Two New York Administrative Law Judges Reject Imposing Sales Tax When ‘Primary Function’ Isn’t Information Service | Vide Rome LLP
Two recent New York State decisions illustrate the importance of the “primary function” test in determining New York State sales tax liability, both involving service tax of information. Applying this test, two separate administrative judges (“ALJs”) ruled that the State of New York could not impose sales tax, in one case, on an online lending market and, in another, on reports assessing potential environmental risks to real estate. In re LendingTree, Inc. (NY Div. of Tax App. DTA No. 829714, December 9, 2021); In re Lender Consulting Servs., Inc. (NY Div. of Tax App. DTA No. 829198, December 2, 2021).
Taxability of the online loan market
In re LendingTree, Inc. involved an online lending marketplace that allowed potential borrowers seeking mortgages and other loans to be matched with participating lenders seeking qualified borrowers. Through its online platform, LendingTree obtained loan application forms from borrowers, which it then verified and conducted a limited investigation of the borrower’s credit score. This information has been forwarded to participating lenders. The lender could then communicate a conditional offer to the prospective borrower.
LendingTree charged lenders a “matching fee” to match a lender with a potential borrower, as well as a “closed loan fee” for loans that were actually closed, although it did not charge any ” closed loan fees” for mortgages and home equity loans. Borrowers paid no fees. The Department of Taxation has taken the position that Lending Tree’s online loan marketplace services are subject to New York sales tax as taxable information services.
The ALJ concluded, however, that the “primary function” of the service – its “true purpose” – was to facilitate the underwriting of loans by participating lenders, even if information was provided to match lenders. He found that the lending institution did not pay a fee for the information, but rather a commission for the closed loan. Therefore, the ALJ held that LendingTree did not provide an information service and therefore was not required to collect sales tax on its fees.
Taxability of environmental reports
In re Lender Consulting involved taxing reports provided to banks and other financial institutions providing loans secured by commercial real estate who needed to know about potential environmental damage to the property. The environmental reports included a review of government environmental database records. Each level of environmental reporting included a search of the government database, with some environmental reports having attached information reports that Lender Consulting had purchased from others.
The tax authorities argued that the environmental reports were a taxable information service, saying their primary function was the underlying information accompanying the environmental reports, not the summary and opinion portion of the environmental reports.
The ALJ held that in reviewing environmental reports in their entirety, their “primary function” was to provide financial institutions with an environmental professional’s review and opinion of potential environmental risks, not informations. The ALJ ruled that Lender Consulting did not provide a taxable information service and voided the sales tax assessment.
While the two In re LendingTree and In re Lender Consulting are subject to appeal, they are an important reminder that the provision of certain information does not necessarily transform a non-taxable service into a taxable information service. Sales tax should only apply where the “primary function” of what is being sold involves the provision of non-personal or non-individual information, for example, the sale of price data or customer lists. While the controversial decision of the New York Court of Appeals in Wegmans Food Markets, Inc. v. State Tax Appeals Court, 33 NY3d 587 (2019), held that a sales tax “exclusion” must be construed against the taxpayer, the application of the “primary function” test does not involve issues of statutory interpretation, but rather an analysis of what is provided. Sellers must always assess whether the “primary function” of what is being sold is truly a taxable service. The same goes for customers who are charged sales tax on what may not be taxable in the first place.