Loveness v. State ex rel. Arizona Dept. of Revenue
| Decision Date | 22 January 1998 |
| Docket Number | CA-TX,No. 1,1 |
| Citation | 963 P.2d 303,192 Ariz. 224 |
| Parties | , 261 Ariz. Adv. Rep. 4 Gary LOVENESS and Elizabeth Loveness, husband and wife, Plaintiffs-Appellants, v. STATE of Arizona, ex rel., ARIZONA DEPARTMENT OF REVENUE, Defendant-Appellee. 97-0003. |
| Court | Arizona Court of Appeals |
¶1 Gary and Elizabeth Loveness ("taxpayers") appeal from a summary judgment granted in favor of the Arizona Department of Revenue ("DOR") on taxpayers' claim for a partial refund of their Arizona income taxes. The taxes at issue arose out of services performed by taxpayers on an Indian reservation in Arizona. They argue that DOR's assessment of a tax on their personal net income, which arose out of on-reservation logging services, was invalid under the Supremacy Clause of the United States Constitution because it:
1. was preempted by the comprehensive federal regulation of on-reservation logging, see White Mountain Apache Tribe v. Bracker, 448 U.S. 136, 100 S.Ct. 2578, 65 L.Ed.2d 665 (1980); or
2. infringed on the right of reservation Indians to make their own laws and be ruled by them, see Williams v. Lee, 358 U.S. 217, 79 S.Ct. 269, 3 L.Ed.2d 251 (1959).
We disagree with taxpayers and affirm.
¶2 The taxpayers are non-Indians who lived in Arizona outside the boundaries of the Fort Apache Indian Reservation ("Reservation") during the relevant period. They were the sole shareholders of Basin Building Materials, Inc., which did business as Pinetop Logging Company ("Pinetop") during 1987 and 1988.
¶3 The Reservation is the preserve of the White Mountain Apache Tribe ("the tribe") and consists of approximately 1.64 million acres in the White Mountains. This area includes about 720,000 acres of commercial forest, of which about 300,000 acres are managed with selective cutting on a sustained yield basis.
¶4 The tribe manages, harvests, mills and sells timber as the Fort Apache Timber Company ("FATCO"). The tribe's timber operation is its most important economic activity. Subject to U.S. Bureau of Indian Affairs ("BIA") supervision, FATCO is responsible for the tribe's timber operation.
¶5 BIA representatives designate the trees that are to be cut on the Reservation. The tribe's contractors cut the trees and transport the logs to FATCO's sawmill. FATCO employees then sort the logs and process them into lumber and pulpwood. Although the tribal government owns and manages the timbering operation on the Reservation, it cannot disburse any profits without first satisfying outstanding obligations to the United States government and obtaining BIA's approval.
¶6 BIA's supervision and control over timbering practices on Indian reservations extended to all activities of FATCO and its contractors during the relevant period. See generally 25 U.S.C. §§ 405-07; 25 C.F.R. § 163; 36 C.F.R. § 200; Bracker, 448 U.S. at 138-39, 145-49, 100 S.Ct. at 2581, 2584-87. The BIA head forester in charge of the Reservation described BIA's supervision as "encompassing all aspects of forest utilization and management, including extensive rules and regulations governing in detail the planning, engineering, construction, maintenance and general regulation of all roads used by loggers."
¶7 FATCO delegates certain portions of the tribe's timber operation to companies like Pinetop. From 1969 through 1988, Pinetop conducted logging operations on the Reservation under contract with the tribe. Pinetop maintained its business office, assets, and business operations on the Reservation. Pinetop owned the trucks and equipment it used in the FATCO logging operation. Over half its employees were members of the tribe. Before Pinetop contracted with the tribe to do this work, it was advised by a representative of DOR's predecessor agency that the agency had no jurisdiction over its proposed transactions, either as to sales tax on timbering or use tax on equipment brought onto the Reservation.
¶8 In 1971, the Arizona Highway Department and Arizona Highway Commission assessed delinquent motor carrier license and fuel taxes against Pinetop. Pinetop disputed their authority to do so. Ultimately, the United States Supreme Court resolved the controversy, finding that the state taxes were preempted. The Court said:
Where, as here, the Federal Government has undertaken comprehensive regulation of the harvesting and sale of tribal timber, where a number of the policies underlying the federal regulatory scheme are threatened by the taxes respondents seek to impose, and where respondents are unable to justify the taxes except in terms of a generalized interest in raising revenue, we believe that the proposed exercise of state authority is impermissible.
Bracker, 448 U.S. at 151, 100 S.Ct. at 2588.
¶9 In December 1986, taxpayers converted Pinetop into a Subchapter S corporation for federal and state tax purposes. The effect of a "Sub S" election is to end taxation of corporate net income and tax it as the personal net income of shareholders. See I.R.C. § 1361 (1994). Pinetop's activities on the reservation continued through 1988, when taxpayers retired.
¶10 For tax years 1987 and 1988, taxpayers received salaries from Pinetop on which they reported and paid federal and Arizona income taxes. They also reported and paid federal income taxes on Pinetop's net income, which included ordinary income, interest income, and recapture of accelerated depreciation. 1 See I.R.C. § 1231. However, in their Arizona resident income tax returns for both years they subtracted Pinetop's net income, which had flowed through to them, in arriving at Arizona taxable income, stating that those sums were immune from Arizona income taxation "by virtue of preemptive federal regulations of harvest of Indian timber," citing Bracker.
¶11 DOR audited taxpayers' individual Arizona income tax returns for 1987 and 1988. In 1990, DOR determined that taxpayers had incorrectly subtracted Pinetop's net income in calculating their Arizona taxable income and proposed to assess corresponding income tax deficiencies against them. 2 After exhausting their administrative remedies, taxpayers commenced this action in the tax court under A.R.S. sections 42-124(C) and (D).
¶12 On cross-motions for summary judgment the tax court distinguished the instant case from Bracker. It found that the motor vehicle registration and use fuel excise taxes were different from the general income tax applied here because the former had taxed on-reservation activity and reduced both tribal revenues from timber sales and tribal contractors' potential profits.
¶13 The tax court found that, in this case, the individual income tax did not tax on-reservation activity, did not burden the tribe or its members, and did not reduce either tribal revenues from timber sales or potential profits of tribal contractors. It also found that taxpayers had not explained how imposing the Arizona individual income taxes on non-Indian, non-residents who earned the income on an Indian reservation infringed upon the right of tribal self-government. It therefore granted summary judgment for DOR.
¶14 Taxpayers bring this timely appeal, which is assigned to Department T of this court pursuant to A.R.S. sections 12-120.04(G) and 12-170(C).
¶15 Both sides agree that the relevant facts are identical to those in Bracker except for one: the tax challenged here is Arizona's resident individual income tax, not its motor carrier registration or use fuel tax. We must decide whether this difference changes the Bracker analysis and compels a different result. We conclude that it does.
¶16 The motor carrier registration tax and use fuel tax that were challenged in Bracker were activity taxes (i.e. taxes that are assessed for conducting an activity). Id. at 139-40, 100 S.Ct. at 2581. The motor carrier license tax was imposed on all common motor carriers of property and the use fuel tax was assessed for using a motor vehicle on Arizona highways. See id. Both taxes are assessed regardless of the income/profit related to the activity and are a cost of doing business. See id.
¶17 By contrast, Arizona's resident income tax is an undifferentiated tax not identified with, or a function of, any particular source of gross income. See A.R.S. §§ 43-1001(1) & (2). This type of tax is an equitable way of distributing the burdens of government and is directly related to the ability of the taxpayer to pay it. See New York ex rel. Cohn v. Graves, 300 U.S. 308, 313, 57 S.Ct. 466, 467, 81 L.Ed. 666 (1937). Related and unrelated exemptions and deductions covering the entire taxable year affect the determination of taxable income for that year, and the resident's income tax liability does not vary with the source of the gross income. See A.R.S. §§ 43-1001(1) & (2).
¶18 Taxpayers argue that the activity taxes at issue in Bracker, in Central Machinery Co. v. Arizona State Tax Commission, 448 U.S. 160, 100 S.Ct. 2592, 65 L.Ed.2d 684 (1980), and in a number of lower court decisions are conceptually the same as the income tax at issue here. They contend that, because these cases all involved a tax on the taxpayers' "gross income," the fact that taxpayers resided off-reservation is immaterial to the preemption analysis.
¶19 We disagree. The taxes in Bracker, and in all of the lower court cases upon which taxpayers rely, were taxes assessed on activities that occurred in Indian country. The character of these taxes was central to the Bracker Court's analysis. See 448 U.S. at 148, 150-51, 100 S.Ct. at 2586, 2587. They affected the cost of logging, impacted the federal regulatory scheme, and eventually took money away from the...
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