United States

Arizona: Software Used in Newspaper Publishing Exempt under Manufacturing Exemption

Mar 23, 2015
From KPMG TaxWatch

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The Arizona Court of Appeals recently addressed whether a taxpayer owed transaction privilege tax on the proceeds received from licensing software and providing software maintenance to a newspaper publisher. The taxpayer developed and sold software to facilitate the production of printed newspapers. Under Arizona law, machinery and equipment used directly in manufacturing is exempt from transaction privilege tax. Following an audit, the taxpayer was assessed transaction privilege tax on sales of software to the publisher of the Arizona Republic. The taxpayer protested the assessment, arguing that the sales were exempt under the manufacturing exemption. After the tax court ruled in the taxpayer’s favor, the Department appealed. Before the appellate court, the Department argued that newspaper publishing was not manufacturing. Further, even if newspaper publishing was manufacturing, the Department asserted, the software at issue was not used “directly” in the manufacturing process and did not qualify for the manufacturing exemption. The Department, however, did not dispute that the software and related maintenance updates were machinery or equipment as contemplated under the exemption. Although the term manufacturing was not defined, the exemption statute directed the court to apply the ordinary meaning of the term. As such, the court looked at established and widely used dictionaries and concluded that the sophisticated, automated process in which the taxpayer converted raw materials (ink, paper, and packaging) into printed newspapers constituted manufacturing. The court also found it significant that the Arizona Administrative Code defined a publisher as “one who manufactures and distributes a publication.” Furthermore, a 1984 letter from the Department to the newspaper advising that computer systems used directly in printing operations were exempt machinery or equipment had never been rescinded. The court next addressed whether the software was used “directly” in manufacturing, as required under the exemption statute. Relying on Arizona Supreme Court precedent, the court analyzed whether the software was essential and necessary to the completion of the printed newspapers. Because the software was used in the layout, formatting and typesetting functions necessary to print the newspaper, the court concluded that the software and related maintenance updates were used “directly” in the manufacturing of newspapers. Thus, the court ruled that the software and maintenance agreements qualified for the manufacturing exemption. For more information on CCI Europe, Inc. v. Arizona Department of Revenue, Dkt. No. 1 CA-TX 13-0002 (Ariz. Ct. App. March 12, 2015), please contact Lorna Pederson at (480) 459-3598.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.