“Primary Function” Analysis Often a Key in New York Sales Tax Disputes

Sales tax controversies often involve the taxability of a transaction that has both taxable and nontaxable components. In determining whether transactions are subject to sales tax, New York tax courts have considered  the “primary purpose of the transaction” as opposed to its individual components. Two recent sales tax disputes in New York illustrate the way the courts can either apply this “primary function” analysis or reject it based on the facts of the case.

In Dynamic Logic Inc. v. Tax Appeals Tribunal of the State of New York (2024), the Tax Appeals Tribunal of the State of New York (the ”Tribunal”) applied the “primary function” test in the context of the taxability of a service. In Strata Skin Sciences Inc v. New York State Tax Appeals Tribunal (2024), however, the Tribunal dismissed the use of this test as the sale of tangible personal property. Together, these cases show how taxpayers operating in New York should consider the impact of a possible “primary function” analysis when commencing a variety of transactions.

Dynamic Logic

In the Dynamic Logic case, the taxpayer provided a service that involved collecting and analyzing data while giving advice and recommendations for improving advertising effectiveness. After an audit, the state tax authority determined that the service constituted a taxable information service and imposed additional sales tax on the taxpayer.

The taxpayer argued that the taxable information was nontaxable consulting, but the Tribunal upheld the state tax authority’s original finding. The Tribunal agreed that the “primary function” of the company was the collection and analysis of information, and the consulting component was an ancillary service.

Strata Skin Sciences

In the Strata Skin Sciences case, the taxpayer manufactured and operated laser devices that physicians used to treat skin conditions. The taxpayer sold the devices and provided use of them under a consignment agreement. The consignment service included placing the device in the medical office and providing a suite of training, maintenance, marketing, and reimbursement services to facilitate the use of the device. The taxpayer retained control over the use of the laser device through software, and the medical practices purchased codes for individual treatments. After an audit, the state tax authority assessed sales and use taxes for this service. The taxpayer argued that transactions involved the provision of tangible property and nontaxable services while the “primary function” of the usage agreements was to provide the nontaxable service.

The Tribunal noted the usage agreements “involve taxable sales in that they involve the transfer of possession of tangible personal property…in return for which petitioner received consideration in the form of treatment code purchases.” The Tribunal found that the “the transaction fell within the unambiguous statutory and regulatory definition of a retail sale.” It also concluded that the primary function analysis was not applicable because the medical practices “received a finished product in the laser device that had market value distinct from the services rendered and was, indeed, sold by petitioner on a standalone basis.”

Performing Your Own Primary Function Analysis

Taxpayers should consider and understand the impact of the “primary function” analysis. It could be to their benefit or detriment with their New York sales tax liabilities. Companies involved in information services should consider how the tax authority could apply the analysis of the primary function to their services. Companies that combine the sale or lease of tangible personal property with support services should consider how the decision of Strata Skin Sciences Inc. v. New York State Tax Appeals Tribunal (2024), might impact their transactions.

For information about whether either of these scenarios may apply to your New York operations, contact us.

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