Joseph Lipari and Aaron S. Gaynor

A few weeks ago, the New York state tax department seized iconic Brooklyn pizzeria Di Fara in connection with some $150,000 in unpaid sales tax. Although Mayor Bill de Blasio vowed to come to the aid of the beloved institution, Gov. Andrew Cuomo was quick to remind the mayor that it is the state—and not the City—that controls the administration of sales tax. This New York state versus City dispute comes mere months after a more prosaic controversy in SoulCycle, DTA Nos. 827698 and 827699 (N.Y. Div. Tax App., May 23, 2019). SoulCycle concerned a particularly knotty interaction of the state and City sales tax rules, leading to an unfavorable result for the taxpayer.

SoulCycle is a provider of "instructor-led indoor cycling classes" (commonly referred to as "spin" classes). A typical class included "35 to 40 minutes of stationary bicycle riding led by an instructor with music, 5 to 8 minutes of upper body strength exercises using hand weights, and a 3 minute cool-down stretch." The classes were not inherently competitive, as, among other things, there was no mechanism by which to "score" participants. The ALJ noted that "[t]he stationary bikes [did] not measure power, speed, cadence or distance." Participants paid either on a class-by-class basis, or by purchasing a "package" for multiple classes.

At issue in the case was a refund claim that the state denied with respect to SoulCycle's spin classes. The ALJ determined agreed that the company was not entitled to a refund, as the fees were properly subject to City sales tax. It is important to note that, even though the fees at issue were not subject to the state sales tax, the state tax department and Division of Tax Appeals administer all sales tax matters.

Under Tax Law §1105(f)(2)(i), the state sales tax applies to "[t]he dues paid to any … athletic club." Additionally, under Tax Law §1105(f)(1), the state imposes sales tax on "[a]ny admission charge … to or for the use of any place of amusement in the state. Tax Law §1105(f)(1) and the applicable regulation, 19 N.Y.C.R.R. §527.10(d)(4), provide for an exception for "charges to a patron for admission to, or use of, facilities for sporting activities in which such patron is to be a participant, such as bowling alleys and swimming pools" (called the "participatory sports" exception).

Tax Law §1101(d)(6) and the applicable regulation, 19 N.Y.C.R.R. §527.11(b)(2)(i)(b) and (c), define "dues" broadly for these purposes, and include "any assessment, irrespective of the purpose for which made" and "any charge for … sports privileges or facilities." Further, 19 N.Y.C.R.R. §527.11(b)(7)(ii) states that the term "'[a]thletic activities' does not include exercising or calisthenics solely for health or weight reduction purposes, as contrasted to sports." That provision continues that "[a]n establishment that merely provides … exercise equipment shall not be considered an athletic club."

Separate from the state sales tax, under Tax Law §1210(a)(1), the state generally empowers the City (and other municipalities) to impose an additional rate of sales tax on any permitted state sale tax. Under N.Y.C. Admin Code §§11-2001(a) and 11-2002(d), the City imposes this tax, and generally conforms to the state sales tax rules. Thus, although it is generally understood that the sales tax in New York City is at a rate of 8.875%, the sales tax actually consists of three separate sales taxes: the state sales tax of 4%, the City sales tax of 4.5% and the Metropolitan Commuter Transportation District tax of 0.375%.

To complicate matters even further, the New York City sales tax deviates from the state sales tax rules in certain regards. Under Tax Law §1212-a(a)(2), the state authorizes the City to impose sales tax on certain services that the state does not tax, including "weight control salons, health salons, [and] gymnasiums," as well as on "every charge for the use of such facilities" (which tax the City imposes under N.Y.C. Admin. Code §11-2002(a)). Additionally, N.Y.C. Admin. Code §11-2001(b)(3) expressly overrides the participatory sports exception with respect to City sales tax. Prior to 2008, the City expressly adopted the participatory sports exception even though the City generally imposed sales tax on the use of health salons and the like. However, in 2008 the City adopted an express rejection of the participatory sports exception. See 2008 N.Y. Sess. Laws 422-424 (L. 2008, c. 57 Part SS-1, sec. 13).

In its refund claim SoulCycle advanced the theory that its fees were not admissions charges, but that the participatory sports exception to the tax on those charges should apply. The ALJ rejected taxpayer's reliance on the participatory sports exception, due to the express "exception to the exception" in the Administrative Code for purposes of the City sales tax. The ALJ also held that the fees were subject to City sales tax as charges for "health salons," etc.

The ALJ applied this exception to the exception and imposition of tax on health salons mechanically in finding against the taxpayer. However, the determination did not in any detail distinguish the three overlapping tax regimes at work in this case: (1) the state sales tax on admissions charges (and its participatory sports exception), (2) the state sales tax on dues paid to athletic clubs, and (3) the City sales tax on health salons and the like. New York Advisory Opinion No. TSB-A-02(8)S illuminates certain distinctions between the first two regimes.

The advisory opinion concerned the operator of a ski facility. The facility had two classes of customers: members and non-members. Both members and non-members were permitted to purchase annual, daily, or hourly passes to use the facility, or to purchase certain packages of passes. Members paid initiation fees and annual dues, and, in return, received discounted passes and certain privileges in connection with the facilities. The opinion concluded that all amounts (including for passes) that members paid were subject to sales tax as dues to an athletic club. The opinion also concluded, however, that the amounts that non-members paid for passes were not subject to sales tax, under the participatory sports exception to the tax on admissions fees. These conclusions indicate that status of the customer matters in determining whether a payment is an admissions charge or athletics club dues. Additionally, the opinion indicated that the participatory sports exception is available only with respect to admissions fees, and not to athletic club dues. As discussed above, the regulations provide an exception from tax on athletic club dues with respect to "exercising … solely for health or weight reduction purposes, as contrasted to sports." However, the view of the tax department, apparently, is that skiing is a "sport" and not "exercise."

When one layers in the third regime (City tax on health salons, etc.), the waters become even murkier. After providing for an "exercise" exception, the immediately aforementioned regulation provides, as a helpful reminder to taxpayers that "there is a … local sales tax in the city of New York on every sale of services by weight control salons, health salons, [and] gymnasiums … and on every charge for the use of such facilities." This may imply a view that services on health salons and the like are akin to athletic club fees, rather than admissions charges. However, if that is the case, one might ask why there was a need to expressly legislate a rejection of the participatory sports exception when mere removal of the express adoption should have been sufficient.

The SoulCycle case is a useful reminder that the state and City tax laws frequently do not operate in lockstep. Unfortunately for taxpayers, it is challenging to navigate the Tax Law or the Administrative Code separately, let alone attempting to the reconcile them. It is understandable how the SoulCycle taxpayer could have gotten lost in this maze of overlapping regimes and exceptions.

Joseph Lipari is a partner and Aaron S. Gaynor is an associate at the law firm of Roberts & Holland.