Cci Europe v. Ador , 237 Ariz. 50 ( 2015 )


Menu:
  •                                IN THE
    ARIZONA COURT OF APPEALS
    DIVISION ONE
    CCI EUROPE, INC., Plaintiff/Appellee,
    v.
    ARIZONA DEPARTMENT OF REVENUE, Defendant/Appellant.
    No. 1 CA-TX 13-0002
    FILED 3-12-2015
    Appeal from the Superior Court in Maricopa County
    No. TX2010-000404
    The Honorable Dean M. Fink, Judge
    AFFIRMED
    COUNSEL
    Steptoe & Johnson, LLP, Phoenix
    By Patrick Derdenger, Bennett Evan Cooper
    Counsel for Plaintiff/Appellee
    Arizona Attorney General’s Office, Phoenix
    By Jerry A. Fries, Benjamin H. Updike
    Counsel for Defendant/Appellant
    OPINION
    Judge Maurice Portley delivered the Opinion of the court, in which
    Presiding Judge Patricia A. Orozco and Judge Randall M. Howe joined.
    CCI EUROPE v. ADOR
    Opinion of the Court
    P O R T L E Y, Judge:
    ¶1            We are asked to determine whether CCI Europe, Inc. (“CCI”)
    is required to pay the transaction privilege tax on the proceeds it receives
    from its software license agreement and maintenance agreements with
    Phoenix Newspapers, Inc. (“PNI”). Because the software is used as part of
    the manufacturing process to produce the printed version of the Arizona
    Republic newspaper, the proceeds from the agreements are statutorily
    exempt. Accordingly, we affirm the tax court’s summary judgment.
    FACTUAL AND PROCEDURAL BACKGROUND
    ¶2            CCI develops and sells software to facilitate the production of
    printed newspapers. The software performs all layout, formatting, and
    typesetting functions necessary to produce printed editions of a newspaper.
    For example, the software automatically: creates the page layout for the
    newspaper, margin width, column width, as well as spacing and location
    of articles, editorials, advertisements, photos, and graphics; assigns a
    naming convention that identifies each page and its relationship to the
    finished product; and in the printing process, dictates whether pages are
    printed in color, or in black and white.
    ¶3           CCI granted PNI a 99-year license to use its software to
    produce the printed Arizona Republic in 1997. Additionally, the parties
    entered into software maintenance agreements where CCI agreed to
    provide PNI with new software updates and releases, as well as support
    and software troubleshooting.
    ¶4            After CCI was audited for the period between June 2002 and
    May 2006, the Arizona Department of Revenue (the “Department”)
    determined that CCI owed transaction privilege tax in the amount of
    $82,511.44 plus interest on its income from the software agreements with
    PNI.     CCI unsuccessfully protested the assessment through the
    administrative process, arguing that the income from the agreements is
    deductible under Arizona Revised Statutes (“A.R.S.”) section 42-5061(B)(1)
    (2014),1 which exempts gross proceeds realized from the sale of machinery
    or equipment “used directly in manufacturing[.]”
    1Absent material revisions after the relevant dates, we cite the current
    version of a statute unless otherwise indicated.
    2
    CCI EUROPE v. ADOR
    Opinion of the Court
    ¶5          CCI filed an appeal to the tax court and subsequently moved
    for summary judgment.2 After briefing and argument, the tax court
    determined that “the software, and by extension the maintenance
    agreements, are exempt under A.R.S. § 42-5061(B)(1)” and granted CCI
    summary judgment. The Department then filed this appeal.
    DISCUSSION
    ¶6            The Department contends the tax court erred by ruling that
    the gross income CCI earns from the sale of software to PNI is exempt from
    taxation under § 42-5061(B)(1). Specifically, the Department argues that:
    (1) newspaper publishing is not manufacturing; but (2) even if newspaper
    publishing is manufacturing, the software is not “used directly” in the
    manufacturing process.
    ¶7            We review de novo the grant of summary judgment.
    Wilderness World, Inc. v. Ariz. Dep’t of Revenue, 
    182 Ariz. 196
    , 198, 
    895 P.2d 108
    , 110 (1995). We also review de novo the tax court’s construction of
    statutes. Ariz. Dep’t of Revenue v. Cent. Newspapers, Inc., 
    222 Ariz. 626
    , 629,
    ¶ 9, 
    218 P.3d 1083
    , 1086 (App. 2009).
    ¶8            When reviewing tax statutes, we liberally construe statutes
    imposing taxes in favor of taxpayers and against the government, but
    “strictly construe tax exemptions because they violate the policy that all
    taxpayers should share the common burden of taxation.” Ariz. Dep’t of
    Revenue v. Capitol Castings, Inc., 
    207 Ariz. 445
    , 447, ¶ 10, 
    88 P.3d 159
    , 161
    (2004). We will not, however, construe an exemption so strictly “as to
    defeat or destroy the [legislative] intent and purpose.” 
    Id. at 447-48,
    10, 88 P.3d at 161-62
    (quoting W.E. Shipley, Annotation, Items or Materials
    Exempt from Use Tax as Used in Manufacturing, Processing, or the Like, 
    30 A.L.R. 2d 1439
    , 1442 (1953)).
    I.
    ¶9             Our transaction privilege tax is an “excise tax on the privilege
    or right to engage in an occupation or business in the State of Arizona.”
    Ariz. Dep’t of Revenue v. Mountain States Tel. & Tel. Co., 
    113 Ariz. 467
    , 468,
    2 CCI simultaneously filed three motions for partial summary judgment
    supported by a combined statement of facts. The first addressed whether a
    newspaper publisher is a manufacturer; the second addressed whether the
    CCI software qualifies for the machinery and equipment deduction; and the
    third motion addressed whether gross receipts from software maintenance
    agreements are subject to Arizona transaction privilege tax.
    3
    CCI EUROPE v. ADOR
    Opinion of the Court
    
    556 P.2d 1129
    , 1130 (1976); Karbal v. Ariz. Dep’t of Revenue, 
    215 Ariz. 114
    , 116,
    ¶ 10, 
    158 P.3d 243
    , 245 (App. 2007). It is not a sales tax, but a tax on the
    gross receipts of the seller’s business activities. See A.R.S. § 42–5008; J.C.
    Penney Co. v. Ariz. Dep’t of Revenue, 
    125 Ariz. 469
    , 472, 
    610 P.2d 471
    , 474
    (App. 1980) (“The legal incidence of the transaction privilege tax is on the
    seller[.]”).
    ¶10           There are a number of statutory exemptions to the transaction
    privilege tax, including an exemption for gross income derived from the
    sale of machinery or equipment “used directly in manufacturing.” A.R.S. §
    42-5061(B)(1). Section 42-5061(B)(1) provides that:
    [T]he gross proceeds of sales or gross income
    derived from sales of the following categories of
    tangible personal property shall be deducted
    from the tax base:
    1. Machinery, or equipment, used directly in
    manufacturing, processing, fabricating, job
    printing, refining or metallurgical operations.
    The terms “manufacturing”, “processing”,
    “fabricating”, “job printing”, “refining” and
    “metallurgical” as used in this paragraph refer
    to and include those operations commonly
    understood within their ordinary meaning.
    A.R.S. § 42-5061(B)(1) (emphasis added).3
    ¶11           The “machinery and equipment exemption” was created to
    promote business investment and increase state revenue from income and
    property taxes. Capitol 
    Castings, 207 Ariz. at 448
    , ¶ 
    13, 88 P.3d at 162
    . And
    § 42-5061(B)(1) furthers that legislative intent. 
    Id. 3 Arizona
    use tax, which is complementary to the transaction privilege tax,
    is subject to the same exemption for machinery or equipment used directly
    in manufacturing. See A.R.S. § 42-5159(B)(1); Ariz. Dep’t of Revenue v. Care
    Computer Sys., Inc., 
    197 Ariz. 414
    , 420, ¶ 25, 
    4 P.3d 469
    , 475 (App. 2000)
    (Fidel, J., dissenting) (explaining that transaction privilege taxes and use
    taxes are complementary taxes).
    4
    CCI EUROPE v. ADOR
    Opinion of the Court
    II.
    ¶12           Although the Department contends that CCI is a retailer
    selling software, including updates and releases,4 the Department does not
    dispute that CCI’s software is machinery or equipment.5 See Capitol
    
    Castings, 207 Ariz. at 450
    , ¶ 
    22, 88 P.3d at 164
    (determining that a computer
    used in business is machinery or equipment). However, the Department
    argues that the statutory exemption does not apply because newspaper
    publishing is not “manufacturing.”
    A.
    ¶13            The term “manufacturing” is not defined, but § 42-5061(B)(1)
    directs us to apply the “ordinary meaning” of the term. A.R.S. § 42-
    5061(B)(1). We do so by looking to established and widely used
    dictionaries. See Stout v. Taylor, 
    233 Ariz. 275
    , 278, ¶ 12, 
    311 P.3d 1088
    , 1091
    (App. 2013); see also Hearst Corp. v. State Dep’t of Assessment & Taxation, 
    308 A.2d 679
    , 684 (Md. 1973) (stating “[m]anufacture as used in those statutes
    is a plain word in everyday use, and as ordinarily understood . . . .”).
    For example, the Oxford dictionary defines “manufacture” as to
    “[m]ake (something) on a large scale using machinery.”
    http://www.oxforddictionaries.com/us/definition/english/manufacture
    (last visited February 26, 2015). The online Merriam-Webster dictionary
    defines “manufacture” as “the process of making products especially with
    4  The Department recognizes that CCI’s support and troubleshooting
    services, standing alone, are not “tangible personal property” and would
    not be subject to transaction privilege tax. However, because CCI did not
    separate its receipts from support and troubleshooting from its receipts
    from the software updates and releases, the Department assessed
    transaction privilege taxes on all the fees PNI paid CCI under the software
    agreements. See A.R.S. § 42-5061(G) (permitting the application of the
    transaction privilege tax to both goods and services if the taxpayer does not
    separate the income attributable to each on its books).
    5 The parties also agree that if CCI’s software is deductible as machinery or
    equipment used directly in manufacturing, then the software updates and
    releases provided pursuant to the software maintenance agreements are
    likewise deductible pursuant to Arizona Administrative Code (“A.A.C.”)
    R15-5-120(B), which exempts gross receipts from the “sale of repair or
    replacement parts for exempt machinery or equipment.” A.A.C. R15-5-
    120(B).
    5
    CCI EUROPE v. ADOR
    Opinion of the Court
    machines in factories.” http://www.merriam-webster.com/dictionary/
    manufacture (last visited March 4, 2015).
    ¶14         PNI uses printing presses and other machinery daily to
    produce large numbers of printed newspapers. The process to create a
    printed newspaper is described in the record as follows:
    Paper is wound through the printing presses
    prior to hanging the plates, and once the plates
    are attached, the presses are started, and they
    apply ink and water to the plates. The paper
    winds through the presses and culminates at a
    piece of equipment called the “folder,” which
    takes in all the pages, cuts them, folds them into
    completed newspapers or sections of
    newspapers, and drops them onto a conveyor
    system.
    Unlike “[p]rinting a newspaper on a hand-operated flat-bed press in the
    18th or 19th century [which was] simply the dissemination of information,”
    Hearst 
    Corp., 308 A.2d at 688
    , “[t]he equipment used in printing a
    newspaper has become much more sophisticated and more fully
    automated.” 
    Id. at 680.
    ¶15           During the audit period, PNI was producing approximately
    3,450,000 copies of the Arizona Republic a week. PNI weekly used
    approximately 4,387,835 pounds of newsprint, 65,568 pounds of ink, 63 rolls
    of strapping, and 54 rolls of packaging. Raw materials are used and printed
    newspapers are the result of the manufacturing process.
    B.
    ¶16           The ordinary dictionary meaning of manufacturing is also
    consistent with regulations used by the Department. In the Arizona
    Administrative Code, “manufacturing” is defined as “the performance as a
    business of an integrated series of operations which place tangible personal
    property in a form, composition, or character different from that in which
    it was acquired and transforms it into a different product with a distinctive
    name, character, or use.” A.A.C. R15-5-120. Moreover, the regulations
    define “publisher” as “one who manufactures and distributes a publication
    from a point within this state.” A.A.C. R15-5-1303(A) (emphasis added).
    6
    CCI EUROPE v. ADOR
    Opinion of the Court
    ¶17           The administrative regulatory definitions support the
    decision that PNI engages in “manufacturing” by producing the printed
    version of the Arizona Republic. Specifically, and using CCI’s software, PNI
    performs an integrated set of operations, to wit: (1) PNI designs, formats,
    lays out, and typesets all content, including articles, editorials,
    photographs, graphics, and advertisements to create newspaper pages; and
    (2) PNI prints newspapers through a mechanized process using newsprint,
    ink, and other materials to produce printed newspapers.                  The
    transformation of newsprint and ink into a different product with a
    distinctive name, character, and use — namely, the printed version of the
    Arizona Republic — is a manufacturing process.
    ¶18           Moreover, in 1984, twenty years before Capitol Castings, PNI
    asked the Department about the taxability of certain machinery and
    equipment it had purchased. By letter, the Department advised PNI that
    the listed items of machinery and equipment, including “[c]omputer
    systems and parts directly related to [the] production process” would be
    exempt from taxation if “used directly in the printing operation” of the
    Arizona Republic. The letter has never been rescinded, and, as a result,
    constitutes an acknowledgement that printed newspaper production is
    “manufacturing.”6 Consequently, based on the ordinary meaning of the
    term “manufacturing,” PNI is engaged in manufacturing when it produces
    the printed version of the Arizona Republic.7
    III.
    ¶19           The Department also contends that, even if newspaper
    publishing is manufacturing, the sale of CCI’s software, and the software
    updates and releases, is still taxable because the software is not “used
    directly” in manufacturing. CCI argues that the software is “used directly”
    in manufacturing the newspaper because it is essential to the completion of
    6The Department also argues that if the Legislature had intended to exempt
    newspaper printing, it would have listed “publishing” in the list of
    deductible activities as it listed “job printing.” See A.R.S. § 42-5061(B)(1).
    Because the production of a printed newspaper is manufacturing, the
    Legislature did not need to list “publishing” separately. Moreover, because
    “publishing” is not separately enumerated in A.R.S. § 42-5061(B)(1), the
    exemption does not apply to the non-manufacturing aspects of publishing.
    7 The Arizona Board of Tax Appeals has determined that computer
    hardware and software utilized in newspaper publication qualifies for the
    machinery and equipment exemption. See New Times, Inc. v. Ariz. Dep’t of
    Revenue, 
    1993 WL 261253
    (Ariz. Bd. Tax Appeals).
    7
    CCI EUROPE v. ADOR
    Opinion of the Court
    the finished product and operates with PNI’s printing equipment as part of
    an integrated system.
    ¶20        To determine whether an item qualifies as machinery or
    equipment used directly in manufacturing, our supreme court directed
    that:
    [A] court should examine the nature of the item
    and its role in the operations. Items essential or
    necessary to the completion of the finished
    product are more likely to be exempt. The
    prominence of an item’s role in maintaining a
    harmonious “integrated synchronized system”
    with the indisputably exempt items will also
    directly correlate with the likelihood that the
    exemption applies.       The closer the nexus
    between the item at issue and the process of
    converting raw materials into finished
    products, the more likely the item will be
    exempt. As part of its analysis, the court should
    consider whether the item physically touches
    the raw materials or work in process, whether
    the item manipulates or affects the raw
    materials or work in process, or whether the
    item adds value to the raw materials or work in
    process as opposed to simply reducing costs or
    relating to post-production activities.
    Capitol 
    Castings, 207 Ariz. at 451
    , ¶ 
    25, 88 P.3d at 165
    (citations omitted). The
    court, however, cautioned that “[t]hroughout its analysis, a court must bear
    in mind that the goal of the exemption — promoting economic
    development — must not be frustrated by too narrow an application of [the
    statutory exemption].” 
    Id. ¶21 The
    CCI software is essential and necessary to the completion
    of the finished printed Arizona Republic newspaper. The software performs
    the layout, formatting, and typesetting functions necessary to create the
    printed newspaper pages. The software assigns a naming convention that
    controls the flow of each page through the production and printing process.
    The software manipulates words, photographs, advertising and graphics
    onto the printed pages. PNI takes the product produced with the CCI
    software and, with other software, hardware and raw materials, uses a
    mechanical process to manufacture the printed newspaper. As a result, the
    8
    CCI EUROPE v. ADOR
    Opinion of the Court
    software, including the updates and releases, is integral to the
    manufacturing of the paper and are deductible under § 42-5061(B)(1). See
    Concord Publishing House, Inc. v. Dir. of Rev., 
    916 S.W.2d 186
    , 190 (Mo. 1996)
    (noting that newspaper publication involves the mechanical processing of
    words and pictures and manufacturing occurs as those works are fixed onto
    a printed page).
    IV.
    ¶22           CCI requests an award of attorneys’ fees pursuant to A.R.S. §
    12-348(B), which permits an award of fees to a party prevailing in an action
    against the State for the assessment or collection of taxes. We grant CCI’s
    request for an award of reasonable attorneys’ fees and costs incurred on
    appeal upon compliance with ARCAP 21.
    CONCLUSION
    ¶23           For the foregoing reasons, we affirm the judgment.
    :ama
    9