Arizona Court of Appeals Holds State and Local Property Taxes Assessed Against Permanent Improvements Located on Leased Trust Land Are Preempted

By Jay M. Jetter and Heidi McNeil Staudenmaier

In a decision that impacts entities and individuals doing business in Indian Country, the Arizona Court of Appeals sided with the Taxpayer in its challenge to the state and county’s power to tax property on tribal land in the case South Point Energy Center, LLC v. Arizona Department of Revenue, decided on April 27, 2021.   

The Taxpayer in this case is a non-Indian entity that owns and operates an electrical generating plant (Facility) in Mohave County on land it leases from the Fort Mojave Indian Tribe.  Under the terms of the lease, Taxpayer owns the Facility and all improvements, but is required to remove most of the above ground improvements and personal property from the leased land at the end of the lease term.

The Taxpayer had originally sued the Arizona Department of Revenue (Department) to recover property taxes it had paid over the course of several years. The Tax Court ultimately ruled that the Facility is not a permanent improvement exempt under § 5108, because the lease requires Taxpayer to remove the above-ground improvements at the conclusion of the term, and it granted summary judgment to the Department, holding that under White Mountain Apache Tribe v. Bracker, 448 U.S. 136, 151, 100 S.Ct. 2578, 65 L.Ed.2d 665 (1980), tribal sovereignty does not preempt taxation of the Facility.

On appeal, Taxpayer first argued that the Tax Court erred by failing to rule that property taxation of its Facility was per se preempted under 25 U.S.C. § 5108 and that it was therefore exempt from the property tax.

25 U.S.C. § 5108 provides, in pertinent part:

The Secretary of the Interior is authorized, in his discretion, to acquire, through purchase, relinquishment, gift, exchange, or assignment, any interest in lands, water rights, or surface rights to lands, within or without existing reservations, including trust or otherwise restricted allotments, whether the allottee be living or deceased, for the purpose of providing land for Indians. . . .

Title to any lands or rights acquired pursuant to this Act or the Act of July 28, 1955 (69 Stat. 392), as amended (25 U.S.C. 608 et seq.) shall be taken in the name of the United States in trust for the Indian tribe or individual Indian for which the land is acquired, and such lands or rights shall be exempt from State and local taxation.

(Emphasis added).

The Department had argued that, whether the tax is preempted is controlled not by § 5108, but instead by Bracker, a case that addressed a challenge to fuel taxes and motor vehicle licensing fees imposed on a non-Indian company doing business on trust land. Bracker applies a balancing test of the state, federal, and tribal interests at stake to determine whether, in the specific context, the exercise of state authority would violate federal law. The Court rejected this argument and distinguished Bracker, noting that “Bracker has nothing to say about property that is categorically exempt from taxation under § 5108.”

The Department had cited to 25 C.F.R. § 162.017, a federal regulation issued by the Bureau of Indian Affairs, in support of its position that Bracker applies to permanent improvements owned by non-Indians on leased land.  The Department argued that the “subject only to applicable Federal law” language in the regulation refers to Bracker. The Court dismissed this argument as well, stating that “[a]lthough we agree that Bracker constitutes “federal law,” “federal law” also includes § 5108 and the cases applying that statute, including Rickert, Mescalero, Chehalis, and Stranburg.”

Thus, applying the text of § 5108 and the reasoning of the several federal cases applying the statute, the Court concluded that a tax on any permanent improvements subject to the Lease is effectively a tax on one of the privileges of the Tribe's ownership of trust land, and therefore is barred by § 5108.  Because § 5108 categorically exempts any permanent improvements subject to the Lease, the Court stated that it did not need to determine whether taxes imposed on those permanent improvements also would be barred under a Bracker analysis.

The Taxpayer also argued that the Tax Court erred by ruling that the entirety of the Facility is personal property, and not permanent improvements to which § 5108 would apply. The parties had agreed that the Facility contained both personal property and permanent improvements, but the Tax Court nevertheless concluded the Facility was entirely personal property, based upon the lease provision that requires Taxpayer to remove all above-ground improvements at the end of the term. The Tax Court had reasoned, “[i]f [Taxpayer] retain[ed] the right to remove an improvement, that improvement is by definition not a permanent improvement.”

The Court noted, however, in making its ruling, the Tax Court disregarded the principle that federal law, not state law, determines whether specific property is a permanent improvement exempt from taxation under § 5108.  Under federal tax law, whether an asset is a permanent improvement or personal property turns on six factors set out in Whiteco Indus., Inc. v. Comm'r, 65 T.C. 664 (1975).  The factors are: (1) “Is the property capable of being moved, and has it in fact been moved?”; (2) “Is the property designed or constructed to remain permanently in place?”; (3) “Are there circumstances which tend to show the expected or intended length of affixation, i.e., are there circumstances which show that the property may or will have to be moved?”; (4) “How substantial a job is removal of the property and how time-consuming is it? Is it ‘readily removable’?”; (5) “How much damage will the property sustain upon its removal?”; and (6) “What is the manner of affixation of the property to the land?” Whiteco, 65 T.C. at 672-73.

The Court noted that, under Whiteco, while the existence of a contract requiring removal of the property is relevant, it is not determinative, and accordingly held that the Tax Court erred by concluding that the Facility was “by definition” not a permanent structure without conducting a Whiteco analysis.

In sum, the Court concluded that 25 U.S.C. § 5108 establishes a categorical exemption for permanent improvements on Indian land held in trust by the United States, and because the tax court erred by concluding the Facility was entirely personal property without conducting the proper analysis, it vacated the Tax Court’s grant of summary judgment to the Arizona Department of Revenue. The Court remanded the case to conduct a Whiteco analysis to determine which, if any, of the assets that make up the Facility are permanent improvements that, therefore, are exempt from taxation under § 5108.  The Court then instructed the Tax Court to consider whether property taxes on the assets that are not permanent improvements are preempted under a Bracker analysis.