If a multi-state company doesn't pay New Mexico gross receipts tax on tuition because its outside accountants never flagged it, can it avoid the negligence penalty by saying it relied on those accountants?

Plain-English summary

Dlorah, Inc. runs the for-profit National American University, with business schools in six states. In New Mexico it paid gross receipts tax on textbook sales but not on tuition — it simply didn't know tuition receipts were taxable here. A 1998 audit (covering 1991–1997) produced an assessment of about $229,000: roughly $124,000 in gross receipts tax, $92,000 in interest, and a $12,398 negligence penalty. Dlorah paid the tax and interest and conceded them; the only thing it fought was the penalty. The case was decided on undisputed facts via summary judgment.

Dlorah's argument was that it wasn't negligent because it reasonably relied on its longtime outside accounting firm (Ketel, based in South Dakota) to keep its taxes in order. The Hearing Officer rejected that and denied the protest.

The reliance-on-an-advisor defense (Regulation 3.1.11.11) is narrow. It excuses a penalty only when the failure to pay was caused by reasonable reliance on the advice of a competent tax advisor about the specific liability, after full disclosure of the relevant facts. Reliance has to be "active and informed — not passive and unaware." Here:

• Dlorah never asked its accountants about New Mexico gross receipts tax on tuition, so there was no advice to rely on.
• The firm was engaged to prepare income tax returns and audit financial statements — not to check New Mexico gross receipts tax compliance — and its own audit report expressly disclaimed any opinion on legal/tax compliance.
• New Mexico law is clear that you can't "abdicate" your tax responsibility "merely by appointing an accountant as [your] agent."

The Hearing Officer distinguished an earlier decision (Kidz Karousel), where owners specifically asked their New Mexico attorney and CPA to make sure all required tax forms — including tax filings — were handled, and the advisors missed the gross receipts tax obligation. That was informed, specific reliance, and the penalty was abated. Dlorah's general delegation was more like Vivigen and Arco Materials, where general reliance on outside auditors did not excuse the penalty.

What this means for you

Multi-state businesses expanding into New Mexico

Each state taxes differently, and New Mexico's gross receipts tax reaches services and receipts — like tuition — that many states wouldn't tax. Don't assume your out-of-state accountant is checking New Mexico gross receipts tax unless you've specifically engaged them to, and confirmed they know New Mexico law. The tax obligation is yours; a knowledge gap is treated as negligence.

If you plan to rely on "my accountant handles taxes"

That defense only works if you can show you asked about the specific tax, disclosed the relevant facts, and got advice you reasonably followed. A broad engagement to "do our taxes," an income-tax-only scope, or an audit report that disclaims tax-compliance responsibility will not shield you from a New Mexico negligence penalty.

Accountants and advisors

Scope letters matter both ways. An engagement limited to income tax returns and financial-statement audits — especially one with a compliance disclaimer — will be read as not covering gross receipts tax. If a client expects you to catch state transaction-tax obligations, that has to be an explicit part of the engagement.

Common questions

Q: My accountant never told me tuition (or a service) was taxable — does that excuse the penalty?
A: Not by itself. You must show you specifically consulted a competent advisor about that liability after full disclosure and reasonably relied on their advice. If you never raised the issue, there's no reliance to excuse the penalty.

Q: We hired a reputable firm to do our taxes — isn't that reasonable reliance?
A: A general delegation isn't enough. New Mexico requires "informed consultation" about the specific tax. General reliance on auditors or income-tax preparers — especially where their scope excludes gross receipts tax — does not defeat a negligence penalty.

Q: The auditors certified our financial statements — shouldn't they have caught this?
A: Financial-statement audits aren't tax-compliance reviews, and here the audit report expressly disclaimed any opinion on legal or tax compliance. That kind of audit does not establish reasonable reliance for tax purposes.

Q: Does this decision apply to my situation?
A: Not automatically. A Decision and Order resolves one taxpayer's protest on its own facts and the law in effect at the time; New Mexico's own rules note that hearing-officer decisions are public but are not legal precedent. It illustrates how the reliance defense is judged, but your facts may differ.

Citations and references

Statutes and regulations:

• Section 7-1-69(A) NMSA 1978 — 10% negligence penalty; Regulation 3.1.11.10 NMAC (negligence); Regulation 3.1.11.11 NMAC (reasonable reliance on a competent advisor)
• Section 7-1-3; 7-1-17 NMSA 1978 — tax includes penalty; assessment presumed correct
• Section 7-1-8(Z) NMSA 1978 — hearing-officer decisions are public records but not precedent

Cases cited:

• El Centro Villa Nursing Center v. Taxation and Revenue Dep't, 108 N.M. 795 (can't abdicate tax duty to an accountant)
• Vivigen, Inc. v. Minzner, 117 N.M. 224; Arco Materials v. Taxation & Revenue Dep't, 118 N.M. 12 (rev'd on other grounds by Blaze Construction, 118 N.M. 647) (general reliance on auditors insufficient)
• C&D Trailer Sales v. Taxation and Revenue Dep't, 93 N.M. 697; Phillips Mercantile v. Taxation and Revenue Dep't, 109 N.M. 487 (informed consultation required)
• Tiffany Construction Co. v. Bureau of Revenue, 90 N.M. 16

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Dlorah, Inc
• Decision PDF: D&O 02-31

Original ruling text

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

IN THE MATTER OF THE PROTEST OF
DLORAH, INC.
d/b/a NATIONAL AMERICAN UNIVERSITY No. 02-31
ID NO. 02-180159-00 2
ASSESSMENT NO. 2260069

DECISION AND ORDER

On November 19, 2002, Dlorah, Inc. (“Dlorah”) filed a motion for partial summary judgment

on its protest to the Taxation and Revenue Department’s (“Department”) assessment of a $12,398.15

penalty on Dlorah’s underpayment of gross receipts tax for the period June 1991 through November

1997. On November 26, 2002, the Department filed its response. On December 9, 2002, a hearing

on Dlorah’s motion was held before Margaret B. Alcock, Hearing Officer. Dlorah was represented

by its attorney, Benjamin A. Roybal, Esq., Betzer, Roybal & Eisenberg, P.C. The Department was

represented by Bridget A. Jacober, Special Assistant Attorney General.

At the December 9, 2002 hearing, the parties agreed that there were no material facts in

dispute and that the Hearing Officer’s ruling on Dlorah’s motion for summary judgment would be

dispositive of the issues raised in the protest. Based on the undisputed facts and the arguments

presented by the parties, IT IS DECIDED AND ORDERED AS FOLLOWS:

STATEMENT OF FACTS

Following are the undisputed facts set out in Dlorah’s motion for summary judgment and

accompanying exhibits, as modified by agreement of the parties at the December 9, 2002 hearing.

1. Dlorah is a South Dakota corporation, engaged in the business of operating for-profit

educational institutions.

2. Dlorah is registered with the Department under CRS No. 02-180159-00-2.
3. The Department is an agency of the State of New Mexico charged by law with the

duty, authority and responsibility to administer the Gross Receipts and Compensating Tax Act.

4. In January 1998, the Department commenced an audit of Dlorah covering the period

June 1991 through November 1997 (“Audit Period”).

5. The Department completed the audit in March 1998.

6. On May 29, 1998, the Department issued Assessment No. 2260069 to Dlorah in the

total amount of $229,046.08, representing $123,981.28 gross receipts tax, $12,398.15 penalty, and

$92,666.65 interest due for the Audit Period.

7. On July 23, 1998, after obtaining an extension of time from the Department, Dlorah

filed a protest of the tax, penalties, and interest assessed pursuant to Assessment No. 2260069.

8. On July 24, 1998, pursuant to Department Regulation 3.1.7.9 NMAC, Dlorah paid

the gross receipts tax due under Assessment No. 2260069.

9. Dlorah does not contest the assessment of gross receipts tax (or related interest)

assessed pursuant to Assessment No. 2260069.

10. Dlorah operates business schools in six states and twelve cities.

11. Each of those states and cities has different state and local tax systems.

12. Dlorah does not have (and during the Audit Period did not have) the expertise or staff

in house to evaluate tax and other legal obligations of every state or jurisdiction in which it conducts

business.

13. Because of the lack of in-house expertise, Dlorah relies (and historically has relied)

on outside experts, including its accountants and lawyers, to advise Dlorah on those issues.

14. Dlorah has a longstanding relationship with Ketel Thortenson, LLP (“Ketel”), an

accounting and consulting firm based in Rapid City, South Dakota.

15. Ketel is very familiar with Dlorah’s business operations, including revenue sources

and expenses.
2

16. Ketel routinely advises Dlorah on financial and other issues, including tax reporting

and compliance issues.

17. From time to time during the years covered by the Audit Period, Dlorah sought

Ketel’s advice on various state tax issues.

18. From time to time during the years covered by the Audit Period, Ketel advised

Dlorah on various state tax issues.

19. Prior to and at all times during the Audit Period, Dlorah engaged Ketel to audit

Dlorah’s books and records and financial statements and to advise Dlorah on financial, tax and other

business issues.

20. Prior to and at all times during the Audit Period, Dlorah engaged Ketel to prepare

Dlorah’s federal and state income tax returns, including its New Mexico Corporate Income Tax

returns.

21. Ketel’s standard practice and procedure in the course of each audit is to identify

issues requiring the attention of Dlorah’s senior management and its owner, including, without

limitation, financial reporting issues, reserve levels and reserves for income and other taxes.

22. Ketel’s standard practice and procedure is to prepare and send a management letter

identifying issues related to the financial statements to ensure that those items are brought to the

attention of Dlorah’s senior management and its owner.

23. If Ketel identifies an issue that needs to be brought to the attention of Dlorah’s senior

management and its owner, Ketel will include that item in the management letter sent to senior

management at the close of an audit.

24. Dlorah’s senior management relies on Ketel’s management letters to apprise them of

undisclosed or unknown liabilities, including tax liabilities.

25. Ketel audited Dlorah’s books and records and financial statements for the years

covered by the Audit Period.
3

26. In conjunction with the preparation of the audit of its books and records and financial

statements, Dlorah supplied Ketel with information pertaining to its New Mexico operations,

including revenue sources and expense information.

27. Ketel produced and delivered management letters and audit reports with respect to

Dlorah’s books and records and financial statements for the years covered by the Audit Period.

28. The Independent Auditors’ Report for the year ending May 31, 1992 states that Ketel

“audited the accompanying balance sheet...and the related statements of operations and retained

earnings and cash flows for the year then ended. These financial statements are the responsibility of

National College’s management. Our responsibility is to express an opinion on these financial

statements based on our audit.”

29. The Independent Auditors’ Report for the year ending May 31, 1992 describes the

scope of Ketel’s review as follows: “we plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material misstatement. An audit includes

examining, on a test basis, evidence supporting the amounts and disclosures in the financial

statements. An audit also includes assessing the accounting principles used and significant estimates

made by management as well as evaluating the overall financial statement presentation.”

30. The Independent Auditors’ Reports for the years ending May 31, 1993, 1994, 1995,

1996 and 1997 describe the purpose and scope of Ketel’s audit in the same terms as the 1992 report.

31. The Independent Auditors’ Report for the year ended May 31, 1997 contains the

following disclaimer: “Compliance with laws, regulations, contracts and grants applicable to the

University is the responsibility of the University’s management. As part of obtaining reasonable

assurance about whether the financial statements are free of material misstatement, we performed

tests of the University’s compliance with certain provisions of laws, regulations, contracts and grants.

However, the objective of our audit of the financial statements was not to provide an opinion on

overall compliance with such provisions. Accordingly, we do not express such an opinion.”
4

32. Dlorah’s senior management reviewed each management letter produced by Ketel for

each year covered by the Audit Period.

33. The management letters for the years covered by the Audit Period did not identify

New Mexico gross receipts or compensating tax as an undisclosed liability or issue requiring the

attention of senior management of Dlorah.

34. Dlorah’s senior management relied on Ketel’s management letters to apprise them of

undisclosed or unknown liabilities, including tax liabilities, for the years covered by the Audit

Period.

35. Ketel also prepared Dlorah’s federal and state income tax returns for the years

covered by the Audit Period, including Dlorah’s New Mexico Corporate Income Tax returns.

36. In conjunction with the preparation of its New Mexico Corporate Income Tax returns,

Dlorah supplied Ketel with information pertaining to its New Mexico operations, including revenue

sources and expense information.

37. As it did in most other states, Dlorah paid tax on textbooks, but was not aware that

New Mexico's gross receipts tax applied to tuition receipts as well.

38. Information provided by Dlorah to Ketel in connection with the preparation of its

New Mexico Corporate Income Tax returns identifies expenditures for New Mexico gross receipts

tax on sales of textbooks, but not on tuition receipts.

39. Ketel reviewed the information supplied by Dlorah in connection with Ketel’s

preparation of Dlorah’s Corporation Income Tax Returns.

40. Ketel did not identify Dlorah’s failure to pay New Mexico gross receipts tax on

tuition receipts as an issue to be addressed by Dlorah’s senior management for the years covered by

the Audit Period.

5

41. Ketel did not inform Dlorah’s senior management or owner of the need to pay New

Mexico gross receipts tax on tuition receipts orally or in the management letters issued for the years

covered by the Audit Period.

42. Because Ketel did not identify it, Dlorah was not aware of the obligation to pay New

Mexico gross receipts tax on tuition receipts.

43. Dlorah relied on Ketel to identify and apprise Dlorah of unpaid tax liabilities,

including New Mexico gross receipts tax liability on tuition receipts.

DISCUSSION

The sole issue to be determined is whether Dlorah is liable for the $12,398.15 negligence

penalty assessed in connection with its underpayment of gross receipts tax for the period June 1991

through November 1997. Section 7-1-17 NMSA 1978 provides that any assessment of taxes made

by the Department is presumed to be correct. Section 7-1-3 NMSA 1978 defines tax to include not

only the amount of tax principal imposed but also, unless the context otherwise requires, “the amount

of any interest or civil penalty relating thereto." Accordingly, the presumption of correctness applies

to the assessment of penalty at issue in this case, and it is Dlorah’s burden to present evidence and

legal arguments to justify an abatement. See, El Centro Villa Nursing Center v. Taxation and Revenue

Department, 108 N.M. 795, 779 P.2d 982 (Ct. App. 1989).

Section 7-1-69 NMSA 1978 governs the imposition of penalty. Subsection A imposes a

penalty of two percent per month or any fraction of a month, up to a maximum of ten percent, that a

taxpayer fails “due to negligence or disregard of rules and regulations” to pay taxes or file required

tax reports in a timely manner. Taxpayer negligence for purposes of assessing penalty is defined in

Regulation 3.1.11.10 NMAC as:

A. failure to exercise that degree of ordinary business care and prudence which
reasonable taxpayers would exercise under like circumstances;

B. inaction by taxpayers where action is required;

6
C. inadvertence, indifference, thoughtlessness, carelessness, erroneous
belief or inattention.

Regulation 3.1.11.11 NMAC sets out several situations that may indicate a taxpayer has not been

negligent, including instances where the taxpayer proves that the failure to pay tax “was caused by

reasonable reliance on the advice of competent tax counsel or accountant as to the taxpayer’s liability

after full disclosure of all relevant facts.”

In this case, Dlorah concedes that its failure to pay New Mexico gross receipts tax on its tuition

receipts was caused by its lack of knowledge of New Mexico law. Dlorah argues, however, that this

lack of knowledge did not constitute negligence because it reasonably relied on the advice of its

accounting firm to insure that all of its state and federal taxes were properly paid. In response, the

Department argues that a general delegation of tax matters to an agent is not sufficient to meet the

requirements of Regulation 3.1.11.11 NMAC. The Department maintains that Dlorah's reliance on its

accounting firm to discover errors in Dlorah’s gross receipts tax reporting was not reasonable because

Dlorah never consulted its accountants on this issue.

As the primary support for its protest, Dlorah cites to Kidz Karousel, Inc., an administrative

decision issued by the Department’s Hearing Officer in August 2001.1 In that case, the owners of

Kidz Karousel, which operated a retail clothing store in New Mexico, consulted with a New Mexico

attorney and a New Mexico CPA at the time the corporation was formed. The owners specifically

asked their attorney and CPA to advise to them on business procedures and to insure that the

corporation filed all legal forms, including tax forms, required by New Mexico law. Neither the

attorney nor the CPA ever advised the owners that the corporation was required to file gross receipts

tax returns to report its receipts from retail sales.

1
Pursuant to the exception to confidentiality set out in Section 7-1-8(Z) NMSA 1978 (2001 Repl. Pamp),
administrative decisions issued by the Department’s hearing officers are public records open to inspection by
the public. Although these decisions are posted on the Department’s web site and provide general guidance
concerning positions taken in past cases, they do not serve as legal precedent for future cases.

7
The facts in this case are quite different. Here, Dlorah operates business schools in six states

and twelve cities, each of which has different state and local tax systems. Dlorah has retained Ketel,

an accounting and consulting firm based in Rapid City, South Dakota, to provide Dlorah with

accounting advice. The scope of Ketel’s work for Dlorah includes preparing its state and federal

income tax returns and auditing its annual financial statements to insure there are no material

misstatements. From time to time during the Audit Period, Dlorah also sought and received Ketel’s

advice on various state tax issues. There is no indication, however, that those discussions related to

Dlorah’s payment of New Mexico gross receipts tax. Nor is there any indication that Ketel, a South

Dakota accounting firm, had any expertise on New Mexico’s tax laws or had been engaged to

determine whether Dlorah was in compliance with those laws. To the contrary, the Independent

Auditors’ Report Ketel prepared for the year ended May 31, 1997 specifically disclaims such

responsibility:

Compliance with laws, regulations, contracts and grants applicable to the
University is the responsibility of the University’s management. As part of
obtaining reasonable assurance about whether the financial statements are
free of material misstatement, we performed tests of the University’s
compliance with certain provisions of laws, regulations, contracts and grants.
However, the objective of our audit of the financial statements was not to
provide an opinion on overall compliance with such provisions. Accordingly,
we do not express such an opinion.

Based on this disclaimer, and the clear language in Ketel’s audit reports setting out the limited scope

of its review of Dlorah’s financial statements, it was not reasonable for Dlorah to have relied on

Ketel to determine whether Dlorah was correctly reporting New Mexico gross receipts tax.

The facts presented in Dlorah’s motion for summary judgment are closer to the facts in Vivigen,

Inc. v. Minzner, 117 N.M. 224, 870 P.2d 1382 (Ct. App. 1994) and Arco Materials, Inc. v. Taxation &

Revenue Department, 118 N.M. 12, 878 P.2d 330 (Ct. App. 1994) rev'd on other grounds by Blaze

Construction Co. v. Taxation & Revenue Department, 118 N.M. 647, 884 P.2d 803 (1994), than they

8
are to the facts in Kidz Karousel. In Vivigen, the taxpayer raised virtually the same defense to the

assessment of penalty as Dlorah raises here, arguing that:

At all times during the audit period, Vivigen was a public corporation,
subject to the reporting rules of the United States Securities and Exchange
Commission. As a consequence, its financial affairs were annually audited
by KPMG Peat Marwick, and that company certified the accuracy of the
financial statements contained in the annual reports to shareholders. There is
no explanation for the failure of Vivigen's bookkeeping system to account for
New Mexico compensating tax liability, or for that failure escaping the
attention of the auditors.

The Court of Appeals was unconvinced, stating:

This response is not persuasive. Apparently, Vivigen's sole excuse is that
the failure to pay compensating use tax was not uncovered by the
accountants who certified the accuracy of Vivigen's financial statements for
the annual reports to shareholders required by federal securities law.
Vivigen offered no evidence that the outside auditors reviewed Vivigen's
monthly state tax returns and does not explain why the audit for the annual
reports should have uncovered failure to pay compensating tax, nor does it
explain why the failure of the auditors to discover the error would excuse
Vivigen's failure to comply with clear state law. We therefore reverse the
district court's determination that the penalty assessment was improper.

117 N.M. at 231-232, 870 P.2d at 1389-1390. In Arco Materials, the Court of Appeals again

dismissed the taxpayer’s general reliance on its outside auditors as a basis for abating penalty:

There was also evidence that the office manager believed the audits
performed by an accounting firm would uncover potential tax problems,
although there did not appear to have been any evidence concerning
discussions with the firm's auditors about these issues. Taxpayer's general
manager and secretary-treasurer testified that he believed materials sold for
repair and maintenance were not taxable. We believe that his testimony was
substantial evidence that Taxpayer's failure to pay the gross receipts tax due
was based on its erroneous beliefs, inattention, inaction where action would
be reasonably required, or a failure to exercise the degree of ordinary business
care that similarly situated businesses would exercise. See Reg. TA 69:3; El
Centro Villa Nursing Ctr., 108 N.M. at 798, 779 P.2d at 985.

118 N.M. at 16-17, 878 P.2d at 334-335.

A taxpayer’s reliance on a tax professional must be active and informed—not passive and

unaware—in order to support a finding that the taxpayer’s failure to pay tax was not negligent for

purposes of Section 7-1-69(A) NMSA 1978. A taxpayer’s responsibility for payment of taxes due to
9
the state cannot be delegated to a third party and then forgotten. As the Court of Appeals held in El

Centro Villa Nursing Center v. Taxation and Revenue Department, 108 N.M. 795, 799, 779 P.2d 982,

986 (Ct. App. 1989):

"[e]very person is charged with the reasonable duty to ascertain the possible tax
consequences of his action [or inaction]." Tiffany Constr. Co. v. Bureau of
Revenue, 90 N.M. at 17, 558 P.2d at 1156. We are not inclined to hold that the
taxpayer can abdicate this responsibility merely by appointing an accountant as
its agent in tax matters.

The fact that a taxpayer employs an attorney or a CPA to provide general tax advice does not establish

that the taxpayer was not negligent in failing to pay tax on a particular transaction. A finding of

nonnegligence requires proof that the taxpayer engaged in “informed consultation” concerning the

specific liability at issue. See, e.g., C&D Trailer Sales v. Taxation and Revenue Department, 93 N.M.

697, 700, 604 P.2d 835, 838 (Ct. App. 1979) (penalty upheld where there was no evidence that the

taxpayer “relied on any informed consultation” in deciding not to pay tax); Phillips Mercantile v. New

Mexico Taxation and Revenue Department, 109 N.M. 487, 491, 786 P.2d 1221, 1225 (Ct. App. 1990)

(penalty upheld where there was no evidence that the failure to pay tax was the result of diligent protest

“based on informed consultation and advice”).

In this case, Dlorah retained a South Dakota accounting firm to prepare its corporate income

tax returns and audit its annual financial statements. There is no evidence that the accounting firm was

asked to prepare or audit Dlorah’s New Mexico gross receipts tax returns. Nor is there any evidence

that Dlorah consulted with or sought the advice of its accountants concerning Dlorah’s liability for New

Mexico gross receipts tax. Dlorah’s failure to pay gross receipts tax on its tuition receipts was not

caused by its reasonable reliance on the advice of its accountants after full disclosure of all relevant

facts, but by its lack of knowledge of New Mexico law and its erroneous belief that tax was not due on

certain transactions. This constitutes negligence for purposes of Section 7-1-69(A) NMSA 1978, and

penalty was properly assessed by the Department.

CONCLUSIONS OF LAW
10

1. Dlorah filed a timely, written protest to Assessment No. 2260069, and jurisdiction lies

over the parties and the subject matter of this protest.

2. Dlorah was negligent in failing to pay gross receipts tax due on its New Mexico receipts,

and penalty was properly imposed pursuant to Section 7-1-69(A) NMSA 1978.

For the foregoing reasons, Dlorah’s protest IS DENIED.

DATED December 20, 2002.

11