United States

New York: ALJ Addresses Sourcing of Receipts from Litigation Support Services under Pre-Reform Law

Sep 11, 2017
From KPMG TaxWatch

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An Administrative Law Judge (ALJ) for the New York Division of Tax Appeals recently addressed whether a taxpayer’s receipts from web-based litigation support services were classified as receipts from sales of services or other business receipts. The taxpayer at issue earned various types of fees from providing web-based litigation support. The taxpayer’s customers, usually legal professionals from around the world, used the Internet to access their documents housed on the taxpayer’s system. This enabled customers to review documents, perform electronic discovery, query information, and perform other tasks. Almost all of the taxpayer’s employees and infrastructure (including servers housing its software) were in Colorado. Under New York law in effect at the time, service receipts were generally sourced to the location where the services were performed. Receipts classified as “other business receipts,” on the other hand, were sourced to where the receipts were earned. On its returns, the taxpayer took the position that its receipts were service receipts sourced to Colorado where the services were performed. On audit, the Division took the position that because there was no human involvement in the transactions that generated the receipts and the taxpayer was simply providing access to software, the receipts could not be considered “service receipts” and therefore must be treated as “other business receipts.” Under the rules for sourcing other business receipts, the receipts attributable to New York customers would be treated as New York receipts.

The ALJ rejected the Division’s position and concluded that the taxpayer was a service provider whose system helped corporations and counsel manage electronic discovery and other complex matters. The taxpayer’s clients did not pay the taxpayer to simply host their documents on servers or pay a fee to access software. Rather, they paid for the use of the taxpayer’s overall system, which included its proprietary software and the use of its technical personnel in order to acquire, store, sort, filter, organize and ultimately find and retrieve the required documents. The services at issue were performed in Colorado where the taxpayer’s servers and computer infrastructure, as well as the majority of its employees, were located. The ALJ observed that the legislature amended the law in 2014 to adopt a market-based approach for service receipts. This law change would have been unnecessary if the Division’s interpretation was correct. As an ALJ decision, the case carries no precedential weight and it is not yet clear whether the Division will appeal to the Tax Appeals Tribunal. Please contact Russ Levitt at 212-872-6717 with questions on In the Matter of Catalyst Repository Systems, Inc.

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The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.