In In the Matter of the Petitions of Checkfree Services Corp.,¹ the New York Division of Tax Appeals (DTA) held, under prior law, that receipts for electronic bill payment and presentment (EBPP) services are properly classified as receipts derived from the performance of services² (rather than "other business receipts"³) and could not be allocated to New York because the services were not performed in the state.

Background

A company providing EBPP services (Company) challenged the assessment of additional corporation franchise tax under New York Tax Law Article 9-A (Article 9-A) in effect for the period from 2004 to 2009. The Company was incorporated in Delaware but headquartered in Georgia and conducted three lines of business: (1) an investment services division, (2) a software division, and (3) an electronic commerce division. The only issues on appeal were whether the Company properly: (1) classified its EBPP receipts as derived from services or other business receipts and (2) allocated (sourced) its Electronic Commerce Division's EBPP receipts under the tax law outside of New York. Employees, assets, or offices involved in generating the EBPP receipts at issue did not generate receipts in New York. The Company's EBPP business primarily allows consumers — who are the customers of consumer service providers (CSPs), direct billers, and health and fitness facilities (i.e., the Company's customers' customers) — to log onto the Company's website and authorize single or recurring payments to any designated vendor in the country with funds drawn from the customer's account with its CSP.

EBPP as services

As New York law does not define "services", the DTA defined "services" as "useful labor that does not produce a tangible commodity"⁴ or "performance of labor for the benefit of another, or at another's command,"⁵ and concluded that receipts from the Company's EBPP transactions were the result of services performed by the Company to the Company's customers and to its customers' customers (consumers). The DTA concluded that the fact that the ultimate fulfillment of the desired service is accomplished electronically does not change its analysis, because the computers, servers, data centers and secure electronic connections are tools used by the Company to perform and provide its EBPP services. The DTA found that the Company utilizes its proprietary technology (including granting access as a necessary component step in allowing consumers to initiate the process of directing and authorizing bill payments) as an integral part of carrying out, and providing, its overall service of online or electronic bill presentment and payment for its customers and consumers.

The New York State Division of Taxation and Finance (Division) argued that, under 20 NYCRR 4-4.3(a), the Company's receipts could not qualify as receipts from services performed and, therefore, must be classified as "other business receipts," because no employees, agents, subcontractors, or other persons on behalf of the Company were physically involved in performing the transactions.⁶ The DTA rejected this argument, finding the Division's interpretation of the regulation would impermissibly expand N.Y. Tax Law former Section 210(3)(a)(2)(B), which does not require human involvement at the moment of sale in order for services to have been performed. Moreover, the regulation is aimed at the allocation of receipts and not at the classification of receipts.

The Division further argued that, based on a review of representative EBPP contracts, the Company is merely providing access to and use of the EBPP technology it has created, and the receipts at issue resulted from intangible asset licensing and, as such, constitute other business receipts. However, the DTA found that the primary purpose of the Company's EBPP business is not the sale, by license, of intangible assets, but rather is the business of providing for its customers an outsourced, turn-key electronic bill presentment (distribution) and payment service. The Company and its personnel were involved throughout the entire process of carrying out payments, as directed and authorized by consumers who accessed the system. The bill presentment and payment functions and all of the necessary accompanying activities required to carry out such functions constitute the service paid for by the Company's customers.

Finally, the Company's use of technology to carry out many aspects of the service (fulfilling payments electronically or by mechanized printing and mailing of paper checks) does not change the conclusion that the Company is providing a service. Aside from the technology required, providing EBPP services is:

— Highly labor intensive and requires a large base of employees (the Company employs approximately 3,000-4,000 employees to provide these services)
— Expensive (requires a large platform and technology infrastructure)
— Complicated and risky (carrying significant regulatory compliance and funds risk components)
— Evolving (both technologically and with respect to the updating of ongoing information input requirements and regulatory compliance matters)

Receipts were not properly allocated (sourced) to New York

The ultimate provision of EBPP services the Company provided for a consumer requires programming and maintenance of the Company's proprietary system, as well as the anti-fraud, credit-worthiness, method of payment, and maintenance of customer service centers. None of these functions were performed in New York, as required under N.Y. Tax Law former Section 210(3)(a)(2)(B), which allocated service receipts to New York based on its former "where the services were performed" standard. Citing Matter of Siemens Corp.,⁷ the DTA found that since the Company's EBPP functions constituted the performance of services, and because all of the functions performed in carrying out such services were performed outside of New York, the resulting receipts may not be allocated to New York. In addition, consistent with the rationale of Matter of Siemens Corp., even if the receipts at issue were "other business receipts," they must be allocated to the location where the work that generated the income was performed — which in this case was still outside of New York. Accordingly, under either classification as services or other business receipts, the DTA agreed that the Company properly allocated its EBPP receipts outside of New York.

Finally, the DTA noted that the New York Legislature recently (and after the period at issue) amended New York Tax Law to change the allocation of service receipts, such as the Company's, to a customer (market based) sourcing approach effective for tax years beginning on or after January 1, 2015.⁸ This change, according to the DTA, would have been unnecessary if former New York Tax Law Section 210 was interpreted as suggested by the Division.

Implications

The DTA's determination in this case is not precedent nor binding upon the Division and it is not yet known whether the Division will appeal the ruling. Accordingly, taxpayers providing services to New York State and City customers from outside of the State and/or City should review this DTA determination as it may offer a basis for filing a claim for refund for New York State and City corporate income (franchise) tax purposes for tax years beginning before January 1, 2015 as long as the applicable statute of limitations on refunds is open (generally three years from the date of filing). Moreover, this determination should be considered for current State and City audits if the auditors are asserting that certain receipts derived from services rendered by electronic means should be sourced to the State/City on a customer/market based approach. Further, considering that taxpayers have now won two recent cases in this area,⁹ there may be further support for claims for refund and/or New York audit proposed adjustments.

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ENDNOTES

¹ In the Matter of the Petitions of Checkfree Services Corp., Nos. 825971 and 825972 (N.Y. Div. of Tax App. Jan. 5, 2017).

² N.Y. Tax Law former Section 210(3)(a)(2)(B).

³ N.Y. Tax Law former Section 210(3)(a)(2)(D).

⁴ Citing Webster's Ninth New Collegiate Dictionary, 1076.

⁵ Citing Black's Law Dictionary 1227 [5th ed. 1979].

⁶ Citing 20 NYCRR 4-4.3(a).

⁷ Matter of Siemens Corp. v. Tax Appeals Tribunal, 89 NY2d 1020 (N.Y. App. Ct. 1997).

⁸ N.Y. Tax Law section 210-A. For additional information, see Tax Alert 2016-1910 addressing amended draft regulations on sourcing receipts from "other services and other business activities, Tax Alert 2016-1780 addressing draft proposed changes to general apportionment regulations, Tax Alert 2015-2017 addressing draft regulations on sourcing "other services and other business receipts" and "sales of digital products," and Tax Alert 2014-655 addressing New York State's corporate franchise tax provisions in Article 9-A.

⁹ In the Matter of the Petitions of Gerson Lehrman Group, Inc., Nos. TAT(H)08-79(GC), TAT(H)12-38(CG), and TAT(H)12-39(GC) (NYC Tax App. Trib. Oct. 4, 2016); In re Expedia, Inc., DTA Nos. 825025 & 825026 (N.Y. Div. Tax App. Feb. 5, 2015). For additional information on Gerson Lehrman Group, see Tax Alert 2016-2182. For additional information on Expedia, see Tax Alert 2015-1089 and Tax Alert 2015-385.