In recent months, the New York State Court of Appeals (Court) refused to hear an appeal by Strata Skin Sciences, Inc. (Strata) regarding the taxability of usage agreements for laser medical equipment. The Court agreed that the usage agreements were taxable as a bundled transaction but refused to apply a “primary purpose” test, affirming a near $500,000 sales tax assessment against Strata. This decision garnered confusion and concern as to when a primary purpose analysis is appropriate under New York law.
“... the use of a physical object is only
incidental to the sale of an intangible thing ...”
the STRATA Structure
Strata manufactures laser devices that utilize ultraviolet light to treat skin conditions. The devices are offered to medical professionals and practices either by direct sale, or for use by the medical practitioners subject to the terms of a usage agreement. When offered for use only, the medical professionals or practices purchase codes from Strata to use the laser devices. The codes correspond with a certain treatment and allow for use of the device. Through this agreement, Strata retains sole ownership and control of the device. Strata collected sales tax from direct sales of the device, but did not collect and remit sales tax on the sales subject to the usage agreement.
In 2018, the New York State Department of Taxation and Finance (Department) issued a notice of determination following an audit of business operations from 2014 to 2017. On appeal, an administrative law judge determined that the usage agreements were nontaxable after conducting an analysis of the transaction’s “primary purpose.” He stated that the “primary function of [Strata’s] sales under its usage agreements is managing the non-medical aspects of providing medical treatments” using the laser devices. The New York State Tax Appeals Tribunal reversed the decision, and this appeal followed.
WHO OWNS WHAT
The Court rejected two arguments from Strata as to why the usage agreements should not be subject to tax. First, Strata claimed that it did not give the medical professionals or practices a license to use the laser devices, because it retained exclusive possession of the devices under the usage agreement. As defined in New York law, a sale includes “the transfer of title or possession or both, exchange or barter, rental, lease or license to use or consume” tangible personal property in exchange for consideration.
Here, the Court noted that there was a clear transfer of possession between Strata and the medical practitioners, since the laser devices were placed in the medical offices in exchange for purchasing the codes used with the devices. Additionally, the terms of the usage agreement granted the medical practitioners “the right to use” the devices. Placing the devices in the medical offices gave the practitioners “actual physical possession” of the devices, and possession allowed the practitioners to use the equipment under the usage agreement.
PRIMARY PURPOSE
Second, Strata claimed the transactions between itself and its customers should be nontaxable because it constitutes a bundled transaction of both taxable and nontaxable components, and the primary function of the usage agreements is for a nontaxable service. With a bundled transaction, courts may interpret the taxable and nontaxable components of the transaction to be so closely intertwined that they cannot easily be separated, thus rendering the entire transaction nontaxable if the overarching “primary purpose” of the transaction is for a nontaxable component. Because the transaction at issue included both a nontaxable service component and the taxable provision of tangible personal property, Strata argued that it was a bundled transaction, and the taxability should depend on the primary purpose of the transaction.
The Court recognized that using a primary purpose analysis is necessary when “the use of a physical object is only incidental to the sale of an intangible thing.” Here, however, the Court found that the primary purpose analysis did not apply because the value of the laser device was distinctly separable from the value of the services provided. Since Strata sold the laser device as a standalone product, the market value of the laser device was easily ascertainable. Thus, the Court rejected both arguments and affirmed the assessment against Strata.
NEW YEAR, NEW POSITION
If your business offers a product or service with both taxable and nontaxable components, such as a nontaxable service combined with a physical product, or a tangible deliverable with a nontaxable software component, there are several tax implications to consider. Learn more about the taxability of your offerings with our guidance.