Much has been written about the New York State Department of Taxation and Finance’s positions on the taxation of software, software as a service (SaaS), and other software-based services. The critiques have concerned, in part, the department’s guidance on the sales and use tax consequences of cloud computing and other service transactions as well as the department’s positions on audit.
While difficult to generalize, it is unquestionable that the department has taken a very intentional stance toward the taxability of services that involve the use of software, the internet, or the provision of information. Services the department has argued are taxable run the gamut from what could generally be described as advertising and marketing services, SaaS, infrastructure as a service (IaaS), analytics services and hosting to some that could be described as consulting services, to name a few. The department’s position is particularly troubling, given that only receipts from sales of services specifically identified in New York tax law are subject to sales tax. See N.Y. Tax Law § 1105(c).
As a general matter, to be taxable under Section 1105(c)(1) of New York State tax law, the service must involve collecting, compiling, or analyzing information. These services are commonly referred to as “information services.” Given the department’s stance on these issues, taxpayers face challenging and contentious audits. Although many articles have focused on cloud computing, this article focuses on the issue of information services in light of a fairly recent case, Wegmans Food Markets Inc. v. Tax Appeals Tribunal of New York, 2017 BL 419635 (N.Y. App. Div., 3rd Dept., November 22, 2017). In that case, the New York Supreme Court, Appellate Division, found that a retailer’s purchase of competitive pricing reports was not a taxable information service, and in that finding swept away years of taxpayer-adverse administrative decisions and audit policies.
What can taxpayers take away from recent victories on appeal that can be applied to ongoing audits?
Answer: Taxpayers are wise to persistently resist aggressive positions by the department when the position is untethered from the controlling tax statutes or the decisional law the department is charged with enforcing. This is true even when the department’s position is supported by departmental guidance or prior decisions of the Tax Appeals Tribunal when the department’s view is inconsistent with a more reasonable interpretation of the tax imposition provision.
The Wegmans Decision
As part of its operations, and in accordance with its pricing strategy, Wegmans Food Markets monitors the retail prices charged by its competitors so as to competitively price its own products. Wegmans contracted with RetailData LLC to perform competitive price audits to determine how much its competitors charge for certain specifically requested retail products. RetailData collected raw data from the grocery stores of Wegmans’ competitors and compiled it into a report according to certain specifications provided by Wegmans. Wegmans then used that report to inform its pricing strategies.
The department asserted that the competitive price reports were subject to tax as an “information service.” As noted above, sales and use tax is generally imposed on the sale of information services, with the caveat that the sale of information “which is personal or individual in nature and which is not or may not be substantially incorporated in reports furnished to other persons” is excluded from tax.
Wegmans argued, contrary to the department’s assertion, that the competitive pricing reports were personal and individual in nature, because the information contained in the reports was based entirely on customized requests. The department focused on the source of the raw data collected by RetailData rather than on the nature of the information contained in the reports. In the department’s view, an information service does not qualify for the tax exclusion if data ultimately incorporated into a report originates from a publicly available source.
The administrative law judge and the Tax Appeals Tribunal affirmed the department’s position that the original source of the data must be personal or individual in nature to qualify for the exclusion. Specifically, the tribunal found that the pricing information that Wegmans purchased from RetailData was obtained from products on the shelves of supermarkets that are open to the public and therefore was neither “uniquely personal” nor confidential.
Wegmans, however, persisted, and on appeal the Supreme Court, Appellate Division, agreed with Wegmans and rejected the tribunal’s conclusion that the pricing reports were subject to tax. The Appellate Division determined that the tribunal had misapplied the test that New York courts historically used to determine whether an information service qualifies for the exclusion.
In prior decisions, courts generally upheld the imposition of tax when furnished reports contained information that was general in nature and derived from a database that was widely accessible to a broad customer base. Applying tax under those circumstances is appropriate because non-customized information derived from a common database clearly lacks the personalization necessary to qualify for the exclusion. On the other hand, the Appellate Division found that prior judicial decisions had not extended the tax to services that used publicly available information to provide a service that is uniquely tailored to meet the specific requirements of each customer. So, consistent with the taxing statute, the judicially developed test delineates a taxable sale of a generalized information service from a nontaxable personalized information service based on the individual characteristics of the service itself and not on the origin of the data incorporated in the service. Accordingly, the Appellate Division rejected the tribunal’s conclusion that the pricing reports were subject to tax, because denying a tax exclusion solely because the information furnished was derived from a public source would defeat the purpose of the exclusion.
Takeaways and Practical Recommendations
The Wegmans decision effectively invalidates years of bad precedent from the Tax Appeals Tribunal that improperly focused on the origin of the data in determining whether an information service is taxable. The decision also reinforces the principle that a statutory exclusion from tax must be strictly construed in favor of the taxpayer; this is particularly relevant in the context of services, which are never subject to sales tax unless expressly stated, whereas tangible personal property is always subject to sales tax unless specifically exempted. It is clear from Wegmans that the department and the Tax Appeals Tribunal have taken opposite approaches—interpreting statutory provisions that apply tax so broadly that virtually nothing escapes and interpreting statutory exclusion provisions so narrowly that virtually nothing qualifies.
We have consistently maintained that taxpayers are wise to resist aggressive positions when the position is untethered from the controlling tax statutes and decisional law the department is charged with enforcing. However, we are fully aware that when taxpayers are faced with a reasonable settlement or the prospect of litigation, they often choose to settle. Such a decision may in fact be prudent in any given audit, but Wegmans is an excellent win for taxpayers faced with information services audits and an important reminder that strong positions are worth fighting for, even if doing so takes a few rounds in the ring. If nothing else, the Wegmans decision represents a clear message to the department that exclusion provisions are intended to curtail the department’s authority to impose tax, and therefore any attempt by the department to nullify or unduly limit an exclusion through creative statutory interpretation will be rejected. Taxpayers are well advised to keep this in mind.
Another illustration of a taxpayer being rewarded for persistence against the department’s improper view of the tax law led to a win before the New York State Division of Tax Appeals in the Matter of SunGard Securities Finance LLC, DTA No. 824336 (February 6, 2014). In SunGard, the department viewed the taxpayer’s service as constituting a license of prewritten software subject to sales and use tax, but the judge effectively overruled the department’s longstanding position on the applicability of sales and use tax to application service providers through the concept of the customer’s “constructive receipt” of software, instead focusing solely on the primary purpose of the transaction.
The judge concluded that the primary purpose of the taxpayer’s product was data processing, which is not taxable merely because it includes a software (or information) component in delivering the service. In SunGard, similar to Wegmans, the taxpayer confidently persisted and eventually prevailed in cases where the department’s position was inconsistent with a more reasonable interpretation of the tax imposition provision.
The Wegmans and SunGard decisions illustrate that when faced with an audit where the department attempts to expand the applicability of an imposition provision at issue in the tax law, taxpayers are well advised to consider forcing the department to defend a dubious position before the Tax Appeals Tribunal or the New York Supreme Court, if necessary, to reach the right result on the law. Often a settlement may be appealing and could be the most efficient outcome, but taxpayers should also consider the implications for future audits and the benchmarking of settlements for future periods when considering whether the costs of litigation may be a wise investment. Although there are certainly increased risks and expenses associated with litigation, resisting an aggressive position by the department that is untethered from the controlling tax statutes and decisional law at all stages of a controversy, including at audit, often results in a far greater benefit.
When negotiating with the department on audit, it is important that taxpayers not defer to departmental guidance or rulings that have gone astray from the explicit provisions of the tax law in how it is interpreted and applied. As Wegmans demonstrated, the department’s policy on any given subject, no matter how longstanding, is meaningless unless it is fully consistent with the statutory text and controlling case law.
Zach Gladney and Matthew Hedstrom are partners at the law firm Alston & Bird.
