Businesses that package goods and services together, which are often referred to as “bundled transactions”, face unique New York state sales and use tax consequences. In prior years, it may have been enough to rely on the “primary function” of the transaction test. However, recently, New York courts have signaled a potential shift.
You may be wondering: which industry will this likely impact? For one, these developments are more than theoretical for companies. For example, offering equipment rentals accompanied by some form of technical support or digital solutions paired with in-person services created bundles transactions issues. Now, businesses must grasp how the state’s courts view the interplay between tangible property and related services.
If your company engages in bundled transactions, it’s time to review your approach. Understanding New York’s evolving tax landscape can help protect your bottom line. Consider consulting a New York sales tax professional or legal advisor to ensure your bundled offerings comply with the latest guidelines.
What is a “Bundled Transaction?”
Before examining the specifics of recent case law, we should clarify and indicate what is meant by “bundled transactions.” A bundled transaction occurs when a seller provides more than one item of property, service, or any combination thereof to a buyer for a single, combined price.
Let’s take a scenario: imagine selling proprietary medical equipment and offering ongoing technical support, marketing assistance, and maintenance as part of the same agreement. The invoice presented to the purchaser does not delineate or bifurcate the price of the medical equipment as compared to the other services of technical support, marketing assistance and maintenance. In this example, everything is combined into one, combined offering.
Traditionally, the New York tax authorities and New York courts have looked at the “primary function” or “true object” of these transactions to determine taxability for sales and use tax purposes. The question has generally been: Are customers principally paying for the tangible property, or are they mainly after the services or intangible elements that the seller provides?
You might have escaped taxation if the tangible good was merely incidental to a more extensive service. Conversely, if the service was just ancillary or secondary for a sale of tangible personal property, the entire deal could very likely be taxable.
As with other New York sales and use tax concepts, this indeed does get quite complicated and cumbersome, as the factual analysis needs to be determined on a case-by-case basis. In some scenarios, it’s not easy to pick apart the motivations behind a purchase. However, recent cases out of New York suggest that when tangible property is a part of the bundle and has an independent market value the courts may presume the entire deal is taxable, regardless of how marginal that property might have seemed.
The Strata Skin Sciences Case
One recent and illuminating example is the Strata Skin Sciences litigation. Strata Skin Sciences, Inc. developed and supplied a specialized excimer laser device dermatologists use to treat certain skin conditions. Traditionally, physicians were able to and had the option of purchasing these laser devices outright, paying sales tax at the point of purchase or an acquisition. Alternatively, under Strata’s newer “usage agreements,” the physicians would have the device placed in their offices at no upfront cost.
Under the so-called usage agreements, doctors did not buy the laser itself. Instead, they purchased “treatment codes” that enabled the device to administer a set number of treatments. In addition to the hardware, Strata provided a suite of related support services, including patient marketing, insurance verification assistance, staff training, maintenance, and software upgrades.
Strata argued that these bundled offerings were not just about handing over a piece of equipment. Instead, it claimed the doctors were buying an integrated healthcare solution service.
The New York Tax Appeals Tribunal disagreed. It treated the usage agreements as effectively granting a license to use tangible personal property, the laser device, tied to purchasing treatment codes. In its view, the physician’s payments were not merely for services but for the practical ability to use Strata’s physical device on a per-treatment basis.
Accordingly, the Division issued a substantial sales tax assessment against Strata Skin Sciences, asserting that the recurring revenue generated by these usage agreements amounted to taxable sales of tangible personal property. Strata challenged the Division’s position through an Article 78 petition, setting the stage for a closely watched dispute over how New York law should treat these types of hybrid business arrangements.
The Appellate Court Chimes In
The Appellate Division, Third Department, affirmed the Tribunal’s ruling. Even though Strata argued that the services and support, rather than the device itself, were the real heart of the deal, the court was not persuaded by this analysis.
In its opinion, the Appellate Division emphasized that the crux of the dispute boiled down to the statutory definition of a “sale” under New York’s Tax Law, specifically sections 1101 and 1105. These provisions broadly define a sale to include any “transfer of title or possession . . . lease or license to use or consume . . . for a consideration.”
The court found that Strata’s usage agreements met this definition: Physicians were, in effect, obtaining a license to use the laser device in exchange for purchasing treatment codes. Having various services bundled into the arrangement did not alter the fundamental fact that doctors received fully functional laser equipment—placed on their premises for their benefit.
A pivotal point in support of the court’s opinion was that the device itself held independent market value. Strata’s business model clarified this, as some doctors purchased the devices outright. Therefore, when the same device was provided under a usage agreement, the court saw little reason to treat it differently, as the overall outcome of the doctor was essentially the same. If the underlying property could be sold as standalone equipment, its inclusion in a usage agreement signaled a taxable event.
Practical Implications for Businesses
The outcome in Strata Skin Sciences conveys a message to businesses that combine tangible personal property with services, that being, a presumption of taxability. Further, the case serves as a battle between substance versus form.
For companies that previously leaned on the “primary function” test to argue that their bundled offerings were not taxable, this decision signals a need to reassess their approach. If your product has standalone value, courts may focus on that factor.
To mitigate exposure, businesses should consider:
- Separating Charges: Break out invoices into distinct and identified line-items for tangible goods and non-taxable services where feasible. By bifurcating taxable products/services from non-taxable products/services, the results of an audit may be less financially cumbersome. Ideally, this bifurcation would occur prior or in the beginning stages of business operations.
- Reevaluating Contract Terms: A tax professional should review your agreements and related contracts and invoices. Provisions that grant control, possession, or a license to use tangible property can make the entire arrangement taxable.
- Staying Current with Guidance: As New York courts continue to refine how the “primary function” test applies, it is key to stay up-to-date with new cases and regulatory administration.
The practical takeaway is that whenever tangible property is part of the equation, you should be prepared to justify why the entire deal shouldn’t be taxed or, where that isn’t possible, structure the transaction to minimize audit and financial risk.
Contact a New York Sales Tax Professional
If your business operates in New York and offers bundled goods and services, reach out to an experienced New York sales tax attorney to ensure your transactions are structured in a way that aligns with current regulations. A professional’s insight will mitigate risk and increase the predictability of tax expenses. Contact us today for a consultation to discuss your business’ New York sales and use tax needs.