New York State Division of Tax Appeals administrative law judge (ALJ) recently ruled in Matter of American Multi-Cinema, Inc., on the question of whether non-taxable licenses to exhibit digital movies become taxable if the movies are delivered to the theatre on hard drives, which are physical media.  The ALJ determined that the delivery of digital movies on hard drives would not cause the transaction to be taxable under the New York sales tax law primarily because the hard drives were not necessary for the display of the movies.

A New York State Division of Tax Appeals administrative law judge (ALJ) recently ruled in favor of a movie theatre operator represented by McDermott Will & Emery on the question of whether non-taxable licenses to exhibit digital movies become taxable if the movies are delivered to the theatre on hard drives, which are physical media.  In Matter of American Multi-Cinema, Inc., DTA Nos. 823589, 823590, 823646 (N.Y. Div. Tax App. June 21, 2012), the ALJ determined that the delivery of digital movies on hard drives would not cause the transaction to be taxable under the New York sales tax law primarily because the use of the hard drives was not necessary for the display of the movies.

American Multi-Cinema, Inc., (AMC) operates many movie theatres in New York.  AMC obtains the movies it shows from distributors that deliver the movies to AMC on 35mm film or in digital form.  Movies in digital form can be delivered electronically or, as in the case at issue, on hard drives from which AMC uploads the movies to its own servers.  When the movies are delivered on hard drives, the drives are returned to the distributors after AMC uploads the movies.

New York imposes its sales tax on retail sales of tangible personal property.  “Sale” is defined as “any transfer of title or possession or both . . . for a consideration.”  Thus, in order for sales tax to apply, there must be a transfer of title or possession of tangible personal property for a consideration.  Further, under New York law, the primary purpose of the transaction controls the taxability of the entire transaction, even if some parts of the transaction would be taxable and other parts would not be if they were purchased separately.

Traditionally, movies have been viewed as constituting tangible personal property because the 35mm film they were recorded on was “corporeal,” and therefore licenses to exhibit movies on the film have been subject to New York sales tax.  However, digital movies delivered electronically are intangible property, and receipts from licenses of them are thus not subject to New York sales tax.  The question before the ALJ was whether the tangible nature of the hard drives would cause the digital movies to lose their non-taxable status.

In reaching his conclusion that the delivery by hard drives would not cause the otherwise non-taxable digital movies to become taxable, the ALJ made several points.  First, he noted that the hard drives, unlike traditional film, were “not necessary to each (or even any) instance of displaying the content.”  Second, the ALJ noted that the hard drive was “not itself the desired object of the transaction.”  Both of these observations led to the conclusion that, under New York’s primary purpose test, the use of the hard drives did not control the taxability of the transaction, but rather the displaying of digital movies—the primary purpose of the transactions—would control the taxability.  The ALJ also likened the hard drives to containers or “ancillary vessels” used for delivery that do not affect the taxability of the intangible property contained in them.

The ALJ found additional support for his conclusion in the fact that AMC did not take title to the hard drives, but rather immediately returned them to the distributors after uploading the movies.

The Department of Taxation and Finance has 30 days from the determination date to file an exception (i.e., an appeal).