Transaction Privilege Tax:Common Problems, Practical Solutions

Presented by:

Mike Galloway

Bancroft Susa & Galloway, PC

Moderator

Ted Irish

Arizona Department of Revenue

Lorna Pederson

KPMG

Lisa Neuville

Office of the Arizona Attorney General

Here’s What We’ll Do Today

• Mike—Opening/A Taxpayer Under Audit

• Ted—TPT Audit Issues

• Lorna—Installation of Exempt Equipment

• Lisa—Litigation Issues

• Mike—Litigation Issues/Cutting Edge

Issue

A Taxpayer Under Audit

• Mike Galloway

If You Are a Taxpayer Under Audit . . .

• Do not put the auditors in the unairconditioned file room in July

• The auditors have the right to review any books and records

Please Bow Your Heads• His Royal Highness, the Most Honorable, the

Esteemed, the Infallible, the Noble, His Directorship, Gale Garriott

If You Are a Taxpayer Under Audit . . .

• Get involved early

• Explain what the taxpayer does

• TPT disputes frequently involve a lack of understanding of what the taxpayer does or how the exemption applies

Audit Issues

• Ted Irish

Audit Selection

• How, why, where and when

• Statutory authority for audit (A.R.S. §§ 42-1108 and 1112)

• ESKORT: Rules and risk points

• MJAC audits - 83 Program, 12 Non-Program cities/towns (A.R.S. § 42-6005)

• Managed audits: The new frontier? (A.R.S. § 42-2301 et seq.)

Audit Process

• Opening interview / Audit questionnaire

• Field work / Computer downloads

• Exit Interview / Tentative Assessment / Post audit follow-up

Audit Protest Process

• Informal conference

• Amended assessment

• Offer-in-compromise/Closing agreements

Conclusions

Installation of Exempt Equipment

• Lorna Pederson

Brink Electric Construction v. ADOR

• Brink installed electrical transmission equipment

• Ball installed large pipes for transporting water

• Brink argued that it was similar to a retailer and could use retail tax exemptions

• Brink also argued it was not a contractor because items it installed were not permanently attached.)

Court’s Conclusions

• The Court disagreed with Brink and ruled that relative degree of permanency was not the issue.

• Brink’s work “improved the realty for electrical transmission purposes” regardless of its movability.

Legislative Action following the Brink Decision

• Legislature acted in 1996 by adding exemption under the contracting classification allowing a deduction for installation of exempt equipment if it is not permanently attached.

A.R.S. § 42-5075.B.7

• The gross proceeds of sales or gross income that is derived from a contract entered into for the installation, assembly, repair or maintenance of machinery, equipment or other tangible personal property that is deducted from the tax base of the retail classification pursuant to section 42-5061, subsection B, or that is exempt from use tax pursuant to section 42-5159, subsection B, and that does not become a permanent attachment to a building, highway, road, railroad, excavation or manufactured building or other structure, project, development or improvement. If the ownership of the realty is separate from the ownership of the machinery, equipment or tangible personal property, the determination as to permanent attachment shall be made as if the ownership were the same. The deduction provided in this paragraph does not include gross proceeds of sales or gross income from that portion of any contracting activity which consists of the development of, or modification to, real property in order to facilitate the installation, assembly, repair, maintenance or removal of machinery, equipment or other tangible personal property that is deducted from the tax base of the retail classification pursuant to section 42-5061, subsection B or that is exempt from use tax pursuant to section 42-5159, subsection B. For the purposes of this paragraph, "permanent attachment" means at least one of the following:

• (a) To be incorporated into real property.

• (b) To become so affixed to real property that it becomes a part of the real property.

• (c) To be so attached to real property that removal would cause substantial damage to the real property from which it is removed.

Exempt Equipment Pursuant to A.R.S. § 42-5061.B

• Manufacturing and Processing

• Mining

• Telecommunications

• Power Production and Transmission

• 4” Pipe and Valves

Permanently Attached

• (a) To be incorporated into real property.

• (b) To become so affixed to real property that it becomes a part of the real property.

• (c) To be so attached to real property that removal would cause substantial damage to the real property from which it is removed.

Practical Solution

• Follow statutory guidelines for permanent attachment

• Most equipment can be removed without causing substantial damage to the real property from which it is removed

• Legislation was intended to reverse the result of the Brink decision

Litigation Issues

• Lisa Neuville

Tie Up Loose Ends Before You Trip Over Them

• How document agreements to pay or withdraw portions of assessment or refund

• Put procedural agreements, including extensions or stays, in writing

• Need to inform the court of agreements seq.)

When Standing On Principle Watch Out For Quicksand

• All or nothing positions may prevent settlements that can yield good results for both sides

• Attorneys’ fees are not fully recoverable against the State

• If you don’t like the law, go to the Legislature to change it

Don’t Bury Your Case Under A Pile Of Manure

• Bad arguments can cause lost credibility

• Focus on the case, not your opponent

• If you don’t understand what is important, nobody else will

The Burden Of Proof Is Not An Excuse To Sit On Your Caboose

• The outcome to most cases does not depend on the burden of proof

• A.R.S. § 42-1255 leaves room for the court to decide who has the burden of proof late in the case

• Don’t expect a court to make your opponent disprove your affirmative defenses

To Cite Or Not To Cite, That Is The Unpublished Question

• Can’t cite unpublished decisions issued by Arizona or non-Arizona courts.

– Daimlerchrysler Servs. N. Am., L.L.C., v. Ariz. Dep’t of Revenue, 210 Ariz. 297, 305 n.8, 110 P.3d 1031, 1039 n.8 (App. 2005)

– Walden Books Co. v. Dep’t of Revenue, 198 Ariz. 584, 589, 12 P.3d 809, 814 (App. 2000)

• Camden Development, an unpublished decision says can’t cite BOTA decisions et seq.)

TPT Litigation Issues/Hot Issue

• Mike Galloway

Litigation Issues

• Appeal, don’t counterclaim

• Spoon feed the judge

• Exemptions are not narrowly construed

• Unpublished cases

• Explain the business or exemption

The Cutting Edge Issue

• Beware of apportionment

• Complete Auto Transit v. Brady

• So. Pacific Trans. Co. v. State and Town of Clifton, 202 Ariz. 326, 44 P.3d 1006 (Ct. App. 2002)

• “Arizona Revised Statutes § 42-5062(A) cannot constitutionally be applied to tax Southern Pacific's gross receipts from shipping goods . . . .

So. Pacific Ruled On the Model City Tax Code

• EMC v. City of Phoenix

• Courts across the country have struck down gross receipts taxes in several jurisdictions because they did not provide a formula that fairly apportioned the income

Other Decisions

• Philadelphia, Pennsylvania (external consistency)

• Upper Moreland, Pennsylvania (external consistency)

• Modesto, California (external consistency)

• Los Angeles, California (internal consistency)

• Los Angeles, California (equal protection)

• San Francisco, California (internal consistency)

Transaction Privilege Tax:Common Problems, Practical Solutions

Presented by:

Mike Galloway

Bancroft Susa & Galloway, PC

Moderator

Ted Irish

Arizona Department of Revenue

Lorna Pederson

KPMG

Lisa Neuville

Office of the Arizona Attorney General