Arizona Taxpayer's Cooperative Direct Mail Advertising Not Subject to Arizona Use Tax

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 Val-Pak East Valley Inc. (Val-Pak), an Arizona business selling cooperative direct mail advertising is not subject to Arizona use tax, the Arizona Court of Appeals held, because the service is the primary object of the mixed transaction and the property is incidental to or an inconsequential element of the service and not separately stated. [Val-Pak East Valley Inc. v. Arizona Dept. of Rev., Ariz. Ct. App., No. 1 CA-TX 10-0005, 3/13/12]

Val-Pak is a franchisee of Florida corporation Val-Pak Direct Marketing Systems Inc. (Val-Pak Florida), and pursuant to a franchise agreement, Val-Pak obtains product and appearance information from its clients and submits that information to Val-Pak Florida. Val-Pak Florida then designs, prints, compiles, and inserts advertising flyers, inserts, and coupons ordered by Val-Pak's clients into envelopes. Val-Pak Florida delivers the envelopes to the U.S. Postal Service for mailing to Arizona addresses.

To determine whether the mixed transaction is nontaxable because the service is the primary object of the transaction and the property is incidental to or an inconsequential element of the service and not separately charged, or taxable because the tangible personal property is the primary object of the transaction and the service is incidental to the property acquired and not separately charged, the court applied the “dominant purpose” test (also known as the “true object” test), and the “common understanding” test.

“The dominant purpose of Val-Pak's business dealings with Val-Pak Florida is to obtain design, mailing, and printing services, not tangible personal property,” the court found. By itself, the paper used for the advertising materials is of little practical value to Val-Pak without Val-Pak Florida's design, printing, and mailing services, the court added.

Taxpayer Is Buying Services


Applying the common understanding test, the court concluded that Val-Pak is buying services, not tangible personal property, from Val-Pak. “Val-Pak is in the cooperative direct mail advertising business,” the court stated, adding that “although people buy paper every day, no one would think Val-Pak is in the business of buying paper and then selling paper to its clients.” It is only when Val-Pak Florida takes blank paper and design, creates, and transforms it into coupons promoting sales does Val-Pak receive what it ordered, the court explained.

Additionally, the court rejected Val-Pak's reliance on Qwest Dex Inc. v. Arizona Dept. of Rev., 210 Ariz. 223, 109 P.3d 118 (App. 2005), in which the court held that use tax was inapplicable to out-of-state printing services obtained by an Arizona taxpayer in the business of publishing telephone directories, because Val-Pak's transactions “do not lend themselves to the type of easy separation of property from services as was presented in Qwest,” where it was easy to separate services from paper.

The court also rejected the department's reliance on Service Merchandise Co. v. Arizona Dept. of Rev., 188 Ariz. 414, 937 P.2d 336 (App. 1996), in which the court held that use tax was applicable to advertising materials prepared at the taxpayer's direction and distributed by out-of-state printers for the taxpayer's use in Arizona. In Service Merchandise, the taxpayer was exercising rights and powers over tangible personal property incidental to its ownership of that property, whereas in this case, Val-Pak does not own the coupons, and Val-Pak Florida rather than Val-Pak retains and exercises complete control over each envelope it distributes and mails to Arizona addresses.

The text of the opinion is available on the internet at http://azcourts.gov/Portals/89/opinionfiles/TX/TX100005.pdf.

By Christine Boeckel