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New York’s Corporate Nexus & Apportionment Rules—Review & Update (Part 2 of 2)

Mark S. Klein and Daniel P. Kelly
Published Date:
Apr 1, 2018

This article is the second in a two-part series about New York’s corporate nexus and apportionment rules. To read the first part published in the March 2018 TaxStringer, please click here.

We’re back to continue our discussion regarding the implementation and development of New York’s 2015 corporate tax reform.  Even though the law is nearly four years old, both tax practitioners and tax administrators struggle to provide form to the framework created by the new law. In this regard, the New York State Department of Taxation and Finance (the “Tax Department”) has worked hard to produce return instructions, draft regulations, and other guidance on the new laws, and practitioners have written numerous articles and commentary regarding them. As noted in March’s TaxStringer, however, questions still abound. This article explores two different topics in detail: issues companies face applying the New York receipt allocation “hierarchies,” and the Tax Department’s evolving draft regulations.

New York’s Market-Based Sourcing for Services—Questions and Complexities

Let’s start with what we know, and what we can be thankful about: the sale of tangible property is still pretty straightforward. Where is the property headed when it leaves the factory or warehouse? Documenting and proving this answer is usually—but not always—straightforward. Note, however, that one gray area continues to be situations in which tangible property is delivered to a regional warehouse in State A for eventual distribution by the customer to locations in States A – H. Is the receipt a State A receipt or a multiple-state receipt?

A key objective behind New York’s 2015 corporate tax reform was to provide clarity and consistent methods to source receipts from “unclassified” transactions, services, and digital products. This goal was set to be accomplished through a statutory tiered hierarchy that on its face provides little wiggle room with these receipts. The hierarchy is set, and service and “other business” receipts are sourced to New York:

  1. If the “benefit is received” in New York.
  2. If (1) is unknown, then if the delivery destination is in New York.
  3. If (1) and (2) are unknown, then the receipts are sourced to New York using the taxpayer’s prior year’s apportionment fraction for such receipts, or
  4. If (1) and (2) are unknown, and (3) does not apply, then the receipts are sourced to New York using the current taxable year’s apportionment fraction for the taxpayer’s receipts that can be sourced using (1) or (2).[Tax Law section 210-A(10)(a), (b)].

Receipts from the sale of digital products are apportioned to New York using a similar hierarchy.

Those familiar with the apportionment worksheets attached to New York Forms CT-3 and CT-3S (Part 6) know that applying this hierarchy takes a fair deal of concentration and, without final regulations, educated guessing. To raise the stakes, we have seen situations under the new apportionment regime where inaccuracies in completing the business apportionment worksheets has resulted in the issuance of bills for additional tax due, with the Tax Department assuming a New York business allocation percentage of 100%. This certainly does not accomplish the legislature’s goals!


Besides the technical difficulties and complexities in the new corporate tax returns, there are a number of practical concerns that, on balance, make life less certain for taxpayers required to source receipts from “unclassified” transactions, services, and digital products to New York. Looking at the hierarchy noted above, answers to several key questions are not obvious. What is the “benefit” of a service?  Where is a service “delivered”? How often will a taxpayer be able to tell where a service is “delivered”, but not be able to tell where its “benefit” is received? Do these rules line up with other states the company does business in? If you or your clients are asking these questions in the many complex situations that arise in the ordinary course of multi-state business, you’re not alone.

Arriving at the Correct New York Apportionment – The Tax Department Issues, and Revises, Draft Regulations

In an effort to address the many questions around the new regime for apportioning unclassified service and digital products receipts, the Tax Department issued draft broad-based regulations covering the new apportionment regime and several related issues. The most recent version of the draft regulations is available here. Here are some of the key concepts reflected in the current draft regulations.

A. Performing Due Diligence While Moving through the Hierarchy. When corporate taxpayers thinks “due diligence,” they probably think “expensive” or “risk.”  And per new Section 210-A and the draft regulations, you realize that before cascading down from one level of the apportionment hierarchy to another, the taxpayer must first stop and make sure that the jump is warranted (and, as the theory goes, is not just to reduce the taxpayer’s New York source receipts).  To exercise “due diligence” when moving down the hierarchies, a corporate taxpayer must apply the following standards per the draft regulations:

  • The taxpayer must base its application of the regulatory standards for moving through the hierarchy on objective criteria.
  • The taxpayer should consider all sources of information reasonably available at the time of filing its original tax return (including the taxpayer’s books and records, contracts, or agreements with customers).
  • The taxpayer’s method for sourcing receipts must be determined in good faith, applied in good faith, and applied consistently with respect to similar transactions.
  • The taxpayer must retain records that explain the determination and application of its method of sourcing receipts.
  • Before a taxpayer moves on from a step in the hierarchy, the taxpayer must document the steps taken to apportion receipts at that level (and the taxpayer must retain such documentation). If a taxpayer moves down a tier only because “its existing systems of recording transactions or the current format of its books and records do not capture the information required by these rules,” the taxpayer has not satisfied the standard of due diligence.
  • In applying the due diligence standards, taxpayers may, in good faith, rely on information provided by their customers (this was added to the second version of draft regulations). See Draft 20 NYCRR sections 4-2.15(a)(2).

If you are an accountant who just let out a slow sigh, we feel you. What is an accountant, internal or external, supposed to do here?  It would be easiest if there was no need to move from one level of the hierarchy to another, or if the source of receipts in the first category was always clear, but muddy situations will occur. The goal of “clarity and certainty” is undercut by the due diligence requirements, which seem onerous. 

According to the draft regulations, sourcing unclassified transaction, services, and digital products receipts may require a consideration of sources other than just the books and records.  The revised draft regulations added “including [the taxpayer’s] contracts or agreements” to the ordinary books and records a taxpayer was required to look to in completing its diligence. We suspected this could be the case a few years ago when the first draft was published, and this is clearly the direction the Tax Department is pursuing. This standard of proposed “due diligence” could be remarkably complex for different taxpayers, due in part to common business realities. A taxpayer could have the same boilerplate contract with all its customers, or it could have different contracts with each of its customers.  More and more these days, a services agreement could apply to a scattered workforce as well as to employees, property, services, etc. across the globe. And even though the revised draft regulations specifically allow a taxpayer to rely in good faith on information provided by customers, is it realistic to ask questions of customers on an annual basis, and will the customer grow tired of pesky New York tax interrogatories or be concerned about getting something wrong?

B. Presumptions & Overcoming those Presumptions under the Draft Regulations. On the heels of the due diligence requirements in the draft regulations are a series of definitions or presumptions taxpayers can use when applying the new sourcing hierarchy—and, naturally, ways taxpayers can rebut these presumptions (more “clarity and certainty” in the new framework).

The first level of the hierarchy revolves around where the “benefit is received” by the taxpayer’s customer. The benefit is received “by the taxpayer’s customer where the customer derives the value from a service or other business activity purchased from the taxpayer.” Presumptions under the draft regulations also split where individual and business customers are deemed to receive the benefit of services. Individual customers are deemed to receive the benefit “at the billing address of the customer in the taxpayer’s records.” For business customers, on the other hand, the benefit “is presumed to be received in New York to the extent the taxpayer’s books and records kept in the normal course of business, without regard to the billing address of the taxpayer’s customer, indicate the customer receives the benefit of the service or other business activity in New York.” Draft 20 NYCRR sections 4-2.15(c)(1)(i), (ii).

Like every good presumption, those included in the draft regulations can be rebutted by both taxpayers and the Tax Department alike. In the first version of the draft regulations published in October 2015, a taxpayer could overcome a presumption and use alternative apportionment if the taxpayer proved, by a preponderance of the evidence, that the method it proposed more accurately sourced the receipts under the applicable rule of the hierarchy. Amendments to the draft regulations, however, switched the standard of proof to “clear and convincing evidence,” a significant standard of proof many New York practitioners are familiar with. The Tax Department can also overcome presumptions and resort to alternative apportionment by proving, now by clear and convincing evidence, “that the method it proposes to use better reflects the intent of the applicable rule of the hierarchy, and that the taxpayer had access to, or could have obtained upon reasonable inquiries when required, information at the time it filed its original return that could have been used to apply the Department’s method.”  Draft 20 NYCRR sections 4-2.15(a)(3). We ask: Why seek certainly and bright line standards, if alternative apportionment is readily available for both sides? We also wonder if this direct reference to legislative intent will kick start more inquiries in audits and disputes into “legislative history,” which typically only arises when the law is ambiguous or unclear.

C. Linking Due Diligence, the Presumptions, and Approximation – Clarifying the Draft Regulations.  The first draft of the regulations noted, “If, upon examination of the contract between the taxpayer and the taxpayer’s [business] customer, and the taxpayer’s books and records kept in the ordinary course of business, the taxpayer cannot determine where the benefit is received, the taxpayer, in exercising due diligence to determine where the benefit of the service is received, must make reasonable inquiries to the customer.” The revised draft regulations contain a similar statement mandating that taxpayers make reasonable inquiries if the books and records do not provide the answer. In both the first and second versions of the draft regulations, this provision has the potential to be quite onerous. 

To combat some of the strain this rule could visit upon taxpayers, the revised draft regulations contain a new safe harbor. If a taxpayer has more than 250 business customers purchasing substantially similar services or unclassified items, and no more than 5% of receipts from such services or activities are from one customer, inquiries are not required. Draft 20 NYCRR sections 4-2.15(c)(1)(ii)(A)(2). Smaller taxpayers, with bespoke service offerings: get ready to bother your business customers. Larger taxpayers, with more standard services offerings: you may well fall into the safe harbor (and thus be less annoying to your customers).

Finally, according to the draft regulations, “Where a taxpayer cannot adequately determine the location or locations where the benefit is actually received and/or the percentage of total value received at each location from the taxpayer’s books and records kept in the ordinary course of business, and after making reasonable inquiries to the customer when required, then reasonable approximation must be used to make that determination.” Draft 20 NYCRR sections 4-2.15(c)(1)(iv).  The ability to reasonably approximate can make the apportionment process less onerous, and provide a cap on “due diligence” in some instances.  Reasonable approximation is narrowly available per the draft regulations, and without sufficient information to reasonably approximate, the taxpayer must move down the hierarchy to delivery destination.



As we’ve alluded to in both parts of this article, there’s certainly more in terms of nuance, application, and final determination to New York’s 2015 corporate tax reform than what we’ve addressed here. These two articles highlight some of the evolving issues and decisions taxpayers and representatives face and, through the first round of revisions to the draft regulations, how the Tax Department is appropriately responding to these matters. As you can probably guess, we’ll be back again in a few years with new twists and turns related to New York’s corporate tax reform.

Mark S. Klein is a partner and chairman in the firm of Hodgson Russ LLP. He concentrates in New York state and New York City tax matters. He has over 35 years of experience with federal, multistate, state and local taxation and speaks frequently on tax topics. He can be reached at 716-848-1411 or

Daniel P. Kelly is a senior associate in Hodgson Russ's tax practice area.  Daniel counsels corporations and individuals on a wide range of tax matters, with a focus on New York state, New York City, Florida, and multistate tax planning and controversy.  Daniel is licensed in New York and Florida.

Views expressed in articles published in Tax Stringer are the authors' only and are not to be attributed to the publication, its editors, the NYSSCPA or FAE, or their directors, officers, or employees, unless expressly so stated. Articles contain information believed by the authors to be accurate, but the publisher, editors and authors are not engaged in redering legal, accounting or other professional services. If specific professional advice or assistance is required, the services of a competent professional should be sought.