Home Depot United Statesa., Inc. v. Ariz. Dep't of Revenue

• Decision Date: 05 December 2013
• Docket Number: No. 1 CA–TX 12–0005.,1 CA–TX 12–0005.
• Citation: Home Depot U.S.A.., Inc. v. Ariz. Dep't of Revenue, 233 Ariz. 449, 314 P.3d 576, 675 Ariz. Adv. Rep. 14 (Ariz. App. 2013)
• Parties: HOME DEPOT U.S.A., INC. and Affiliates, Plaintiff/Appellant, v. ARIZONA DEPARTMENT OF REVENUE, an executive administrative agency of the State of Arizona, Defendant/Appellee.
• Court: Arizona Court of Appeals

233 Ariz. 449

314 P.3d 576

675 Ariz. Adv. Rep. 14

HOME DEPOT U.S.A., INC. and Affiliates, Plaintiff/Appellant,

v.ARIZONA DEPARTMENT OF REVENUE, an executive administrative agency of the State of Arizona, Defendant/Appellee.

No. 1 CA–TX 12–0005.

Court of Appeals of Arizona, Division 1.

Dec. 5, 2013.

Frazer Ryan Goldberg & Arnold, LLP, Phoenix By Michael G. Galloway, Kacie N. Dillon, for Plaintiff/Appellant.

Morrison and Foerster, LLP, Sacramento, CA By Eric J. Coffill, Carley A. Roberts, Pro Hac Vice, for Plaintiff/Appellant.

Arizona Attorney General's Office, Phoenix By Kimberly J. Cygan, for Defendant/Appellee.

Bade Baskin Richards, PLC, Tempe By William A. Richards, for Amicus Curiae Multistate Tax Commission.

Multistate Tax Commission, Washington, D.C.By Shirley K. Sicilian, Bruce J. Fort, Pro Hac Vice, for Amicus Curiae Multistate Tax Commission.

Chief Judge DIANE M. JOHNSENdelivered the opinion of the Court, in which Presiding Judge LAWRENCE F. WINTHROP and Judge MARGARET H. DOWNIE joined.

OPINION

JOHNSEN, Chief Judge.

¶ 1 Home Depot U.S.A., Inc. challenges the tax court's ruling that it must file a combined return incorporating income its subsidiary, Homer TLC, Inc., generated from licensing Home Depot trademarks.Because the activities of the two corporations are substantially interdependent, we affirm the judgment.

FACTS AND PROCEDURAL BACKGROUND

¶ 2 Home Depot is a Delaware corporation headquartered in Atlanta.It operates retail stores selling home improvement products throughout the United States.In 1991, Home Depot created Homer as a wholly owned subsidiary and assigned to it all of Home Depot's trademarks, trade names and service marks, including “The Home Depot,”“Do–It–Yourself Warehouse” and “Where Low Prices Are Just the Beginning.”

¶ 3 At the time of the assignment, an independent appraisal concluded the market value of the assigned marks was $354 million.Homer entered a 10–year licensing agreement with Home Depot under which, consistent with the appraisal, Home Depot paid a royalty of 1.5 percent of gross sales for use of the marks.Two years before that license agreement was to expire, Homer and Home Depot entered a second 10–year licensing agreement that specified a royalty of four percent of gross sales, based on an appraisal dated October 28, 1999.Pursuant to the license, Home Depot placed the marks on its advertising, website, store facades, shopping carts, tags, signs and employee aprons and on some but not all of the products it sold.

¶ 4 Following an audit of Home Depot's Arizona income, the Arizona Department of Revenue(the “Department”) required Home Depot to include Homer in its Arizona return as part of its unitary business for the tax years ending January 30, 2000, January 28, 2001 and February 3, 2002.¹After timely protesting and exhausting its administrative remedies, Home Depot appealed the Department's assessments to the tax court pursuant to Arizona Revised Statutes(“A.R.S.”)section 42–1254(C)(2013).²

¶ 5 The tax court ruled in the Department's favor on crossmotions for summary judgment.We have jurisdiction of Home Depot's timely appeal pursuant to Article 6, Section 9 of the Arizona ConstitutionandA.R.S. § 12–2101(A)(2013).

DISCUSSION

A.Legal Principles.

¶ 6 A corporation that does business in Arizona and has income that “is the result of activity within [Arizona] or derived from sources within” Arizona must file an Arizona income tax return, A.R.S. § 43–102(A)(5)(2013), and must pay tax on its “entire Arizona taxable income,”A.R.S. § 43–1111(2013).

¶ 7 When a group of affiliated corporations does business in multiple states and one of them has income from Arizona, we apply the “unitary-business principle” to determine whether a member of the group “has the requisite minimal state connection to include its income in the tax base.”R.R. Donnelley & Sons Co. v. Ariz. Dep't of Revenue,224 Ariz. 254, 257, ¶ 11, 229 P.3d 266, 269(App.2010)(citations omitted).If the affiliated corporations qualify for unitary treatment, Arizona may require them to file a combined return.Ariz. Admin. Code(“A.A.C.”)R15–2D–401(B);seealsoA.R.S.§ 43–942(B)(2013).The taxpayer's consolidated income then is apportioned in accordance with Arizona's Uniform Division of Income for Tax Purposes Act, A.R.S. §§ 43–1131 to –1150 (2013).

¶ 8 In State ex rel. Arizona Department of Revenue v. Talley Industries, Inc.,182 Ariz. 17, 23, 893 P.2d 17, 23(App.1994), this court adopted an “intermediate approach” to determining whether to apply unitary treatment to a company and its affiliate(s).Under this approach, unitary treatment is appropriate when there is “substantial interdependence of basic operations among the various affiliates or branches of the business.”Id. at 24, 893 P.2d at 24(quoting1 Jerome R. Hellerstein & Walter Hellerstein, State Taxation (“Hellerstein”)¶ 8.11[5], at 8–92).

¶ 9 In Talley,we examined 25 subsidiaries that, inter alia, manufactured distinct lines of products, imported apparel and bought and sold real property.182 Ariz. at 18–19, 893 P.2d at 18–19.The taxpayer-parent sought unitary treatment, arguing it controlled the operations of the subsidiaries.Id. at 19, 893 P.2d at 19.The parent created accounting, operating and personnel policies for the subsidiaries and provided company-wide training, benefit and pension plans and information services.Id.

¶ 10 In adopting the Hellerstein approach, we quoted a discussion by the Pennsylvania supreme court in Pennsylvania v. ACF Industries, Inc.,271 A.2d 273(1970), which examined whether the business activities at issue there were part of a “single enterprise” or were instead “a truly divisionalized business.”182 Ariz. at 24, 893 P.2d at 24.Consistent with that analysis, we held the taxpayer and its subsidiaries in Talley could not file a combined return because there was “no substantial interrelationship or interdependence of basic operations” between the parent and its affiliates.Id. at 18, 893 P.2d at 18.We explained:

There were no transfers of materials, products, goods, technological data relating to products, processes, machinery, or equipment by subsidiaries operating wholly outside Arizona to subsidiaries with operations in Arizona.Also, virtually no flow of product and no vertical or horizontal integration of business operations exists between the subsidiaries with, and those without, income-producing factors and business operations in Arizona.No basic operational ties existed between the two Arizona real estate subsidiaries and any other Talley subsidiary.

Id. at 19, 893 P.2d at 19.

¶ 11 In Donnelley,we applied the Talley standard to a subsidiary that, like Homer, licensed the parent company's trademarks to the parent, and held unitary treatment was required.224 Ariz. at 261–65, ¶¶ 29–45, 229 P.3d at 273–77.We observed that the trademarks, which were found on the parent company's shipping labels, letterhead, signs and website, “were a core part” of the parent's operations.Id. at 262, ¶ 33, 229 P.3d at 274.We concluded that because the parent paid the subsidiary royalties of between $25 million and $100 million a year and the subsidiary did not license the trademarks to any third party, the trademarks were part of the parent's “basic operations” and the subsidiary's licensing business was “functionally interdependent” with the parent's.Id. at 263, ¶¶ 35–36, 229 P.3d at 275.

B.Home Depot and Homer Require Unitary Treatment.

¶ 12 Home Depot filed an amicus curie brief in the Donnelley appeal, prompting us to comment in that decision that the subsidiary's operations in that case were dissimilar to Home Depot's description of Homer's business.Id. at 264, ¶ 41, 229 P.3d at 276.Directly presented for the first time with the facts of the relationship between Home Depot and Homer, however, we reach the same result as in Donnelley: Unitary treatment is required because the operations of Home Depot and Homer are substantially interrelated.³

¶ 13 There is no dispute that Home Depot and Homer are separate organizations: The two companies do not share headquarters, books and records, software systems, bank accounts, purchasing, employees, officers or directors.Moreover, while Home Depot sells home improvement products, Homer does not; its sole business is the management of the Home Depot trademarks.Homer actively manages those marks; according to the record, it has sent hundreds of cease-and-desist letters and commenced more than 50 lawsuits aimed at protecting the marks.And of course, having assigned its trademarks to Homer, Home Depot is not in the business of licensing those trademarks to third parties.

¶ 14 But Home Depot would not be “Home Depot” without the trademarks that it licenses from Homer for its retail stores, advertising and website.Home Depot argues it sells 1,000 different brands of products, most of which do not bear its own trademark.That argument overlooks the obvious—it is the “Home Depot” brand on the company's advertisements and website and throughout its retail stores that Home Depot relies on to distinguish the quality of its products, selection and customer service from those of its competitors.As one of the appraisals the company obtained of the licensed marks concluded, “Together these trademarks identify Home Depot's operations[,] products, and services.These trademarks are a signal to the consumer of the level of quality and service that is associated with Home Depot.”

¶ 15 By the same token, without Home Depot's continuing efforts to promote its brand, the trademarks that constitute Homer's only assets would be worthless.One of the appraisals supports this conclusion, noting that the appropriate royalty rate was based in part on Home Depot's financial performance and on the company's expenditure of “significant advertising dollars to establish and maintain [its] name recognition.”That appraisal noted Home Depot's strong market share and ...