Arizona – Bad Debt Deductions on Transaction Privilege Tax Returns

SALT Report 1815 – An Arizona Court of Appeals denied a Taxpayer’s claim for a transaction privilege tax refund. The Taxpayer operates a chain of home-improvement stores throughout the United States and offers private label credit cards (PLCC) to certain customers.  The Taxpayer requested a refund for bad debts that occurred when its private label credit card customers defaulted on their payments.

Arizona law A.A.C. R15-5-2011 provides that taxpayers may claim a bad debt deduction against the transaction privilege tax under the following conditions:

  • The gross receipts from the transaction on which the bad debt deduction is being taken have been reported as taxable,
  • The debt arose from a debtor/creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money, and
  • All or part of the debt is worthless

The crux of the Taxpayer’s case is whether the regulation requires that the Taxpayer be the creditor in the “debtor/creditor relationship.”  However, the Court determined that the Taxpayer was not the creditor because the Taxpayer enters into a contract with a finance company to manage the distribution of the PLCCs and the collection of payments. The Taxpayer has no involvement with the debt once the original sales transaction takes place.

Therefore, because the court determined that the Taxpayer was not the creditor in the “creditor/debtor relationship” it could not be the owner of the bad debts that arose from the PLCC’s. Consequently, the Taxpayer’s request for refund was denied.

For Further Information:

Court of Appeals of Arizona Division One – Case Number TX 11-0004