, nationally recognized leaders in California and multistate tax matters, joined Sutherland SALT in Sacramento.

Read full details on our latest addition to Sutherland SALT in our press release, "Sutherland Expands National State and Local Tax Practice in New York."

Quellos was promoting the allegedly abusive tax shelter in 2001. California law tied the amount of the applicable penalty to that in I.R.C. § 6700, which established a maximum penalty of $1,000. Cal. Rev. & Tax Cd. § 19177. In 2003, California amended section 19177 to substantially increase the promoter penalty from $1,000 to 50% of the income derived by the promoter from the tax shelter promotion activity. The FTB assessed the 50% promoter penalty against Quellos in November 2009 for its promotion activities alleged to have occurred in 2001. Quellos argued that the pre-2003 law imposed a maximum penalty of $1,000 and the 2003 amendment could not be applied retroactively to Quellos’s 2001 activities.

The court was able to resolve the case on statutory interpretation grounds and, therefore, did not have occasion to address the taxpayer’s constitutional due process claims. Interestingly, another recent case involving an attempt to retroactively deny New York Enterprise Zone tax credits did reach the constitutional claims and ruled that the retroactive denial of credits in that case constituted a violation of the taxpayer’s due process rights. James Square Assocs. LP v. Mullen, No. 11-00675, 2011 N.Y. Slip Op. 08423 (N.Y. App. Div. Nov. 18, 2011).

These cases serve as important reminders that taxpayers are entitled to know the consequences of their actions at the time they occur, and subsequent law changes should not change those consequences retroactively. The FTB is expected to appeal the decision.

The Department (or taxpayer) must prove three elements to require a combined report: 

1. Sufficient ownership 
2. Existence of a unitary business 
3. Distortion

The Department attempted to combine an accounts receivable factoring subsidiary and a shared services subsidiary with the Kellwood parent company. The Tax Appeals Tribunal upheld the Administrative Law Judge’s determination that the factoring company lacked economic substance and was thus properly combined. However, regarding the shared services company, the Tribunal held that the taxpayer: (1) satisfied the subjective and objective prongs of the sham transaction analysis; and (2) rebutted the presumption of distortion by proving that the intercompany transactions reflected arm’s-length pricing pursuant to a transfer pricing study.

The Department is actively seeking to combine and de-combine taxpayers (depending on the circumstances). Taxpayers should review the Kellwood decision (and the burden to rebut the taxpayer’s transfer pricing analysis) if they have a forced combination risk.

In the opinion, the Parent is a Delaware corporation headquartered in New York. It owns and operates an Internet-based platform (Exchange) that serves as a marketplace for over-the-counter (OTC) global futures markets. Although the Parent is not a registered broker-dealer, the Exchange serves as a marketplace for buyers and sellers of certain commodities contracts, financial contracts, and other derivatives contracts in futures and OTCs to meet and execute trades on a real-time basis. All of the Parent’s property and equipment associated with the Exchange is located outside of New York, and all of the clearing administration for the OTC is performed outside of New York. In addition to the Parent’s activities, its affiliates generate receipts from various transactions, including open outcry trading, digital auction, flat monthly subscriptions, and trades executed with the assistance of interdealer brokers.

1. Fees derived from pure electronic facilitation of trading activities, such as electronic trade confirmation fees and charges to access trading data generated by the Exchange.
2. Fees derived from interdealer trading or other trading activities that involve the expertise of individuals, which are fees associated with trading services and advice facilitated by a “live” broker.
3. Brokerage commissions earned by a registered broker-dealer. 

Under the first category, the Department determined that all of the receipts generated by the Parent and its affiliates from electronic trading activities, such as fees derived from electronic trade confirmations, commissions earned on trades executed via the Parent’s electronic trading platform, and fees generated from the provision of data, were “other business receipts” and should be sourced to the location of the customer (or their mailing address). The Department relied heavily on the principles of New York Merchantile Exchange (monthly subscription fees to access market data treated as “other business receipts,” sourced to the location of modems and transmission equipment), Insurance Services Offices, Inc. (fees received from a subscriber’s right to access intangible databases constituted other business receipts, sourced to the location of modems and transmission equipment), and Deloitte & Touche, LLP (receipts from online processing of gift certificates and gift cards deemed “other business receipts,” sourced based on the location of the customer).  

The Affiliate’s commissions for open outcry transactions were sourced to the location of the physical trading floor in New York, and the interdealer broker fees and voice brokerage fees were sourced to the location of the representative who facilitated the trades. The Department drew a distinction between the first and second category of receipts because an actual representative, as opposed to an electronic system, facilitated and provided expertise in executing the trades. The Department concluded that these activities constitute services that must be sourced to the location where the transactions took place.  

The Department relied on the special apportionment rules available to registered broker-dealers and concluded that revenue generated from the digital auction business, revenue received for the execution of purchase and sale orders, and trading commission receipts were brokerage commissions. Pursuant to N.Y. Tax Law § 210.3(a)(9), brokerage commissions are treated as service receipts that are sourced to the location of the counterparty or customer responsible for paying for the commission.

With the release of this advisory opinion, it is clear that the Department will apply the principles of New York Merchantile Exchange, Insurance Services Offices, Inc., and Deloitte & Touche LLP to a broad range of electronic commission receipts.  Taxpayers should take note of the Department’s revised characterization of electronic trading activities and be aware of the Department’s propensity to apply a market approach to receipts from activities that may arguably constitute service receipts.

The layoffs could not come at a worse time for taxpayers, who have been demanding more from the Office of Counsel. Taxpayers have been requesting more guidance to obtain certainty (e.g., whether a service constitutes an "information service"), which takes on an even greater importance in the sales tax context when companies are collecting and remitting tax for the Department.

While there is still hope that the PEF and the Governor can come to an agreement, October 19 is approaching rapidly. Check out the Times Union (a New York Capital District news outlet) for the most recent news on the negotiations.

Read the full article, "Returning Jeter’s Big Hit: No Good Deed Goes Untaxed (Perhaps)," from The New York Times.

Andy has been writing about the tax implications of record-setting baseballs since 2008. He published the award-winning law review article, "Ball Busters: How the IRS Should Tax Record-Setting Baseballs and Other Found Property under the Treasure Trove Regulation," in the Fall 2008 Vermont Law Review.

The taxpayer, Ward Lumber Co., was incurring substantial losses and appeared destined for bankruptcy. In an effort to prevent Ward Lumber, one of Essex County’s largest employers and businesses, from going under, several local officials recommended that Ward Lumber pursue QEZE credits to ease its financial difficulties. One state official told Ward Lumber that it would have to form a new entity to qualify for the QEZE program. Ward Lumber merged with a Delaware corporation in 2001, kept the original business’s name, and qualified for and received QEZE benefits for 2002 through 2004.

The Department challenged whether the reorganization was done for a valid business purpose, arguing that the taxpayer reorganized solely to receive the benefits of the QEZE credit. The Department supported its claim with the taxpayer’s 2001 federal tax return, which included a signed statement of one of its officers declaring that the purpose of the reorganization was to qualify for QEZE benefits.

Because Ward Lumber failed to prove that it had a valid business purpose for undertaking the reorganization, the judge disallowed its claims for QEZE tax benefits for 2005 through 2008. It is important to note that the judge applied the “valid business purpose” requirement, added to the statute in 2005, only prospectively—Ward Lumber’s QEZE benefits for 2001 through 2004 went unchallenged.

Interaudi Bank (Interaudi), a commercial banking corporation organized and chartered in New York, formed and transferred its investment portfolio to an investment holding subsidiary, BA (USA) Investments Inc., (BA Investments) domiciled in Delaware. BA Investments limited its activities to the management and maintenance of marketable securities. During the 1997-1999 period, Interaudi filed a New York Article 32 (Bank Tax) combined return that included all of its subsidiaries, except BA Investments—which did not file a New York tax return. Interaudi then claimed interest expense deductions paid to BA Investments.

The TAT affirmed the ALJ determination because the Division demonstrated that the arrangement between Interaudi and BA Investments improperly or inaccurately reflected Interaudi’s income. Although this case was a loss for the taxpayer, it may prove helpful to other taxpayers desiring combination even if they lack the requisite level of intercorporate transactions to satisfy the distortion presumption. The decision provides an example of combination in an instance where the distortion presumption is not met, but transactions between related members still rise to the level where New York considers the activity, business, income, or assets of the taxpayer to result in the improper or inaccurate reflection of income. 

While the FCA has been in existence in New York since 2007, the recent amendment repeals a statutory preclusion for actions related to the tax law. Under the amendment, a taxpayer is subject to the FCA if it has at least $1 million in income or sales in a tax year and the whistleblower pleads damages in excess of $350,000. Id. § 189(4)(a). This dramatic change occurred quietly because the FCA is in the Finance Law rather than the Tax Law. Interestingly, Eric Schneiderman, New York’s Attorney General, was a chief proponent of the amendment while a member of the New York Senate, and he now has enhanced authority to investigate and commence civil actions under the amended FCA. Id. § 190(1).

Under the FCA, a false claim is “any request or demand...for money or property” that is fraudulent, in whole or part, and “is presented to...a state or local government” or a contractor on a government’s behalf. Id. § 188(1)–(2). Taxpayers could fall within this definition by filing a return for a refund or reduced liability. If so, liability would hinge on whether the taxpayer “knowingly” filed a false claim. A false claim is “knowingly” filed if the taxpayer had actual knowledge of the information or acted in “deliberate ignorance” or “reckless disregard” of the information’s veracity. Id. § 188(3). As a result, liability could exist even if the false claim is not intentional. Furthermore, the line between a recklessly filed false claim, which creates liability, and a negligently filed false claim, which does not create liability, is gray. For example, a taxpayer may file a return that knowingly contradicts guidance published by the Department of Taxation and Finance because the taxpayer believes that the guidance exceeds the Department’s authority or violates a constitutional limitation on state taxation. Even if such returns were filed under a reasonable belief that the guidance is incorrect, taxpayers may nonetheless incur liability under the FCA.

Tax practitioners should also have significant concerns. A person that “conspires” to knowingly file a false claim is subject to the FCA. Id. § 189(1)(c). This would include attorneys advising on the filed claim. Moreover, conspirators have the same liability as the taxpayer, which includes civil penalties, treble damages, and attorney fees. Id. § 189(1)(c), (g). Rest assured, we will be following this one closely!