New York Tax Insights, Volume 1, Issue 1

Editors' Note:

With this issue, Morrison & Foerster introduces a new monthly publication: New York Tax Insights. It will be a companion to our State & Local Tax Group's longstanding publication, State & Local Tax Insights, and will, as its title promises, focus on recent decisions, advisory opinions and other developments in New York State and New York City taxation. We hope you find it a useful source of information on the many important tax matters in New York, and we welcome your comments and suggestions for future issues.

ALJ Rejects New York State Attempt to Tax Research and Consulting Services as Information Services in Nerac

By Irwin M. Slomka

It is no secret that the New York State Department of Taxation and Finance has become more aggressive in its application of the sales tax on information services. However, in a recent case (in which Morrison & Foerster represented the taxpayer), an Administrative Law Judge rejected the Division's attempt to treat the furnishing of technical research reports as a taxable information service.

Consulting Services Not Taxable

The determination, while not binding precedent, is noteworthy for its application of the "primary function" test, and as an indication of the obstacles that the Division faces in seeking to expand the scope of the tax administratively. Matter of Nerac, Inc., DTA Nos. 822568 & 822651 (N.Y.S. Div. of Tax App., July 15, 2010).

Under Tax Law § 1105(c)(1), sales tax is imposed on:

[t]he furnishing of information by printed . . . matter . . ., including the services of collecting, compiling or analyzing information . . . and furnishing reports thereof to other persons, but excluding the furnishing of information which is personal or individual in nature and which is not or may not be substantially incorporated into reports furnished to other persons. . . .

Existing regulations provide only limited guidance as to what constitutes an information service (e.g., a weekly newsletter containing commodities prices or the furnishing of a list of potential customers' telephone numbers).

Nerac is a research and advisory firm that provides technical, scientific and engineering research and tracking services to its clients. As part of those services, it furnishes written reports in response to specific client requests for solutions and advice. The reports are prepared by the firm's team of scientists, engineers, and other professional analysts, most of whom have notable professional credentials and advanced educational degrees. Nerac charges clients a flat subscription fee to be able to consult with these analysts, and in most cases the analysts prepare a written research report at no extra charge.

The reports are prepared in response to specific client inquiries. In conducting their research, Nerac's analysts have access to more than 100 public and private databases.

The Division assessed sales tax against Nerac, claiming that sales tax should have been collected on the total subscription fees. It argued that Nerac was providing its clients with a taxable information service, or at a minimum was providing them with some information services as part of a "bundled transaction" consisting of both taxable and nontaxable services. The Division claimed that since Nerac did not break down the allegedly taxable component of the total charge, the entire "bundled charge" was taxable.

The ALJ in Nerac held that the furnishing of the research reports was not a taxable "information service," but rather a nontaxable consulting service. While the reports necessarily contained "information," the ALJ concluded that the "primary function" of the reports was to provide solutions or advice in response to specific client problems and questions. Since this did not merely involve the retrieval, compilation and furnishing of information, it was not an enumerated taxable service under the sales tax:

To be sure, [Nerac's] clients receive information, in the form of citations to scientific and technical papers, studies and reports derived from the Analyst's research efforts. . . . However, to conclude that the client's receipt of information in this fashion is enough to make [Nerac's] business a taxable information service leaves the Analysts as mere conduits who simply find and funnel raw data or information to the clients. This view ignores the critical role of the Analysts and the value of their expertise, education and experience in the process of resolving clients' problems.

The ALJ also held that even if Nerac was furnishing "information" – which he held it was not – the services would still not be taxable because it qualified for the exclusion for information that is "personal or individual in nature" and not capable of being "substantially incorporated" into the written reports furnished to other clients. The ALJ rejected the Division's contention that the "personal or individual" exclusion did not apply because the information was obtained from "common databases," and therefore was capable of being furnished to more than one client. The ALJ noted that each client inquiry was unique and specific. Moreover, to impose sales tax based on the possibility that information furnished in response to one client inquiry might appear in a report furnished in response to another client inquiry would have the effect of completely removing the word "substantially" from Section 1105(c) (1) (which excludes from sales tax information that is not capable of being "substantially incorporated" in another client's report).

Additional Insights

The Division did not file an exception with the Tribunal, so the ALJ determination is final. Nerac can be viewed as a significant rejection of the Division's attempt to expand the definition of taxable "information services" to what are essentially consulting services. The determination takes on added significance in light of the Division's somewhatConsulting Services Not Taxablecontroversial recent pronouncement regarding the taxation of information services, released just days after Nerac was decided. "Sales and Compensating Use Tax Treatment of Certain Information Services," TSB-M-10(7)S (N.Y.S. Dep't of Taxation & Fin. July 19, 2010).

The holding in Nerac may call into question the position taken in the TSB-M that under the "primary function" test, the purpose for which the purchaser seeks the services is irrelevant. Indeed, Nerac suggests that it is necessary to look to the function as a whole, and therefore one cannot ignore what the purchaser is seeking. That view seems fully consistent with the Tribunal's decision in Matter of SSOV '81 Ltd., DTA Nos. 810966 & 810967 (N.Y.S. Tax App. Trib., Jan. 19, 1995), where a dating referral service's furnishing of print-outs of member profiles containing information was found not to be an information service because the taxpayer's primary business function was not the furnishing of information. While TSB-M-10(7)S contains a list of taxable information services (e.g., the furnishing of stock market reports and forecasts), it leaves unanswered the important question of how the "primary function" test should be applied with respect to those enumerated services.

Also seemingly inconsistent with Nerac, and questionable as a matter of law, is the statement in TSB-M-10(7)S that "furnishing information created or generated from a common database, or information that is widely accessible, is a taxable information service." It is doubtful that the use of a common database, without more, should be sufficient to support a finding of a taxable information service.

Executives Beware: Responsible Officer Liability

By Hollis L. Hyans

In Matter of David Steinberg, DTA No. 822971 (N.Y.S. Div. of Tax App., Sept. 9, 2010), an Administrative Law Judge held the petitioner, a founder and Chief Executive Officer of a publicly traded company, to be personally liable for the company's outstanding sales and use tax. While the legal principles may be unremarkable, the case stands as a reminder to senior executives that they remain personally liable for unpaid taxes, even in a large company with many employees, and the risks of responsible officer liability are not limited to those who operate small businesses.

New York law, like that of most other states, imposes personal liability for any sales tax that was or should have been collected. The class of persons who can be held personally liable "include[s] any officer, director or employee of a corporation or of a dissolved corporation, any employee of a partnership, any employee or manager of a limited liability company, or any employee of an individual proprietorship who as such officer, director, employee or manager is under a duty to act for such corporation, partnership, limited liability company or individual proprietorship . . . and any member of a partnership or limited liability company." Tax Law § 1131(1). The many cases dealing with responsible officer liability provide that simply holding the title of corporate officer does not necessarily impose personal liability, and that each case must be determined based upon the particular facts and circumstances. The cases have considered...