Service Merchandise Co. v. Arizona Department of Revenue

Citations: 937 P.2d 336; 188 Ariz. 414; 226 Ariz. Adv. Rep. 45; 1996 Ariz. App. LEXIS 215Docket: 1 CA-TX 95-0002

Court: Court of Appeals of Arizona; October 3, 1996; Arizona; State Appellate Court

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The Arizona Department of Revenue assessed use taxes against Service Merchandise Company for the costs related to catalogs and sales fliers produced by out-of-state printers and distributed to Arizona customers. After exhausting administrative remedies, Service Merchandise filed a tax court action challenging the assessment. The tax court ruled in favor of the Department of Revenue, leading to Service Merchandise’s appeal. The case was reviewed de novo, affirming the tax court's decision.

Service Merchandise operates retail stores in multiple states, including two in Arizona, and distributes catalogs to customers throughout the year. Although the catalogs are designed in Tennessee and printed by non-Arizona companies, they are sent to Arizona households. The court determined that Service Merchandise “used” the catalogs in Arizona by distributing them, making them liable for the use tax as defined under Arizona law. The law imposes a tax on the use or consumption of tangible personal property purchased from a retailer, and the court concluded that the act of distributing the catalogs constituted such use.

Service Merchandise acknowledges that it exercised ownership rights over catalogs and fliers while they were outside Arizona, including contracting with printers, determining content, compiling address lists, and managing shipping logistics from Tennessee. However, it claims that no such rights were exercised within Arizona, asserting that all actions occurred in Tennessee and that it had no control over the materials after they were shipped. The ruling holds that the distribution of the catalogs and fliers in Arizona constitutes a use incidental to ownership, as Service Merchandise contracted for their distribution to specific Arizona customers, exercising control over the delivery process through agents in Arizona. The court references legal precedents from other jurisdictions that have recognized distribution as an incidental act of ownership, which supports imposing use taxes on such activities. Although Service Merchandise argues that Arizona law does not explicitly define 'distribution' as an act of ownership, the broad definition of 'use' in Arizona law encompasses the rights associated with distribution. Thus, Service Merchandise is deemed to have used the catalogs in Arizona by directing their delivery to specific customers, reinforcing that a non-owner would not possess the authority to dictate such distribution. The ruling is further supported by analogous cases involving out-of-state taxpayers who contracted for the distribution of advertisements, affirming the applicability of use taxes in similar contexts.

Out-of-state taxpayers are required to pay a use tax for materials distributed within a state. Courts have determined that the taxpayer 'used' the materials by controlling their distribution, regardless of whether the distributing agents are in-state or out-of-state. Service Merchandise's distinction regarding the distribution methods is not legally significant; the focus is on whether it retained control over the distribution of catalogs and fliers in Arizona. Service Merchandise's ability to schedule distribution is comparable to that of advertisers in prior cases, such as Drackett Products Co. v. Limbach, which upheld a use tax for similar circumstances. Consequently, Service Merchandise is deemed to have 'used' its catalogs in Arizona, thus making it subject to the state's use tax. Furthermore, the application of Arizona's use tax does not violate the Commerce Clause of the U.S. Constitution, as supported by the precedent set in D.H. Holmes Co. Ltd. v. McNamara, which established a four-part test to evaluate the constitutionality of state taxes on interstate transactions, focusing on nexus, apportionment, discrimination, and relation to state benefits.

The Court determined that the second and third elements of the relevant tax test were satisfied, confirming that Louisiana's use tax was fairly apportioned and non-discriminatory. The tax allowed a credit for sales tax paid in other states and equaled the sales tax that would have been applied had purchases been made in Louisiana. This principle also applies to Arizona’s use tax, which mirrors its sales tax rate and exempts property already subjected to an equivalent or higher excise tax from another state. 

The Court noted that Louisiana provides various benefits related to the tax, including public safety, infrastructure, and civic services, which support Holmes' operations. Despite Holmes having thirteen stores in Louisiana compared to only two for Service Merchandise in Arizona, Arizona still provides sufficient benefits related to its tax imposition due to the distribution of catalogs aimed at encouraging shopping in its stores.

The Court established a substantial nexus between the distribution of catalogs and Arizona, as Service Merchandise directed the mailing of catalogs to Arizona residents to promote sales in its stores or via mail orders. This nexus was deemed adequate despite the limited number of stores, drawing parallels to a prior ruling involving a national magazine. The Court affirmed that Arizona's use tax applies to out-of-state printed catalogs and is consistent with the Commerce Clause, upholding the tax court's judgment. Additionally, a related case confirmed that out-of-state newspaper supplements distributed in Arizona are subject to the state's use tax, affirming the taxpayers' control over distribution.

If newspapers reject supplements, they are returned to Taxpayers. The tax court differentiated this situation from cases where the use tax was not applied to out-of-state printers mailing materials into the taxing state, as in those cases, the taxpayer lost control of the materials upon mailing. The court disapproves of earlier dicta that distinguished between newspaper distribution and postal service distribution of out-of-state materials. Support for this position is found in jurisdictions that ruled taxpayers did not 'use' materials printed out-of-state due to lack of in-state control over those materials once shipped. Some cases specifically differentiated between catalogs delivered by carriers and flyers in newspaper inserts, but the court disagrees, asserting that distribution through agents is incidental to ownership. Service Merchandise did not contest the application of the Arizona use tax on Commerce Clause grounds at the lower court level, and generally, new issues cannot be raised on appeal. However, constitutional questions may be considered for the first time on appeal, and the court opts to address the Commerce Clause issue as it was adequately briefed and relates to the factual inquiries regarding the application of the use tax.