Background
The Court of Appeals of New York, the highest court in the state, recently affirmed the taxability of certain advertising related research services in Matter of Dynamic Logic, Inc. v Tax Appeals Trib. of the State of New York. The opinion, dated April 17th, involved Dynamic Logic’s (“Dynamic”) AdIndex service. Dynamic sells AdIndex to customers seeking to measure the efficacy of their advertising campaigns. It does so by conducting surveys, which are a mix of general questions about the respondents along with inquiries about the specific campaign. The results are compared against broader market-based data contained in another Dynamic product called MarketNorms. Dynamic generates reports and recommendations for the client based upon the results of this survey and comparison to the MarketNorms benchmark. Importantly, the results of each AdIndex report are incorporated (albeit on an anonymized basis) into the MarketNorms database. MarketNorms itself is also a stand-alone product sold to clients.
Taxability of Information Services
The court’s decision hinges on the definition of taxable information services found in N.Y. Tax Law § 1105(c)(1). That section reads, in pertinent part, that taxable information services includes “…[t]he furnishing of information by printed, mimeographed or multigraphed matter or by duplicating written or printed matter in any other manner, including the services of collecting, compiling or analyzing information of any kind or nature 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 in reports furnished to other persons.”
Dynamic was assessed in 2014 by the Commissioner of Taxation and Finance (the “Commissioner”). It exhausted its administrative appeals, losing every step of the way, and sued in the Appellate division seeking to annul the decision. It likewise lost at that stage and appealed to the Court of Appeals.
The Majority Opinion
The majority spent the initial part of its opinion determining the appropriate standard of review for the Appellate division’s decision. It determined that the determination should be upheld so long as it was rational and supported by substantial evidence.
The majority then parsed the definition of taxable information services found in the statute. The majority briefly considered whether the AdIndex service met the general description of an information service in the first clause of the definition, noting that the core purpose of AdIndex was data analysis and that any advice or recommendations included in the AdIndex reports was ancillary to this core purpose. Its focus, rightly, was on the exclusion in the latter part of the statute that applied to information that was both “personal and individual in nature” and which “is not or may not be substantially incorporated in reports furnished to other persons.” Both parties to the litigation conceded that the AdIndex report information was personal and individual in nature; that is, it was derived from information about a specific client’s campaign. Thus, according to the majority, Dynamic’s entitlement to the exemption hinged upon whether it was substantially incorporated in reports furnished to other persons (via its inclusion in the MarketNorms database, which both informed future AdIndex sales and was sold as a separate stand-alone product, albeit with minimal sales).
The majority then considered whether the information in the AdIndex reports is substantially incorporated in reports furnished to others, noting that the taxpayer bears the burden of establishing that an exclusion such as this one applies in order to overcome a presumption in favor of the taxing power. Dynamic argued that “substantial” meant that the data had to be incorporated “to a great extent or degree” into reports that followed. The Tax Appeals Tribunal (“Tribunal”) countered that the “substantial” test was met so long as the information that was subsequently blended with other data represented a valuable addition to later reports.
The majority found that the word substantial was somewhat vague and looked to interpretations of the word in other contexts. It noted that various interpretations of the word from the Supreme Court (substantial means “…justified to a degree that could satisfy a reasonable person), the Court of Appeals itself (the word substantial imposes a minimal requirement, less than a preponderance) and the Federal Rules of Civil Procedure (substantial does not mean “justified to a high degree”) to interpret a relatively low standard for the critical word at issue. Further, the Black’s law definition of substantial at the time 1105(c)(1) was enacted suggested that anything with more than nominative qualitative value would be considered substantial.
In light of this relatively low threshold to meet substantiality, the Court of Appeals found that the Tribunal’s interpretation that AdIndex data was substantially incorporated into subsequent reports was a reasonable one, noting “…[t]his reincorporation of data represents an appreciable portion of each subsequent report, without which there would be no ability to compare a client’s campaign to any baseline data.” The majority acknowledged that the reincorporated data in later reports was a small part of these later reports, but nonetheless noted that this data was qualitatively important to the analytical value of these reports.
Finally, the majority considered whether its opinion would be different if it adopted Dynamic’s interpretation of “substantial incorporation” to mean inclusion to a great extent or degree. It concluded that it would not, largely because of the inclusion of the data in the MarketNorms database that was sold as a stand-alone product.
Forvis Mazars Insight: The majority opinion shows once again the value that the principles of statutory construction can play in interpreting a nominally vague statute; such principles should almost always be considered in applying a statute.
A Vociferous Dissent
The dissenting opinion thinks that the critical clause, “…which is not or may not be substantially incorporated in reports furnished to other persons,” is plain and unambiguous and as a result would not apply principles of statutory construction to it. It cites to regulations that the Division of Taxation and Finance (the “Division”) promulgated with illustrative examples as to when the exception would apply. These examples stand for the proposition that by looking at the report in question, one can determine whether it may be incorporated into reports furnished to others. As the dissenting justice phrased it, one must determine whether, “…the specific information furnished to one customer may be substantially incorporated in reports furnished to others.”
The dissent notes that, per the factual record, the answers to eight basic questions are used to determine the ad campaign’s performance across various demographics. It is the answers to these questions – and not the more customized survey questions – that is aggregated, anonymized and incorporated into MarketNorms and used in subsequent reports. It minimizes the role that the MarketNorms based demographic data plays in the AdIndex reports.
It also took issue with the deferential standard that the majority applied to the statutory exclusion, claiming that such deference is only appropriate in instances where the statutory language is ambiguous. Courts should give effect to the plain meaning of the statute, on the other hand, when the statute is clear and unambiguous. It disputes the premise that any AdIndex report could be substantially incorporated into a report issued to another client. According to the dissent, any institutional knowledge that was somehow reflected in subsequent reports could be construed as a substantial incorporation; such an interpretation, according to the dissent, renders the exclusion meaningless. Finally, it also notes that the clause in question has typically been interpreted to require taxation when there is “substantial overlap” between the information contained in differing reports; such substantial overlap is missing in the instant case. It dismisses the premise that the MarketNorms data common to the multiple reports, characterized as the average performance of unnamed anonymous advertising campaigns, can rise to the level of such substantial overlap.
Forvis Mazars Insight: The dissent raises some interesting issues, namely as to whether the statutory language in question can be considered ambiguous. In the absence of some sort of percentage standard defining the term, however, it seems like the critical term is open to interpretation. The majority’s standard of review – whether the underlying decisions are rational and supported by substantial evidence – raises the question as to whether it would have affirmed a taxpayer favorable decision below as well given the ambiguity.
How Forvis Mazars Can Help
Many services exist on a continuum between pure professional services on one end (such as legal services or management consulting services) and information services on the other end (such as a generic database made available to a broad client base). Prior experience certainly informs any services provided, even to those on one end of the spectrum. To the extent that this prior experience is provided in some sort of tangible or written form to one client and then subsequently re-used with other clients (such as the results of studies used in performing services for other consulting clients), a risk may exist that state taxing authorities could deem this a taxable information service. Forvis Mazars can help you identify potential vulnerabilities in your service offerings and consider remediation and risk reduction alternatives.