The Tax Man Cometh – Even for Research Providers

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New York, NY – As fiscal troubles deepen across most of the U.S., many states are desperately seeking ways to collect more tax revenue from sources never targeted before.  This is clearly the case with some states considering whether to charge sales taxes on internet sales – much to the chagrin of internet merchants like Amazon.com.  However, some financial market participants are reporting that the State of New York is now setting its sites on collecting sales tax from investment research providers, a move that could have a significant impact on the investment research industry.

It is important to note that the following blog should not be construed to be tax advice for any particular company or their specific business.  Firms should seek the advice of their own accountants or tax advisors to determine whether or not their products or services are subject to sales tax.


Sales Tax on Products Not Services

Traditionally, most states have charged consumers sales tax on “products” not “services” including services that are customized for the individual user.  In other words, you did not have to pay sales tax on a dentist visit (a customized service), though you would have to pay sales tax on dental floss, toothpaste, or a toothbrush.  States historically have required the sellers of these products to collect the sales tax from consumers.

In 1992, the U.S. Supreme Court ruled in Quill v. North Dakota, that only sellers with a physical presence (or “nexus”) in a state are required to collect that state’s sales taxes.  Just shipping a product into a state isn’t enough to establish a nexus. Consumers still owe the sales tax (also known as a “use tax”) to their states, but few ever pay this tax.  Internet merchants like Amazon.com have historically been able to exploit these rules to avoid having to charge customers sales tax, while bricks and mortar merchants selling the same products to the same consumers have been required to charge sales tax on their goods.


New York Issues Clarification for Information Services

On July 19, 2010 the New York State Department of Taxation and Finance issued guidance on the sales and use tax treatment of information services.  In general, only services that have as their primary function the provision of information are taxable.  The New York State Department of Taxation and Finance will determine a service’s primary function based on an examination of the nature of the services being sold.  Based on this approach, a service is taxable as an information service if its primary function is one of the following: 

  • Advertising rate reports for a given medium or market
  • Consumer product reports, including product evaluations
  • Credit monitoring services
  • Directory and mailing list services
  • Employment history reports
  • Employment placement reports and employment registries (but not charges to merely post information)
  • Information furnished by credit reporting bureaus
  • Internet-based data and Web search services (e.g., Internet entertainment information services, Internet sports information sites, Internet newsletters, and Internet search portals)
  • Investment reports and services (including stock market quotes and forecasts, and mutual fund rating services)
  • Newsletter subscriptions
  • Patent search services (unless provided by an attorney)
  • Public records furnished by a private entity
  • Real property information databases
  • News reporting services

The above list IS NOT considered to be exhaustive, but merely for explanatory purposes.

This clarification on the part of the New York State of Taxation and Finance last summer, was a clear indication that information services are subject to sales tax.  It is also clear from this list that New York feels that investment research reports and newsletter subscriptions are taxable services.


Sell-Side Response

As you might guess, Wall Street did not want to be subject to charging New York domiciled clients sales tax on sell-side research, nor did it want to be subject to any sales tax liability for the past.  Consequently, the industry aggressively argued its case to New York State that it should not have to charge sales tax for its research. 

While we don’t know for sure, we would guess that some of the arguments used by the industry include that sell-side research is bundled with execution, making it impossible to determine what value should be ascribed to the execution and what should be ascribed to the research.  In addition, the industry probably argued that sell-side institutional research is largely customized to the needs of individual clients, and therefore should not be subject to sales tax as it is more of a consulting service rather than a published service.    

We have heard from various sources that Wall Street ultimately succeeded in its efforts and the New York State of Taxation and Finance has decided not to require sell-side firms to have to charge clients sales tax for its research product.


Indies Not So Lucky

However, it is our understanding that independent research providers have not been so lucky with the sales tax issue.  In fact, we have received calls from a few firms that have been approached by New York state regarding sales tax owed for the sale of their research to customers in New York.

Unfortunately, most independent research firms cannot rely on the same arguments used by the sell-side to avoid this obligation.  First, many (though not all) indie research providers don’t bundle their research with execution, and they have a defined subscription price for their research making it clear what clients should pay sales tax on.

However, most indie research firms are not registered broker-dealers or investment advisers.  Consequently, we would think these firms’ primary services would have to be considered “published information services”, not customized or personalized advisory services.  In fact, we wonder if indie research providers who try to make the argument that their research services are primarily customized advisory services and not really published research reports, won’t get into hot water with regulators for acting as investment advisers without being registered as such.

The Upshot

As we said earlier, this blog is not meant to provide tax advice to any particular research provider, but rather to raise a topic that could have significant ramifications for a large portion of the research industry.  The big question for research providers who have clients in New York state is whether your research qualifies as an “information service” as discussed above that should be subject to sales tax, or whether you provide a customized or personalized service which is typically not subject to sales tax.  Unfortunately, we suspect that the tax man will be visiting a large number of independent research providers in the coming months to discuss this very topic.

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