The city and state utility tax ... tax, tax.

It is no surprise to the real estate community that both the City and State of New York have become increasingly zealous in attempting to raise tax revenues. The city's and state's aggressive application of tax statutes is manifested in attempts to charge both sales and utility taxes on commercial owners who charge for non-metered electricity and other traditional tenant services, such as overtime HVAC.

As a result of recent tax audits of commercial owners, deficiency notices have been issued alleging tax arrears for non-payment of sales and utility taxes. These notices require payment of the tax, interest and penalties. The state sales tax is a 4 percent tax on receipts from every sale, other than sales for resales of gas, electricity, refrigeration and steam. The state utility tax is a 3.5 percent tax and the city utility tax is a 2.35 percent tax imposed on commercial owners who sell or furnish gas, electricity, steam, water or refrigeration to tenants.

Commercial owners and tenants have challenged the validity of these taxes as they apply to rent-inclusion electric and other tenant services which are incidental to occupancy of commercial office space.

The courts have invalidated the imposition of the sales tax on rent-inclusion electric and overtime HVAC.

In Empire State Building Company vs. New York State Department of Taxation and Finance, the Appellate Division affirmed the Supreme Court and held the State's imposition of the sales taxes impermissible. In so holding the Court stated:

"Non-metered electricity service charges are incidental to the commercial tenants' rent charges, and do not constitute 'sales' or 'resales' of electricity for purposes of Tax Section 1105(b)."

The court concluded that:

"Although pro-rated per square foot for each lease, such charges are for use and occupancy and are not indicative of the amount of electricity consumed by each tenant.

The court also held that the imposition of sales tax on non-metered electricity charges amounted to a double taxation "since tenants pay commercial occupancy rent tax as well."

The state's sales tax has also been held inapplicable to utility-type services provided to commercial tenants.

Recently, the Court of Appeals held that the State sales tax does not authorize a tax on overtime HVAC services provided by Commercial owners incidental to the rental of office space.

In Debevoise and Plimpton vs. New York State Dept. of Taxation and Finance, the court of Appeals gave four reasons why the State's sales tax is not applicable to the supply of overtime HVAC.

First, the Court held that:

The statute authorizes a tax only on the receipts from transactions which can be identified as independent services.

There is no question that HVAC is furnished solely as an incident of the leasehold and for the purpose of assuring that the leasehold premises are maintained at a reasonably comfortable temperature for use by the tenant."

The second reason given by the court for declaring the sales tax inapplicable is that:

"The decision to tax the landlord's supply of overtime HVAC as a sale of 'refrigeration and steam service' to the tenant is inconsistent with the [State Finance Department's] position in imposing a sales tax under Section 1105(b) on the landlord's acquisition of its supply of steam from Con Edison. "

The steam supplied by Con Edison to a landlord can only be taxed under Section 1105(b) if it is a "sale, other than ... for resale." In Debevoise, and in most instances, the Con Edison-landlord transaction is taxed as a sale, thus not a non-taxable sale for resale.

The third reason the court rejected the state's application of the sales tax is that:

"Steam and refrigeration costs constitute only a minor component of the landlord's charges for heating and air conditioning which include the purchase or electricity, labor, maintenance, depreciation and overhead and the furnishing of ventilation and air circulation."

The fourth reason the court rejected the state's imposition of the sales tax is that the state only imposed the sales tax on overtime HVAC service and not daytime HVAC service. The court held that there is no distinction between daytime and overtime HVAC service. The court found no significance in the fact that tenants pay additional charges for overtime HVAC service as opposed to daytime HVAC service for which payment is included in rent.

Obviously, the state has been thwarted in its attempt to expand the scope of sales tax provisions to non-metered electric service and other utility-type services provided to tenants on a rent-inclusion basis.

Applies to Profit Only

Unlike the sales tax, the city and state have had some success in applying the utility tax to commercial owners who supply non-metered electric and other utility-type services to tenants on a rent-inclusion basis. However, the courts have limited the utility tax's application and several issues still remain unresolved.

Recently, the Appellate Division, in Sage Realty Corporation vs. O'Cleireacain, held that the utility tax applies only to profits received by an owner from the redistribution of non-metered electric. Without defining "profit", the court stated that the: "tax in question falls only on profits received from the redistribution of electricity, The owner is able to deduct the cost of electricity, upon which the vendor utility has already paid a utility tax."

Currently, pending before the courts are several cases in which taxpayers are attempting to clarify exactly to what portion of receipts the utility tax applies. In many instances the "profit" from supplying non-metered electricity and other utility-type services is not identifiable.

Additionally, the Court of Appeals' reasoning in Debevoise is applicable to the utility tax. Namely, the supply by commercial owners of services such as condenser water and overtime HVAC are not defined in either the City or State provision as taxable services. Additionally, as with the sales tax, the city is attempting to distinguish daytime HVAC service from overtime HVAC service. Such a distinction has been found to be irrational.

It should be noted that the city in the past has agreed to limit the retroactivity of utility tax charges to 1988, and has also agreed to waive the penalties imposed in its deficiency notices. While these issues and others are being litigated and clarified in the Courts, it is imperative that owners preserve their rights by filing the proper challenges to city or state notices of utility tax deficiency.