This Week in State Tax

The Arizona Court of Appeals held that a taxpayer's laundry business did not qualify as a processing operation for a use tax exemption related to its machinery and equipment. The taxpayer provided industrial laundry services to healthcare clients, sanitizing over 600,000 pounds of textiles weekly. The taxpayer's sanitizing process involved sorting, prewashing, four wash cycles using certified chemicals to remove microbes and spores, specialized drying methods, inspection, and folding. Additionally, the taxpayer’s business was regulated by several federal agencies, and it was required to maintain certifications that mandated strict adherence to guidelines in the sanitizing process.

The central issue was whether the taxpayer's business met the definition of a processing operation to qualify for the use tax exemption on machinery or equipment used directly in processing. The taxpayer argued its operations transformed contaminated, unmarketable healthcare textiles into clean, disinfected, and marketable textiles, thereby constituting a processing operation. The taxpayer referenced previous cases in which “processing” was defined as a series of actions converting tangible personal property into a marketable form. The Arizona Department of Revenue, however, relied on dictionary definitions accepted in prior precedents which referred to processing as subjecting material to manufacturing or preparation for market.

In its analysis, the appellate court examined the ordinary meaning of “processing” and determined that it did not encompass the taxpayer's activities. The court noted that the taxpayer's business involved sanitizing textiles that were later returned to the taxpayer for repeated processing rather than introducing new products to the market. In some cases, the textiles were owned by the taxpayer and rented to customers, with the laundering and sanitizing occurring after each use. This restoration of original articles to a usable form did not align with the concept of processing as intended by the tax exemption. Therefore, the court concluded that the taxpayer was not entitled to the exemption under Arizona law. For more information on 9W Halo Opco, LP v. Ariz. Dept. of Rev., contact Brian Phillips. 

Download PDF >

The Virginia Court of Appeals recently upheld a trial court ruling that a corporation did not operate as a unitary business with a partnership in which it owned a minority interest because there was no functional integration, centralized management, or economies of scale between the businesses. As a result, the Commonwealth inappropriately apportioned the corporation’s income. FJ Management, Inc. (FJM) is a stock corporation headquartered in Utah that was in the business of operating interstate travel centers and certain other businesses in multiple states including Virginia. In 2008, FJM, as part of a bankruptcy, transferred its travel centers to Pilot Travel Centers, LLC (PTC) in exchange for a minority ownership interest in PTC. FJM also entered an agreement to sell fuel to PTC through its separate oil refinery business. Pilot Corporation and Propeller Corp. owned the majority interest in PTC.

On its original returns for tax years 2015-2017, FJM reported its distributive share of income from PTC, a pass-through entity, as income subject to Virginia apportionment and combined PTC’s apportionment factors with its own factors to determine its Virginia apportionable income. In 2017, FJM amended its original filings for these years and treated the income from PTC as allocable non-unitary business income and removed PTC’s apportionment factors from its own factors. The Department of Taxation (Department) denied the amended returns, arguing that FJM’s ownership interest in PTC was not sufficiently limited so as to call for removing PTC’s apportionment factors. The issue at trial was whether the Department’s denial of the amended returns resulted in an apportionment method that violates the U.S. Constitution.

The Virginia Court of Appeals upheld the earlier trial court decision and determined that the income from PTC could not be apportioned as part of FJM’s apportionable income because a unitary business relationship did not exist between FJM and PTC. Requiring apportionment of FJM’s income from PTC would violate the Due Process and Commerce Clauses of the U.S. Constitution because “the apportioned tax has no “rational relationship between the tax and the ‘values connected with the taxing State’” and subjects FJM to an “unfairly apportioned tax”.” The court found that FJM and PTC met none of the three tests of unity used in the Commonwealth.

• Functional integration. FJM and PTC were engaged in separate and distinct lines of business. PTC was in the business of operating the interstate travel centers, whereas FJM was in the business of operating an oil refinery and a bank. FJM and PTC did not share any business operations, and the fuel FJM sold fuel to PTC was based on pricing terms used for other purchasers.
• Centralized management. FJM cannot exercise any significant management control over PTC. FJM owned a 17 percent interest in PTC and could appoint only two members of the board of managers. The majority shareholders (Pilot Corporation and Propeller Corp.) owned roughly 80 percent interest in PTC with the ability to appoint the remaining members of the board and exercise major control over PTC’s operations.
• Economies of Scale. FJM and PTC did not share any business activities or resources, and they did not derive any cost advantages or efficiencies from their relationship.

Historically, Virginia has been reluctant to acknowledge income as non-unitary, but in this matter, clearly comparing the facts with the judicially developed tests for unity proved persuasive with the court.  Please contact Diana Smith with questions on Commonwealth of Virginia v. FJ Management, Inc.

Download PDF >

Over 7,800 legislative seats were on the ballot on November 5^th.  While trend in votes was similar to the presidential election, the overall impact on party control of state legislative bodies was modest at best. According to the National Conference of State Legislatures (NCSL), prior to the election, Republicans held the majority in both houses of the legislature in 28 states, and Democrats controlled both bodies in 20 states, with just Pennsylvania having divided control. [Nebraska has a single body unicameral legislature, and members are elected on a nonpartisan basis.] In post-election results, Michigan will move to divided control as Republicans won control of the house as will Minnesota where Republicans gained sufficient seats in the house to move into a tie with Democrats. Pennsylvania will remain under divided control as Democrats retained their majority in the house.

Maine and Alaska remain in a bit of flux. The Maine Morning Star reports that while not all results are final, it appears that Democrats will retain control of the house of representatives as well as the state senate. In Alaska, the Anchorage Daily News and other outlets are reporting that a coalition of Democrats and Independents have announced a coalition that will operate as the majority in the house of representatives, replacing a Republican and Independent coalition that controlled the house for the last two years. If those results hold, Republicans will control both houses of the legislature in 27 states, Democrats will control both bodies in 18 states, and control of the chambers will be split in four states. There was no change in party control among the 11 gubernatorial elections. Post-election, Republicans will have a “trifecta” (both legislative chambers and governorship) in 22 states, Democrats will control all three in 15, and 12 will have divided control. Readers are advised that with recounts and potential realignments of coalitions, these results could change somewhat.

Download PDF >