The Court having taken Plaintiff, Walgreen Arizona Drug Company's ("Walgreen") Motion for Summary Judgment, and Defendant, Arizona Department of Revenue's ("Department") Cross-Motion for Summary Judgment under advisement; having reviewed the memoranda of the parties and legal authorities cited therein; and good cause appearing,

IT IS ORDERED denying in part and granting in part Walgreen's Motion for Summary Judgment and the Department's Cross-Motion for Summary Judgment as follows:

Walgreen engages in the retail sale of prescription drugs and other items.  Walgreen collects and consolidates its daily sales receipts at its Illinois headquarters, which is charged with the company's cash management function.  Walgreen uses the revenue from its daily receipts to make all but incidental disbursements in payment of their entire operations.  These payments include purchasing and leasing real estate, constructing tenant improvements, acquiring fixtures, and purchasing stock and inventory.  Occasionally, after making these disbursements, Walgreen has money left over.  Walgreen invests this money in short-term interest or dividend-paying instruments and marketable securities.  Walgreen refers to these investments as their "Treasury Function."  At issue here is the taxability of this excess revenue, and the income it generates.

Arizona adopted, with modification, the Uniform Division of Income for Tax Purposes Act ("Act").  The Act enables multi-state businesses to apportion their income in those states in which they do business so those states may determine their tax liability.  Pursuant to the Act, income is apportioned by multiplying the business' income by a fraction.  The fraction divides the Property Factor plus the Payroll Factor plus two times the Sales Factor, by four.  E.g. Property Factor + Payroll Factor + 2(Sales Factor) / 4. A.R.S. 43-1139.

Only the sales factor is at issue here.  The Act defines "sales" as "all gross receipts of the taxpayer not allocated under this article."  A.R.S. 43-1131(5).  The Act does not define "gross receipts."  "The sales factor is a fraction, the numerator of which is the total sales of the taxpayer in this state during the tax period, and the denominator ... is the total sales of the taxpayer everywhere during the tax period...."  A.R.S. 43-1145.  The two exceptions listed in the statute are not relevant here.

Walgreen argues that both the excess revenue or "principal" that is invested and the interest earned on that investment constitute gross receipts and should be included in the denominator of the sales factor.  The Department argues that neither the return of the investment of the excess revenue nor the interest earned on that investment constitute gross receipts and both should be excluded.  The obvious effect is that inclusion reduces the amount of tax Walgreen owes Arizona, and exclusion increases the tax owed.  The Department also claims that if this Court determines that the investment principal and interest amounts are gross receipts, then the Department has the authority to exclude the excess revenue from the factor pursuant to A.R.S.  43-1148 because it does not fairly reflect Walgreen's business activities in Arizona.

Although only the Act as adopted by the Arizona Legislature controls as legal authority in this state, this Court finds the original Act and the Regulations set forth by the Multistate Tax Commission, instructive here.

This Court agrees with the Department's contention that the return on investment or principal is not gross receipts intended for inclusion in the sales factor.  Walgreen has explained to this Court that their daily sales receipts are sent to their Illinois office, which makes all but incidental disbursements.  That daily revenue from Walgreen's sales would be considered gross receipts when received.  Any excess revenue after payment of debt or other disbursements remains a part of those gross receipts and should be counted as such.  However, once that excess revenue is invested in securities or other interest-bearing mediums, it loses its characterization as gross receipts and may not be counted a second time as gross receipts simply because the money was withdrawn from an investment in a marketable security or interest bearing account.  This is akin to someone taking the $100 left from their weekly paycheck which is considered income when it was received, depositing it into an interest bearing account then withdrawing the $100 one month later and claiming it as income a second time.  That $100 is not income.  Were the $100 to earn $5 interest, the interest is income.  If the excess revenue has already been included as gross receipts once in the sales factor formula, it cannot be added a second time.  Doing so would improperly reflect and inflate the true amount of the gross receipts.

With respect to the dividends and interest earned from the investment of the excess revenue, this Court believes the dividend and interest should be included in the calculation of gross receipts.  A.R.S. 43-1137 states that "[I]nterest and dividends are allocable to this state if the taxpayer's commercial domicile is in this state unless the interest or dividend constitutes business income."  One may reasonably interpret this provision as meaning if the domicile is in Arizona, all interest and dividends are allocable to Arizona.  However, if the domicile is elsewhere, then the interest and dividends are allocable as business income and subject to apportionment by the formula set forth in A.R.S. 43-1139, referenced above.  Walgreen prudently invests their excess revenue in short-term securities.  The income from this investment arises out of and is directly related to the investment of the excess gross receipts and is incidental to the business.  At maturity, the principal and interest are often used to pay business debts.  The dividends and interest earned in this case are not from investment holdings wholly unrelated to its primary business.  Although the investment income technically is not direct "sales" income, the interest or earnings from the investment of the excess gross receipts are sufficiently related to Walgreen's primary business for it to constitute business income and for it to be included in its gross receipts and allocated accordingly.  See generally, Multistate Tax Commission, Reg. IV.1.(c)(3) and (4); Reg. IV.2.(a)(5).  The return on investment principal constitutes gross receipts and there is insufficient information before this Court for it to conclude that the allocation and apportionment of the dividends and interest unfairly reflects the extent of Walgreen's business activity in this State.


IT IS ORDERED granting the Department's Cross-Motion for Summary Judgment with respect to the exclusion of the return of investment principal from the sales factor and denying said Motion with respect to the income earned thereon and upon the Department's claim that it has the authority to exclude such income pursuant to A.R.S. 43-1148.

IT IS FURTHER ORDERED denying Walgreen's Motion for Summary Judgment with respect to the categorization of the return on investment principal as gross receipts and the inclusion of the investment principal in the sales factor, and granting said Motion with respect to the inclusion of the dividends and interest in the sales factor as they were incurred as a result of the investment of the excess gross receipts and constitute business income.



1996 Michael G. Galloway

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