The Arizona Court of Appeals recently decided R.R. Donnelley & Sons Co. v. Arizona Dep’t of Revenue, No. 1 CA-TX 08-0007 (Ariz. Ct. App. April 29, 2010), holding that a commercial printing company’s subsidiaries, R.R. Donnelley Receivables Inc. (“Receivables”) and Caslon Inc. (“Caslon”), which provided accounts receivables and investment services respectively, performed “accessory” functions and thus were not unitary with the taxpayer’s commercial printing business. However, the court ruled that the taxpayer’s trademark holding subsidiary, Heritage Preservation Corp. (“Heritage”), provided “basic operations” and must be included in the taxpayer’s combined return.
Arizona law requires affiliated corporations that comprise a unitary business to file a combined Arizona income tax return. Following a lengthy audit, the Arizona Department of Revenue (the “Department”) concluded that all three of RR Donnelley & Sons’ subsidiaries were unitary with its commercial printing business and assessed additional tax. The taxpayer appealed, and the Arizona Tax Court found that Receivables and Caslon’s investment business were not unitary with the taxpayer’s commercial printing business and that Heritage, an intangible holding company, was unitary with the taxpayer. The Department appealed, and the taxpayer cross appealed.
The Arizona Court of Appeals began its analysis by emphasizing that in determining whether a business is unitary, a “key factor … is the distinction between ‘basic operations’ and ‘accessory’ functions.” Id.
When services are accessory, they are “not embodied in the product or its delivery to the customers,” and “‘not so pervasive as to negate functional independence’ of the subsidiaries.” Id. The court then determined that the services performed by Receivables and Caslon did not create a unitary relationship because they were accessory services rather than basic operational components of the core business. The court explained that even though a significant part of Receivables’ factoring income came from R.R. Donnelley, it purchased the accounts without recourse, at fair market value and also earned revenue from third-party purchases. The court further found that Caslon’s property consisted of intangible personal property investment assets and that it did not share any centralized management or property with R.R. Donnelley.
On the other hand, the trademarks held and managed by Heritage were a core part of Donnelley’s operations in delivering the commercial printing materials it produced. The trademarks were fully operationally integrated with the delivery and distribution of Donnelley’s products and services to its customers.
Ultimately the court concluded that Heritage was functionally interdependent and must be included in Donnelley’s unitary group. The court further noted that although Arizona regulations identify a unitary business by a substantial transfer of tangible items, intangible items such as trademarks may be treated as tangible products under the unitary business standard.