Broker-Dealer Successfully Fights Look-Through Sourcing in New York

An administrative law judge in the New York State Division of Tax Appeals rejected the New York State Division of Taxation’s use of a look-through approach for sourcing fees paid to a broker-dealer for marketing, recordkeeping, and support services.  The April 28, 2022 determination in Matter of TD Ameritrade, Inc., confirms that such fees are properly sourced to the location of the customer responsible for payment, in this case two banks.

TD Ameritrade offered its brokerage clients a cash sweep option in which excess cash in the brokerage account would be transferred daily to an insured deposit account (IDA), where it would earn interest.  IDAs were maintained by TD Bank, N.A. or TD Bank USA, N.A., two national banks headquartered in New Jersey that were operated and managed independently from TD Ameritrade.  Excess cash in the IDAs was aggregated in a single omnibus account.

The banks contracted with TD Ameritrade for services related to the IDAs.  TD Ameritrade maintained for the banks books and records, including daily balances, accrued interest, and brokerage client names, addresses, and social security or tax identification numbers; provided independent auditors, examiners, and regulatory authorities access to the books and records; and maintained an emergency backup system for the books and records.  It also provided the banks with reports in connection with their asset/liability management and forecasting programs.  In exchange for such services, the banks paid TD Ameritrade a fee based on the weighted average yield earned on the client IDA balances, less interest paid to clients, an annual servicing fee, FDIC deposit insurance costs, and certain other adjustments.

For purpose of computing the receipts factor, New York’s broker-dealer rules in effect for the tax years 2012-2014 sourced the fees at issue to the “mailing address in the records of the taxpayer of the customer who is responsible for paying” the fees.  The Division claimed the fees had to be sourced to the location of the brokerage clients.  The Division argued that brokerage clients were “responsible for paying” because the fees were based on the total yield earned on cash in the IDAs.  The ALJ squarely rejected that argument.  The ALJ found that the banks were TD Ameritrade’s customers and the banks incurred and paid the fees for TD Ameritrade’s marketing, recordkeeping, and support services.  Because the banks were responsible for paying the fees, the fees had to be sourced to the location of the banks in New Jersey.

Look-through sourcing, i.e., sourcing receipts to the location of the customer’s customer, is gaining popularity with state taxing authorities, particularly when the taxpayer’s customer is located outside the taxing jurisdiction.  As Matter of TD Ameritrade, Inc. illustrates, whether a look-through approach is appropriate obviously depends on what the relevant statutes say.  In most cases, the source of the funds used to pay a service provider’s fees should not have any bearing on sourcing.

The case is Matter of TD Ameritrade, Inc., DTA No. 829523 (Apr. 28, 2022).  The determination is available here.