The Arizona Supreme Court has held that machinery used in an industrial healthcare textile laundering process qualifies for a “processing operation” use tax exemption, reversing earlier decisions of the tax court and court of appeals.
The decision came in 9W Halo OPCO, LP v. Arizona Department of Revenue, where the Court clarified the meaning of “processing operations” under A.R.S. § 42-5159(B)(1)—a provision that exempts certain machinery and equipment used directly in manufacturing or processing activities from use tax.
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Background of the Dispute
The appellant, 9W Halo OPCO, LP, operating as Angelica Textile Services, runs a large industrial facility that provides reusable healthcare textiles—such as hospital bedsheets, patient gowns, and surgical scrubs—to medical institutions across Arizona.
The facility processes nearly 30 million pounds of healthcare textiles annually. These textiles, once used in hospitals, are contaminated with bacteria and viruses and must undergo specialized laundering and disinfection before they can be safely reused in healthcare settings.
Between 2014 and 2018, the company purchased machinery and chemicals used in this sanitization process and paid state and city use taxes on those purchases. Later, it sought tax refunds, arguing that the equipment qualified for the statutory exemption applicable to machinery used in “processing operations.”
The Arizona Department of Revenue (ADOR) partially denied the refund claim. The Arizona Tax Court sided with the department, holding that the company’s linen rental business did not qualify as a processing operation because it did not convert raw materials into finished products. The Arizona Court of Appeals affirmed that reasoning.
Angelica then appealed to the Arizona Supreme Court.
Supreme Court Clarifies Meaning of “Processing Operation”
The Supreme Court examined the statutory language and earlier judicial interpretations to determine what constitutes a “processing operation.”
The Court ultimately held that a processing operation means: “a series of integrated actions or methods that prepares a product for the market or converts a product into marketable form.”
In other words, the exemption applies when machinery is used in a sequence of activities that transform or prepare a product so that it can be sold or used in the relevant market.
The Court emphasized that the statute focuses on individual operations within a business, rather than the overall nature of the business itself.
Downstream Transactions Not Relevant
A key issue before the Court was whether a company’s business model—selling versus renting products—affects eligibility for the exemption.
The lower courts had reasoned that because Angelica rented textiles instead of selling them, its activity did not constitute processing.
The Supreme Court rejected this reasoning, stating that the statute does not require that processed goods be sold. Instead, the inquiry should focus solely on whether the machinery is used in a qualifying processing activity.
Thus, the Court held that downstream transactions such as renting or selling are irrelevant in determining whether a processing operation exists.
Two-Step Test Established by the Court
To guide future cases, the Court formulated a two-step framework for determining whether the tax exemption applies:
- Whether the operation prepares a product for the market or converts it into marketable form.
- Whether machinery or equipment is used in a series of integrated actions or methods during that preparation process.
If both conditions are satisfied, the machinery used directly in that process may qualify for the exemption.
However, only equipment that touches, manipulates, affects, or adds value to the product during the process is eligible for the exemption.
Court Finds Industrial Laundry Meets the Test
Applying this framework, the Court concluded that Angelica’s operations clearly qualified as processing.
Healthcare textiles—whether new or used—cannot be safely used in hospitals until they undergo the facility’s specialized laundering and disinfecting process. This process includes a twelve-module cleaning cycle involving precise chemical injections and sanitation procedures that remove contaminants from textile fibers.
Because these procedures transform contaminated textiles into marketable healthcare-ready products, the Court held that the machinery involved qualifies for the statutory tax exemption.
Final Outcome
The Arizona Supreme Court vacated the Court of Appeals’ decision, reversed the tax court’s summary judgment in favor of the Department of Revenue and remanded the case for further proceedings consistent with its interpretation of the statute.
The Court also declined to award attorney fees at this stage but allowed the company to renew its request once the case is fully resolved.
Case Details
Case Title: 9W Halo OPCO, LP v. Arizona Department of Revenue
Date: 07/11/2024
