In In the Matter of the Petitions of Catalyst Repository Systems, Inc.,¹ the New York Division of Tax Appeals (DTA) determined that a corporation's receipts from online litigation support are services sourced to the location where they were performed under the law² applicable for the years at issue (i.e., 2008 through 2010; the law was substantially changed by New York tax reform in 2015.) The DTA determined that the services were performed in Colorado, where its servers, computer infrastructure and the majority of the corporation's employees were located. The DTA noted that the allocation-sourcing approach applied to the corporation's receipts by the New York Division of Taxation (Division) based on the location of the customers' addresses did not become effective until January 1, 2015, when the New York revised its law.³ Consequently, the Division's receipts-sourcing allocation method did not apply retroactively to the tax years at issue.

Background

Catalyst Repository Systems, Inc., (Catalyst) is a Colorado-based corporation engaged in the electronic data and document repository business by providing online litigation support to its clients. Catalyst hosts data provided by clients, and clients license and use Catalyst's system to search, analyze, review and retrieve their own data. It does not sell any information or tangible personal property to its clients. Its system (including data, proprietary software and servers) and technical staff are in Colorado. All included and related services are performed by Catalyst's employees, who are based and work in Colorado.

Catalyst computed a zero receipts factor for each of the tax years ending December 31, 2008, 2009 and 2010 (audit period). On its New York tax returns for the audit period, it reported its receipts outside of New York for services entirely performed in Colorado. Upon audit, the Division recomputed Catalyst's receipts factor for the audit period and sourced Catalyst's receipts based upon its customers' location (i.e., based on a market state sourcing method).

Provision of services

Catalyst argued the receipts were derived from services performed entirely in Colorado. The Division argued the receipts were "other business receipts" (not services) and sourced them based upon the customer's location (many of whom were in New York). The DTA determined Catalyst's receipts from its litigation support service are receipts from the sale of services and therefore, were appropriately sourced by the taxpayer to the location where the services were performed, as required by New York law in effect for the years during the audit period. The DTA reasoned that the language of the applicable statute⁴ does not limit the type of services to be provided to only those provided by humans, as the Division argued. It also found that "services" can be defined as: (1) "useful labor that does not produce a tangible commodity"; or (2) "performance of labor for benefit of another, or at another's command." Additionally, the Division's applicable regulation cannot be interpreted to add a human involvement requirement at the moment of sale in order for services to be performed.⁵ The regulation does not define "services" or "services within the state," and provides that all services performed in New York are allocated there whether the services are performed by employees or not.

The Division further argued that Catalyst's receipts during the audit period were derived from the provision of access to and use of its system and, therefore, the resulting receipts were from the licensing of intangible assets, which should have been treated as "other business receipts" under the law. The DTA likewise rejected the Division's argument, finding Catalyst is a service provider because its systems help corporations and counsel manage electronic discovery and other complex matters. Clients pay to use the system, which includes its proprietary software and the use of its technical personnel in order to acquire, store, sort, filter, organize, and ultimately find and retrieve the documents the clients require.

Sourcing

The DTA determined Catalyst's services were performed in Colorado, the state in which its servers, computer infrastructure, and the majority of its employees were located. Therefore, the receipts from these services were properly allocated to Colorado by the taxpayer during the audit period. ⁶ The DTA further found that, even if the receipts were properly classified as "other business receipts," the fee-generating activities were earned in Colorado rather than New York and likewise, would have been sourced outside New York.⁷ Lastly, the DTA noted that the New York Legislature changed the allocation of service receipts to a customer-sourcing approach beginning in 2015. If the law were interpreted as the Division asserted, it would not have been revised.

Implications

The DTA's determination in this case is not precedent nor binding upon the Division. 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.

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ENDNOTES

¹ In the Matter of the Petitions of Catalyst Repository Systems, Inc., DTA No. 826545 (N.Y. Div. Tax App. Aug. 24, 2017).

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

³ See Tax Alert 2015-725 and Tax Alert 2015-667.

⁴ N.Y. Tax Law former Section 201(3)(a)(2)(B)

⁵ 20 NYCRR 4-4.3(a).

⁶ N.Y. Tax Law former Section 210(3)(a)(2)(B); see also 20 NYCRR 4-4.3(a).