PCS, Inc. v. Arizona Dept. of Revenue

• Decision Date: 29 December 1995
• Docket Number: No. 1,CA-TX,1
• Parties: PCS, INC., a Delaware corporation, Plaintiff-Appellant, v. ARIZONA DEPARTMENT OF REVENUE, an agency of the State of Arizona, Defendant-Appellee. 94-0006.
• Court: Arizona Court of Appeals

Page 680

925 P.2d 680

186 Ariz. 539

PCS, INC., a Delaware corporation, Plaintiff-Appellant, v. ARIZONA DEPARTMENT OF REVENUE, an agency of the State of Arizona, Defendant-Appellee.

No. 1 CA-TX 94-0006.

Court of Appeals of Arizona,

Division 1, Department T.

Dec. 29, 1995.

Review Denied Oct. 21, 1996. ^*

Lewis and Roca by John P. Frank, Patrick Derdenger and Anthony Blackwell, Phoenix, for Plaintiff-Appellant.

Grant Woods, Attorney General by James M. Susa, Assistant Attorney General, and Joseph A. Kanefield, Assistant Attorney General, Phoenix, for Defendant-Appellee.

OPINION

KLEINSCHMIDT, Judge.

The taxpayer, PCS, Inc., appeals from summary judgment for the Arizona Department of Revenue on PCS's claim for a refund of use taxes which it paid under protest. The tax was assessed on certain plastic cards PCS uses in its business. We believe the cards were subject to the tax, and accordingly, we affirm.

FACTS AND PROCEDURE IN THE TAX COURT

PCS is in the business of providing a service to various insurance plans. The service permits pharmacies to determine by computer whether a customer is covered by insurance that will pay for the customer's drug purchases. If coverage exists, the system also pays the pharmacy for the purchases immediately and then bills the payment to the customer's insurance plan.

PCS issues identification cards encoded with eligibility and other information about each individual beneficiary. These are given to the beneficiaries, and, when the beneficiaries want to purchase drugs, the cards are "swiped" through a participating pharmacy's card reader which transmits the necessary information to PCS for action on the customer's claim.

PCS makes plan identification cards in Arizona to the order of its clients. PCS purchases blank cards from out-of-state vendors. The cards have blank magnetic data strips and may carry printing or legends specific to the plan in question. Because these purchases take place in interstate commerce, no Arizona transaction privilege tax is imposed on the non-Arizona retail seller or passed on to PCS.

At its offices in Scottsdale, Arizona, PCS accumulates data about each beneficiary of its clients and enters the data onto magnetic tapes. These tapes are then used on machines that feed the blank cards purchased by PCS into a mechanical heat process that punches each beneficiary's name and other personal information onto each card in raised letters and encodes information onto the magnetic data strip on the card. After quality checking, the finished cards are shipped in bulk to the plan sponsor or mailed directly to the beneficiaries themselves. Most of the finished cards are sent to plan sponsors outside of Arizona, but some go to plan sponsors in Arizona. Only those cards which are shipped outside of Arizona are at issue in this case.

At any one time, PCS may own as many as 14 million blank cards. Three to 4 million of these will be entirely blank cards in inventory in Arizona, and 4 million will be unprocessed sponsor-specific cards for various active plan sponsors, also on hand in Arizona. The remainder will be held by out-of-state card vendors or overflow processors.

PCS includes a fee for the initial issuance of cards in its base processing charges to its clients. It also makes separate charges for specialized art work related to the production of cards and for reissuance of cards more frequently than normal.

Once PCS has processed and distributed the cards, it has nothing more to do with them. When a beneficiary becomes ineligible, his or her card is canceled electronically.

In 1983, following an audit, the Department decided the cards should be taxed. PCS protested, and, at an informal conference in June 1983, representatives of the Department and the Arizona Attorney General's Office acquiesced in that view. Between 1983 and 1990, PCS relied on the Department's agreement that no tax would be imposed on the cards.

In 1990, the Department changed its position and issued a use tax assessment for all cards provided to out-of-state plan sponsors for the period of January 1, 1986 through January 31, 1990. The Department's appeals section abated any penalties for late filing and payment, but rejected PCS's contention that the cards were not subject to the use tax. The Board of Tax Appeals, Division Two, affirmed. After paying the use tax and interest under protest, PCS brought this action for a refund in the tax court. ¹

On cross-motions for summary judgment, the tax court ruled for the Department in a published opinion. PCS, Inc. v. Arizona Dep't of Revenue, 176 Ariz. 628, 863 P.2d 920 (Tax Ct.1993). PCS appealed.

THE PLASTIC CARDS USED OUTSIDE ARIZONA ARE SUBJECT TO THE USE TAX

Arizona Revised Statutes Annotated ("A.R.S.") section 42-1408(A) imposes "an excise tax on the storage, use or consumption in this state of tangible personal property purchased from a retailer, as a percentage of the sales price." The tax rate is the same as would apply to retailers under the Arizona transaction privilege (sales) tax on the business of selling tangible personal property at retail. See A.R.S. § 42-1408(C). If the gross receipts from the sale are included in the measure of the Arizona transaction privilege tax, such property is exempt from the use tax. So is tangible personal property which has already been subjected to another state's sales or use tax equal to or exceeding the Arizona transaction privilege tax. A.R.S. § 42-1409(A)(1) and (2). As the tax court generally noted in People of Faith v. Arizona Dep't of Revenue, 161 Ariz. 514, 779 P.2d 829 (Tax Ct.1989), appeal dismissed, 164 Ariz. 102, 791 P.2d 369 (App.1990):

Typically, sales taxes and use taxes are complementary. [Citations omitted.] Both taxes start with a retail sale. The sales tax is a transaction tax on the sale. It is imposed upon the seller but ordinarily is passed through to the buyer. The use tax is a tax on the privilege of using the purchased property within the state and is imposed on the buyer. Both taxes are computed by multiplying the sale price by the tax rate. To be truly complementary, both taxes should be at the same rate. If the sale was subject to sales tax, the buyer is exempt from use tax....

If the foregoing scheme works as it is designed to work, the buyer (the real payer of the sales tax, whether passed through or not), pays one tax or the other on retail purchases, regardless of where the purchase is made. If all retail sales within a state are subject to a sales tax, then, because the buyer is exempt from use taxes on such sales, use taxes can only be imposed on the use of property purchased outside the state.

Id. 161 Ariz. at 517, 779 P.2d at 832.

The Arizona use tax is an excise, or privilege tax, on the "storage, use or consumption" of tangible personal property in Arizona. Arizona Revised Statutes section 42-1401(6) defines "storage" as "keeping or retaining tangible personal property purchased from a retailer for any purpose except sale in the regular course of business or subsequent use solely outside this state." Section 42-1401(8) defines "use or consumption" as "the exercise of any right or power over tangible personal property incidental to owning the property except holding for sale or selling the property in the regular course of business."

PCS contends that it does not use the cards in Arizona but merely stores and processes them for ultimate use outside the state. It relies primarily on two cases, Cosmair, Inc. v. Director, New Jersey Div. of Taxation, 109 N.J. 562, 538 A.2d 788 (1988), and Exxon Corp. v. Wyoming State Bd. of Equalization, 783 P.2d 685 (Wyo.1989), cert. denied, 495 U.S. 910, 110 S.Ct. 1937, 109 L.Ed.2d 300 (1990).

In Cosmair, the taxpayer, a perfume manufacturer, bottled samples in New Jersey for distribution to its retail customers outside the state. It stored the samples on its premises and boxed and labelled the boxes for shipment out of state. New Jersey's use tax statute excepted "mere storage, keeping, retention or withdrawal from storage" in the state. The Cosmair court held that:

Cosmair's activities in this case--packaging, sorting, assembling, and labelling--were incidental to the withdrawal from storage of the samples. These tax-neutral activities arise whenever a manufacturer moves its inventory. If the incidental activities performed by Cosmair with respect to the samples render the exemption inapplicable, it is difficult to see how manufactured goods could ever be withdrawn from storage without losing the use tax exemption.

538 A.2d at 792.

Our first observation about Cosmair is that the court was generous to the taxpayer in labeling the taxpayer's packaging and labeling activities as "incidental" to storage of the samples. More important, PCS does more than box and place shipping labels on batches of the cards that it buys outside Arizona. It subjects them to sophisticated, capital-intensive processing that transforms them from blank cards into unique, individualized information-storage and identification devices that can be used only by a single member of a single prescription drug plan. It uses the cards as raw material for crafting items which, when presented by its clients' beneficiaries, facilitate PCS's performance of the services for which its clients pay. It uses or consumes the cards within the meaning of A.R.S. sections 42-1401(8) and 42-1408(A).

Exxon does not advance the taxpayer's case. Exxon bought pipe imported from Japan from a Texas company for the purpose of fabricating it into a pipeline. The pipeline was in Wyoming. While the pipe was in Colorado en route to Wyoming, Exxon inspected it, blasted it, and coated it with epoxy, all of which was necessary before the pipe could be used in the pipeline. Exxon voluntarily paid use taxes on the pipe to Colorado.

Wyoming, whose statute taxed the purchase or lease of property outside the state for "first use, storage or consumption within this state,"...