12 August 2019 New York Tax Appeals Tribunal classifies online litigation support as other business receipts, sourced to location where the receipts were earned based upon prior statute In its ruling In the Matter of the Petition of Catalyst Repository Systems, Inc.,1 the New York Tax Appeals Tribunal (Tribunal) determined that an out-of-state corporation's receipts from online litigation support are not derived from the performance of a service but rather are for the license to use a technologically advanced tool (the receipts for which should be treated as from the sale of an intangible). As such, these receipts are properly classified as other business receipts (OBR) and, based on the law2 applicable for the years at issue (2008 - 2010)3 are sourced to Colorado, where the income was earned. Although the Tribunal reached the same outcome as the Administrative Law Judge (ALJ) of the New York Division of Tax Appeals (i.e., who held that these receipts were for services properly sourced to Colorado), it reached its conclusion on different grounds. Catalyst Repository Systems, Inc., (Catalyst) is a Colorado-based corporation engaged in the electronic data and document repository business and provides 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 all located in Colorado. Moreover, the ALJ and the Tribunal found that all included and related services are performed by Catalyst's employees in Colorado. Catalyst reported a 0% receipts factor for New York State (NYS) tax purposes for each of the tax years ended December 31, 2008, 2009, and 2010 (audit period) because it treated them as derived from the provision of a service that was entirely performed in Colorado. Upon audit, the New York State Department of Taxation and Finance (Division) recomputed Catalyst's receipts factor for the audit period and sourced such receipts based upon the location of Catalyst's customers (i.e., the Division applied a market-based sourcing method). Catalyst challenged the Division's assessment. The ALJ ruled in favor of Catalyst, finding that its receipts from online litigation support were derived from the sale of a service and thus should be sourced for NYS tax purposes based upon the location where the services were performed. These services, the ALJ determined, were performed in Colorado, where Catalyst's servers, computer infrastructure, and the majority of its employees were located. On appeal, the Tribunal first considered whether the ALJ properly classified the receipts for online litigation support as services. The Tribunal determined that Catalyst provided its customers with the right and license to access and use its system to search, analyze, review and retrieve documents that were previously uploaded by its customers. The Tribunal found that Catalyst's customer service agreements actually granted a right and license to use its online litigation support software system. In its view, the agreements did not reflect a sale of a service. Moreover, it also found that Catalyst's employees were paid to operate and maintain the system, not to render direct services to its customers. Instead, the Tribunal found that Catalyst licensed to its customers the right to use a technologically advanced tool, receipts from which were properly classified as OBR. Having determined that the receipts were properly classified as OBR, the Tribunal sourced the receipts to the location where they were earned as required by New York law in effect for the audit period.4 In this case, "virtually all of the work" relating to the OBR occurred in Colorado (e.g., development, monitoring, and maintenance of Catalyst's system). In so holding, the Tribunal rejected the Division's reliance on certain advisory opinions regarding the sourcing of receipts from digital transactions,5 which would have resulted in a sourcing of receipts based upon the location of the electronic devices used by customers to access the system. The Tribunal did not find these advisory opinions persuasive, noting that "they offer no statutory or regulatory justification for the conclusion that receipts for digital transactions as described in the opinions are properly sourced to the customers' location; they simply assert it … ." Instead, the Tribunal said it is "constrained to follow" the holding by the N.Y. Court of Appeals (the state's highest court) in Matter of Siemens Corp.,6 which held " … that the location of the work that resulted in the income is the location where the receipts must be allocated." Lastly, the Tribunal rejected the Division's contention that the 2015 law change mandating customer-based sourcing was "consistent with the long-standing purpose of the receipts factor … to reflect the location of a taxpayer's customers." The Tribunal agreed with the ALJ's conclusion that the law would not have been revised if it were interpreted as the Division asserted. The Tribunal's decision in this case is precedential and cannot be appealed by the Division. While the Tribunal reached the same outcome as the ALJ, it did so on different grounds. Accordingly, taxpayers that earned receipts from the sale of certain intangibles for tax years beginning before January 1, 2015 (i.e., under pre-2015 tax reform) that remain open under the applicable statute of limitations should consider whether the Tribunal's ruling in this case offers a basis for filing a refund claim. Furthermore, any taxpayers that may have filed a protective refund claim based on the ALJ's earlier finding in this case that the receipts were derived from the sale of a service should review the Tribunal's decision and consider their procedural options (including amending their claims to reflect the OBR findings in this ruling).
1 In the Matter of the Petition of Catalyst Repository Systems, Inc., DTA No. 826545 (N.Y. Tax App. Trib. July 24, 2019). 3 The law was substantially amended by the legislature with the enactment of NYS tax reform, effective in 2015. Under NYS Tax Law §210-A(10), effective for tax years beginning on or after January 1. 2015, OBR are sourced under a "market state approach" (i.e., generally based upon where the taxpayer's customer received the benefit of the OBR). 5 See TSB-A-99[16]C (April 7, 1999); TSB-A-00[15]C (September 6, 2000); TSB-A-02[3]C (April 18, 2002); TSB-A-11[8]C (July 12, 2011). Document ID: 2019-1452 | |||||||||||||||||
