If a customer gives me an exemption certificate that turns out to have been altered, do I lose my deduction, or does good-faith acceptance protect me?

Plain-English summary

A seller that accepted an exemption certificate its customer had secretly altered still got its deduction, because it accepted the certificate in good faith with no reason to know of the alteration. Protest GRANTED; the Department was ordered to refund the tax.

Duke Engineering & Services provides nuclear engineering services in New Mexico and elsewhere. Starting in 1997 it contracted with Johnson Controls, which in turn contracts with the University of California (operator of Los Alamos National Laboratory) and resold Duke's services to Los Alamos. To support a deduction for its receipts from Johnson Controls, Duke relied on a nontaxable transaction certificate (NTTC) that Johnson Controls had issued to it.

When the Department audited Duke in late 1999, it gave the standard "sixty day letter" requiring Duke to have any NTTCs supporting its deductions within 60 days. Duke produced the Johnson Controls certificate within that window, but the auditors rejected it because Johnson Controls had altered it: the form had originally been issued by the Department to Johnson Controls in 1992 as a Type 15 (federal contractor) certificate, and Johnson Controls had later typed in an extra line, "05-SERVICE FOR RESALE," above the "15 FEDERAL CONTRACTORS" line. Duke immediately asked Johnson Controls for a clean Type 5 certificate, but it did not arrive until January 19, 2000 — after the 60 days had run. The Department disallowed the deduction and assessed $97,184.05 in gross receipts tax, which Duke paid (with penalty and interest abated under an amnesty) before filing a claim for refund.

The "good faith acceptance" safe harbor

Section 7-9-43(A) says that when a seller accepts a properly executed NTTC within the required time and in good faith that the buyer will use the service in a nontaxable way, the certificate is "conclusive evidence, and the only material evidence," that the receipts are deductible. New Mexico courts (in Leaco Rural Telephone) read that as three requirements: timely acceptance, good-faith acceptance, and a properly executed certificate. The hearing officer found all three met:

• A form prescribed by the Department / properly executed. The certificate was a genuine Department NTTC form issued to Johnson Controls, completed and signed by an authorized Johnson Controls employee. "Properly executed" means filling out and signing the certificate (Leaco), which was done. The Department's argument that the alteration made it not "in a form prescribed by the Department" failed, because the alteration was made by Johnson Controls after the fact.
• Good faith. Duke knew Johnson Controls would resell the services to Los Alamos, and the certificate on its face indicated it covered resale of services. Critically, the Department never argued that Duke should have recognized the certificate was altered or improper — Duke had no notice of the alteration until the auditors pointed it out, long after it had accepted the certificate.
• Timeliness. The altered certificate was in Duke's possession during the audit and in response to the 60-day letter, so it was timely. The later, clean Type 5 certificate being past the deadline did not matter, because the timely certificate already supported the deduction.

Why the usual "wrong certificate" cases did not defeat Duke

The good-faith safe harbor has limits. Under McKinley Ambulance, it does not protect a seller who accepts a certificate that on its face does not apply to the type of transaction, and under Arco Materials it does not protect against a later change in law that makes a formerly exempt transaction taxable. Neither applied here: on its face this certificate did cover resale of services, and there was no change in law. So Duke qualified for the safe harbor and was entitled to the Section 7-9-48 deduction for selling a service for resale.

The hearing officer noted that the party at fault was Johnson Controls, which improperly altered the certificate. The good-faith safe harbor exists precisely because a seller usually cannot know what a buyer will do; the Department's normal remedy is to pursue the buyer that misused a certificate (through compensating tax under Sections 7-9-7(A)(3) and 7-9-3(C), or by suspending its NTTC privileges under Section 7-9-44). The decision observed that Section 7-9-44 did not squarely cover a buyer's alteration of a certificate, but that did not change Duke's entitlement to rely on it in good faith.

Result: protest GRANTED; the Department was ordered to grant the refund, with applicable penalty and interest until paid.

What this means for you

Good-faith acceptance can protect you when a customer's certificate turns out to be flawed

If you accept a valid-looking NTTC on time and in good faith that the buyer will use the service in a nontaxable way, it is conclusive evidence your receipts are deductible — even if the buyer later turns out to have altered or misused it, as long as you had no reason to know. The risk of the buyer's wrongdoing shifts to the buyer and the Department, not you.

But the certificate must, on its face, fit the transaction

The safe harbor does not save a certificate that plainly does not cover the kind of transaction you are doing (the McKinley situation seen in other rulings where sellers used the wrong type). Duke won because the certificate, as it appeared, did indicate resale of services and matched what was happening — not merely because the buyer supplied it.

Meet the 60-day deadline with the certificate you have

Duke prevailed on the certificate it already held within the 60 days, not on the clean replacement that came late. When the Department sends a 60-day NTTC letter, gather the certificates you actually possess and present them in time; do not count on a corrected certificate arriving later.

Keep evidence of what you knew and when

The result turned on the absence of any evidence that Duke knew of the alteration before the audit. Records showing your good-faith understanding of the customer's use — and that the certificate looked regular when you accepted it — are what support the safe harbor.

Common questions

Q: My customer's exemption certificate was altered. Do I automatically lose my deduction?
A: Not if you accepted it on time and in good faith with no notice of the problem. Under Section 7-9-43(A), a properly executed certificate accepted in good faith is conclusive evidence your receipts are deductible; the buyer's later-discovered alteration is the buyer's fault, not yours.

Q: My replacement certificate came after the 60-day deadline. Does that sink me?
A: Not here. Duke won on the certificate it already had within the 60 days. A late replacement does not matter if a qualifying certificate was timely in your possession.

Q: How is this different from cases where taxpayers lost for using the 'wrong type' of NTTC?
A: Those cases (like the McKinley line) involved certificates that on their face did not cover the transaction. Duke's certificate did indicate resale of services and fit the transaction, and Duke had no notice it had been altered — so the good-faith safe harbor applied.

Q: Who ends up responsible for the tax?
A: The wrongdoer — here Johnson Controls, which altered the certificate. The Department's usual tools are compensating tax against the misusing buyer or suspension of its NTTC privileges, not disallowing the good-faith seller's deduction.

Citations and references

Statutes:

• NMSA 1978, § 7-9-43(A) — NTTCs must be in the seller's possession within 60 days of the Department's notice or related deductions are disallowed; a properly executed NTTC accepted timely and in good faith is conclusive and the only material evidence that the receipts are deductible
• NMSA 1978, § 7-9-48 — deduction for receipts from selling a service for resale, supported by an NTTC
• NMSA 1978, § 7-9-44 — the Department may suspend a buyer's right to use NTTCs
• NMSA 1978, § 7-9-7(A)(3) and § 7-9-3(C) — compensating tax reaches a buyer's later use of property or services purchased with an NTTC

Cases cited:

• Leaco Rural Telephone Cooperative, Inc. v. Bureau of Revenue, 86 N.M. 629, 526 P.2d 426 (Ct. App. 1974) — the three requirements (timely, good-faith, properly executed) for an NTTC to be conclusive
• McKinley Ambulance Service v. Bureau of Revenue, 92 N.M. 599, 592 P.2d 515 (Ct. App. 1979) — no safe harbor when a certificate on its face does not apply to the transaction
• Arco Materials, Inc. v. State, Taxation and Revenue Department, 118 N.M. 12, 878 P.2d 330 (Ct. App. 1994) — good-faith acceptance does not protect against a change in law making transactions taxable

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Duke Engineering & Services, Inc.
• Decision PDF: D&O 01-11

Original ruling text

THE HEARING OFFICER
OF THE TAXATION AND REVENUE DEPARTMENT
OF THE STATE OF NEW MEXICO

IN THE MATTER OF THE PROTEST OF
DUKE ENGINEERING & SERVICES, INC. NO. 01-11
ID. NO. 02-130115-00 8, PROTEST TO
DENIAL OF CLAIM FOR REFUND

DECISION AND ORDER

This matter came on for formal hearing on June 18, 2001 before Gerald B. Richardson,

Hearing Officer. Duke Engineering & Services, Inc., hereinafter, “Taxpayer”, was represented

by Mr. Cooper Monroe, its Tax Manager. The Taxation & Revenue Department, hereinafter,

“Department, was represented by Mónica M. Ontiveros, Special Assistant Attorney General.

Based upon the evidence and arguments presented, IT IS DECIDED AND ORDERED AS

FOLLOWS:

FINDINGS OF FACT

1. The Taxpayer is in the business of providing nuclear engineering services in New

Mexico and elsewhere.

2. Commencing in 1997, the Taxpayer contracted to provide engineering services to

Johnson Controls Worldwide Services, which later became Johnson Controls Northern New

Mexico, hereinafter, “Johnson Controls”.

3. Johnson Controls contracts with the University of California, which operates Los

Alamos National Laboratory, to provide various services.

4. Johnson Controls resold the services provided to it by the Taxpayer to Los Alamos

National Laboratory.

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5. Between October 21-29, 1999, the Department audited the Taxpayer at its

headquarters in Charlotte, North Carolina.

6. As part of its standard audit procedures, on October 28, 1999, the Department’s

auditor provided the Taxpayer with what is known as a “sixty day letter”, which provides notice

to taxpayers that within sixty days of the notice, they must possess any New Mexico non-taxable

transaction certificates (“NTTCS”) to support deductions requiring such NTTCs which were

claimed during the periods under audit. The letter further informs taxpayers that if they are not

in possession of the NTTCs, that deductions previously claimed in reliance on such NTTCs will

be disallowed.

7. During the audit and within the sixty day period for providing NTTCs, the Taxpayer

provided the Department with the NTTC which Johnson Controls had provided to the Taxpayer

and upon which the Taxpayer based a claim for deduction for its receipts from Johnson Controls

when the Taxpayer reported and filed its monthly gross receipts taxes with the Department.

8. The Department’s auditors orally informed the Taxpayer that they would not accept

the NTTC presented from Johnson Controls because it had been altered, and the auditors

informed the Taxpayer that it needed to obtain a proper NTTC from Johnson Controls to support

the deductions which had previously been claimed.

9. The NTTC which was disallowed by the Department’s auditors was issued by

Johnson Controls to the Taxpayer on January 27, 1998. It is a Type 15 NTTC, which can be

issued by taxpayers who contract with the Federal government under certain limited conditions.

The NTTC was issued by the Department to Johnson Controls on April 7, 1992 and is a

Department form NTTC. The NTTC was signed by David M. Williams, an employee of

Johnson Controls, who was authorized to sign and issue NTTCs on behalf of Johnson Controls.

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Johnson Controls altered this NTTC by typing in an additional line, “05-SERVICE FOR

RESALE”, above the line indicating, “15 FEDERAL CONTRACTORS”.

10. On the same day that the Department auditors informed the Taxpayer that it would

not accept the NTTC from Johnson Controls, the Taxpayer contacted Johnson Controls and

informed them of the Department’s refusal to accept the NTTC and requested an unaltered Type

5 NTTC.

11. Johnson Controls provided the Taxpayer with a Type 5 NTTC on January 19, 2000,

but this was after the 60 days for presenting such NTTCs to the Department had expired.

12. As a result of the Department’s audit and the Department’s disallowance of the

deductions which the Taxpayer had claimed for its gross receipts from Johnson Controls, the

Department assessed the Taxpayer $97,184.05 in gross receipts tax, plus applicable penalty and

interest.

13. The Taxpayer paid the assessment during the time that the Department was

administering a legislatively authorized tax amnesty program which allowed the Department to

abate the penalty and interest assessed upon payment of the tax principal.

14. On February 2, 2000, the Taxpayer submitted a claim for refund to the Department,

requesting a refund of the $97,184.05 in gross receipts taxes paid on the audit assessment issued

by the Department and claiming that it had accepted the altered NTTC from Johnson Controls in

good faith and that its claim of deduction for its receipts from Johnson Controls should not have

been disallowed by the Department’s auditors.

15. On March 23, 2000, the Department denied the Taxpayer’s claim for refund on the

basis that the Taxpayer could not have accepted the NTTC from Johnson Controls “in good

faith”.

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16. On June 20, 2000, the Taxpayer submitted a written protest to the Department’s

denial of its claim for refund.

DISCUSSION

The sole issue to be determined herein is whether the Department properly denied the

Taxpayer’s claim for refund which was based upon the Department’s prior denial of the

Taxpayer’s claimed deduction for its receipts from Johnson Controls, which had provided the

Taxpayer with an altered NTTC. The Department did not argue or attempt to establish that the

Taxpayer should have recognized or known that the NTTC was an improper or altered NTTC at

the time it filed its original returns and claimed the deduction. Instead, the Department argued

that the Taxpayer had the opportunity to obtain a proper NTTC prior to the expiration of the 60

day period and failed to present a proper Type 5 NTTC in support of its claim for deduction

within the 60 day time frame allowed by statute. The Department agrees that a proper Type 5

NTTC would support the Taxpayer’s claim of deduction, but in the absence of one, the

Department argues that the Taxpayer could not properly deduct those receipts.

The Taxpayer argues that it accepted the altered NTTC in good faith, that it was not

aware of the fact that the NTTC had been altered, that the NTTC was properly executed by

Johnson Controls, that the NTTC was on a form prescribed by the Department, although it was

subsequently altered, and the NTTC was in its possession within the time required by statute.

Based upon these circumstances, the Taxpayer argues that the original, but altered NTTC, was

valid insofar as the Taxpayer’s claim of deduction for its receipts from Johnson Controls.

The ultimate issue to be determined, then, is whether the original, but altered, NTTC can

support the Taxpayer’s claim of deduction for its receipts from Johnson Controls. This case

presents a unique set of facts, the legal consequences of which have not previously been

determined under the Gross Receipts and Compensating Tax Act.

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Section 7-9-43(A) NMSA 1978 (1998 Repl. Pamp.) is the statute which governs the

determination of the issue at hand. It provides as follows:

All nontaxable transaction certificates of the appropriate series
executed by buyers or lessees should be in the possession of the
seller or lessor for nontaxable transactions at the time the return is
due for receipts from the transactions. If the seller or lessor is not
in possession of the required nontaxable transaction certificates
within sixty days from the date that the notice requiring possession
of these nontaxable transaction certificates is given the seller or
lessor by the department, deductions claimed by the seller or
lessor that require delivery of these nontaxable transaction
certificates shall be disallowed. The nontaxable transaction
certificates shall contain the information and be in a form
prescribed by the department. The department by regulation may
deem to be nontaxable transaction certificates documents issued by
other states or the multistate tax commission to taxpayers not
required to be registered in New Mexico. Only buyers or lessees
who have a registration number or have applied for a registration
number and have not been refused one under Subsection C of
Section 7-1-12 NMSA 1978 shall execute nontaxable transaction
certificates issued by the Department. If the seller or lessor has
been given an identification number for tax purposes by the
department, the seller or lessor shall disclose that identification
number to the buyer or lessee prior to or upon acceptance of a
nontaxable transaction certificate. When the seller or lessor
accepts a nontaxable transaction certificate within the required
time and in good faith that the buyer or lessee will employ the
property or service transferred in a nontaxable manner, the
properly executed nontaxable transaction certificate shall be
conclusive evidence, and the only material evidence, that the
proceeds from the transaction are deductible from the seller’s or
lessor’s gross receipts. (Emphasis added.)

The Department bases its denial of the Taxpayer’s claimed deduction on the fact that it does not

consider the altered NTTC to be a proper NTTC because it, being altered, is not “in a form

prescribed by the Department”. Section 7-9-43(A). Thus, the Department denied the Taxpayer’s

claim of deduction because it failed to demonstrate possession of a proper Type 5 NTTC within

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the sixty days from the notice the Department gave the Taxpayer to be in possession of any

NTTCs it needs to claim a deduction.1

I disagree with the Department’s application of Section 7-9-43(A). I believe that the

altered NTTC was in “a form prescribed by the department”. The NTTC was a form NTTC

issued to Johnson Controls by the Department. It was altered by Johnson Controls, after the fact,

to add language indicating that it applied to the transactions in which the purchaser will resell the

services being sold to the purchaser, but there was no evidence or even the contention by the

Department that the Taxpayer was aware of the alteration or was in any way on notice that the

Department’s certificate form was improper to cover the transaction at issue until the alteration

was pointed out to the Taxpayer by the Department’s auditors. This occurred long after the

acceptance of the NTTC by the Taxpayer in support of the deductions at issue.

The Taxpayer argues that under the good faith acceptance language of Section 7-9-43(A),

that the Department may not deny the deductibility of the receipts in question, citing Leaco

Rural Telephone Cooperative, Inc., v. Bureau of Revenue, 86 N.M. 629, 526 P.2d 426 (Ct.

App. 1974). In that decision, the court stated:

There are three requirements to be met before an NTTC becomes
conclusive evidence that proceeds of a transaction are deductible.
The requirements are timeliness of acceptance of the NTTC, good
faith acceptance of the NTTC and a properly executed NTTC.

Id., 86 N.M. at 632. There is no issue of timeliness of the altered NTTC, since the Taxpayer

demonstrated that it was in its possession during the audit when such certificates were requested

as part of the Department’s audit procedures and in responses to the Department’s sixty day

letter. Good faith acceptance under the language of Section 7-9-43(A) requires that the seller

accept the certificate “in good faith that the buyer or lessee will employ the property or service

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Section 7-9-48 NMSA 1978 provides a deduction for receipts from selling a service for resale “if the sale is made
to a person who delivers a nontaxable transaction certificate to the seller.” Thus, a NTTC is required to support the

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transferred in a nontaxable manner”. That requirement is met here because the Taxpayer was

aware that Johnson Controls would be reselling the services pursuant to its relationship with the

Los Alamos laboratories and the certificate, on its face, indicates that it covers the resale of

services. Finally, the certificate was properly executed. The Court of Appeals, in Leaco, found

that “properly executed”, in an earlier version of Section 7-9-43, is used “in the sense of

completing—filling out and signing—the NTTCs.” Id., 86 N.M. at 632. The certificate at issue

was completed properly by the issuer and signed by its authorized representative. When these

three requirements are met, the properly executed certificate “shall be conclusive evidence and

the only material evidence that the proceeds from the transaction are deductible….” Section 7-9-

43(A).

The Court of Appeals’ ruling in Leaco has been limited by two subsequent decisions. In

McKinley Ambulance Service v. Bureau of Revenue, 92 N.M. 599, 592 P.2d 515 (Ct. App.

1979), the court held that when a party accepts a NTTC which, on its face, does not apply to the

type of transaction being conducted, the good faith acceptance language in Section 7-9-43 does

not cover the situation to provide a safe harbor for the person accepting the transaction. Good

faith acceptance was further limited in Arco Materials, Inc. v. State, Taxation and Revenue

Department, 118 N.M. 12, 878 P.2d 330 (Ct. App. 1994), which found that it did not protect

taxpayers from the consequences of a change in law that renders formerly nontaxable

transactions taxable. Neither of those exceptions to good faith acceptance have any applicability

to the instant matter.

claim of deduction at issue herein.

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The Taxpayer in this case has met its burden to establish its entitlement to the safe harbor

provided by the “good faith acceptance” requirements of Section 7-9-43(A) NMSA 19782.

Accordingly, the Taxpayer’s protest will be granted.

CONCLUSIONS OF LAW

1. The Taxpayer filed a timely, written protest, pursuant to Section 7-1-26(B) NMSA

1978, and jurisdiction lies over both the parties and the subject matter of this protest.

2. The altered NTTC was in a form prescribed by the Department.

3. The altered NTTC was properly executed by Johnson Controls.

4. The Taxpayer accepted the altered NTTC in good faith that the buyer would employ

the service in nontaxable manner.

5. The Taxpayer is entitled to the deduction found at Section 7-9-48 for its receipts from

selling services to Johnson Controls based upon its good faith acceptance of the altered NTTC

provided to it by Johnson Controls.

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The good faith acceptance safe harbor is intended to protect Taxpayers who claim a deduction in reliance on the
issuer’s representation, by issuing a NTTC, that the goods or services transferred will be used in a nontaxable
manner, since sellers would usually have no way to actually know what a purchaser will do with the goods or
services purchased. In such instances, the Department may usually go after the purchaser who misused the
certificate by assessing compensating tax against the purchaser on the value of the transaction. See, Section 7-9-
7(A)(3) (where tangibles were purchased with an NTTC, initially avoiding the imposition of tax), and Section 7-9-
3(C) (where services were purchased with an NTTC, initially avoiding the imposition of tax). Section 7-9-44(A)
further gives the Department the right to suspend a purchaser’s right to use NTTCs if they fail to pay the
compensating tax on the subsequent use of property or services purchased through the use of an NTTC. The party in
the wrong in this matter was Johnson Controls, who improperly altered the NTTC. Unfortunately, Section 7-9-44
does not cover the situation presented in this case, where the purchaser altered an NTTC to cover a transaction not
otherwise covered by the NTTC because compensating tax is only imposed based upon the purchaser’s subsequent
use of the property or service purchased, and not upon an improper alteration of a NTTC.

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For the foregoing reasons, the Taxpayer’s protest IS HEREBY GRANTED.

The Department IS HEREBY ORDERED TO GRANT THE TAXPAYER’S CLAIM

FOR REFUND, TOGETHER WITH APPLICABLE PENALTY AND INTEREST UNTIL

SUCH CLAIM IS PAID.

DONE this 18th day of July, 2001.

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