Various subsidiary corporations of Central Newspapers, Inc., owned 13.5 percent of a general partnership based in Washington. The partnership made sales to Arizona customers, but had no other business activities in Arizona. Central Newspapers has other subsidiaries that are Arizona corporations. Between 1995 and 1999, Central Newspapers and its subsidiaries (collectively “CNI”) filed Arizona consolidated corporate income tax returns. Because CNI conducts multi-state business, Arizona law requires it to allocate and apportion its net income under Arizona’s Uniform Division of Income for Tax Purposes Act (“UDITPA”), A.R.S. §§ 43-1131 to -1150. Apportionment is done according to a statutory formula under which a taxpayer’s Arizona sales, property, and payroll are compared to the taxpayer’s operations in all states.
When apportioning its multi-state income, CNI did not include its subsidiaries’ share of the partnership’s Arizona sales in the numerator of the apportionment formula. After audits of the five tax returns, the Arizona Department of Revenue (“Department”) concluded that the partnership’s Arizona sales should have been included in the formula’s numerator. CNI protested and appealed to the Arizona State Board of Tax Appeals, which found in CNI’s favor. The Department successfully appealed to the Arizona tax court and CNI appealed.
In a unanimous opinion, the Arizona Court of Appeals affirmed the Arizona tax court. The Court explained that when multiple corporations file a “consolidated” return in Arizona, some of the constituent, or “affiliated,” corporations may have no connection to Arizona and would not report income to Arizona but for the parent corporation’s election to file a consolidated return. In addition, when a group of affiliated corporations choose to file a single consolidated return, Arizona treats the group as a single taxpayer. Among the non-Arizona corporations that reported business income in CNI’s consolidated tax return were the subsidiaries with income from the Washington partnership, including income derived from the partnership’s sales to Arizona customers.
CNI argued that a federal law, 15 U.S.C. § 381, precluded Arizona from taxing the partnership income of the non-Arizona subsidiaries. The federal law prevents a state from taxing income earned by foreign businesses whose only business activities in the state are “solicitation of sales.” CNI asserted that the benefit of this federal restriction passed through from the Washington partnership to CNI, thus precluding Arizona from requiring CNI to include the partnership’s Arizona sales income in the numerator of the apportionment formula.
Rejecting CNI’s pass-through argument, the Court held that CNI had to include the partnership’s Arizona sales income in the numerator of the apportionment formula. The Court reasoned that the federal law did not make the income itself tax exempt; rather, the law limits Arizona’s power to tax a business’s income if that business “does nothing more than solicit sales in Arizona.” Thus, the relevant question is whether the taxpayer reporting the income has an “independent nexus” with Arizona, and not whether the income by itself derived only from interstate sales. Because CNI was “independently subject to Arizona” taxing jurisdiction, the federal law does not shield CNI’s share of the Washington partnership’s income from Arizona taxing authority.
Judge Irvine authored the opinion; Judges Winthrop and Hall concurred.