“Processing Operations” Use-Tax Exemption Turns on Marketability Transformation, Not Sales vs. Rental, and Is Assessed by Discrete Operations

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 taxpayer, 9W Halo OPCO, LP d/b/a Angelica Textile Services, LP (“Angelica”), operates an industrial healthcare textile facility. It provides hospitals and similar facilities with reusable textiles (gowns, sheets, scrubs) under a rental model. Because used (and even new) healthcare textiles must be disinfected and sterilized to be suitable for patient care, Angelica performs a regulated, multi-module laundering and chemical disinfection process using specialized equipment.

After paying state and City of Phoenix use taxes on equipment and chemicals purchased from 2014–2018, Angelica sought refunds, arguing its machinery was exempt as used directly in a “processing operation.” The Department (joined by the City) denied much of the claim. The tax court granted summary judgment to the Department, reasoning it had to view Angelica’s business “as a whole.” The court of appeals affirmed, concluding Angelica’s rental model meant it was not “processing” because it did not “convert” goods for “market” in the relevant sense. The Supreme Court granted review to resolve a recurring statewide question: how the “processing operations” exemption applies to Arizona businesses.

Summary of the Opinion

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

  • The “processing operations” exemption applies to machinery/equipment used in operations that change the marketability of a product—i.e., prepare it for the market or convert it into marketable form.
  • A taxpayer’s downstream transactions (whether the product is sold or rented) are irrelevant to whether a discrete operation is a “processing operation” under § 42-5159(B)(1).
  • The “processing operation” inquiry focuses on distinct operations within a business, not on characterizing the business “as a whole.”
  • The Court disavowed Ariz. Dep't of Revenue v. Blue Line Distrib., Inc. and rejected Meredith Corp. v. State Tax Comm'n to the extent those decisions suggest analyzing the taxpayer’s entire business rather than discrete operations.

Applying its framework, the Court concluded Angelica’s industrial laundering and disinfecting process qualifies as “processing” because it transforms healthcare textiles from not-usable/not-marketable for patient-care purposes into a marketable form for that healthcare market.

Analysis

Precedents Cited

1) Ordinary meaning and tax-statute interpretation

  • Planned Parenthood Ariz., Inc. v. Mayes and Franklin v. CSAA Gen. Ins. Co. supplied the Court’s baseline method: begin with statutory text, apply clear language, and use ordinary meaning where directed.
  • Premier Physicians Grp., PLLC v. Navarro framed ambiguity analysis (turning to secondary interpretive factors when text is reasonably susceptible to differing meanings).
  • Ariz. State Tax Comm'n v. Staggs Realty Corp. reinforced restraint against “strained construction” expanding taxation by implication.
  • For exemptions, the Court reiterated the dual principles from Tucson Transit Auth., Inc. v. Nelson (strictly construe exemptions; presume against them) and State ex rel. Ariz. Dep't of Revenue v. Capitol Castings, Inc. (do not construe so strictly as to defeat legislative purpose).

2) What “processing” means (and whether it requires “raw material”)

  • Moore v. Farmers Mut. Mfg. & Ginning Co. provided an early Arizona definition of “processing” (“preparation for the market” / “convert into marketable form”). The Department argued Moore implied raw materials are required. The Court rejected that reading, emphasizing Moore’s “especially raw material” language was contextual and not a statutory element.
  • Emp. Sec. Comm'n of Ariz. v. Bruce Church, Inc. reinforced “process” as a “mode, method or operation, whereby a result is produced” and as “prepare for market or convert into marketable form.” Critically, Bruce Church provided the Court’s market-selection concept: the proper test is whether the process is incident to preparation for the market selected, not whether the product could be used at an earlier stage.
  • Ariz. Dep't of Revenue v. Sonee Heat Treating Corp. was cited as consistent with defining processing as “a series of actions or operations conducing to an end.”

3) “Integrated system” and the boundaries of the exempt operation

  • Duval Sierrita Corp. v. Ariz. Dep't of Revenue contributed the “integrated system” concept for drawing the boundaries of an operation and illustrated that exempt “operations” have beginnings and ends (e.g., mining ends at shipment; smelting begins upon receipt).
  • State ex rel. Ariz. Dep't of Revenue v. Capitol Castings, Inc. supplied the “used directly” limitation—equipment must “touch[], manipulate[], affect[], or add[] value” to material/work in process, and post-production activities are excluded.

4) Correcting drift: business-wide characterization vs. operation-specific analysis

  • The Court traced how Meredith Corp. v. State Tax Comm'n shifted the inquiry toward what the “ordinary man” thinks the business is (broadcasting, not processing), rather than what operation the equipment is used in.
  • The Court held Ariz. Dep't of Revenue v. Blue Line Distrib., Inc. went further by making exemption depend on whether the taxpayer’s business is commonly understood to be a processing/manufacturing business. The Court disavowed Blue Line and rejected Meredith to the extent it supports that approach.

5) Legislative acquiescence doctrine (and why it didn’t control)

  • The Court summarized the doctrine using Daou v. Harris, Delgado v. Manor Care of Tucson AZ, LLC (quoting Sw. Paint & Varnish Co. v. Ariz. Dep't of Env't Quality), Madrigal v. Indus. Comm'n, and Calvert v. Farmers Ins. Co. of Ariz..
  • It clarified that acquiescence generally requires construction by a “court of last resort” and reenactment in the same/substantially same terms; thus, an Arizona Board of Tax Appeals decision could not trigger acquiescence. The Court nonetheless read the court of appeals’ reference as not truly invoking the doctrine.

Legal Reasoning

  1. Textual anchor: “processing operations” is the unit of meaning. The statute directs that “processing” is interpreted within its “ordinary meaning,” and the Court treated “processing” and “operation” as an integrated phrase—requiring an operational (process-based) lens rather than a business-label lens.
  2. Ordinary meaning synthesized into a single operative definition. Using dictionaries from the 1967 enactment and 1989 reenactment era and Arizona case law (especially Moore and Bruce Church), the Court defined a “processing operation” as:
    “a series of integrated actions or methods that prepares a product for the market or converts a product into marketable form.”
    This definition simultaneously (a) captures “operation” as a series of integrated steps and (b) captures “processing” as market-preparation/marketability conversion.
  3. Two-step framework for “processing operations.” The Court articulated a practical 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 both are satisfied, only machinery/equipment that “touches, manipulates, affects, or adds value” qualifies (from Capitol Castings).
  4. Downstream transactions (sale vs. rental) are irrelevant. Nothing in § 42-5159(B)(1) conditions “processing” on a sale. The Court held the court of appeals improperly treated Angelica’s rental model as dispositive. The statutory question is what operation the equipment is used in, not how the taxpayer monetizes the output.
  5. Discrete operations, not the “business as a whole.” The Court rejected the Department’s attempt to equate “operation” with “business,” distinguishing § 42-5159(G)(1)(b) as limited to a different paragraph and a different exemption (energy inputs for “qualified manufacturing or smelting business”). It also relied on Bruce Church’s reference to multiple distinct “operations” (cooling, sizing, sorting) to confirm that “operation” can mean a step within a broader business.
  6. Application to Angelica: marketability transformation for the chosen market. Healthcare textiles (new or used) are not marketable for patient care until disinfected/sterilized. Angelica’s twelve-module chemical process removes contaminants and changes the textiles’ condition in a way that makes them marketable for the healthcare market. Under Bruce Church’s market-selected principle, it does not matter that textiles might be marketable for some other use before processing; the relevant market is the one Angelica serves.

Impact

The opinion makes three doctrinal shifts with significant practical consequences:

  • Marketability transformation becomes the organizing concept for “processing.” This can broaden eligibility beyond paradigmatic “raw material to finished goods” settings, capturing industrial operations that recondition, sanitize, refine, or otherwise render goods fit for a particular market.
  • Rent-to-reuse and circular models are not disfavored. By deeming downstream transactions irrelevant, the Court removes an analytic barrier that could have penalized rental/service models (industrial textile services, tool/equipment reconditioning, sterilization services tied to reusable goods, and other closed-loop supply chains).
  • Operation-level analysis replaces business-label analysis. Disavowing Ariz. Dep't of Revenue v. Blue Line Distrib., Inc. and rejecting Meredith Corp. v. State Tax Comm'n (to the extent they point toward whole-business characterization) is likely to redirect litigation and audits toward mapping discrete operations and their integrated systems, rather than arguing over whether a taxpayer “is” the kind of business that “sounds like” a processor.

The Court also signaled caution: it acknowledged concerns about outer limits (e.g., restaurants or neighborhood laundromats) and stated its holding on Angelica’s regulated, industrial medical-textile operation is “limited to its facts,” leaving other applications for future cases. Still, the framework it announced is general and will likely be invoked wherever taxpayers can show an integrated equipment-driven operation that changes marketability for a selected market.

Complex Concepts Simplified

Use tax
A tax on using, storing, or consuming tangible personal property in the state when sales tax was not paid (often for out-of-state or otherwise untaxed purchases).
Tax exemption (and “strict construction”)
Exemptions are interpreted narrowly, but not so narrowly that they defeat the Legislature’s purpose (here, encouraging investment and economic development).
“Processing operation”
Under this decision: a series of integrated steps using machinery/equipment that prepares a product for a market or converts it into marketable form—i.e., changes its marketability for the relevant market.
“Used directly”
Only equipment that directly acts on the product (touches/manipulates/affects/adds value) qualifies, not peripheral or post-production tools.
Downstream transactions
How the taxpayer makes money after processing—sale versus rental—does not decide whether the processing operation exists.
Legislative acquiescence
A limited doctrine suggesting the Legislature accepts a judicial interpretation when it reenacts a statute without change after a court of last resort construed it.

Conclusion

9W HALO v. ADOR resets Arizona’s § 42-5159(B)(1) “processing operations” analysis around marketability transformation and an operation-by-operation inquiry. The Court held that Angelica’s industrial healthcare textile laundering and disinfecting process is “processing” because it converts textiles into a marketable form for the healthcare market, and it made clear that rental versus sale is irrelevant. By disavowing Ariz. Dep't of Revenue v. Blue Line Distrib., Inc. and limiting Meredith Corp. v. State Tax Comm'n, the Court redirected future disputes toward identifying discrete integrated operations and evaluating whether the machinery is used directly to achieve a marketability-changing transformation.