Are a firm's three financial-pricing 'advice services' taxable information services or nontaxable consulting in NY?

Plain-English summary

The petitioner provides financial-product pricing "advice services" to financial institutions, using its internally-developed proprietary valuation formulas and a large internally-built database (compiled from both proprietary and public sources, and constantly updated). It asked about three services:

• Advice Service P -- advice on the proper pricing of derivatives, generated by applying the firm's most-current proprietary formulas to its most-current database. Clients access it remotely; the advice is specific to the instrument and the moment.
• Advice Service R -- independent valuations of a client's financial products, where the firm's experts prepare and deliver a valuation report.
• Advice Service V -- mark-to-market / volatility risk-reference data for sophisticated clients, requiring the experts' subjective analysis and frequent client communication.

The Office of Counsel split the three:

• Advice Service P -- taxable information service (from 9/1/2010). P collects, compiles, and analyzes information and furnishes the result, so it's an information service (Tax Law 1105(c)(1)). It does not qualify for the "personal or individual" exclusion:
• The exclusion needs information uniquely personal/individual, and the source controls (ADP Automotive). P's advice comes from a common database (partly from public sources), so it isn't uniquely personal/individual.
• The exclusion also fails its second prong: because all clients' advice rests on the same formulas and database, the information can be substantially incorporated in reports to others -- even when customized (Rich Products; Towne-Oller).
• Separately, P is a risk-management analysis service, which is a taxable information service since September 1, 2010 (TSB-M-10(7)S) -- pricing the derivative necessarily analyzes its risk/volatility.
• Situs: sourced to the client's employee-users; no NY tax on use outside New York, with apportionment for users in/out of NY (KPMG, TSB-A-03(5)S).
• Advice Services R and V -- nontaxable consulting. Even though they use the same database and algorithms, both involve significant expert involvement -- the experts apply experience and judgment to value complex products, communicate with clients, devise valuation strategies, develop data when it's missing, recheck results, and resolve pricing discrepancies. The primary function is a consultation service, which is not an enumerated taxable service (SSOV'81). So R and V are not taxable.

What this means for you

Financial-data, analytics, and valuation firms

The dividing line is automated output from a common database vs. expert judgment. A service that runs your data/formulas to generate pricing or risk analysis -- drawing on a common database (especially with public sources) -- is a taxable information service (and risk-management analysis has been taxable since 9/1/2010), and you can't escape via the personal/individual exclusion if the underlying data is common or the output could be incorporated into others' reports. By contrast, a service whose primary function is your experts' analysis and judgment -- genuine consulting on a client's specific problem -- is not taxable, even if your experts lean on the same databases and models. Document where the human expertise is the core of the engagement.

Buyers

Automated pricing/risk feeds are likely taxable (allocated to your NY users); bespoke expert valuation/consulting generally isn't.

Common questions

Q: Is our automated pricing/risk-analytics service taxable?
A: Generally yes -- it's a taxable information service (and risk-management analysis taxable since 9/1/2010), and the personal/individual exclusion won't apply if it draws on a common/public database.

Q: Why are the expert valuation services (R and V) not taxable?
A: Their primary function is consulting -- experts applying judgment to a client's specific products -- which isn't an enumerated taxable service, even using the same data/models.

Q: How is the taxable service sourced?
A: To the client's user locations; no NY tax on use outside New York, with apportionment for users in and out of the state.

Citations and references

• Tax Law section 1105(c)(1) (information services; personal/individual exclusion)
• 20 NYCRR section 527.3 (information services)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_2010.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a10_61s.pdf

Original ruling text

New York State Department of Taxation and Finance TSB-A-10(61)S
Office of Counsel Sales Tax
Advisory Opinion Unit December 17, 2010

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE

ADVISORY OPINION PETITION NO. S100817A

Petitioner I cequests an Advisory Opinion about whether three services

it provides are subject to New York State and local sales and use taxes. We conclude that Advice Service
P, as described in the petition, is an information service that is subject to State and local sales and use
taxes, and Petitioner must collect tax on these services beginning September 1, 2010, if they are delivered
in New York State. Advice Services R and V, as described, are not services subject to sales and use

taxes.

Facts

Petitioner provides advice services to its financial institution clients about the pricing of certain
financial products. Petitioner seeks advice on three services, known as (“Advice Service

P”), BR (Advice Service R”), and WN (“Advice Service V”).

Advice Service P

Advice Service P provides advice to financial institution clients about the proper pricing of
derivatives the clients are buying or selling on their own behalf or on behalf of the clients’ customers.
This service increases the transparency and accuracy in pricing options. Petitioner provides pricing
advice for the widest possible range of instruments and underlying assets, including those trading based
on: (1) foreign currency exchange rates; (2) interest rates; (3) equities; (4) commodities and energy; and

(5) credit.

Petitioner performs its function with internally-developed valuation and risk management
formulas, along with an internally-developed database. Petitioner constantly updates both the valuation
and risk management formulas and the database. To do the updating, Petitioner maintains a large staff of
quantitative analysts who are highly trained and have extensive backgrounds in financial modeling and
with financial institutions, some with as many as 15 years’ experience. amg analysts have
PhDs in Mathematics and Physics. In addition, Petitioner employs for these tasks programmers,
quality assurance engineers, database administrators, information technology experts, security experts,
and graphic designers. Petitioner’s Research and Development Department now consists of over
‘employees, many of whom hold Master’s degrees.

Petitioner uses proprietary formulas developed by its principals and others who are highly
educated in mathematics, finance, and physics. Petitioner’s founder, who has been the company’s
President and CEO since its inception, has a —_— and an MBA and Master of Science [jj
BME. Prior to founding Petitioner, he was the . Together with Petitioner’s Chief Technology .
Officer, he developed a formula that was a substantial improvement on the existing mathematical models _
for pricing options. That early formula was the basis for Petitioner’s development of the formulas it .
currently uses. Thereafter, Petitioner’s several formulas were further developed by its CEO and his co-
founder, who has a PhD QM. With assistance from many mathematicians, they developed

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December 17, 2010

Petitioner’s advice system after dedicating years and many thousands of hours of research and
development, a process that has continued without interruption.

The formulas and mathematical codes are constantly enhanced in terms of asset and instrument
coverage, in order to reflect the market’s ever-changing needs. The quality of the mathematical code is
constantly checked and ‘confirmed against actual trades from the market, which are aggregated to a
database that includes J trades. Formulas are constantly being remodeled and improved. At any
time in recent years, Petitioner has between | and ma employees with degrees in
mathematics or science who are dedicated to research and development.

The formulas consist of multiple pages of algorithms that take into account numerous variables
and assigned weightings. The formulas are proprietary and highly confidential. They are not disclosed to
any outsiders, nor is the possession or use of the formulas ever transferred to clients.

In addition to the proprietary and confidential formulas, Petitioner has created internally, and at
great expense, a proprietary and confidential database. The information contained in the database has
been collected, culled, maintained, improved, and developed over many years from both proprietary and
public sources and is constantly updated. The updating is monitored by more than Py employees
daily. The information is purchased/gathered, checked/cleansed/ monitored, and combined, as described

below:

e Purchased/Gathered -- Information is obtained from three primary sources. For exchange-
traded commodities (e.g., energy products, precious metals, agriculture), information is
obtained from commodity exchanges and market data vendors. The information is updated
during the trading session and when available during after-market hours. In addition,
settlements are obtained daily. For commodities traded over-the-counter, data are obtained
from a network of brokers for swaps, differentials, volatilities, and skews for a wide range of
products (e.g., oi! and refined products, natural gas). In instances when data are not
contributed, Petitioner internally derives the data points. For all markets, some information is
obtained from data aggregators and vendors.

e Checked/Cleansed/Monitored — Petitioner runs the collected data through its internally-
developed filters and monitors. Among the validity checks are a constantly functioning
escalation and alerting system. These validation tests isolate for further review data
registering outside pre-defined ranges, and review the consistency of data throughout a single
day and across multiple days and the relationship between data points (e.g, volatility ask
should exceed the bid). Events triggering an alert include, but are not limited to: (1) data
contributor’s price that falls outside of the average bid-ask spread; (2) data that differ by more
than an established percentage from the previous value from the same provider; (3) a bid-ask
spread that increases by more than a predefined amount or volatility resulting in a “Zig. zag”
in pricing between short and long-term tenors (ordinarily, volatility is smooth). When an
alert is triggered, Petitioner’s Market Data Unit, staffed with | | professionals, analyzes
the issue. This review can permit use of the entirety of data that were reviewed, disallow all
or some of the data, or result in the temporary or permanent suspension of this data source

~ and replacement with data obtained from market makers and other participants on a regular or

ad hoc basis.

TSB-A-10(61)S
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December 17, 2010

e Combined — Incoming data arrive throughout the day from throughout the world.
Information sources include options exchanges, market makers, brokers, data vendors, and
other public and private sources. When analyzing incoming market data sources and
combining them with Petitioner’s market data, Petitioner uses internally developed methods
and algorithms. In the process of introducing new data into its filtered pool, Petitioner
weights the data, taking into consideration the parameters for the data (eg.,
instrument/structure, maturity, liquidity), the time of day the data were received, and a variety
of other subjective and objective criteria.

Petitioner maintains a help desk 24 hours per day, six days per week, which services its clients
worldwide. The help desk’s staff consists of naz trained market and derivatives specialists who
assist clients with questions about everything from inputting information to interpreting Petitioner’s

advice.

Petitioner sells its Advice Service P to large financial institutions located throughout the world.
The institutions access the system remotely through the Internet. The institutions purchase their desired
number of portals, allowing that number of users access to the service. Petitioner does not provide any.of
its clients with any tangible personal property or possession or control over its formulas, database, or

software.

The advice provided to a client is unique to the derivatives being priced by the client. Further, the
advice is specific to the time that the pricing occurs, because the pricing of those derivatives is determined
by Petitioner’s most recently updated version of the relevant proprietary formula, which is then applied to
the most recently updated version of the proprietary database. Petitioner does not and cannot incorporate
the information generated for one client into reports furnished to other persons. Advice previously -
provided is not useful in providing current advice to.a client. Company does not maintain a library of
advice it has provided and does not reference advice previously provided. Moreover, the information
provided Petitioner by its clients is highly confidential. Neither the information received nor the results
of any advice provided are shared with another client or used in providing advice to another client.

Advice Service R

Advice Service R is provided in addition to the other advice services offered by Petitioner, but it
relies on the same proprietary formulas and database described above with reference to Advice Service P.
This service provides advice to financial institutions that require an independent valuation or whose
existing valuations have become stale or for other reasons are doubtful. This service is available for all
types of financial products, including but not limited to derivatives. To receive this service, the financial
institution submits specific information about its holdings in an agreed-upon electronic format, which is
uploaded onto Petitioner’s.servers. Petitioner’s experts then prepare valuations for each financial product
in the client’s portfolio, and generate an output in the form of a report in the agreed-upon format, which is
then transmitted electronically to the client. These experts typically have many years of experience as a
senior trader or head of a trading desk in the relevant field at leading financial institutions, and generally
hold advanced degrees in mathematics or physics. Because the clients typically request assistance with
complex financial products, Petitioner assigns an expert with many years of experience as the individual
with primary responsibility for pricing the items in the portfolio. The advice provided is unique to the
institution requesting the information, is not archived in a library, and cannot be reused.

TSB-A-10(61)S
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December 17, 2010.

Advice Service V

Advice Service V (Market-to-Market Data) is provided in addition to the other advice services
offered by Petitioner, but it relies on the same proprietary formulas and database described above with
reference to Advice Service P. As is true of all Petitioner’s services, Advice Service V provides risk
reference data for commodities, energy, equities, foreign exchange, and interest rates derivatives — here
for Petitioner’s most sophisticated clients. These clients consist of financial institutions with considerable
expertise in the pricing of financial products of all kinds, including derivatives. Nevertheless, they
recognize the Petitioner has greater expertise in determining the volatility of the prices of financial
products. ‘The advice is provided in an agreed-upon format and is transmitted electronically to the client.
Accurate volatility coefficients are essential to accurately pricing a financial product, and their
determination requires a subjective analysis in addition to a quantitative analysis. To provide this service,
Petitioner may require numerous communications with the client, both by telephone and through the

Internet.

Both Advice Services R and V involve customization, which may occur in both the customer’s
desired analysis (“output”) and the information Petitioner requires to conduct the analysis (“input”). The
services provided by Petitioner’s experts vary with the financial product to be analyzed, whether a single
security, a basket of securities, options, indices, commodities, debt issuances, foreign currencies, or
swaps. In the case of a structured financial product, the customization may take the following forms:

¢ Petitioner’s experts use their extensive industry experience to develop a strategy for valuing the
structured product, including analyzing the term sheet describing the product to convert a single
product to component parts for valuation purposes, determine the correlation between these
components, and value the structured product as a whole.

e In circumstances when the client either requires revaluation of certain assets and/or instruments
or requires Petitioner to generate data when data are either insufficient or unavailable, the experts
must define the gap between the required and available information and develop the required
market data and/or determine the adjustments to the formulae required to compensate for the

limited information.

e Petitioner’s experts conduct follow-up analysis relating to the generated valuations, and for
Advice Service V, the generated data. At times, this requires the experts to re-check the entire
valuation and/or data generation process. More often in conducting follow-up, the experts
investigate a client’s challenge of some aspect of the valuation (in the case of Advice Service R)
or the generated output data (in the case of Advice Service V). For example, in the case of
Advice Service R this can occur when a client claims that the financial product Petitioner priced
at a certain dollar value receives an entirely different valuation by the buyer or seller of that
product. The expert must then make necessary inquiries to understand how the client’s counter-
party generated its price and explain the discrepancies in the pricing results.

Petitioner asks whether its services are subject to State and Local sales and use taxes: (1) for
periods through and including August 31, 2010; and (2) for periods on and after September 1, 2010.

TSB-A-10(61)S
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December 17, 2010

Analysis

We conclude that Advice Service P is an information service subject to State and local sales and
use taxes for periods on and after September 1, 2010. Advice Services R and V are not within the

enumerated services subject to sales and use taxes.

Tax Law section 1105(c)(1) imposes sales tax on the receipts for the service‘of furnishing of
information by printed matter, including the services of collecting, compiling, or analyzing information of
any kind or nature and furnishing reports thereof to other persons, but excluding the furnishing of
information that is personal or individual in nature and that is not or may not be substantially incorporated
in reports furnished to other persons. With Advice Service P, Petitioner’s information is obtained from a
variety of sources, both public and private. This information is compiled into a database that is used,
along with Petitioner’s proprietary formulas, to provide advice to clients about the pricing of financial
products. The analysis and results provided to clients are based, in part, on the information aggregated
and collected by Petitioner. Consequently, Advice Service P is an information service subject to sales and
use taxes. See Tax Law §1105(c)(1); 20 NYCRR § 527.3(a)(2).

The exclusion for information that is personal or individual in nature and that is not or may not be
substantially incorporated in reports furnished to other persons does not apply to Advice Service P. The
first criterion (information that is personal or individual in nature) is satisfied only by information that is
uniquely personal or individual in nature. See Matter of Allstate Ins. Co. v. Tax Comm'n of the State of
New York, 115 AD2d 831, (3d Dep’t 1985); affd 67 NY2d 999 (1986); Twin Coast Newspapers, Inc. v.,
State Tax Commission, 101 AD2d 977 (3d Dep’t 1984). It is the source of the information that controls
whether the report prepared will meet the criteria of "personal and individual." See Matter of ADP
Automotive Claims Service Inc., Tax Appeals Tribunal, August 8, 1991. Information is not uniquely
personal or individual in nature if it comes from a common source or a data-repository that itself is not
confidential. See Matter of ADP Automotive Claims Service Inc. v Tax Appeals Tribunal, 188 AD2d 245
(3 Dep’t 1993); Rich Products Corporation v Chu, 132 AD2d 175 (3d Dep’t 1987); T owne-Oller &
Assoc. v State Tax Comm, 120 AD2d 873 (3d Dep’t 1986); Alan/Anthony, Inc., TSB-A-92(51)S. With
Advice Service P, the information provided to clients comes from a common database compiled by
Petitioner. Moreover, the information in the database comes, at least in part, from public sources.
Therefore, the information in the databases is not personal or individual in nature.

Furthermore, Advice Service P does not satisfy the second criterion of the exclusion. The
information provided to Petitioner’s clients is based on the same formulas and database. Consequently,
the information provided to clients by definition can be substantially incorporated in reports furnished to
others. See Matter of Rich Products, supra; Twin Coast Newspapers, supra. Even when the information
provided to a client is customized in some manner, the information service would still be taxable if
customized information is substantially derived from a common data source maintained by the
information service provider. See Matter of Rich Products., supra; Matter of Towne-Oller and Associates,
supra; Economic Cycle Research Institute, Inc., TSB-A-97(42)S. ,

Beginning on September 1, 2010, the sale of a service the primary function of which is to provide
risk management analysis reports is the sale of a taxable information service. See Sales and
Compensating Use Tax Treatment of Certain Information Services, TSB-M-10(7)S. Petitioner’s services
are similar to the risk management services described in TSB-M-10(7)S. With Advice Service P, in order
to arrive at the proper price for a client’s financial products, Petitioner must necessarily analyze the risk
and volatility inherent in that product. Accordingly, Advice Service P is subject to tax beginning on

September 1, 2010.

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_6- Sales Tax
December 17, 2010

Petitioner delivers Advice Service P to clients both within and outside of New York State.
Receipts from the sale of information services delivered to and used by a client outside New York State
are not subject to New York State and local sales and use taxes. If the client’s employees that access this
service are located both in and out of New York State, Petitioner should collect tax based on the portion
of the receipt attributable to the employee users located in New York. See KPMG, LLP, TSB-A-03(5)S.

Advice Services R and V are not within the enumerated services subject to sales and use taxes.
While these two services use the same databases and algorithms as Advice Service P, both Advice
Services R and V include significant involvement by Petitioner’s experts. With each of these services, the
experts apply their experience and judgment to arrive at a valuation of a client’s financial products. The
experts communicate with the clients, analyze the data, identify strategies for valuing complex products,
assess the adequacy of the available data, and develop data when necessary. to compensate for limited
information. The experts recheck the valuation process and results and also evaluate discrepancies in
valuations. Based on the degree of professional experience and judgment applied in these services, we
conclude that the primary function of both Advice Services R and V is that of a consultation service,
which is not among the enumerated services subject to sales and use taxes. See Matter of SSOV’8/ Ltd.

(Tax Appeals Tribunal, Jan. 19, 1995).

DATED: December 17, 2010 _1S/
DANIEL SMIRLOCK

Deputy Commissioner and Counsel

NOTE: An Advisory Opinion is issued at the request of a person or entity. It is limited to the facts set
forth therein and is binding on the Department only with respect to the person or entity to
whom it is issued and only if the person or entity fully and accurately describes all relevant
facts. An Advisory Opinion is based on the law, regulations, and Department policies in effect
as of the date the Opinion is issued or for the specific time period at issue in the Opinion.