Qwest Dex, Inc. v. Arizona Dept. of Revenue

• Decision Date: 05 April 2005
• Docket Number: No. 1 CA-TX 03-0017.,1 CA-TX 03-0017.
• Citation: 210 Ariz. 223,109 P.3d 118
• Parties: QWEST DEX, INC., (formerly US West Dex, Inc.), License No. 07-405645-P, Plaintiff-Appellee, v. ARIZONA DEPARTMENT OF REVENUE, an agency of the State of Arizona, Defendant-Appellant.
• Court: Arizona Court of Appeals

109 P.3d 118

210 Ariz. 223

QWEST DEX, INC., (formerly US West Dex, Inc.), License No. 07-405645-P, Plaintiff-Appellee, v. ARIZONA DEPARTMENT OF REVENUE, an agency of the State of Arizona, Defendant-Appellant.

No. -0017.

Court of Appeals of Arizona, Division 1, Department T.

April 5, 2005.

Fennemore Craig, P.C. By Paul J. Mooney, Steven R. Partridge, Phoenix, Attorneys for Plaintiff-Appellee.

Terry Goddard, Attorney General By Sara D. Branscum, Assistant Attorney General, Elizabeth S. Hill, Assistant Attorney General, Deborah L. Bryant, Assistant Attorney General, Phoenix, Attorneys for Defendant-Appellant.

OPINION

KESSLER, Judge.

¶ 1 This is a use tax case. It arises out of Arizona's taxation of out-of-state printing services provided to Qwest Dex, Inc. ("Taxpayer"). The tax court ruled that, as a matter of law, the use tax does not apply to these services and that the printers are not "retailers" for purposes of Arizona Revised Statutes ("A.R.S.") section 42-5155(A) (Supp.2004). For the reasons stated below, we affirm the tax court.

FACTS AND PROCEDURAL BACKGROUND

¶ 2 Taxpayer is in the business of publishing the White Pages and Yellow Pages telephone directories. It contracted with out-of-state printing companies (the "Printers")¹ to print the directories, and contracted with out-of-state mills (the "Mills")² for the paper.

¶ 3 The grade and type of paper required for Taxpayer's directories is not the type regularly kept in the Printers' inventories. Accordingly, Taxpayer entered into separate contracts with the Mills to supply paper for use in the directories. The contracts determined the amount of paper to supply and the paper's price, and Taxpayer determined the paper's weight, color, quality, and type. Taxpayer was financially responsible to the Mills for all paper orders shipped to the Printers on Taxpayer's behalf. ¶ 4 In accordance with the agreements with its Printers, Taxpayer was required to supply the paper on which Taxpayer's information would be printed. The Printers were allowed to accept and pay for paper orders on Taxpayer's behalf. Although the Printers might pay the Mills for the paper, they invoiced Taxpayer for the cost.

¶ 5 Once the Printers received the paper from the Mills, they would print the information supplied by Taxpayer on that paper, glue the papers together into directories, and ship the directories to Taxpayer. The Printers then sent Taxpayer an invoice for the printing services and the incidental amount of tangible personal property, such as glue and ink. The printing charges were stated separately from the requests for reimbursement for payments for paper orders.

¶ 6 Taxpayer paid a state use tax on the total invoiced cost of the telephone directories used in Arizona, but later claimed a refund of $3,357,529 for the period between January 1995 and June 2000. Taxpayer claimed that it owed a use tax only on the paper that went into directories, but not for the printing services. The Arizona Department of Revenue ("ADOR") denied the refund claim on the basis that Taxpayer properly paid the use tax on all components of the directories. Taxpayer timely protested the denial.

¶ 7 Taxpayer then appealed the refund denial to the Arizona Tax Court pursuant to A.R.S. § 42-1254(C) (Supp.2004). Both parties moved for summary judgment. The tax court granted Taxpayer's motion and denied ADOR's motion. This appeal followed.

DISCUSSION

¶ 8 When the material facts underpinning a summary judgment are undisputed, this Court must determine whether the tax court correctly applied the substantive law to those facts. Brink Elec. Constr. Co. v. Ariz. Dep't of Revenue, 184 Ariz. 354, 358, 909 P.2d 421, 425 (App.1995). We review issues of law de novo, and are bound neither by the tax court's conclusions of law nor by its findings combining both fact and law. Id.

¶ 9 In interpreting the use tax statutes, we must bear in mind that "tax statutes are interpreted strictly against the state, and any ambiguities are resolved in favor of the taxpayer." Wilderness World, Inc. v. Ariz. Dep't of Revenue, 182 Ariz. 196, 199, 895 P.2d 108, 111 (1995). We read the statutes' words "to gain their fair meaning, but not to gather new objects of taxation by strained construction or implication." Arizona State Tax Comm'n v. Staggs Realty Corp., 85 Ariz. 294, 297, 337 P.2d 281, 283 (1959).

Nature of Use Tax

¶ 10 Section 42-5155(A) of A.R.S., which codifies Arizona's use tax, imposes an excise tax "on the storage, use or consumption in this state of tangible personal property purchased from a retailer or utility business, as a percentage of the sales price." "Use or consumption" is defined by statute as "the exercise of any right or power over tangible personal property incidental to owning the property...." A.R.S. § 42-5151(20) (Supp.2004).

¶ 11 The relevant statutes do not define "tangible personal property." The transaction privilege tax statutes, however, define "tangible personal property" as "personal property which may be seen, weighed, measured, felt or touched or is in any other manner perceptible to the senses." A.R.S. § 42-5001(16) (Supp.2004). Arizona's use tax defines "retailer" as "[e]very person engaged in the business of making sales of tangible personal property for storage, use or other consumption...." A.R.S. 42-5151(17)(a) (Supp.2004).

¶ 12 Whereas transaction privilege taxes are imposed on transactions consummated within a state, use taxes are designed to reach out-of-state sales of tangible personal property to a state's residents for use, storage, or consumption in the state. See People of Faith Inc. v. Ariz. Dep't of Revenue, 161 Ariz. 514, 519, 779 P.2d 829, 834 (T.C.1989); Nathaniel T. Trelease and Andrew W. Swain, The Law's Long Arm: The Taxation of Electronic Commerce, Ariz. Att'y, June 2002, at 20. The use tax thus prevents the erosion of a state's tax base when its residents make purchases in other states. Trelease and Swain, Ariz. Att'y, June 2002, at 20. Because states cannot audit all residents for use tax purposes, they must rely upon the vendors to collect and remit use taxes. Id.

¶ 13 Although the use tax is complementary to the transaction privilege tax, their objectives differ. The transaction privilege tax is more akin to a business privilege tax on gross receipts from taxable activity. A.R.S. § 42-5008 (Supp.2004); see Southern Pac. Transp. Co. v. Ariz. Dep't of Revenue, 202 Ariz. 326, 333, ¶ 25, 44 P.3d 1006, 1013 (App.2002). The tax is imposed on the vendor, not its customers, and although the vendor may elect to pass the burden of the tax onto the customer, the vendor is ultimately liable. A.R.S. §§ 42-5001(8) (Supp.2004), 42-5008(A) (Supp.2004), and 42-5010(A)(1) (Supp.2004). It applies to a variety of businesses, including those not otherwise engaged in the retail sale of tangible personal property. A.R.S. § 42-5010. The transaction privilege tax extends to the business of job printing. See A.R.S. § 42-5066 (1999). Arizona's use tax, however, imposes no specific tax on printing services. A.R.S. § 42-5155(A).

Tangible Personal Property vs. Service

¶ 14 On appeal, ADOR asserts that the use tax applies to the purchase of the directories because the directories qualify as "tangible personal property" and the printers are "retailers" pursuant to A.R.S. § 42-5155(A). According to ADOR, the printers created tangible personal property because they created a new product — the directories — from the paper and content. Therefore, ADOR reasons that Taxpayer must pay the use tax on the purchase of the directories in their final form, not just on the cost of the blank paper.

¶ 15 Taxpayer counters that A.R.S. § 42-5155(A) does not apply here because Taxpayer ultimately purchased a service from the printers and not tangible personal property. Taxpayer points out that it supplied the content and paper to the printers and in turn the printers merely "converted the content to printing plates, printed it on [Taxpayer's] paper and glued the individual pages of the directories together." Taxpayer also asserts that the printers acted as Taxpayer's agents in acquiring the paper. Taxpayer arranged for the printers to purchase the paper on Taxpayer's behalf to print the directories and the cost of the paper was passed on to Taxpayer. Taxpayer also asserts that the printers are not engaged in selling tangible personal property but instead are engaged in providing a service — here, the printing of the directories.

¶ 16 We agree with Taxpayer's position that the out-of-state printing services are not subject to the use tax. We reach that conclusion by applying two tests: the objective "dominant purpose" test, adopted in Goodyear Aircraft Corp. v. Arizona State Tax Comm'n, 1 Ariz.App. 302, 402 P.2d 423 (1965) (the "Goodyear" test), and the "common understanding" test.

A. Dominant Purpose Test and Goodyear

¶ 17 In cases dealing with a purchase of a combined product and service, courts generally apply a "true object" or "dominant purpose" test. See Jerome R. Hellerstein and Walter Hellerstein, Sales and Use, Personal Income, and Death and Gift Taxes and Intergovernmental Immunities in State Taxation, ¶ 12.08, at 78 (3d ed.2001-2003) (hereinafter, "Hellerstein") (noting that courts in Virginia, Massachusetts, Minnesota, Ohio, Montana, Rhode Island, and Wisconsin apply the dominant purpose test to determine whether a transaction constitutes a taxable sale of tangible personal property or a nontaxable sale of services). Thus, if the dominant purpose of the transaction is a service, then the transaction is not taxable. See id. As Hellerstein notes, however, this type of test is difficult to apply because most cases deal with a blending of the service and product components. See id. at ¶ 12.08(1). The result is often inconsistent rulings which are difficult to reconcile. See id. Thus, the Ohio Supreme Court in several decisions, such as Miami Citizens Nat'l Bank & Trust Co. v....