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In an advisory opinion this week, the Department of Taxation and Finance (the “Department”) found that a Virginia corporation (“VirginiaCo.”) headquartered in Pennsylvania that did not have a physical sales location in New York but used 16 independent contractors located in New York was subject to the business corporation franchise tax in New York.  Before proceeding to discuss the main findings of the opinion, below is a brief overview of the business corporation franchise tax in New York.

Overview of New York franchise tax on business corporations

New York imposes the business corporation franchise tax on domestic and foreign corporations for the privilege of exercising its corporate franchise, doing business, employing capital, owning, or leasing property in New York in a corporate or organized capacity. Franchise tax is also imposed if a corporation maintains an office in New York. However, New York law does not deem a foreign corporation to be conducting any of the activities that would subject it to New York franchise tax if its only New York activities are fulfillment services provided by an independent contractor (the “Fulfillment Exception”).

What is included in the definition of “fulfillment services” is key to determining the application of the Fulfillment Exception. Fulfillment services in New York generally include accepting orders by electronic means or mail, responding to customer inquiries electronically or by mail, conducting billing or collection activities, or shipping orders from an inventory of products offered for sale.

Additionally, a foreign corporation will not be considered to have engaged in taxable activities in New York merely by reason of sales or the solicitation of orders for tangible goods in New York by an independent contractor.

All these exceptions make it initially appear fairly easy for businesses to avoid the New York franchise tax by using independent contractors to run their fulfillment operations within New York. Unfortunately, based on this recent advisory opinion, escaping the broad reach of the New York franchise tax is not as simple as it may initially appear.

Facts and findings of the advisory opinion

VirginiaCo. shipped products by a common carrier to its independent contractors who would store and treat the products as inventory. These contractors were responsible for the products shipped into New York and held the products at locations located throughout New York. The contractors sold the products on a consignment basis on behalf of VirginiaCo. Furthermore, the contractors made in-person sales visits and sold VirginiaCo.’s products at the customer’s site, wrote orders at the customer’s site, and accepted and sent credit information to VirginiaCo. VirginiaCo. would then decide whether to approve the customer’s credit application, approve the sale and then bill the customer.

The Department found that VirginiaCo. failed to avoid being subject to New York corporate franchise tax for several reasons. First, VirginiaCo. retained title to the inventory located in New York. This gives VirginiaCo. nexus because the consignment arrangement resulted in VirginiaCo. owning property in New York.  Second, the services provided by the contractors did not fall into the fulfillment services exception. The contractors did more than accept or ship orders in New York -- they made sales visits, processed orders and physically delivered VirginiaCo.’s products. Finally, because the contractors were doing more than just soliciting orders for sales in New York, it did not satisfy the mere solicitation exception described above.

Note that advisory opinions are not binding on anyone other than the petitioner. If your business is currently conducting activities in New York through independent contractors, it would be prudent to evaluate your activities to ascertain if the advisory opinion discussed above could negatively impact your operations in New York, thus subjecting your business to the New York business corporation franchise tax.