Tucson Mechanical Contracting, Inc. v. Arizona Dept. of Revenue

• Decision Date: 29 December 1992
• Docket Number: CA-TX,No. 1,1
• Citation: 854 P.2d 1162,175 Ariz. 176
• Parties: TUCSON MECHANICAL CONTRACTING, INC.; Lloyd Construction Co., Inc.; and Clyde Smith General Contractors, Inc., Plaintiffs-Appellants, v. ARIZONA DEPARTMENT OF REVENUE; Paul Waddell, in his official capacity as Director of the Arizona Department of Revenue, Defendants-Appellees. 91-0039.
• Court: Arizona Court of Appeals

Page 1162

854 P.2d 1162

175 Ariz. 176

TUCSON MECHANICAL CONTRACTING, INC.; Lloyd Construction Co., Inc.; and Clyde Smith General Contractors, Inc., Plaintiffs-Appellants, v. ARIZONA DEPARTMENT OF REVENUE; Paul Waddell, in his official capacity as Director of the Arizona Department of Revenue, Defendants-Appellees.

No. 1 CA-TX 91-0039.

Court of Appeals of Arizona Division 1, Department T.

Dec. 29, 1992.

Review Denied July 7, 1993.

[175 Ariz. 177] Durazzo & Eckel, P.C. by Neal A. Eckel, Tucson, for plaintiffs-appellants.

Grant Woods, Atty. Gen. by Patrick Irvine, Asst. Atty. Gen., Phoenix, for defendants-appellees.

OPINION

McGREGOR, Judge.

The primary issue in this appeal is whether the legal incidence of Arizona's transaction privilege tax falls upon the purchaser of prime contracting services and thereby violates the federal government's constitutional immunity from state taxation when the federal government acts as a purchaser. We also consider whether the Arizona Department of Revenue, in enforcing the transaction privilege tax, systematically discriminated against in-state contractors in its audit selection process and thereby violated their right to equal protection of the law. We find no constitutional violation.

I.

The three appellants (Taxpayers) are licensed Arizona contractors. The Arizona Department of Revenue (Department) audited each of them for various periods between 1983 and 1987 and assessed unpaid transaction privilege taxes against them on their gross income from federal contracts. The Taxpayers paid the assessed amounts under protest. After exhausting their administrative remedies, the Taxpayers commenced these actions in the Arizona Tax Court seeking refunds and declaratory relief.

Following a three day trial, the tax court ruled for the Department on the Taxpayers' claim that the transaction privilege tax is unconstitutional as applied to contracting income from federal government projects. The court also held that the Department had not discriminatorily enforced the tax.

The Taxpayers timely appealed. We have jurisdiction pursuant to Ariz.Rev.Stat.Ann. ("A.R.S.") § 12-2101.B. The appeal is assigned to Department T of this court pursuant to A.R.S. § 12-120.04.G.

II.

Arizona levies a transaction privilege tax on those doing business within the state, "measured by the amount or volume of business transacted by persons on account of their business activities, and in the amounts to be determined by the application of rates against values, gross proceeds of sales or gross income, as the case may be, as prescribed in this article." A.R.S § 42-1306.A. The statutory scheme specifies the tax basis for each of the seventeen business classifications on which the tax is imposed, see A.R.S. §§ 42-1310.01 through 42-1310.18, and establishes the tax rate applicable to each classification. A.R.S. § 42-1317.

This litigation concerns the "prime contracting" classification, which is governed by A.R.S. § 42-1310.16. The tax base for this classification is sixty-five percent of gross proceeds of sales or gross income derived from the business of prime contracting. A.R.S. § 42-1310.16.B. Unique to the prime contracting classification is A.R.S. § 42-1310.16.G., ¹ which provides:

Every person engaging or continuing in this state in the business of prime contracting or dealership of manufactured buildings shall present to the purchaser of such prime contracting or manufactured building a written receipt of the gross income or gross proceeds of sales from such activity and shall separately state the taxes to be paid pursuant to this section.

Arizona's statutory scheme does not impose the requirement that a purchaser be provided a receipt separately stating the tax to be paid upon any classification other than prime contracting.

Unlike liability for property taxes, which arises from the affirmative act of the state or county government, ² liability for transaction privilege taxes arises automatically when a taxpayer engages in taxable business activity in Arizona. In other words, transaction privilege taxes, including the prime contracting tax, are self-assessed. Taxpayers must file periodic returns, with remittances of taxes due, on forms provided by the Department. A.R.S. § 42-1322. To encourage taxpayers to return and pay transaction privilege taxes, the statute authorizes the Department to audit selected taxpayers' returns and records. A.R.S. § 42-117.

III.

A.

The basic principle that the supremacy clause of the United States Constitution prohibits states from directly taxing the federal government has been long established. See McCulloch v. Maryland, 17 U.S. (4 Wheat) 316, 4 L.Ed. 579 (1819); United States Constitution, Art. VI, cl. 2. While the principle is simple to state, its application "has been marked from the beginning by inconsistent decisions and excessively delicate distinctions." United States v. New Mexico, 455 U.S. 720, 730, 102 S.Ct. 1373, 1380-81, 71 L.Ed.2d 580 (1982). To obviate the confusion caused by earlier decisions, the United States Supreme Court "return[ed] to the underlying constitutional principle," id. at 733, 102 S.Ct. at 1382, and held:

[T]ax immunity is appropriate in only one circumstance: when the levy is on the United States itself, or on an agency or instrumentality so closely connected to the Government that the two cannot realistically be viewed as separate entities, at least insofar as the activity being taxed is concerned.

Id. at 735, 102 S.Ct. at 1383. The Supreme Court recently again summarized the modern theory of intergovernmental tax immunity:

[T]he States can never tax the United States directly but can tax any private parties with whom it does business, even though the financial burden falls on the United States, as long as the tax does not discriminate against the United States or those with whom it deals.... A tax is considered to be directly on the Federal Government only "when the levy falls on the United States itself, or on an agency or instrumentality so closely connected to the Government that the two cannot realistically be viewed as separate entities."

South Carolina v. Baker, 485 U.S. 505, 523, 108 S.Ct. 1355, 1366-67, 99 L.Ed.2d 592 (1988) (citations omitted); see also New Mexico, 455 U.S. at 733-38, 102 S.Ct. at 1382-85; Washington v. United States, 460 U.S. 536, 540-44, 103 S.Ct. 1344, 1347-50, 75 L.Ed.2d 264 (1983).

These Supreme Court decisions establish that intergovernmental tax immunity does not result "simply because the tax has an effect on the United States, or even because the Federal Government shoulders the entire economic burden of the levy," New Mexico, 455 U.S. at 734, 102 S.Ct. at 1382, because "the state tax falls on the earnings of a contractor providing services to the [federal] Government," id., or "because the tax is paid with Government funds...." Id. at 735, 102 S.Ct. at 1383. Indeed, the Court has abandoned the "notion that the economic--as opposed to the legal--incidence of the tax is relevant...." Id. at 735 n. 11, 102 S.Ct. at 1383 n. 11.

Therefore, Arizona's transaction privilege tax on prime contractors doing business with the federal government does not violate the doctrine of intergovernmental immunity unless the tax falls directly on the federal government, falls on an instrumentality indistinguishable from the federal government, or somehow discriminates against the government or a private party with which it does business.

B.

The Taxpayers contend that Arizona's transaction privilege tax falls directly on the federal government whenever the government purchases prime contracting services. Acknowledging that in most instances the legal incidence of Arizona's transaction privilege tax falls on the seller, the Taxpayers argue that the language of A.R.S. § 42-1310.16.G changes the legal incidence of the tax. They assert that, because a prime contractor must furnish his customer with a written receipt separately stating the transaction privilege taxes to be paid, the statute effectively compels the prime contractor to collect the tax from its customers, resulting in the legal incidence falling on the customer. The Taxpayers find support for their argument in United States v. California Bd. of Equalization, 650 F.2d 1127 (9th Cir.1981), aff'd, 456 U.S. 901, 102 S.Ct. 1744, 72 L.Ed.2d 157 (1982). They assert that, like the California statute invalidated in that decision, the Arizona statute effectively exerts "economic compulsion" on prime contractors to collect the tax from their customers. ³ We disagree.

In California Bd. of Equalization, the court considered California statutes ⁴ that permitted the taxpayer to deduct from his taxable gross receipts or gross income all amounts he collected from his customers as sales tax reimbursement but allowed no similar deduction if the seller chose to retain the economic burden of the tax. Sustaining the district court's declaration that the California sales tax was unconstitutional as applied to gross receipts under federal contracts, the United States Court of Appeals for the Ninth Circuit stated:

Despite the facial neutrality of [California Civil Code] Section 1656.1, ⁵ the strong economic incentive created by Section 6012 all but compels the lessor to collect the tax from the lessee. In sum, the California sales tax scheme manifests a legislative intent that the lessee pay the sales tax. It places the legal incidence of the tax on the United States and, therefore, violates the United States' constitutional immunity from state taxation.

650 F.2d at 1132 (emphasis added); accord United States v. State of Michigan, 851 F.2d 803 (6th Cir.1988) (invalidating Michigan sales tax as applied to federal credit unions because Michigan regulations required taxpayers to include sales tax as part of price, and statute denied exclusion of tax from gross proceeds of sales unless taxpayer collected sales tax from purchaser directly).

The Arizona statutes in...