In Arizona, furnishing natural or artificial gas, water, or electricity is generally subject to Arizona’s transaction privilege tax (TPT). Imposed by statute, the tax is levied on the utility company (or distributor) rather than the end user; however, the utility company may pass (and almost always does) the economic burden to the end user. An often ignored deduction exists for qualifying hospitals and health care organizations. As the tax is passed onto the end user, a qualifying entity can provide an exemption letter to the utility company that would end the transferred tax obligation. In short, it can help reduce the qualifying hospital or health care organization’s utility expenses. A short summary of those provisions are provided below.
The Utility Classification
Arizona’s TPT is imposed by statute – it explains that the amount taxed is determined by calculating a business’s gross income, as adjusted by various exemptions and deductions. Different types of businesses enjoy different deductions and exemptions depending on, in part, statutorily prescribed business classifications. One such classification is the Utility Classification, which taxes the “producing and furnishing to consumers natural or artificial gas and water [and] providing to retail electric customers ancillary services, electric distribution services, electric generation services, electric transmission services and other services related to providing electricity.”
In other words, the Utility Classification taxes the furnishing of water, natural or artificial gas and electricity to retail electric customers and consumers. The term “retail electric customers” is defined as a person who purchases electricity for their own use, not for resale, redistribution or retransmission. The word “consumer” is not defined in the statute, but would likely be interpreted as any purchaser of water or natural or artificial gas.
The Utility Classification Deduction for Qualifying Hospitals and Health Care Organizations
The Utility Classification allows a deduction from the tax base for certain sales to “qualifying hospitals” and “qualifying health care organizations.” In other words, any sale to these qualifying organizations would be reported on the return, but then would be entitled to a corresponding deduction under the applicable category. The qualifying entity would benefit from that deduction because the tax cost would no longer be passed along on its utility invoice. The deduction to qualifying hospitals is broad and includes all sales to eligible organizations.
A “qualifying hospital” is defined by statute and means any of the following:
- A licensed hospital [that] is organized and operated exclusively for charitable purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual.
- A licensed nursing care institution or a licensed residential care institution or a residential care facility operated in conjunction with a licensed nursing care institution or a licensed kidney dialysis center, which provides medical services, nursing services or health related services and is not used or held for profit.
- A hospital, nursing care institution or residential care institution [that] is operated by the federal government, [Arizona] or a political subdivision of [Arizona].
- A facility that is under construction and that on completion will be a facility under subdivision (a), (b) or (c) of this paragraph.
Thus, to qualify for a “qualifying hospital” deduction, the facility must either be a non-profit or operated by a state or federal institution. Although the organization must be a non-profit, there is no requirement that the organization operate as a tax exempt entity. Additionally, the deduction applies to the construction of facilities that would otherwise qualify.
A “qualifying health care organization” is also defined by statute and is more narrowly defined. It means an entity that is recognized as tax-exempt under § 501(c) of the Internal Revenue Code and that uses at least eighty percent (80%) of all monies received from all sources only for health and medical related education and charitable services. This expenditure ratio must be audited yearly by an independent certified public accountant under generally accepted accounting principles. The results of the audit must be filed with the Arizona Department of Revenue.
Additionally, the deduction for “qualifying health care organizations” is more limited than that available to a “qualifying hospital.” This deduction is limited to the gross proceeds of sales or gross income from sales to a qualifying health care organization if the electricity, natural or artificial gas, or water is used by the organization “solely to provide health and medical related educational and charitable services.”
Qualifying organizations should request from the Arizona Department of Revenue an exemption letter confirming their eligibility for the deduction. Hospitals, nursing and residential care facilities, licensed kidney dialysis centers, and other tax exempt entities that operate in the health and medical field should seek the advice of competent legal counsel familiar with Arizona’s TPT to determine whether they qualify for this deduction, and for assistance with preparing a request for an exemption letter.
Paul J. Valentine‘s practice emphasizes structuring corporate, partnership, and real estate transactions, counseling medium and small businesses and tax-exempt organizations in tax matters, litigating tax cases in federal courts, and handling administrative controversies before the IRS. His experience with Arizona state and city tax controversy includes income tax, sales tax, and commercial rent tax. firstname.lastname@example.org