Three Strikes, You’re Out! New York Has Another Miss in Sales Tax Case Against a Service Provider Under the “Primary Function” Test

An administrative law judge (ALJ) in the New York State Division of Tax Appeals cancelled the New York State Division of Taxation’s notice of determination asserting sales tax on petitioner’s verification services. The October 6, 2022 determination in Matter of Employment Screening Services, LLC, confirms that petitioner’s services are properly characterized as nontaxable information services because this verification report is tailored and customized based upon the specific applicant.

Petitioner offered its clients employment screening services including verification services of a customer’s prospective employee’s social security number, name, address, criminal record, and education. Petitioner accesses various databases to verify background information provided by a client’s prospective employee when applying for a job, including those maintained by the New York State courts system, the New York State Department of Corrections, the National Criminal and Sex Offender Database, and the New York State Department of Motor Vehicles. If different clients request verification of the same applicant, petitioner will perform separate searches. Petitioner does not use any data verified for a client in any other way nor share the data that it verifies for one client with another party. Petitioner did not file sales tax returns during the audit period nor was it a registered vendor for sales tax purposes.

The Division claimed that petitioner’s services are “protective services” subject to sales tax under N.Y. Tax Law § 1105(c)(8). The ALJ justly rejected that argument as impermissibly extending the reach of the statute beyond its intent. The ALJ found that petitioner’s screening services provided some assurance to clients that they are screening out “bad actors,” but that these services can hardly be considered protective services.[1]

The Division also claimed petitioner’s services were a taxable information service pursuant to N.Y. Tax Law § 1105(c)(1), which imposes sales tax on the furnishing of information. That law explicitly excludes taxing information that is personal or individual in nature and that is not or may not be substantially incorporated in reports furnished to other persons. The ALJ was not convinced and referred to Matter of SSOV’81 Ltd.[2] where the Tax Appeals Tribunal (Tribunal) focused on the service in its entirety, as opposed to reviewing the service by components. The Tribunal held that the proper focus should be on the primary function and that the Division cannot dissect the service a business provides into what appears to be taxable events to stretch the application of the law beyond that contemplated by the Legislature. The ALJ determined that petitioner’s clients were principally paying for verification of information provided by job applicants, not finding its clients potential employees. Thus, because the reports petitioner generated are tailored and customized based upon the specific applicant, they are individual and personal in nature.

As the marketplace of goods and services evolves, states have expanded their sales tax by attempting to expand the sales tax base by subjecting new transactions and services to tax.[3] As Matter of Employment Screening Services, LLC illustrates, states’ attempts to expand the reach of sales tax through tax base changes and increasing the number of services and transactions, subject to tax, have not been successful.

The case is Matter of Employment Screening Services, LLC, DTA No. 829702 (Oct. 6, 2022). The determination is available here.


[1] See Matter of Allied Barton Security Services, LLC, Tax Appeals Tribunal (Feb. 6, 2016).

[2] See Matter of SSOV’81 Ltd., Tax Appeals Tribunal (Jan. 19, 1995).

[3] See, e.g., Matter of 1Life Healthcare, Inc., Div. Tax App. (Nov. 10, 2021); Matter of 1Life Healthcare, Inc., Div. Tax App. (Nov. 10, 2021); Matter of LendingTree Inc., Div. Tax App. (Dec. 9, 2021); Matter of Breakdown Services Ltd., Div. Tax App. (Jan. 27, 2022).