Appeal from the Arizona Tax Court

DIVISION 1 COURT OF APPEALS STATE OF AR.IZONA IN THE COURT OF APPEALS STATE OF ARIZONA DIVISION ONE FILED AUG3 0 Z005 CABEZON CABLE OF ARIZONA, INC., an Arizona corporation, v. Plaintiff-Appellant, ARIZONA STATE DEPARTMENT OF REVENUE, an agency of the State of Arizona, Defendant-Appellee. 1 CA-TX 04-0002 DEPARTMENT T MEMORANDUMDECISION (Not for Publication Rule 28, Arizona Rules of Civil Appellate Procedur Appeal from the Arizona Tax Court Cause No. TX 2001-000229 The Honorable Paul A. Katz, Judge AFFIRMED Fennemore By Attorneys Craig Steven R. Partridge Paul J. Mooney for Plaintiff-Appellant Phoenix Terry Goddard, Attorney General By Lisa A. Neuville, Assistant Attorney General Attorneys for Defendant-Appellee Phoenix HAL L, Judge 9[1 This is an appeal from a grant of partial summary judgment and a trial on stipulated facts. Cabezon Cable of Arizona, Inc. (Taxpayer challenges the tax court's rulings that it was engaged in prime contracting and did not qualify as an exempt

subcontractor for purposes of the Arizona transaction privilege tax, Arizona Revised Statutes (A.R.S. section 42-5705 (1999. For the reasons that follow, we affirm the tax court's judgment. FACTS AND PROCEDURAL BACKGROUND Between January 1993 and April 1996, Taxpayer installed cable television services in new developments and performed service repairs. The relevant governmental enti ties granted easements allowing Taxpayer and utilities to place their lines. 9[3 All cable lines Taxpayer serviced were in trenches or buried underground. The trenches holding the cable lines were multi-use trenches and also housed other utility lines, including those for electricity and telephones. In a new development, Taxpayer would typically place the conduit in trenches previously excavated by the developer, pull the cable through the conduit, set the pedestals,1 and activate the electronics. Taxpayer also spliced the cables, which entailed hooking up the electronics to the cable. In addition, Taxpayer would dig trenches or potholes to repair broken conduit or cable, or to access tap boxes (also called dog boxes where the main feeder trunk carne in. Because the 1 A pedestal is a box, ranging between six and eighteen inches wide and between six and twenty-four inches tall, which stores the electronics. There is a pedestal at every other house in a development with cable spanning the distance between the pedestals. 2

devel'oper or utility contractor could only excavate within a certain distance from the utility connection, Taxpayer would have to dig the rest of the way to reach the tap box. Taxpayer would also dig trenches ten to fifty feet long for line extensions when a developer forgot a location. On occasion, Taxpayer installed tap boxes in the ground that could be accessed via a manhole cover. 9[5 At times, Taxpayer would trench through asphalt and bored holes if a contractor had not completed a trench because of a preexisting sidewalk. On occasion, Taxpayer would provide a backhoe and operator to the cable company, usually to dig potholes. Taxpayer would subcontract aerial work and hand-digging in asphal t. 9[6 When a cable company needed to upgrade its wiring, Taxpayer would replace the old pedestal with a new one, replace and splice the cable, and change out the pedestal's electronics. Taxpayer's contracts with the cable companies provided that Taxpayer's foreman would supervise Taxpayer's contract activities, and that Taxpayer's project manager would be responsib~e for the contract work's progress. 9[7 The Arizona Department of Revenue (the Department or ADOR issued an assessment for transaction privilege tax on Taxpayer's contracting income on December 18, 1998 for $204,318.71, together with interest and penal ties. Taxpayer unsuccessfully appealed to the State Board of Tax Appeals, and then brought a 3

comp~~int in Arizona Tax Court pursuant to A.R.S. 42-1254 (Supp. 2004. 9[8 The parties then filed cross-motions for summary judgment on whether (1 Taxpayer was engaged in prime contracting, and (2 Taxpayer was acting as an exempt subcontractor. The tax court ruled in the Department's favor as to the first issue, and requested additional facts concerning the second issue. The parties complied by issuing a Stipulated Statement of Facts and presenting oral arguments. The tax court resolved the second issue in the Department's favor and entered judgment. 9[9 Taxpayer timely appealed. We have jurisdiction pursuant to A. R. S. 12-21 0 1 (B (2 003.. DISCUSSION 9[10 On appeal, Taxpayer contends that the trial court erred by finding it is a contractor and prime contractor because: (1 it merely acts as an agent of the cable companies, assisting in the assembly of their cable systems, and (2 its acti vi ty is limited to the "manufacturing of tangible personal property,u a non-taxable activity. Alternatively, Taxpayer also argues that even if it is a prime contractor, the trial court erred by finding it is not an exempt subcontractor. 9[11 We review the tax court's grant of partial suitutiary judgment de novo. Wilderness World, Inc. v. Dep't of Revenue, 182 Ariz. 196, 198, 895 P.2d 108, 110 (1995. When the material facts 4

are undisputed, we must determine whether the tax court correctly applied the substantive law to those facts. S. Pac. Transp. Co. v. Ariz. Dep't of Revenue, 202 Ariz. 326, 329-30, ~ 7,44 P.3d 1006, 1009-1 0 (App. 2002. Questions of statutory interpretation are issues of law also subject to de novo review. Walls v. Ariz. Dep't of Pub. Safety, 170 Ariz. 591, 594, 826 P.2d 1217, 1220 (App. 1991. I. As a Matter of Law, Taxpayer Engaged in Contracting for Purposes of 42-5075 9[12 The transaction privilege tax is akin to.a business privilege tax on the gross receipts from the taxable acti vi ty. A.R.S. 42-5008 (Supp. 2004; see S. Pac. Transp., 202 Ariz. at 333, ~ 25, 44 P.3d at 1013. Businesses engaged in prime contracting are subj ect to the transaction pri vi lege tax. See A.R.S. 42-5010 (A (1 (b (Supp. 2004. To qualify as a pn.me contractor for transaction privilege tax purposes, Taxpayer's activities must fall under the statutory definition of "contracting." In Arizona, contracting means "engaging in business as a contractor." A.R.S. 42-5075 (G (1 (2000 (retroactively effective to Dec. 31,1993 [now codified at A.R.S. 42-5075(K (1 (Supp. 2004]. A "contractor" is synonymous with the term "builder" and means any person, firm, partnership, corporation, association or other organization, or a combination of any of them, that undertakes to or offers to undertake to, or purports to have the capacity to undertake to, or submits a bid 5

to, or does personally or by or through others, construct, alter, repair, add to, subtract from, improve, move, wreck or demolish any building, highway, road, railroad, excavation, manufactured building or other structure, project, development or improvement, or to do any part of such a project, including the erection of scaffolding or other structure or works in connection with such a project, and includes subcontractors and specialty contractors. For all purposes of taxation or deduction, this definition shall govern without regard to whether or not such contractor is acting in fulfillment of a contract. A.R.S. 42-5075 (G (2 (2000 [now codified at 42-5075 (K (2]. 91:13 First, Taxpayer claims it is not subject to the transaction privilege tax because it is a "service business," a subset of businesses not delineated in A.R.S. 42-5061 to -5077 (Supp. 2004. As support for this argument, Taxpayer relies on Arizona State Tax Commission v. Parsons-Jurden Corp., 9 Ariz.App. 92, 449 P.2d 626 (1969. That case concerned whether the taxpayer was making taxable retail sales to the Duval Corporation or whether it was merely providing a procurement service and purchasing materials as Duval's agent. Id. at 92, 449 P.2d at 626. The retail classification covers the business of selling tangible personal property at retail. A.R.S. 42-5008 (Supp. 2004 (general transaction privilege statute [formerly A.R.S. 42-1309], -5061{A (Supp. 2004 (retail classification statute. The classification specifically exempts professional or personal service occupations. A.R.S. 42-5061{A (I. In contrast, the 6

prime' contracting classification expressly includes services such as alteration, repair, and movement. A.R.S. 42-5075(G (6 (1999 [now A. R.S. 42-5 075 (K (6 (Supp. 2004]. Whether Taxpayer provided labor or services is not at issue; the issue is whether its activities fell within the broad definition of contracting. 9[14 Second, Taxpayer maintains that it does not engage in contracting because its "manufacture of personal property" does not qualify as an improvement to real property. Taxpayer cites Arizona Department of Revenue v. Arizona Outdoor Advertisers, Inc., 202 Ariz. 93, 41 P.3d 631 (App. 2002, as support, but its reliance upon that case is misplaced. 9[15 The Arizona Outdoor taxpayer contested the imposition of the transaction privilege tax under A.R.S. 42-5069(F (2 (1999 on business income generated by leasing the use of real property for consideration. Id. at 95, ~ 10, 41 P.3d at 633. The pivotal issue was whether billboards located on real property became fixtures and part of the realty once erected or remained personalty. Id. If they were personalty, the taxpayer would not be liable for the transaction privilege tax under 42-5069(F (2. Id. The Department contended that the billboards constituted improvements to real property under 42-5069(F (2, which defines real property to include "improvements, rights or interest in such property. " Id. 7

~16 Applying a reasonable person test, this court held that the billboards were personalty. rd. at 100, 102, S[S[38, 51, 41 P.3d at 638, 640. We reasoned that the lease agreements "unequivocally declare that [taxpayer].would remain the owner of the billboards, and the agreements grant [taxpayer] the right to remove the billboards without any significant event occurring(.] " rd. at 101, S[ 43, 41 P.3d at 639. We therefore affirmed the ruling that the taxpayer was not liable for the transaction privilege tax. rd. at 102, S[ 51, 41 P.3d at 640. ~17 Taxpayer appears to argue that, like the billboards, the cable equipment remained the personalty of the cable companies and thus does not subject Taxpayer to liability under 42-5075. This logic is flawed. Taxpayer simply constructed the cable system, and is not the lessor, owner, or provider of cable television. Thus, Taxpayer is one step removed from the analysis of whether installed cable equipment becomes a fixture or remains personalty. ~18 A case discussed in Arizona Outdoor, Brink Electric Construction Co. v. Arizona Department of Revenue, 184 Ariz. 354, 909 P.2d 421 (App. 1995, deals with the more relevant issue whether contracting extends to the business of installing electrical transmission equipment. The taxpayer furni shed and installed portable electrical transmission equipment at two substations for an electrical provider. rd. at 357-60, 909 P.2d at 424-27. The taxpayer maintained that it was not in the business of 8

contracting and not subject to the transaction privilege tax because it did not permanently attach or affix equipment to real property. Id. at 360, 9a9 P.2d at 427. 91:19 We relied upon a similar case from the South Dakota Supreme Court, also involving the taxpayer and analyzing its liability for taxes on gross receipts from realty improvement contracts. Id. at 361, 909 P.2d at 428 (analyzing Brink Elec. Constr. Co. v. S. Dakota Dep't of Revenue, 472 N.W.2d 493 (S.D. 1991».2 Applying a precursor of the reasonable person test, we analyzed whether the installation of electrical transmission equipment qualified as an improvement to real property. Id. The controlling factor for both Brink courts was "whether the party intends to make the article a permanent accession to the realty." Id. While permanency was also required, we did not equate it with perpetuity. Id. "It is sufficient if the item is intended to remain where affixed until worn out, until the purpose to which the :realty is dev0ted is accomplished or until the item is superseded by another itern more sui table for the purpose." Id. (quoting Brink, 472 N.W.2d at 499-500. Other factors included the article '.s actual or constructive annexation to the realty and its 2 Although Arizona law did not incorporate the phrase "realty improvement contract," we found that the definition in A.R.S. 42-1310(16 [renumbered as 42-5075 and amended by 1997 Ariz. Sess. Laws, ch. 150, 87, 99, eff. Jan. 1, 1999] fully subsumed the concept of "realty improvement." Brink, 184 Ariz. at 361, 909 P.2d at 428. 9

adaptability to the use and purpose for which the realty is used. rd. 9[20 We noted that the equipment the taxpayer supplied was clearly intended to remain where installed "until the purpose to which the realty is devoted is accomplished." rd. at 362, 909 P.2d at 429. In the context of taxpayer's overall Arizona work, we found that it "improved the realty for electrical transmission purposes," and.t.husthe taxpayer "engaged in the business of contracting when it installed this equipment, and is subject to the tax on contracting." rd. at 361-62, 909 P.2d at 428-29. 9[21 As in Brink, Taxpayer failed to establish that the cable equipment installed is not a permanent accession to realty. Even though Taxpayer points.out that digging accounted for less than two percent of its activity, Taxpayer's "overall work" of installing the cable system is analogous to Brink's improvement of the realty for electrical transmission purposes. Like the e~ectrical equipment, the cable systems..ins.talled by Taxpayer are clearly intended to remain where installed until the purpose to which the realty is devoted is accomplished. Accordingly, Taxpayer "engaged in the business of contracting" for purposes of Arizona's transaction privilege tax. 9[22 As pointed out by the Department, Taxpayer's reliance upon cases from other jurisdictions is misplaced because those cases apply statutes that do not deal with a tax on the business of 10

contracting similar to 42-5075. See Cont'1 Cablevision of Michigan, Inc. v. City of Roseville, 425 N.W.2d 53 (Mich. 1988 (applying fixture analysis to determine whether the cable company was liable for the personal property tax on the value of house drops that the cable company had installed; Capital Dist. Better TV Inc. v. Tax Appeals Tribunal of State of New York, 606 N.Y.S.2d 930 (App. Div. 1994 (construing the same exemption to the statute that imposed a sales tax on the services of installing tangible personal property--a trunk distribution system--except for property that would become a capital improvement to real property when installedi Glenville Cablesystems Corp. v. State Tax Comm'n, 531 N.Y.S.2d 137 (App. Div. 1988 (declining to apply the exemption from retail sales tax for capital improvements, which the statute defined similarly to fixtures, for the taxpayer's antennas, supporting structures, signal-processing equipment, distribution plants on utility poles, and subscriber connections. 9[23 Moreover, Taxpayer meets the contracting definition because its work involved adding to or subtracting from an excavation. A majority of the work involved installation of cable service facili ties in new developments. It is sufficient that Taxpayer did only part of the project. Thus, Taxpayer qualifies as a contractor and not a manufacturer as it contends. 11

II. Taxpayer Was a Taxable Prime Contractor and Not Covered By the Subcontracting Exemption 91:24 The seminal case on the prime contracting issue is Granite Construction Co. v. State ex rei. Arizona Department of Revenue, 168 Ariz. 93, 811 P.2d 345 (App. 1990. The taxpayer, Granite Construction Company, was a mine reclamation contractor for Peabody Coal Company (Peabody, a mining company. Id. at 94, 811 P.2d at 346. Peabody strip-mines coal on Navajo and Hopi Indian Reservation land pursuant to leases with those nations. Id. In accordance with federal law, Peabody contracted with the taxpayer to reclaim strip-mined areas. Id. 91:25 After auditing the taxpayer's activities between 1980 and 1985, the Department determined that taxpayer engaged in prime contracting and assessed additional privilege taxes on taxpayer's gross receipts from Peabody for its reclamation services. Id. at 96-97, 811 P.2d at 348-49. This court looked to the prime contracting and prime contractor definitions in the former A.R.S. 42-1310 (2 (i [now codified at A.R.S. 42-5075 (K (5, (6 (Supp. 2004]: (16 "Prime contracting" means engaging in business as a prime contractor. (17 "Prime contractor" means the contractor who supervises, performs or coordinates the construction, alteration, repair, addition, subtraction, improvement, movement, wreckage or demolition of any building, highway, road, railroad, excavation or other structure, project, development or improvement including 12

the contracting, if any, with any subcontractors or specialty contractors and is responsible for the completion of the contract. Id. at 100-01, 811 P.2d at 352-53 (citing A.R.S. 42-1310(2(i(16, (17. In addition, this court considered the taxpayer's argument that it was exempt from tax as a subcontractor under former A.R.S. 42-1310(2 (i: Subcontractors or others who perform services in respect to any improvement, building, highway, rc&d, railroad, 2xcavation or other structure, proj ect, development or improvement shall not be subject to such tax if they can demonstrate that the job was within the control of a prime contractor or prime contractors and that such prime contractor is liable for such tax upon the gross income, gross proceeds of sale or gross receipts attributable to the job and from which the subcontractors or others were paid. Id. at 101, 811 P.2d at 353. Thus, the subcontractor exemption requires that (1 the job was within the control of a prime contractor or prime contractors;3 and (2 the prime contractor is liahle for such tax upon the gros.s income, gross proceeds of sale or gross receipts attributable to the job and from which the subcontractors or others were paid. 3 A contractor is presumed to be a prime contractor and taxable on its contracting receipts unless the contractor can prove that it is a subcontractor. See A.A.C. R15-5-602(C ("[E]very person engaging in a contracting activity is considered to be a prime contractor unless it can be demonstrated [] that he is not a prime contractor['j"' 13

9[26 " The Granite Construction court found that neither requirement was satisfied. Id. at 101-02, 811 P.2d at 353-54. For purposes of that case, we construed the statutory reference to "the contractu to be the contract between a prime contractor and another that requires the prime contractor to supervise, perform or coordinate the contracting activities referred to in the statute for that other party. Id. at 101, 811 P.2d at 353. We found that '\Pt=!~bQdvis, a lessee leasing lands from the Navaj 0 and Hopi tribes U and "Peabody mines and sells the coal on its own account.u Id. Because Peabody did not perform any of the statutorily designated (i.e., reclamation services for the tribe, it could not be considered a prime contractor, and consequently the taxpayer could not be a subcontractor. Id. 9[27 The same logic applies here. The cable companies received a license from the municipalities to construct a cable television system, which was analogous to Peabody's lease of land from the tribes. Taxpayer 00fltr-clctecwith the cable compani~s to construct the cable system. Therefore, Taxpayer is the prime contractor supervising, performing or coordinating the contracting activities. 9[28 Taxpayer also cannot succeed on the alternate theory that the cable companies are the prime contractors and Taxpayer is the exempt subcontractor. The only relationship between the cable companies and the municipalities is a license permitting 14

construction of the cable television system. Like the Grani te Construction lease allowing, but not requiring, the mining of coal, the license does not contractually mandate the cable companies to construct a cable system.4 Moreover, the cable companies ultimately receive income from the sale of cable television which, like Peabody's sale of coal from its mining operations, the cable companies do on their own account, apart from the license with the municipalities. 9[29 Taxpayer also cannot support the argument that the cable companies were liable for transaction privilege taxes on gross income. In Granite Construction, we explained that the job consisted of reclamation activities to restore strip-mined land. rd. Although the job was clearly within Peabody's control, "it is clear that any transaction privilege taxes for which Peabody was liable were not paid on gross income 'attributable to the job., within the meaning of A.R.S. 42-1310(2 (i " rd. Taxpayer argues that the municipalities and cable companies must be in a contractual relationship because the license authorizes the municipalities to recover liquidated damages from those companies for untimely work. The nature of these entities' relationship is regulatory, not contractual. The license granted is "revocable" and "non-exclusive." Government entities regulate various utilities, and may grant utility companies easements that allow the companies to place their lines and impose monetary penalties. See Phoenix City Code 5-2(d. This authority does not translate into a contract of hiring utility companies to put in place the utili ty systems that they operate. Utilities are independent from the government and provide services for their own profit and benefit. 15

., J 9[30 Likewise, the cable companies were not liable for transaction privilege taxes on the gross income "attributable to the job" from which Taxpayer was paid. The cable companies receive gross income for the sale of cable television access, which is analogous to the coal sales in Granite Construction. They do not receive gross income for the installation of the cable system; accordingly, Taxpayer is solely liable for the transaction.._,.k. p~ivilege _._..... taxes attributable to that function. 9[31 Nonetheless, Taxpayer contends that there are several sources of income relating to contracting activity o~t of which Taxpayer is paid. Taxpayer asserts that "[the cable company derives gross receipts from a variety of sources" including a "monthly fee for service" and an "installation fee or connection charge to a new customer." 9[32 This argument misses the point of the second requirement of the subcontractor exemption. The exemption requires "gross proceeds of sale or gross receipts ettributable to the job and from which the subcontractors or others were paid." Grani te Cons tr., 168 Ariz. at 101, 811 P.2d at 353. The "job" refers to Taxpayer's installation of the cable television system. The record is devoid of facts relating to Taxpayer's "job" with new customer installations. In fact, Taxpayer concedes that it cannot "trace the source of income, by dollar, from payment by a customer to payment to Cabezon(.]" Consequently, Taxpayer's installation of the 16

cable system fails to meet the second statutory prerequisite for eligibility under the subcontractor exemption. CONCLUSION 9[33 Taxpayer engaged in prime contracting within the meaning of the Arizona transaction privilege statutes and does not qualify as an exempt subcontractor. Accordingly, we affirm the grant of summary judgmen t to the Department, and deny Taxpayer's reques t for attorneys' fees Qn.appe~l. CONCURRING:. 17