United States

Arizona: Department Addresses Whether a Taxpayer is an Instrumentality of the Federal Government

Sep 07, 2015
From KPMG TaxWatch

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Recently, the Arizona Department of Revenue addressed whether a 501 (c)(3) organization that had entered into a cooperative agreement with a federal agency was exempt from paying use tax on purchases of goods used in Arizona in conjunction with its obligations under its agreement with the federal government. The entity was a Federally Funded Research and Development Center that operated certain federal facilities and programs.  The taxpayer argued that it was considered an instrumentality of the federal government so that its purchases of goods were exempt from Arizona transaction privilege tax (TPT). Under the terms of the various cooperative agreements, legal title to personal property acquired by the taxpayer with agency funds vested in the federal government. As support for its requested ruling, the taxpayer provided letters from 1960 in which Arizona had granted the taxpayer tax exempt status as an instrumentality of the federal government.

The Supremacy Clause prevents state from levying taxes directly on the federal government, but does not prevent a state from imposing a tax on those doing business with the government even though the federal government may bear the economic burden of the tax. Only when an agency or instrumentality is so closely connected to the Government that the two cannot be realistically viewed as two separate entities will tax immunity be appropriate. After reviewing a key U.S. Supreme Court case in which the Court upheld the imposition of New Mexico’s gross receipts tax on various contractors providing services to the federal government, the Department noted that the law had changed considerably since the taxpayer received its exemption letters in 1960. Furthermore, the taxpayer was not so closely connected to the federal government that it could not be seen as a separate entity. In fact, per its website, the taxpayer was a separate, identifiable entity that was even referred to as such in a memorandum to Congress on its budget. Although the taxpayer was monitored by the government, the Department noted that the U.S. Supreme Court had rejected the argument that monitoring activities by the government meant an entity was akin to an instrumentality. Please contact Lorna Pederson at (480) 459-3598 with questions on Arizona Private Letter Ruling LR15-003.

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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.