MoFo New York Tax Insights - Volume 6, Issue 12, December 2015

NYC TRIBUNAL REJECTS CLAIM THAT FIRST AMENDMENT REQUIRES USE OF AUDIENCE FACTOR FOR SOURCING RECEIPTS FROM CREDIT RATINGS

By Irwin M. Slomka

The New York City Tax Appeals Tribunal, reversing an Administrative Law Judge decision, has held that McGraw-Hill does not have a First Amendment right to source its credit ratings receipts for New York City general corporation tax purposes using an "audience-based" methodology similar to that available to publishers and broadcasters. The City Tribunal also rejected McGraw-Hill's claim that the receipts in question were "other business receipts," sourced to where the receipts are "earned," rather than arising from the performance of services and sourced to where the services were performed. Matter of The McGraw-Hill Companies, Inc., TAT(E) 10-19 (GC) et al., (N.Y.C. Tax App. Trib., Oct. 28, 2015).

Facts. McGraw-Hill, through its Standard & Poor's ("S&P") division, operates a credit rating agency to provide ratings, risk evaluations, and investment research. Debt issuers hire S&P to prepare credit ratings for use by investors, intermediaries, and the issuers themselves. S&P employs approximately 1,200 analysts who prepare the ratings. Upon approval by an S&P ratings committee, the ratings are communicated to the issuer, and then usually made public on the S&P website to registered users free of charge. The issuers, rather than the website users or investors, pay S&P for providing the credit ratings, usually based on a percentage of the offering amount, and also pay for followup monitoring.

For the tax years 2003 through 2007, McGraw-Hill filed general corporation tax ("GCT") returns, and in its receipts factor treated the credit rating fees of its S&P division as from the performance of services, sourced based on a place-of-performance method. In 2009, McGraw-Hill filed amended GCT returns, requesting refunds for those years totaling approximately $35 million. The refund claims were based on sourcing the credit rating receipts, which McGraw-Hill now reported as "other business receipts," to "customer" locations. The Department of Finance ("Department") disallowed the refund claims on the grounds that the credit rating fees were from the performance of services, sourced based on where the services were performed. McGraw-Hill filed its 2008 GCT return consistent with the receipts factor reported in its amended returns and, following an audit, the Department issued a Notice of Determination for $3.2 million, also sourcing the credit rating fees based on place of performance.

ALJ decision. After an administrative hearing, in February 2014 the Chief ALJ held that, on First Amendment grounds (pertaining to freedom of the press), McGraw-Hill was entitled to a discretionary adjustment to source its credit rating receipts using an audience-based allocation methodology. The Chief ALJ held that as a financial information publisher, McGraw-Hill's S&P division "was entitled to the same [First Amendment] protections afforded other members of the press." She cited McGraw-Hill, Inc. v. State Tax Commission, 75 N.Y.2d 852 (1990), where the Court of Appeals affirmed a decision of the Third Department, holding that the State of New York could not for Article 9-A purposes source McGraw-Hill's revenues from advertisements in its magazines based on place of performance because this represented differential treatment between the print media and the broadcast media, in violation of the First Amendment. She also concluded that S&P's credit rating fees constituted "other business receipts" under Admin. Code §11-604(3)(a)(2).

Tribunal decision. The City Tribunal reversed the Chief ALJ's decision, and in doing so rejected each of McGraw- Hill's three principal arguments. First, the Tribunal held that the denial of use of an audience method did not violate McGraw-Hill's First Amendment rights. It addressed the First Amendment implications of the U.S. Supreme Court decision in Leathers v. Medlock, 499 US 439 (1991), which rejected a First Amendment challenge to...