Construction Developers, Inc. v. City of Phoenix

Citations: 194 Ariz. 165; 978 P.2d 650; 277 Ariz. Adv. Rep. 3; 1998 Ariz. App. LEXIS 152Docket: No. 1CA-TX 97-0015

Court: Court of Appeals of Arizona; September 1, 1998; Arizona; State Appellate Court

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An appeal was made concerning whether Construction Developers, Inc. (CDI), a wholly owned subsidiary created solely to hold title to real property for its parent company, Dillard Department Stores, Inc. (Dillard), is liable for City of Phoenix excise taxes as a business leasing real property. The tax court previously ruled in favor of CDI, allowing it to challenge the City's excise tax assessment for the period from October 1984 to September 1993. Dillard had historically acquired properties using borrowed funds, securing loans with mortgages or deeds of trust, and was required to establish CDI to hold property titles separate from its general creditors. Since its inception in 1967, CDI has had no employees, business location, revenue, or financial accounts. Dillard ceased external financing in 1982 but continued to use CDI for property titles out of habit, including three properties acquired in 1984 and 1985. During the audit period, Dillard operated stores on these properties without any lease agreements with CDI, while covering all occupancy costs and taxes. Following an audit, the City claimed CDI owed over $357,000 in delinquent taxes, which was protested by CDI. After losing some claims in a hearing, CDI paid a revised assessment and sought a refund in tax court. Both CDI and the City filed for summary judgment, with the City providing two documents mentioning CDI’s name; however, these lacked proper authentication. Ultimately, the appellate court affirmed the tax court's summary judgment in favor of CDI.

The tax court granted summary judgment in favor of Construction Developers, Inc. (CDI), concluding that CDI was not engaged in the business of leasing real property and thus not subject to taxation under Phoenix City Code sections 14-2 or 14-445. The court referenced prior rulings, specifically Arizona State Tax Commission v. First Bank Building Corp., which established that merely leasing property without maintaining it or providing services does not constitute engaging in a business for tax purposes. CDI's role was limited to owning the buildings used by Dillard’s without any additional involvement, which aligned with the precedent that 'business' implies more than passive property ownership. The City appealed the judgment that refunded CDI’s tax payment, including attorneys’ fees and interest. The appellate review will consider the case in the light most favorable to the City, confirming the absence of genuine issues of material fact and assessing whether the trial court appropriately applied the law. Both parties concurred that for an entity to be taxable under the relevant sections, it must be actively engaged in leasing or renting real property within the City. The codes in effect from October 1984 to March 1987 defined taxable business activities and established a framework for measuring privilege taxes based on gross income from such activities.

The tax rate for activities, excluding certain local advertising, is set at 1.2% of gross income derived from business activities, specifically including leasing, renting, or licensing real property within the City. This tax is applied to the entity leasing or renting to the tenant in possession. If that entity is exempt or not engaged in leasing, the tax will be collected from the nearest lessor in the sublease chain who is involved in leasing activities. Current Phoenix City Code mandates that payments made by the lessee for property-related expenses are included in taxable gross income. 

In its appeal, the City contests the tax court’s ruling favoring CDI, asserting that CDI was engaged in "business" under city code due to its leasing activities. The City claims CDI held property title, paid taxes, and maintained the property, thus qualifying as a business. However, the tax court finds no evidence that CDI engaged in activities for direct or indirect benefit as defined by the Phoenix City Tax Code. The City provided only two construction-related documents, one dated after the audit period, without sufficient evidence to support the claim that CDI conducted business activities. The record shows that CDI had no employees, no operational location, no revenue sources, no bank account, and no independent records during the audit period, suggesting it did not engage in any corporate acts apart from disputing the tax assessment.

Evidence indicates that CDI acted solely as a business tool for its parent company, Dillard, and did not engage in activities constituting 'business' as defined by law. The court referenced prior rulings to emphasize that a corporate taxpayer must demonstrate engagement in activities aimed at profit, which CDI failed to do. The City’s argument that CDI’s existence conferred benefits to Dillard was not substantiated by evidence of any current gain to Dillard from CDI. The court distinguished CDI from other cases cited by the City, noting those involved active subsidiaries rather than a dormant entity like CDI. Consequently, the tax court rightly ruled that the City's excise tax did not apply to CDI during the audit period. The court also stated that even if there were business activities, that alone would not impose excise tax without evidence of leasing arrangements between CDI and Dillard. The court did not address potential penalties related to tax filings. CDI was awarded attorneys’ fees on appeal under relevant Arizona statutes, with instructions for establishing the amount.