“Processing Operations” Use-Tax Exemption Turns on Marketability Transformation, Not Sale-vs.-Rental or the Taxpayer’s Overall Business

I. Introduction

In 9W HALO OPCO, LP v. Arizona Department of Revenue (Ariz. Mar. 3, 2026), the Arizona Supreme Court addressed the scope of the tangible personal property use tax exemption in A.R.S. § 42-5159(B)(1) for “[m]achinery, or equipment, used directly in manufacturing, processing, fabricating, job printing, refining or metallurgical operations.” The case arose after 9W Halo OPCO, LP, doing business as Angelica Textile Services, LP (“Angelica”), sought refunds of state and City of Phoenix use taxes paid on equipment and chemicals used in an industrial laundering and sterilization operation for reusable healthcare textiles that Angelica rents to healthcare providers.

The key legal disputes were: (1) what “processing operations” means under § 42-5159(B)(1), and (2) whether a taxpayer’s downstream transactions (selling versus renting) and/or the characterization of its business as a whole controls eligibility for the exemption.

II. Summary of the Opinion

The Court vacated the court of appeals’ memorandum decision, reversed summary judgment for the Department, and remanded. It held:

  • The § 42-5159(B)(1) “processing operations” exemption applies to machinery or equipment used in an operation that changes a product’s marketability—i.e., prepares it for the market or converts it into marketable form.
  • A taxpayer’s downstream business model—renting rather than selling the product—is irrelevant to the “processing operation” inquiry.
  • The statute focuses on distinct operations within a business, not on whether the taxpayer’s overall enterprise is “commonly understood” to be a processing business; the Court expressly disavowed Ariz. Dep’t of Revenue v. Blue Line Distrib., Inc. and rejected Meredith Corp. v. State Tax Comm’n to the extent they pushed the analysis toward the whole business rather than the operation.

Applying these principles, the Court concluded Angelica’s regulated industrial laundering and disinfecting process qualifies as a processing operation because it transforms contaminated (and even new) healthcare textiles into a form marketable for healthcare use.

III. Analysis

A. Precedents Cited (and How They Shaped the Decision)

1. Defining “processing” and “process”

  • Moore v. Farmers Mut. Mfg. & Ginning Co., 51 Ariz. 378 (1938): The Court relied on Moore’s formulation that processing includes “preparation for the market” and “convert into marketable form,” but rejected the Department’s attempt to turn Moore into a raw-material requirement. Moore’s reference to “especially raw material” was treated as illustrative of cotton ginning, not an exclusion of other materials.
  • Emp. Sec. Comm’n of Ariz. v. Bruce Church, Inc., 109 Ariz. 183 (1973): Bruce Church supported the idea that “process” can be “a mode, method or operation, whereby a result is produced,” and that “prepare for market” or “convert into marketable form” captures “processing.” Critically, Bruce Church supplied a market-focused test: the relevant inquiry is whether the activity is incident to preparing the product for the selected market, not whether it is edible/usable at some earlier point.
  • Ariz. Dep’t of Revenue v. Sonee Heat Treating Corp., 178 Ariz. 278 (Tax Ct. 1994): Cited as consistent authority recognizing “processing” as “a series of actions or operations conducing to an end.”
  • Alsco, Inc. v. Tennessee Dep’t of Revenue, No. M2022-01019-COA-R3-CV, 2023 WL 5737452 (Tenn. Ct. App. Sept. 6, 2023): Not binding, but used as persuasive reinforcement that industrial laundering/sanitization can constitute processing when it changes state/form (soiled to sanitized).

2. Interpreting § 42-5159(B)(1) and limiting “used directly”

  • State ex rel. Ariz. Dep’t of Revenue v. Capitol Castings, Inc., 207 Ariz. 445 (2004): The Court used Capitol Castings in two ways. First, it clarified that Capitol Castings’ instruction to apply “flexible and commonly used definitions ... within the relevant industry” pertains to defining “machinery” and “equipment,” not the statutorily constrained ordinary meaning of “processing.” Second, it imported Capitol Castings’ operational test that qualifying machinery/equipment must “touch[], manipulate[], affect[], or add[] value” to raw material or work in process, while excluding post-production activities.
  • Duval Sierrita Corp. v. Ariz. Dep’t of Revenue, 116 Ariz. 200 (App. 1977): Duval Sierrita’s “integrated system” concept was treated as a baseline for how to identify the scope of the exempt operation—items essential to the operation and forming an integrated system can qualify. But the Court emphasized Duval Sierrita actually contemplated that exempt “operations” have “a beginning and an end,” and may be distinct stages within a broader enterprise.

3. Rejecting “whole business” framing (disavowal of Blue Line; partial rejection of Meredith)

  • Meredith Corp. v. State Tax Comm’n, 23 Ariz. App. 152 (1975): The Court agreed with Meredith only to the extent it aligns with the statute’s command to apply ordinary meaning, but rejected Meredith’s drift toward evaluating what the “ordinary man” thinks of the taxpayer’s industry or end product (“broadcast,” “generated”) rather than evaluating the statutory operation and the equipment’s direct use in it.
  • Ariz. Dep’t of Revenue v. Blue Line Distrib., Inc., 202 Ariz. 266 (App. 2002): The Court expressly disavowed Blue Line because it made exemption eligibility depend on whether the taxpayer’s business is commonly understood to be a manufacturing or processing operation, effectively narrowing the statute contrary to its structure and text.

4. Core tax/statutory interpretation principles

  • Tucson Transit Auth., Inc. v. Nelson, 107 Ariz. 246 (1971): Reinforced that exemptions are strictly construed and presumed against.
  • Ariz. State Tax Comm’n v. Staggs Realty Corp., 85 Ariz. 294 (1959): Supported a plain-meaning approach to avoid “strained construction” expanding taxation by implication.
  • Premier Physicians Grp., PLLC v. Navarro, 240 Ariz. 193 (2016); Franklin v. CSAA Gen. Ins. Co., 255 Ariz. 409 (2023): Supplied the text-first framework and ambiguity methodology.
  • Garibay v. Johnson, 259 Ariz. 248 (2025): Supported consulting dictionaries and contemporaneous sources for ordinary meaning.

5. Legislative acquiescence limitations

  • Daou v. Harris, 139 Ariz. 353 (1984); Delgado v. Manor Care of Tucson AZ, LLC, 242 Ariz. 309 (2017) (quoting Sw. Paint & Varnish Co. v. Ariz. Dep’t of Env’t Quality, 194 Ariz. 22 (1999)); Madrigal v. Indus. Comm’n, 69 Ariz. 138 (1949); Calvert v. Farmers Ins. Co. of Ariz., 144 Ariz. 291 (1985): These cases anchored the Court’s clarification that legislative acquiescence applies only when the Legislature reenacts a statute after a court of last resort has construed it. The Court noted the Arizona Board of Tax Appeals is not the court of last resort, rendering the doctrine inapplicable to reliance on G.B Inv. Co. v. Ariz. Dept. of Revenue, No. 629-88-S (Ariz. Bd. of Tax App. June 20, 1989).

B. Legal Reasoning

1. “Processing operation” must be read as a unit, using ordinary meaning

The Court began with the statute’s explicit instruction that “processing” and similar terms “refer to and include those operations commonly understood within their ordinary meaning.” Because the text ties “processing” to “operations,” the Court treated the relevant concept as “processing operation,” not “processing” in isolation.

2. The Court’s operative definition: marketability transformation plus integrated operational series

Synthesizing dictionaries and Arizona precedent, the Court announced a controlling definition:

A “processing operation” under § 42-5159(B)(1) is “a series of integrated actions or methods that prepares a product for the market or converts a product into marketable form.”

This definition carries two key moves: (1) “processing” is tied to market preparation/marketable form, and (2) “operation” is framed as a series of integrated actions or methods (a system, not an isolated act).

3. Two-step eligibility inquiry (newly articulated framework)

The Court then operationalized its definition into a two-step test:

  1. Does the operation prepare a product for the market or convert it into marketable form?
  2. Does the operation use machinery/equipment in a series of integrated actions or methods during that preparation?

Even if the operation qualifies, the exemption reaches only machinery/equipment that “touches, manipulates, affects, or adds value” to the product (drawing from Capitol Castings, Inc.).

4. Downstream transactions are irrelevant; focus is on distinct operations within the business

The Court rejected the court of appeals’ focus on Angelica’s rental model. The statute does not require sale of a product; it asks what machinery/equipment is used directly in which operation. Similarly, the Court rejected construing “operation” to mean the taxpayer’s entire enterprise, explaining that the statutory structure calls for analyzing individual operations and their equipment, not re-labeling the taxpayer’s business as “a laundry” or “a linen rental business” and deciding the case at that level of generality.

5. Application to Angelica’s healthcare textile laundering and disinfecting

Angelica’s textiles (new or used) were not marketable for their intended healthcare use until they underwent the multi-module wash/chemical/disinfection process; the process removes contaminants and changes the condition/composition of the textiles by cleaning textile fibers. Under Bruce Church, Inc., the relevant market is the “market selected”—here, healthcare use under regulatory constraints. Because Angelica’s process is an integrated series of steps converting the textiles into a marketable condition for that market, the operation qualifies, and the directly used qualifying machinery/equipment is exempt.

C. Impact

1. A doctrinal shift away from “industry labeling” and toward “operation-based” analysis

By disavowing Ariz. Dep’t of Revenue v. Blue Line Distrib., Inc. and limiting Meredith Corp. v. State Tax Comm’n, the Court reorients § 42-5159(B)(1) toward: (1) what the equipment does in (2) a defined operation that changes marketability, rather than whether the taxpayer’s enterprise resembles a prototypical factory. This is a meaningful broadening of analytical access to the exemption for non-traditional production settings (including service-oriented operations) where the product’s marketability is created or restored by an integrated process.

2. Clarification that “processing” is not limited to raw materials and first-time production

The Court rejected a raw-material prerequisite and accepted that repeated reconditioning can qualify if it converts the product into marketable form for the relevant market. This supports refund and audit positions for businesses engaged in regulated remediation, reconditioning, sterilization, refurbishment, and similar processes—provided the equipment is used directly in an integrated process that changes marketability.

3. Rental-versus-sale neutrality

The holding that downstream transactions are irrelevant removes a barrier for industries where products are provided through rental/service models (e.g., textiles, instruments, devices) yet must be processed to be marketable for use.

4. Practical litigation and administrative consequences

  • Refund claims and audits: Taxpayers can frame claims around discrete operations and marketability transformation, rather than fighting over the label of the whole business.
  • City codes mirroring § 42-5159(B)(1): Because Phoenix City Code §§ 14-110(a)(1) and 14-660(g) adopt an identical exemption, the reasoning is likely to influence municipal use-tax disputes with parallel language.
  • Line-drawing remains: The Court acknowledged concerns about how far the reasoning could extend (restaurants; neighborhood laundromats) and expressly limited its holding to the industrial, regulated healthcare-textile facts—signaling future boundary cases will turn on marketability and the “used directly”/integrated-system constraints.

IV. Complex Concepts Simplified

  • Use tax (vs. sales tax): A tax on the use/storage/consumption of tangible personal property in the state, often applying when sales tax was not collected at purchase.
  • Tax exemption statutes are “strictly construed”: Courts start skeptical of exemptions, but (as Capitol Castings, Inc. notes) not so strictly that the Legislature’s economic-development purpose is defeated.
  • “Processing operation”: Not a business label. It is an operation—an integrated series of steps—whose function is to prepare a product for a market or make it marketable.
  • “Marketability”: Whether the product is in a condition suitable for the intended market. A product can be “marketable” for one purpose but not for the target market at issue (as emphasized via Bruce Church, Inc.).
  • “Used directly” / “touches, manipulates, affects, or adds value”: The exemption is limited to equipment that plays a direct role in the marketability-transforming operation, not peripheral or post-production functions (drawing from Capitol Castings, Inc.).
  • Legislative acquiescence: The idea that legislative reenactment after a high-court interpretation can signal acceptance; here, it was limited because interpretations by bodies like the Arizona Board of Tax Appeals are not from a “court of last resort” (see Madrigal v. Indus. Comm’n; Calvert v. Farmers Ins. Co. of Ariz.).

V. Conclusion

9W HALO OPCO, LP v. Arizona Department of Revenue establishes that § 42-5159(B)(1)’s “processing operations” exemption turns on whether an operation’s integrated steps transform a product’s marketability, not on whether the taxpayer sells or rents the product, and not on whether the taxpayer’s overall business resembles a traditional manufacturing enterprise. By disavowing Ariz. Dep’t of Revenue v. Blue Line Distrib., Inc. and limiting the “whole business” approach associated with Meredith Corp. v. State Tax Comm’n, the Court resets the doctrinal focus to operation-specific, equipment-specific analysis—an approach likely to reshape Arizona use-tax exemption disputes involving regulated processing, reconditioning, and other market-preparation operations.