Arizona Court Holds That Service Revenue is Included in Property Rental Business Tax Base

December 14, 2018

Arizona’s Transaction Privilege Tax is like a sales tax in some ways but not others, which can result in unexpected liabilities if the unique rules are not fully understood.

While states typically impose many of the same taxes, there are some nuances that can give rise to unexpected exposure if not fully understood.  Arizona’s Transaction Privilege Tax (“TPT”) is one such example. While it functions similarly to a sales tax (i.e., it is collected from customers and remitted to the states), it is technically not imposed on sale transactions. Rather, it is a privilege tax that is imposed on businesses for the privilege or right to engage in a business or occupation within the state.  As a result, certain commonly understood sales tax principles may not be applicable in the same way under the TPT, and if a business is not aware of this, it may be in noncompliance with the TPT rules.  On Oct. 23, 2018, the Arizona Court of Appeals issued a decision that highlights one of these differences, specifically the requirement to include service revenue in the tax base.[1]

The taxpayer, Roadsafe Traffic Systems (“Roadsafe” or the “Company”), rents traffic control equipment (i.e., barricades, cones, signage, etc.) for use at construction sites and other locations that require traffic control. Roadsafe sometimes drafts traffic control plans and provides personnel, such as flaggers and police officers, to assist with traffic control.  The Arizona Department of Revenue (“ADOR”) audited Roadsafe and determined that revenues derived from providing traffic control personnel and drafting traffic control plans were subject to Arizona’s TPT.

The TPT applies to 16 different business classifications, and the one applicable to Roadsafe is the personal property rental classification. This classification “imposes a tax on the business of leasing or renting tangible personal property for a consideration.” Rental businesses are taxed based on the “gross proceeds of sales or gross income derived from the business.” While Roadsafe acknowledges that its revenues from the rental of traffic control equipment are taxable, it argues that the revenues derived from drafting traffic control plans and providing traffic control personnel are not part of the rental transaction.

The Court concluded that the company’s service revenue is included in the TPT base for several reasons.  First, it notes that the tax is based on gross income derived “from the business” and not specific rental transactions, and that the term “business” is broadly defined to includes all activities engaged in that provide a gain, benefit or advantage.  Second, Arizona defines gross income as “the gross receipts of a taxpayer derived from trade, business, commerce or sales and the value proceeding or accruing from the sale of tangible personal property or service, or both.” Finally, Arizona’s regulation includes the word “labor” within its definition of a rental company’s gross income, and the Court determined that “labor” was not limited to those services provided specifically in connection with the rental equipment (i.e., installation, set-up, etc.).

The Court also explained that in some cases, gross income from a separate business should be excluded from the TPT base, and that the Arizona Supreme Court established a three-part test for this analysis. To exclude income, the taxpayer must show: (1) the receipts from the separate business can be “readily ascertained”; (2) the income from the separate business is “not inconsequential” in relation to the taxpayer’s total income; and (3) the separate business is not “incidental” to the main business.

In this case, the Court concluded that Roadsafe revenues from drafting traffic control plans and providing traffic control personnel failed the second and third parts of the test (the revenues were readily ascertained under the first part). Roadsafe’s revenues derived from flaggers, police officers, and traffic control plans are inconsequential to the taxpayer’s total income since they accounted for only 3.07 percent, 3.80 percent, and .67 percent, respectively, during the audit period.  Further, relying on Black’s Law Dictionary’s definition of incidental as “subordinate to something of greater importance or having a minor role,” the Court concluded that these serves are incidental to Roadsafe’s traffic control equipment rental business. The company’s primary business is renting traffic control equipment, and it supplements its rental business with those services.

This ruling demonstrates that companies need to be aware that not all states follow typical sales tax rules. Under a traditional sales tax, when a taxpayer sells/rents taxable goods and also provides nontaxable services, the taxpayer typically does not need to collect sales tax on the nontaxable services provided that such services are separately stated.  Under the TPT, however, because it is imposed on the revenue derived from engaging in business, the state applies different principles, as summarized above.  Therefore, businesses must be aware as they enter new jurisdictions to reach out to their tax advisors so that they understand fully the tax obligations in that state.

Aprio’s SALT team is experienced in the nuances of each state’s tax rules can help ensure that your business is in compliance with its tax obligations in all states so that you do not get assessed for unexpected tax liabilities and penalties.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at for more information.

This article was featured in the November/December 2018 SALT Newsletter.

[1] Roadsafe Traffic Systems, Inc. v. Arizona Department of Revenue, No. 1 CA-TX 17-0005 (Az. Ct. of App. Div. One, October 23, 2018).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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