The Arizona Court of Appeals affirmed the summary judgment of the tax court which found that the Arizona Department of Revenue (DOR) correctly denied a refund of use tax to Arizona taxpayer 9W HALO OPCO, LP, dba Angelica Textile Services, LP (“Angelica”), who had claimed a manufacturing exemption. Angelica and the DOR were not in dispute over the material facts describing technical aspects of the day-to-day business, but they disagreed on the definition of “processing” needed for the manufacturing exemption and the applicability of the exemption. The tax court upheld the DOR’s denial and explained that though the operations may include some processing as items are cleaned and disinfected, the business as a whole would be considered a laundry. This is the judgment Angelica appealed to the Court of Appeals.
Angelica is a business that sanitizes textiles and rents them to healthcare facilities. The sanitization process includes sorting, prewash, multiple wash cycles with certified, specialized chemicals, specialized drying, folding, and inspection which Angelica considered “processing” because, as their general manager claimed in an affidavit, the composition of the textiles was changed by removing the contaminants which had bonded or affixed to the fabric. Both new and used textiles were subjected to treatment to remove oils, bacteria, waxes and other chemicals. In 2018, Angelica sought a refund of use tax claiming Arizona’s manufacturing exemption from both the state and the city of Phoenix.
The DOR and city of Phoenix denied the refund, stating that Angelica is not, in fact, a manufacturer and it is really a laundry and linen rental service. The DOR went on to note that rental businesses are not commonly thought of as processing operations in Arizona and that the definition of “processing” in Arizona requires the use of raw materials and must be related to manufacturing.
Since the term “processing” was not defined by the legislature in setting out the exemption and it has not been clarified by the DOR enacting a rule, the Court of Appeals sought a definition under the directive to construe exemption claims against the taxpayer and presume against exemptions. Angelica held that “processing” could be defined as “a series of actions or operations by which tangible personal property is prepared or converted into a marketable form.” The DOR held that processing must change raw materials into a “manufactured or developed form,” highlighting that even though raw materials may not be critical, Angelica is cleaning items, not transforming them. Further, the DOR insists that the only reason for the sanitizing is for the business’s primary purpose—renting textiles. Though Angelica claimed the processing was the principal purpose of their operation and the fact they were renting textiles instead of selling them was irrelevant, the Court of Appeals disagreed.
The Court of Appeals pointed out the importance of the phrase “preparation for market” and that none of the examples of processing presented in previous cases would suggest that preparing an item for market would end with the item being returned to the processor for re-processing. The examples all point to items being offered for purchase and perhaps being made into something else entirely. While the Court and the DOR do not dispute Angelica does perform intense, specialized, industrial-scale sanitization, the fact that Angelica owns, rents, delivers, and collects the textiles it sanitizes means they are not creating new items; they are restoring original items for repeated use, which means Angelica is a laundry. Since a laundry is a service that is not included as a “processing operation”, Angelica is not entitled to the manufacturing exemption.
This case shows the benefit of paying the tax and then asking for a refund. Since Angelica did pay the tax, they did not accrue penalties and interest while the case was considered, both of which can be substantial. However, this case also highlights the importance of definitions when determining if exemptions apply and the effect of strict consideration. Though Angelica does manipulate and sanitize laundry, they do not process materials under Arizona’s definition. Due to strict consideration, rather than a taxpayer being entitled to exemptions, taxpayers must prove beyond any doubt they qualify under the specific rules of a state. Taxpayers need to be aware of the definitions within any state where they do business when considering possible exemptions, but if there is any question, it is generally better to pay the tax and ask for a refund or appeal or to seek a private letter ruling. (9W HALO OPCO, LP, dba Angelica Textile Services, LP, v. Arizona Department of Revenue, Case No. 1 CA-TX 23-0003. Decision dated 7 November, 2024, Judge Furuya, Bryan Y, joined by Presiding Judge Anni Hill Foster and Vice Chief Judge Randall M. Howe)