At a Glance...

In a surprising development, the New York State Department of Taxation and Finance (the "Department") has filed an exception with the New York State Tax Appeals Tribunal (the "TAT") to the determination issued by the New York State Division of Tax Appeals ("DTA") in the Matter of Catalyst Repository Systems, Inc.1 The filing of this exception means that, for the first time, binding guidance will likely be issued regarding the proper classification and sourcing of receipts for apportionment purposes under Article 9-A of New York's legacy corporate franchise tax regime (the "Tax").


On August 24, 2017, the DTA issued a third2 decision granting a taxpayer victory regarding the proper classification of electronically delivered service receipts in the Matter of Catalyst Repository Systems, Inc.3 Catalyst is a Colorado-based electronic data and document repository corporation that provides litigation support services to its clients. On audit, the Department took the position that Catalyst's litigation support service receipts were not receipts from the performance of services, because no employees, agents, subcontractors or other persons were involved in performing the services in question, and should instead be classified as 'other business receipts.' The Department also argued that Catalyst's receipts were generated as the result of the sale of access to, and use of, its software. These arguments were identical to those raised by the Department in the Matter of CheckFree Services Corporation4 and Matter of Expedia, Inc.

In all three cases, the administrative law judges ("ALJs") determined that there is no requirement – in the statute or regulations – for human involvement in an activity in order to properly classify receipts from the activity as service receipts. In addition, in both the Matter of CheckFree Services Corporation and Matter of Catalyst Repository Systems, Inc., the ALJs (1) rejected the Department's attempt to classify the receipts as derived from the granting of access to, or use of, intangible assets, and (2) concluded that even if the receipts were properly classified as 'other business receipts,' the fees were not earned in New York simply because the client was in New York.

The Department's Appeal

The Department has previously chosen not to appeal the determinations issued in the Matter of CheckFree Services Corporation and Matter of Expedia, Inc. Without an appeal, the determinations were merely binding as between the Department and the two taxpayers at issue, but had no binding effect on audits and appeals between the Department and other taxpayers. Consistent with this approach, the Department has continued to assert that taxpayers who perform electronic services should be required to source the receipts from those transactions based on customer location.

As a result of the exception filed with the TAT in the Matter of Catalyst Repository Systems, Inc., taxpayers and the Department can expect to finally receive a binding determination on this issue.5 The appeal comes at a surprising time, given that the Department has previously chosen to resolve many cases involving this issue through negotiated settlement, and the fact that the New York's 2015 corporate tax reform eliminates the distinction between receipts from services and 'other business receipts,' and moves to a market-based sourcing methodology.

What Does This Mean to You?

If a decision is ultimately issued by the TAT, it will be binding on both taxpayers and the Department, finally providing clear guidance on the proper classification and sourcing of electronic service receipts.6 Taxpayers who have paid Tax based on the "other business receipts" theory and who are actively engaged in an audit on this issue should consider the impact of this appeal, and the role it may play in settlement negotiations. We remind taxpayers that an adjustment to their business allocation percentage may also have an impact on their computation of their prior net operating loss conversion subtraction pool, computed on the first tax return filed pursuant to corporate tax reform (first return filed on or after January 1, 2015).


1. In the Matter of Catalyst Repository Systems, Inc., DTA No. 826545 (August 24, 2017).

2. See In the Matter of Expedia, Inc., DTA Nos. 825025 & 825026 (February 5, 2015); In the Matter of CheckFree Services Corporation, DTA Nos. 825971 & 825972 (January 5, 2017).

3. Reed Smith's prior client alert on this issue can be viewed here.

4. This case was successfully litigated by Reed Smith's New York office.

5. While we believe it is unlikely that settlement will occur, the Department and Catalyst do continue to maintain the ability to settle this matter prior to a decision being issued by the TAT.

6. If the determination in Catalyst is affirmed, the Department cannot appeal the result and the case will be final. However, if the Department prevails before the TAT, Catalyst will have the right to initiate an article 78 proceeding in the Appellate Division of the Supreme Court, Third Department.

This article is presented for informational purposes only and is not intended to constitute legal advice.