New York State owes the United Parcel Service a $2.7 million refund after it misclassified packaging materials used by the parcel carrier as subject to taxation, a state appeals court has decided. The materials were used by UPS to promote awareness of its brand and a new overnight air delivery service with existing customers and, as such, were exempt from state sales and use taxes under Tax Law §1101[b][12], a panel of the Appellate Division, Third Department, ruled in Matter of United Parcel Service v. Tax Appeals Tribunal of the State of New York, 512224.

The court ruled that the appeals tribunal, a board which hears appeals of disputed tax charges, made an “irrational and clearly erroneous” determination not to classify the promotional materials as gifts. Customers were under no obligation to use the envelopes, maps and order forms to ship via UPS’s new overnight air service and were allowed to use the materials to ship via other parcel carriers, if they chose, the court noted. “It would be illogical to eliminate an item from the category of promotional ‘free gifts’ because the donor realistically expects that the gift will generate increased sales,” Justice Leslie Stein (See Profile) wrote for the 4-1 majority in the Aug. 16 ruling. “Indeed, that is the very purpose of the promotional materials.”

Justices Thomas Mercure (See Profile) and John Egan Jr. (See Profile) joined Stein’s ruling. Justice William McCarthy (See Profile) wrote a concurrence upholding the refund for UPS in which he questioned whether the promotional materials could be classified as tax-free under one provision of Tax Law §1101[b][12] that provided an exemption for “tangible personal property” related to gifts. Justice E. Michael Kavanagh (See Profile) said in a dissent that UPS had not met its “significant” burden to show that the tax exemption applied to the parcel carrier. The tax tribunal has wide discretion to determine what is and what is not subject to sales and use taxes in such cases, Kavanagh wrote.