The state Court of Appeals has slapped down a bid by a major retailer to get a tax refund for bad debts -- debts that really did not reduce its income.
In a unanimous ruling, the judges rejected the claim by Home Depot that it was entitled to a refund of more than $1.4 million in sales taxes paid over a three-year period on transactions where customers had defaulted on purchases made with a the company’s private-label credit card. That was based on the total taxable sales that the finance companies which issued the credit cards for Home
Depot had written off.
Appellate Judge Peter Swann, however, said there was one major thing missing from the company’s claim: An actual loss.
Court records show Home Depot contracted with three related finance companies to issue credit cards with the retailer’s name to customers.
Those wanting to use the cards apply to one of the finance companies for credit. It is up to each finance company whether to extend credit and then establish a credit line for those approved.
When a customer makes a purchase using one of those cards, the finance company forwards to Home Depot the amount of the purchase, including the sales tax built in, less a service fee. From this amount, Home Depot then pays the applicable sales tax to the state.
The finance companies, Swann said, deduct losses from unpaid accounts as bad debts on their federal income tax returns.
In 2003, Home Depot filed that $1.4 million claim for a sales tax refund. The Department of Revenue rejected that, as did the Arizona Tax Court, leading to this appeal.
Swann said state regulations allow taxpayers to claim bad-debt deductions against sales taxes under certain limited conditions. One of those, he said is that the debt arose from a debtor-creditor relationship.
The way Home Depot operated with its finance companies and its customers, Swann wrote, did not fit that definition.
He said the contracts provide that the finance companies own all the credit accounts established for Home Depot’s credit card customers and are entitled to receive all payments made by cardholders on accounts. They also say that any credit losses are borne solely by the finance companies “and shall not be passed on to retailer.’’
“Taxpayer therefore does not suffer any direct loss associated with delinquent accounts, nor does it stand to benefit if those accounts are ultimately collected,” Swann wrote.
Attorneys for the retailer argued that nothing in the regulation actually requires it to suffer the bad debt loss to claim the refund. Swann, however, said that makes no sense.
“If we were to adopt (Home Depot’s) argument, then taxpayer would reap the benefit of the bad debt deduction while simultaneously avoiding the risk of future tax liability on amounts later collected,” he wrote.
And Swann pointed out that under the arrangement Home Depot had with the finance companies, the retailer received the full amount it was owed, even if customers ultimately did not pay their credit card bills.
“There were no debts — much less bad debts — that served to reduce the gross amount that it realized from its sales of goods,’’ the judge said.
The court also rejected the retailer’s arguments that the service fees it paid the finance companies essentially reimbursed those firms for anticipated bad debts — and that the payment of those fees should entitle it to the bad-debt deduction.
Swann said, though, there is nothing in the record to show that the service fees actually reimburse the finance companies for bad debts.
And the court also brushed aside Home Depot’s contention that allowing the state to retain the sales taxes even after customers defaulted on credit card payments resulted in “unjust enrichment’’ of the state.
“The customers’ failure to pay the financing companies does not change the fact that (Home Depot) was paid for the purchases,” Swann wrote.