Carter Oil v. Ador

Citation: Not availableDocket: 1 CA-TX 19-0002

Court: Court of Appeals of Arizona; January 29, 2020; Arizona; State Appellate Court

Original Court Document: View Document

SummaryOriginalCytator Case TreatmentBackward CitatorAnalysis

EnglishEspañolSimplified EnglishEspañol Fácil

The Arizona Court of Appeals reversed a tax court decision favoring Carter Oil Company, Inc. regarding the applicability of the transaction privilege tax on dyed diesel fuel sold to Hanson Aggregates Arizona, Inc. The court determined that dyed diesel, used to power mining machinery, is subject to this tax. Carter Oil had claimed a refund of $11,769.45 for taxes paid from January 2011 to June 2013, arguing that the revenue from these sales was exempt under A.R.S. 42-5061(B)(1) and (2) as "machinery or equipment" used in mining operations. The Department of Revenue denied the refund and, after Carter Oil pursued legal action, the tax court ruled in favor of Carter Oil, stating the dyed diesel qualified for the exemption. However, on appeal, the Court of Appeals highlighted that exemptions from the transaction privilege tax should be strictly construed, ultimately concluding that the dyed diesel fuel does not meet the criteria for exemption and thus remanded the case for summary judgment in favor of the Department.

Numerous exemptions to the retail transaction privilege tax are outlined in A.R.S. 42-5061, specifically for machinery or equipment used directly in manufacturing and mining operations. The exemptions include: 

1. Machinery or equipment for manufacturing, processing, fabricating, job printing, refining, or metallurgical operations, defined by their ordinary meanings.
2. Mining machinery or equipment used in extracting ores or minerals for commercial purposes, encompassing all extraction methods and necessary handling equipment.

The central issue is whether dyed diesel sold to Hanson qualifies as "machinery or equipment" in mining and processing operations. Similar exemptions exist for use tax under A.R.S. 42-5159. The transaction privilege tax is levied on in-state sales, while the use tax applies to out-of-state sales to Arizona purchasers. These taxes are complementary.

The term "machinery or equipment" has the same interpretation across both tax categories, following a statutory construction principle that identical terms in the same act carry the same meaning. Legislative intent is paramount, and if a statute is clear, it is applied without further interpretation. 

Previous rulings indicate that the exemptions aim to promote mining activity in Arizona, thereby increasing revenue from other taxes. The Arizona Supreme Court has recognized that the lack of definitional specificity in the exemptions serves the broader purpose of stimulating business investment, which can be better achieved through a broader interpretation of "machinery or equipment." Thus, a more expansive definition aligns with legislative goals and prior court interpretations.

The Capitol Castings case established criteria for determining exemptions from transaction privilege tax regarding "machinery or equipment." The Arizona Supreme Court ruled that specific items, such as silica sand and chemical binders, are exempt when used directly in a qualifying process. This decision built on the Duval Sierrita case, which introduced two tests—the "ultimate function" and "integrated rule" tests—to ascertain whether items qualify as machinery or equipment in mining and processing operations. The ultimate function test focuses on how an item contributes to the industrial process, while the integrated approach considers the item's necessity within the overall process. 

In Duval Sierrita, items like spare parts and conveyor belts were deemed exempt as machinery or equipment. The court emphasized that items not conventionally classified as machinery may still qualify based on their functional role. Notably, the Department conceded that the items in Duval Sierrita were machinery or equipment, but acknowledged that other items could also qualify depending on their function. For instance, certain chemicals were recognized as machinery due to their functional similarity to traditional machinery in ore extraction processes. 

To determine if an item qualifies for the exemption, courts must consider flexible industry definitions of machinery and equipment and assess the nature of the item and its role in operations.

Capitol Castings defines "equipment" in the mining context as items used for specific purposes, without a standard industry definition provided by the parties. Several factors are outlined for courts to assess the nature and role of items in operations: (1) necessity for the finished product, (2) contribution to an integrated system with exempt items, (3) connection to the conversion of raw materials, (4) physical interaction with raw materials, (5) manipulation of raw materials, and (6) value addition to raw materials rather than cost reduction. Applying these factors, the court determined that dyed diesel used by Hanson did not qualify as machinery or equipment directly involved in mining, as it did not contact or interact with raw materials, but merely powered the machinery. Unlike other exempt items that directly affected the raw materials, dyed diesel was essential for operation but did not function as traditional equipment. The court noted the Arizona Legislature's specific exemptions for fuels separate from exemptions for machinery and equipment, indicating an intentional distinction. This distinction precludes interpreting "machinery and equipment" to include fuels, as the legislature's separate provisions suggest.

The goal of the exemption from taxation is to promote economic development, but this is not hindered by taxing dyed diesel used for mining and processing equipment. Carter Oil's dyed diesel is already favorably taxed compared to non-dyed diesel, which incurs a twenty-six cents per gallon excise tax while dyed diesel is subject to a retail sales tax of five and six-tenths percent. A specific statutory framework governs the taxation of fuels, emphasizing that specific statutes take precedence over general ones. The legislature has clearly delineated tax exemptions, and if it intended to exempt dyed diesel from transaction privilege tax, it would have done so explicitly rather than relying on ambiguous interpretations. Legislative intent suggests that the existence of one exemption implies the exclusion of others. Arizona imposes a per-gallon excise tax on motor fuels and has provided an exemption for dyed diesel used in non-highway vehicles, such as those employed by Hanson. The 1968 mining and processing exemptions were established when non-dyed diesel was subject to both transaction privilege and fuel taxes. An exemption for non-dyed diesel from transaction privilege tax was enacted in 1980, but no similar exemption for dyed diesel used in off-highway applications was created. Thus, dyed diesel remains subject to transaction privilege tax, while non-dyed diesel used on the road is taxed under fuel tax provisions. The legislature had opportunities to exempt diesel used in mining and processing from transaction privilege tax but did not do so.

The legislature intended that dyed diesel, not taxed as fuel, remains subject to the transaction privilege tax, reflecting a deliberate choice to give effect to all provisions involved. Consequently, Carter Oil's sale of dyed diesel to Hanson is taxable under Arizona law. The dyed diesel does not qualify as machinery or equipment used directly in mining operations, based on the criteria established in Capitol Castings, rendering further arguments from the Department unnecessary.

Carter Oil's reliance on prior cases—Chevron and Empire Southwest—does not apply to dyed diesel. In Chevron, the court ruled that "industrial oils and greases" were exempt due to their function as equipment in mining operations, a distinction not applicable to dyed diesel. The legislature created a specific fuel tax exemption for dyed diesel, which does not extend to the transaction privilege tax, unlike the situation for industrial oils and greases. Additionally, although dyed diesel has some lubricating properties, this alone does not justify an exemption as a lubricant.

Previous interpretations by the Department regarding exemptions do not carry weight under current law, which mandates courts to determine legal questions independently of agency determinations. If the Department had previously classified dyed diesel as exempt equipment, the court would not defer to that interpretation. Thus, sales of diesel fuel to consumers, including dyed diesel, are subject to taxation.

The court's decision in Empire Southwest does not support Carter Oil, as it focused on whether a fuel truck was used directly in extracting ore, leading to its tax exemption. The case established that there was no dispute regarding the truck being classified as "machinery or equipment," but rather whether its use in transporting fuel was integral to extraction. The court likened the truck's function to booster pumps in another case, Duval Sierrita. However, Empire Southwest did not address whether diesel fuel itself qualifies as machinery or equipment. The court clarified that fuel does not engage with raw materials in a way that adds value or manipulates them; therefore, it is not considered machinery or equipment. The ruling aligns with previous analyses, emphasizing that while equipment includes necessary parts, fuel lacks an explicit exemption, thus not qualifying. The conclusion asserts that the case involves a legal question suitable for summary judgment, allowing the court to reverse the trial court's decision and direct judgment for the Department.