State Taxation of Tribal Construction Projects
In Barona v. Yee the Ninth Circuit Court of Appeals (“Court of Appeals”) held that federal law does not preempt application of California sales tax on construction materials purchased for a tribal project by a non-Indian subcontractor from non-Indian vendors, but delivered to a tribe’s reservation. If not overturned by the Court of Appeals en banc or reversed by the U.S. Supreme Court, this decision may lead other states in the Ninth Circuit to tax tribal construction projects since, by and large, most construction industry providers are non-Indian.
In Barona v. Yee, the Barona Band of Mission Indians (“Barona” or “Tribe”) entered into a lump-sum contract with a non-Indian general contractor to construct a $75 million casino expansion (“Project”). In turn, the general contractor hired Helix Electrical, Inc. (“Helix”), a non-Indian subcontractor, to perform the electrical work for the project.
Under California’s statutes and regulations, “either sales tax or use tax applies with respect to the sale of the materials to or the use of materials by the construction contractor.” Further, California defines a lump-sum contract as “a contract under which the contractor for a stated lump sum agrees to furnish and install materials or fixtures, or both.”
To avoid imposition of California sales tax on its casino expansion, Barona included the following conditions in its contract with the general contractor: (i) Barona designated the general contractor and subcontractors as Tribal purchasing agents for the procurement of construction materials; (ii) construction materials had to be delivered and accepted by the Tribe on-reservation; (iii) title to construction materials would pass to the purchaser on-reservation; and (iv) advance payments for construction materials could not be made prior to the delivery of such items to the construction site.
After completion of the Project, the California State Board of Equalization (“Board”) audited Helix’s books and records and, despite the Tribal conditions recited above intended to avoid the application of State sales tax, the Board assessed approximately $200,000 in sales tax against Helix related to the purchase of construction materials. Indemnification provisions in the prime contract and Helix’s subcontract required Barona to indemnify the parties against imposition of state sales tax. Therefore, Barona filed for declaratory relief in the United States District Court for the Southern District of California (“District Court”) to contest the application of the State sales tax to Helix, and, therefore, the Tribe.
The Tribe asserted that federal law barred application of the State sales tax because: (i) the legal incidence of the tax fell upon Barona since it designated Helix as a tribal purchasing agent and the sale of construction materials occurred on-reservation; (ii) if the legal incidence of the tax fell upon Helix, federal law preempts the tax since federal and tribal interests in promoting tribal economic development and self-sufficiency outweigh state interest in raising tax revenue; and (iii) the Indian Gaming Regulatory Act (“IGRA”) preempts the tax.
Although the District Court declined to accept Barona’s designation of Helix as a tribal purchasing agent, it determined that the legal incidence of the sales tax fell upon Helix and that federal law preempted such tax. The District Court’s Bracker preemption analysis focused on the effect the tax would have on Indian gaming, an industry significantly regulated under federal law – IGRA. The District Court reasoned that application of state sales tax on construction materials would substantially increase the cost of Barona’s casino expansion and perhaps discourage Barona from building an optimal casino facility to attract gaming patrons. The District Court also noted that Barona contributes pursuant to its tribal-state gaming compact revenue to California to mitigate off-reservation impacts caused by its tribal gaming activities. Based upon these considerations, the District Court concluded that the federal and tribal interests expressed in IGRA to promote tribal economic development, self-sufficiency and strong tribal governments outweighed the State’s general interest in raising tax revenue.
The Court of Appeals summarily rejected the idea that Barona could designate Helix as it purchasing agent for purposes of avoiding state sales tax and reversed the District Court decision that federal law preempted the sales tax. The Court of Appeals construed the Project’s sales tax mechanism as a contractual manipulation to create a non-taxable event in Indian Country that would otherwise be taxable off-reservation. This perception significantly affected the Court of Appeals’ analysis under the Bracker preemption test resulting in a decision favoring the application of State sales tax.
The Court of Appeals discounted Tribal interests in territorial autonomy, economic development and self-sufficiency because it concluded that Barona sought to create an artificial economic advantage over non-Indian businesses akin to those discussed in the historical tribal smoke shop cases. In regard to federal interests in tribal self-sufficiency, the Court of Appeals explained that such interest “fades when the commercial activity is rigged to trigger a tax exemption.” The Court of Appeals agreed that IGRA comprehensively regulates Indian gaming, but that the State sales tax on construction materials was too far removed from IGRA to serve as a basis to preempt such tax. Similarly, Barona’s payments to the State to mitigate off-reservation impacts were considered too far removed from the subject matter of the state sales tax to be relevant.
Alternative California Project Delivery Methods
The California sales tax regulation that applies to Indian reservations exempts state sales tax upon sales of tangible personal property to tribes when delivery of the property and title to the property transfers to the tribe on-reservation. Thus, if the Tribe, and not Helix, had purchased the construction materials, State law would have exempted such sales from State sales tax assuming delivery of the property and title transferred to the Tribe on-reservation.
California regulations also provide that State sales tax does not apply to Indian contractors if construction materials sold to Indian contractors are delivered on-reservation. The Indian contractor is not required to be a tribal member or reside on the reservation of the tribe for which such contractor is performing the work.
Finally, California law allows tribes to enter into properly structured time and materials contracts wherein non-Indian general contractors and non-Indian subcontractors are deemed retailers of construction materials sold to the tribe. Although the contractors install the construction materials sold to tribes as in lump-sum projects, the sale of construction materials are exempt under a time and materials contract if: (i) construction materials are delivered to the tribe on-reservation; (ii) title to the materials passes to the tribe on-reservation prior to installation; and (iii) the retail transactions are documented by exempt resale certificates. In the District Court case, the Board admitted that state sales tax would not have applied to Barona’s casino expansion had the parties entered into a properly structured time and materials contract.
Arizona Transaction Privilege Tax
Unlike California, Arizona imposes a transaction privilege tax on the business of prime contracting rather than a direct tax upon the sale of construction materials. The Arizona transaction privilege tax rate of 5% applies to 65% of the gross proceeds of sales or gross income derived from the business of prime contracting. However, local governments also tax construction activities and depending upon the location of the project, the combined State and county transaction privilege tax rates for prime contracting range from 5.85% to 6.725%. Since on-reservation tribal construction projects do not occur within city territorial limits, this article does not address city taxes applied to construction projects.
The legal incidence of the Arizona transaction privilege tax falls upon the prime contractor. A “prime contractor” is a contractor that supervises, performs or coordinates the construction project, hires subcontractors, if any, and is responsible for completion of the project. In a typical construction project involving an owner, general contractor and subcontractors, the general contractor is the prime contractor. Under certain circumstances a project manager, construction manager or subcontractor may be deemed the prime contractor.
Subcontractors are not subject to transaction privilege tax if: (i) the job is within the control of a prime contractor; and (ii) the prime contractor is liable for the transaction privilege tax on the gross income, gross proceeds of sales or gross receipts attributable to the job from which the subcontractor was paid. Subcontractors are exempt from transaction privilege tax unless they act in the capacity of a prime contractor. A Subcontractor is deemed a prime contractor and liable for the tax if the subcontractor performs work for and receives payment from: (i) an owner-builder, or (ii) an owner or lessee of real property.
Arizona exempts on-reservation construction projects from the application of transaction privilege tax. In April 1995, the Arizona Department of Revenue (“Department of Revenue”) issued Transaction Privilege Tax Ruling 95-11 (“TPR 95-11”). In regard to construction activities, TPR 95-11, subsection I(C), provides that transaction privilege tax does not apply to the gross proceeds derived from on-reservation contracting activities performed by an Indian tribe, a tribal entity or a tribal member. In addition, subsection I(C) provides that the tax does not apply to the gross proceeds derived from construction projects performed on-reservations by non-Indian prime contractors when: (1) the activity is performed for the tribe or a tribal entity on its reservation; or (2) the activity is performed for a tribal member on his or her reservation.
Based upon the Arizona transaction privilege tax scheme and the exemption provided in TPR 95-11, non-Indian contractors performing on-reservation tribal construction projects are not subject to transaction privilege tax imposed on prime contracting. If Barona v. Yee stands, it will be interesting to see whether the Department of Revenue will seek to eliminate the non-Indian contractor exemption in TPR 95-11.
Elimination of the on-reservation prime contractor exemption and attempted tax of tribal construction projects may present challenges for the State. Key factors in the Barona v. Yee case may be inapplicable to the Arizona transaction privilege scheme for taxing prime contracting. First, the structure of the Arizona transaction privilege tax, itself, does not require contractual manipulation to create a taxable event on-reservation for purposes of the Bracker preemption analysis. Since the taxable event is prime contracting, on-reservation construction by non-Indian contractors results in the legal incidence of the transaction privilege tax occurring within Indian Country. Thus, federal and tribal interests should not be automatically discounted under the Bracker preemption analysis, as in Barona v. Yee, since contractual manipulation is not required to place the taxable event in Indian Country.
Second, the transaction taxed in Barona v. Yee involved non-Indian purchases of construction materials. The Court of Appeals more than once noted that under the Bracker preemption test the weighing of federal, tribal and state interests tips in favor of the state where its taxes are imposed on the purchases made by non-Indians. However, Arizona’s transaction privilege tax applies to prime contracting activities and not upon the prime contractor’s purchase of construction materials. Therefore, under the Bracker preemption analysis a presumption that state interests outweigh federal and tribal interest by the mere structure of the taxing scheme should not apply.
It is also worth mentioning that, Arizona’s transaction privilege tax on prime contracting is similar to the New Mexico’s gross receipts tax that was preempted as applied to the construction of an on-reservation tribal school. See, Ramah Navajo School Board, Inc. v Bureau of Revenue of New Mexico. In Ramah, a tribal school board contracted with a non-Indian contractor to construct a tribal school on-reservation. New Mexico imposed a tax on the gross receipts received by the non-Indian contractor from the tribal school board. In that case, the Supreme Court determined that federal law preempted New Mexico’s gross receipts tax applied to the non-Indian contractor because federal regulation and financing of Indian education was comprehensive and federal interest in promoting educational opportunities for Indians outweighed New Mexico’s interest in raising general tax revenue. Depending upon the individual factors involved in a given tribal construction project, Ramah may be a difficult case to overcome regarding the potential application of Arizona transaction privilege tax on prime contractors hired by tribes to construct on-reservation tribal projects.
Finally, the removal of the non-Indian prime contractor exemption from TPR 95-11 would likely not affect the ability of Arizona tribes to form their own construction companies to perform tax exempt tribal construction projects on-reservation. Federal law bars state taxation of on-reservation tribal activity where the legal incidence of the tax falls on the tribe or its tribal members. The legal incidence of Arizona’s transaction privilege tax falls upon the prime contractor.
Conclusion
Barona v. Yee’s potential application is not limited to California tribal construction projects. Based upon the broad wording of the decision, it is arguable that an enterprising Department of Revenue could seek to modify TPR 95-11 to apply the transaction privilege tax on current and future construction projects involving the non-Indian prime contracting. However, it would be imprudent to determine that Barona v. Yee applies to all tribally owned construction projects utilizing non-Indian contractors given that individual tribal projects could involve government or commercial components or both and could involve significant comprehensive and pervasive federal regulation.
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