A three-panel Arizona Court of Appeals (the “panel”) unanimously ruled on January 10, 2023, that, under U.S. Supreme Court precedent, the gross proceeds from work performed under federal contracts on Native American reservations by a nonaffiliated Native American contractor are subject to Arizona’s transaction privilege tax.

The Ute Mountain Ute Tribe (“Ute Mountain”) and the Weeminuche Construction Authority (“WCA”) (collectively, “Appellants”) challenged the Arizona Tax Court’s judgment upholding the Arizona Department of Revenue’s (the “Department”) determination that WCA owed transaction privilege taxes on its earnings from three different construction projects on reservation lands. In 2014 and 2015, WCA performed the construction work under federal contracts with the Bureau of Indian Affairs for the benefit of the Hopi and Navajo tribes.

As a general matter, Arizona law imposes an excise tax on persons and entities engaging in business within the State under certain business classifications, including the business of prime contracting.

Appellants argued primarily that U.S. Supreme Court precedent of White Mountain Apache Tribe v. Bracker, which made state law generally inapplicable to tribal conduct on reservations, preempted the Department’s taxation of the income derived from these projects on tribal land.

In the alternative, Appellants argued that the income from the projects were exempt from Arizona transaction privilege tax under a Department transaction privilege tax ruling (“TPR”) in effect during the relevant period, as well as under certain exemptions provided by a later-enacted Arizona statute.

Federal Preemption

Instead of accepting Appellants’ argument that the Arizona Tax Court should have engaged in a fact-specific inquiry under Bracker and weighed the interests of the parties to determine whether federal law preempted the Department’s taxing authority, the Court of Appeals panel found as controlling the “bright-line” test for federal preemption enunciated in Arizona Department of Revenue v. Blaze Construction.

The panel opined the “the Supreme Court clarified that Bracker’s balancing test is inapplicable when a state seeks to tax a transaction between the federal government and a nontribal contractor” and emphasized that Blaze established a bright-line standard in favor of taxing federal contracts, regardless of whether the contracted-for activity takes place on Native American reservations.

Because Blaze held that a tribal contractor who was not a constituent of the tribe for whom it performed the work was effectively a non-Native American for most practical purposes, WCA was likewise considered a nontribal contractor for tax purposes because it performed federal contract work on a reservation other than its own. Thus, as a nontribal contractor for tax purposes, Appellants were subject to Arizona taxation.

The panel acknowledged, however, that the applicability of this bright-line rule was less clear if the tribe for whom the work was performed retained contracting responsibility under the Indian Self-Determination and Education and Assistance Act. Under such circumstances, the Supreme Court in Blaze did not consider whether the preemption doctrine “would apply when [t]ribes choose to take a more direct and active role in administering [] federal funds.” Here, where the federal government retained contracting responsibility through the Bureau of Indian Affairs, the bright-line standard favoring taxation of federal contracts made WCA subject to the Arizona transaction privilege tax. State Exemption

Appellants alternatively argued that the project proceeds were exempt from Arizona’s transaction privilege tax under both TPR 95-11 and A.R.S. Section 42-5122.

First, Appellants argued the project proceeds were exempt under TPR 95-11, which addressed the imposition of transaction privilege tax on activities performed on Native American reservations located within Arizona. Appellants’ reliance on TPR 95-11 was ineffective because the Department lacks the authority to create an exemption. The panel clarified that neither TPR 95-11 nor any other Department ruling created a legal exemption to Arizona’s transaction privilege tax and that such rulings are advisory only and not controlling.

Appellants invoked reliance on TPR 95-11 to estop the Department from also taxing the project proceeds. Aside from the procedural defects of the estoppel claim, the panel concluded the Appellants could not reasonably rely on the Department’s ruling. The exemption found in the ruling could only apply to the tribe for whose benefit the reservation was established, not any tribe. Because neither Ute Mountain nor WCA were the intended beneficiaries of the Navajo or Hopi reservations, they were not contemplated within this administrative guidance. Second, A.R.S. Section 42-5122 was not enacted until 2021, well after the relevant tax periods. As such, Appellants could not rely on the broad statutory exemption for gross income derived from tribally owned businesses for business activity taking place on a reservation. To apply retroactively, a statute must contain an express statement of retroactive intent, and A.R.S. Section 42-5122 contained no such retroactive effect language.

Notwithstanding the Court of Appeals’ decision, Native American tribes conducting business in Arizona on a prospective basis may have broad exemptions from the transaction privilege tax under A.R.S. Section 42-5122. Appellants have the option of appealing their case to the Arizona Supreme Court by filing a petition for review within 30 days after entry of the Court of Appeals’ decision, but it is unknown at this juncture whether they will appeal.