Were a franchise regional developer's shares of monthly royalty fees taxable commissions, and which local gross-receipts rate applied?

Plain-English summary

BBCB's monthly shares of franchise royalty fees were taxable commissions for supervisory services—not royalties earned by BBCB. But the Department calculated the tax with rates from the franchisees' locations instead of the rate for BBCB's Bernalillo County business, so BBCB received an additional $83.80 refund.

BBCB served as a regional developer for an Arizona-based massage corporation. It sold licenses, helped franchisees obtain corporate approval and open clinics, and retained limited “police” duties after opening. Its territory included New Mexico, Oklahoma, and parts of Texas.

BBCB earned a commission when it sold a license and also received monthly commissions based on royalties paid by franchisees it had helped establish.

The royalty source did not change the payment's character

BBCB argued that its monthly receipts were royalties because they came from royalty payments to the corporation. The decision disagreed.

The franchisees paid the corporation for use of the corporation's intellectual property and brand. BBCB owned no identified royalty right in those payments. Instead, its contract called its receipts “Commissions on Royalty Fees” and required it to inspect and report on franchisees for the corporation.

BBCB would lose the monthly commission if it did not perform those supervisory duties. It did not matter that the corporation rarely called upon BBCB to act: the continuing service obligation was the consideration for the payment.

Commissions and amounts paid for services were expressly within gross receipts. The portion tied to franchisees in New Mexico was therefore taxable.

The Department used the wrong local rates

The auditor reviewed royalty reports for all franchisees and isolated the payments connected to New Mexico locations. She found $6,935.65 of taxable December 2008 receipts.

The Department then applied the rates for the various franchisees' locations—6.7500%, 6.9375%, and 7.9375%—and calculated $486.93 of tax. Because BBCB had paid $652.24, the Department initially refunded $165.31.

At the hearing, the auditor acknowledged that BBCB should instead have been taxed at the rate for its principal place of business in Bernalillo County. Applying that county's 5.8125% rate produced $403.13 of tax and a total refund of $249.11.

Result: protest GRANTED IN PART AND DENIED IN PART. The commissions remained taxable, but the Department was ordered to issue an additional $83.80 refund.

What this means for you

Franchise regional developers

A payment calculated from another party's royalty revenue is not necessarily a royalty to you. Contract terms and the duties you must perform can make it a taxable service commission.

Businesses with continuing oversight duties

Compensation may be for services even when the customer rarely asks you to perform them. In this decision, the obligation to remain available for inspection and reporting work supported taxation.

Refund claimants

Check both the taxable-receipts base and the location rate used in the calculation. BBCB lost on taxability but recovered money because the Department used the wrong local rate.

Common questions

Q: Were the franchisees' royalty payments themselves at issue?
A: No. The issue was BBCB's commission from royalties paid to the corporation.

Q: Why were BBCB's receipts treated as service income?
A: Its contract conditioned payment on its continuing supervision, inspection, and reporting duties.

Q: Did receipts connected to out-of-state franchisees remain in the tax base?
A: The auditor's calculation isolated commissions connected to franchisees located in New Mexico.

Q: How much more was BBCB refunded?
A: $83.80, bringing the total refund for December 2008 to $249.11.

Citations and references

Statutes and regulation:

• NMSA 1978, §§ 7-9-3 and 7-9-3.5 — gross receipts and commissions for services
• NMSA 1978, § 7-9-5 — presumption that business receipts are taxable
• Regulation 3.2.1.18(A) NMAC — services performed in New Mexico

Source

• Listing: New Mexico Decisions & Orders
• Decision post: BBCB, LLC
• Decision PDF: D&O 14-33

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
BBCB, LLC, No. 14-33
TO THE DENIAL OF REFUND ISSUED UNDER
ID NO. L0748686656

DECISION AND ORDER

A formal hearing on the above-referenced protest was held July 23, 2014, before Dee Dee

Hoxie, Hearing Officer. The Taxation and Revenue Department (Department) was represented by Ms.

Kathleen Carlow, Staff Attorney. Ms. Mary Griego, Auditor, also appeared on behalf of the

Department. BBCB, LLC (Taxpayer) appeared for the hearing by and through its owners, Mr. Earl

Brooks and Ms. Elaine Brooks, and represented itself. Mr. Troy Scott, an enrolled agent, was also

present at the Taxpayer’s request. The Hearing Officer took notice of all documents in the

administrative file. Based on the evidence and arguments presented, IT IS DECIDED AND

ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. On October 11, 2012, the Taxpayer filed an application for refund of gross receipts tax for

the tax period from December 1, 2008 through December 31, 2008.

2. On October 31, 2012, the Department denied the request for refund.

3. On November 26, 2012, the Taxpayer filed a formal protest letter.

4. In April 2013, the Department granted a partial refund for the December 2008 tax period, in

the amount of $165.31.

5. On September 9, 2013, the Department filed a Request for Hearing asking that the

Taxpayer’s protest be scheduled for a formal administrative hearing. The hearing was

promptly set, but was continued several times at the requests of the Taxpayer.

6. The Taxpayer serves as a Regional Developer for a massage corporation that is based in

Arizona. As the Regional Developer, the Taxpayer sells licenses to franchisees for the

corporation, helps to obtain the license from the corporation, and helps the franchisee to set

up the clinic. The Taxpayer also has very limited “police” duties after the franchisee has

opened the clinic.

7. The Taxpayer receives a commission on every license sold. The Taxpayer also receives a

commission on monthly royalties that are paid to the corporation by franchisees who worked

with the Taxpayer in opening their clinics.

8. The Taxpayer’s development area includes New Mexico, Oklahoma, and parts of Texas.

9. The Taxpayer was filing and paying gross receipts tax to include the commission on the

monthly royalties that it receives.

10. Mr. Scott began working with the Taxpayer and advised that its commission on the monthly

royalties was not subject to gross receipts tax.

11. The Taxpayer filed an application for refund for the December 2008 tax period based on this

advice.

12. The Taxpayer provided to the Department a copy of its royalty reports from the corporation

for the 2008 tax year.

13. Ms. Griego reviewed the royalty report and determined the total amounts that were paid to

the Taxpayer in December 2008.

14. Ms. Griego then determined which payments were received for commissions on royalties

paid on the franchisees that were within the state of New Mexico.

15. Ms. Griego applied the gross receipts tax to those commissions at the rate where the

franchisees were located.

16. The Taxpayer’s principal place of business is in Bernalillo County, New Mexico.

BBCB, LLC
Letter ID No. L0748686656
page 2 of 6
DISCUSSION

The issue to be decided is whether the Taxpayer is entitled to a refund of the gross receipts

tax paid on the payments it received in December 2008 that were derived from royalties paid to the

massage corporation.

Gross Receipts.

Services performed within the State of New Mexico are subject to the gross receipts tax. See

NMSA 1978, § 7-9-3. See also 3.2.1.18 (A) NMAC (2003). Gross receipts include commissions,

fees, and amounts paid for the performance of services. See NMSA 1978, § 7-9-3.5 (2007). There is

a presumption that all receipts of a taxpayer from engaging in business are subject to the gross

receipts tax. See NMSA 1978, § 7-9-5 (2002).

The Taxpayer argues that the statutes on gross receipts are silent on the issue of royalty

payments. The Taxpayer argues that the monthly commissions it receives are royalties since they are

derived from royalty payments to the corporation and that its receipts on those should not be subject

to the gross receipts tax.

The Department argues that the monthly commissions paid to the Taxpayer are compensation

for services that it provides to the corporation. The Department points out that the Taxpayer’s

contract with the corporation requires the Taxpayer to provide inspections and reports on franchisees

and that the failure to do so during any month will negate the Taxpayer’s right to receive the

commissions from the corporation.

Royalties are not specifically mentioned in the gross receipts statute. See NMSA 1978, §§ 7-

9-3 and 7-9-3.5. However, commissions are specifically mentioned and are clearly subject to the

gross receipts tax. See NMSA 1978, § 7-9-3.5 (A) (2). The Taxpayer’s contract with the corporation

identifies the monthly payments made to the Taxpayer as “Commissions on Royalty Fees”. See TRD

“C”, ¶ 8.2. The franchisees are paying a monthly royalty to the corporation, not to the Taxpayer, for

BBCB, LLC
Letter ID No. L0748686656
page 3 of 6
the use of the corporation’s intellectual property or its brand name. The corporation has contracted

with the Taxpayer to check up on its franchisees to ensure that its brand is being used in accordance

with its standards. In exchange for this supervision, the corporation pays the Taxpayer a commission

from the royalties that it receives each month. The Taxpayer is not entitled to that commission if it

does not perform its duties of supervision. The Taxpayer argues that it is rarely ever called upon to

perform those duties. Regardless of the frequency that the corporation actually calls upon the

Taxpayer to do so, the Taxpayer is receiving a monthly commission from the corporation in

exchange for the performance of supervisory services. Consequently, the receipts derived from the

monthly commission are for the services performed in the state of New Mexico and are subject to the

gross receipts tax.

Amount of Refund.

The Taxpayer argues that the amount of refund that was granted by the Department was

incorrect. The Taxpayer argues that the tax rate used to calculate the tax was not the tax rate for

Bernalillo County, which is where the Taxpayer’s business is located.

The Department argues that the Taxpayer might not have been entitled to a refund at all since

Mrs. Brooks testified that the Taxpayer only reported the gross receipts of the commissions paid on

the New Mexico franchisees. However, Ms. Griego’s testimony was clear that she received the raw

data on all of the payments made for all of the franchisees related to the Taxpayer, including those

from out of state. Ms. Griego reviewed the data and determined which payments were related to the

franchisees located within the state of New Mexico.

Ms. Griego then calculated what tax was owed on those payments and issued a refund for the

amount in excess of the tax owed for those payments. Ms. Griego explained that she used the tax

rates of the franchisees’ locations. Ms. Griego admitted that this was probably a mistake and that the

Taxpayer’s tax rate should have been the location of its business. Ms. Griego determined that the

BBCB, LLC
Letter ID No. L0748686656
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total amount of receipts subject to the gross receipts tax for December 2008 was $6,935.65.

Applying tax rates from the various franchisee locations, she determined that the total amount of

gross receipts tax due for December 2008 was $486.93. The Taxpayer reported and paid $652.24

gross receipts tax for December 2008. Therefore, the Department issued the Taxpayer a refund of

$165.31. The tax rates applied were 6.7500%, 6.9375%, and 7.9375%. The Department provided a

gross receipts tax schedule for December 2008, which indicates that Bernalillo County’s gross

receipts tax rate was 5.8125%. The Taxpayer should have been charged the Bernalillo County rate as

its business is located within Bernalillo County. Therefore, the Taxpayer’s gross receipts tax liability

for December 2008 was $403.13. The amount that should have been refunded to the Taxpayer was

$249.11. Consequently the Taxpayer is entitled to a refund of an additional $83.80.

CONCLUSIONS OF LAW

1. The Taxpayer filed a timely written protest to the denial of refund issued under Letter

ID number L0748686656, and jurisdiction lies over the parties and the subject matter of this protest.

2. The Taxpayer was receiving monthly commissions for acting as a supervisory agent on

behalf of the corporation. The Taxpayer was subject to the gross receipts on the commissions paid for

supervising franchisees located within the state of New Mexico.

3. The Department conceded that the Taxpayer was entitled to a partial refund of the gross

receipts tax paid in December 2008.

4. The Taxpayer was subject to the gross receipts tax in Bernalillo County, New Mexico.

The tax rate applied to the Taxpayer was in excess of the rate for Bernalillo County. Consequently, the

Taxpayer is entitled to an additional refund of $83.80.

For the foregoing reasons, the Taxpayer's protest is GRANTED IN PART AND DENIED IN

PART. The Department will issue an additional refund of $83.80 to the Taxpayer.

BBCB, LLC
Letter ID No. L0748686656
page 5 of 6
DATED: September 22, 2014.

Dee Dee Hoxie
DEE DEE HOXIE
Hearing Officer
Taxation & Revenue Department
Post Office Box 630
Santa Fe, NM 87504-0630

BBCB, LLC
Letter ID No. L0748686656
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