Arizona Income / Franchise Tax - Net gains from secondary loan market are included in sales factor, but sourcing is not based on location of realty

MDC Holdings, Inc. and Subs v. Department, Ariz. Ct. App. (10/6/09). An Arizona Court of Appeals partially affirmed the Arizona Tax Court's previous decision by holding that a home-building/selling unitary business could only include the net gains from its secondary market mortgage sales in its Arizona sales factor, because the gross amounts contained double-counted returns of principal that would distort the apportionment formula and unfairly represent its in-state business activity. The Court concluded that state law allows only the net gain from such short-term investments to be included as a "sale" for sales factor purposes. The business unsuccessfully argued that sales of mortgage loans (and related servicing rights) on the secondary market were distinct income-producing activities that comprised a separate business:
- Conducted by a mortgage subsidiary, and
- Performed independently from its regular homebuilding/selling business so as to allow inclusion of the "gross" receipts in its Arizona sales factor.

Regarding a second issue, the Court partially reversed the Arizona Tax Court's previous decision to hold that the numerator of the Arizona sales factor should not include the net proceeds from the sales of these mortgage loans or the sales of mortgage servicing rights when, as under the facts in this case, the costs of performance are not incurred in Arizona. The Court agreed with the company that mortgages/mortgage servicing rights are generally considered intangible personal property under state law, and that the location of a mortgage for tax purposes is not necessarily the same as the location of the underlying property, even if the mortgages at issue were secured by Arizona real property. Reasoning that the specific "income producing activity" at issue here was the income from the sale of mortgages, rather than the costs of building and selling the underlying homes, a greater proportion of the income producing activity related to these mortgage sales on the secondary market occurred outside Arizona under the given facts. The same was true regarding the income from the sale of mortgage servicing rights.