Are the franchise royalty fees I collect from my New Mexico franchisees taxable, or is the trademark-license part of the fee exempt from gross receipts tax?

Plain-English summary

A & W Restaurants, Inc. is a franchisor. It signs Franchise Agreements with New Mexico businesses that grant each franchisee a limited license to use the A&W trademarks in running a single A&W restaurant. In exchange, the franchisee pays A&W (among other charges) a continuing royalty fee equal to 5% of gross sales — described in the agreement as consideration for the trademark license — plus a continuing advertising fee of 4%.

The Department audited A&W and assessed gross receipts tax of $25,554.31 plus interest on the royalty fees received for periods from June 15, 2007 through December 31, 2011. A&W protested. On cross-motions for summary judgment (the facts were undisputed), the single question was one of statutory construction: are the franchise royalty fees taxable gross receipts?

• A&W's argument: the royalty is payment for a trademark license, and the definition of taxable "property" in Section 7-9-3(J) expressly excludes "licenses other than the licenses of copyrights, trademarks or patents and franchises." So the trademark component should be unbundled from the franchise and left untaxed.
• The Department's argument: the royalty is receipts from "granting a right to use a franchise employed in New Mexico," which the 2007 franchise clause in Section 7-9-3.5(A)(1) makes taxable — and a franchise is a bundle that includes the trademark.

Chief Hearing Officer Brian VanDenzen granted summary judgment to the Department:

• A franchise is bundled property that includes the trademark. Black's Law Dictionary, the Court of Appeals' definition in Sonic Industries, and the Department's own Regulation 3.2.1.7(E) all treat a franchise as an arrangement that "usually conveys a license to use the franchisor's trademark." The trademark is an essential element of the franchise, not a severable add-on.
• The Department need not unbundle. In Sonic Industries (2000-NMCA-087), the Court of Appeals held a franchise is a "compound or 'bundled' form of property" and rejected the claim that the Department must break a franchise into components to tax the franchise fees. Practically, unbundling would be incoherent here — under the agreement, not paying the royalty is a default that terminates the whole franchise, not just the trademark license.
• The trademark carve-out is for stand-alone licenses. Section 7-9-3(J)'s exclusion for trademark licenses is aimed at a separate transaction — e.g., licensing a mark to a t-shirt manufacturer who resells shirts. That reading harmonizes with the resale deduction in Section 7-9-47. It does not reach a trademark embedded in a franchise. (Trademark value is inseparable from the business behind it, Barnesandnoble.com.)
• The 2007 amendments confirm the intent. After Sonic Indus. (2006-NMSC-038) held pre-2007 franchise receipts were sales of property outside New Mexico and untaxed, the Legislature added the distinct franchise clause to Section 7-9-3.5(A)(1) specifically to tax franchise-licensing receipts employed in New Mexico.

Result: all of A&W's receipts are presumed taxable (Section 7-9-5), the franchise royalty fees fall under the franchise clause, and the protest was denied.

What this means for you

Franchisors licensing into New Mexico

If you grant a franchise "employed in New Mexico," the royalty and license fees you receive are New Mexico gross receipts, taxable under the franchise clause of Section 7-9-3.5(A)(1) — even the portion attributable to the trademark. You cannot carve the trademark license out of the franchise to escape the tax. Build the gross receipts tax into your New Mexico franchise pricing and compliance.

Franchisees

This decision is about the franchisor's tax on the fees it collects, but it explains why those fees are treated as consideration for a single bundled franchise right. If your franchisor passes the tax through, this is the legal basis.

Businesses that license trademarks outside a franchise

The trademark exclusion in Section 7-9-3(J) is still meaningful — but for stand-alone trademark licenses (the decision's example is licensing a mark to a t-shirt maker for resale). If the trademark travels as part of a franchise, the exclusion does not apply.

Accountants and tax professionals

The holding turns on treating "franchise" and "property" as separate clauses in Section 7-9-3.5(A)(1): the Section 7-9-3(J) property definition (with its trademark carve-out) modifies the property clause, not the franchise clause. When advising on New Mexico franchise receipts, do not assume the trademark component is severable — post-2007, the franchise clause captures the whole bundle.

Common questions

Q: Aren't trademark licenses exempt from New Mexico gross receipts tax?
A: Only stand-alone ones. Section 7-9-3(J) excludes trademark licenses from the definition of "property," but when the trademark is part of a franchise, the receipts are taxed under the separate franchise clause of Section 7-9-3.5(A)(1), not the property clause.

Q: Can I split my franchise fee into a taxable part and an exempt trademark part?
A: No. The decision holds a franchise is a bundled form of property that includes the trademark, and the Department is not required to unbundle it. The full franchise royalty is taxable.

Q: Why did the law change in 2007?
A: In Sonic Indus. (2006), the Supreme Court found franchise receipts under the then-current definitions were sales of property outside New Mexico and untaxed. The Legislature responded by adding a specific franchise clause to the gross receipts definition to tax franchises employed in New Mexico.

Citations and references

Statutes:

• § 7-9-3.5(A)(1) NMSA 1978 (2007) — "gross receipts" includes value received from granting a right to use a franchise employed in New Mexico
• § 7-9-3(J) NMSA 1978 (2007) — defines "property"; excludes licenses of copyrights, trademarks, patents, and franchises
• § 7-9-4 NMSA 1978 — imposes gross receipts tax for the privilege of engaging in business
• § 7-9-5 NMSA 1978 — all receipts of a person engaged in business are presumed taxable
• § 7-9-3.3 NMSA 1978 — "engaging in business" means carrying on any activity for direct or indirect benefit
• § 7-9-47 NMSA 1978 — deduction for property or licenses purchased for resale
• § 7-1-17(C) NMSA 1978 — a Department assessment is presumed correct

Regulation:

• Regulation 3.2.1.7(E) NMAC — defines a "franchise," which usually conveys a license to use the franchisor's trademark or trade name

Cases cited:

• Sonic Indus. v. State, 2006-NMSC-038, 140 N.M. 212 — pre-2007 franchise receipts were sales of property outside New Mexico; prompted the 2007 franchise clause
• Sonic Industs., Inc. v. State, 2000-NMCA-087, 129 N.M. 657 — a franchise is a compound, "bundled" form of property; the Department need not unbundle it to tax franchise fees
• N.M. Taxation & Revenue Dep't v. Barnesandnoble.com LLC, 2012-NMCA-063 — trademark value and goodwill are inseparable from the underlying business
• Romero v. Philip Morris, Inc., 2010-NMSC-035, 148 N.M. 713 — standard for summary judgment
• Archuleta v. O'Cheskey, 1972-NMCA-165, 84 N.M. 428 — the taxpayer bears the burden to overcome an assessment

Source

• Listing: New Mexico Decisions & Orders
• Decision post: A & W Restaurants, Inc.
• Decision PDF: D&O 16-49

Original ruling text

STATE OF NEW MEXICO
ADMINISTRATIVE HEARINGS OFFICE
TAX ADMINISTRATION ACT

IN THE MATTER OF THE PROTEST OF
A & W RESTAURANTS, INC. No. 16-49
TO ASSESSMENT ISSUED UNDER LETTER
ID NO. L1323919824

DECISION AND ORDER
ON MOTIONS FOR SUMMARY JUDGMENT

A summary judgment hearing on the above-referenced protest occurred on September 30,

2015, before Brian VanDenzen, Chief Hearing Officer. Staff Attorney Peter Breen appeared

representing the Taxation and Revenue Department (“Department”). Attorney Timothy R. Van

Valen appeared representing A & W Restaurants, Inc. (“Taxpayer”). The matter came before the

Chief Hearing Officer on the Taxpayer’s Motion for Partial Summary Judgment filed on July 6,

2015 and the Department’s Response thereto filed on August 3, 2015 in which the Department

also moved for summary judgment.

The Taxpayer’s motion presents a statement of facts which the Department does not

dispute. Based on the undisputed facts, review of exhibits and arguments presented, IT IS

DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

Procedural History

1. On September 27, 2013, the Department assessed Taxpayer $25,554.31 for Gross

Receipts Tax and $3,795.02 in interest for a combined total of $29,349.33 for the periods from

June 30, 2007 to December 31, 2011.

2. Taxpayer filed a timely protest of the assessment on December 23, 2013.
3. On January 17, 2014, the Department requested a hearing in this matter with the

Administrative Hearings Office. A scheduling conference was set for March 11, 2014.

4. On March 12, 2014, a Scheduling Order and Notice of Administrative Hearing was

entered which in addition to establishing various prehearing deadlines, set a hearing on the merits

for June 15, 2015.

5. Upon Taxpayer’s unopposed motion, the scheduling order entered on March 12,

2014 was vacated and a second telephonic status conference was set for May 1, 2015.

6. On May 19, 2015, a Second Scheduling Order and Notice of Motion Hearing was

entered which established the deadlines for the Taxpayer and the Department to file motions for

summary judgment, cross-motions, responses, and replies, and set a hearing on such motions for

September 16, 2015. The deadline for motions was June 26, 2015.

7. On June 26, 2015, the Taxpayer and the Department stipulated to an Order

Extending Summary Judgment Deadline to July 6, 2015.

8. Taxpayer filed its Motion for Partial Summary Judgment on July 6, 2015

(hereinafter “Taxpayer’s Motion”).

9. The Department filed a Response to Motion for Summary Judgment on August 3,

2015 which also contained a cross-motion requesting that summary judgment be granted in favor

of the Department.

10. On September 16, 2015, a Continuance Order and Amended Notice of Motion

Hearing was filed which continued the hearing on the motions for summary judgment to

September 30, 2015, the date upon which the parties appeared through their counsel and presented

oral arguments in the above-captioned matter.

In the Matter of A & W Restaurants, Inc., page 2 of 17.
Undisputed Material Facts

11. Taxpayer entered into contracts with New Mexico businesses entitled “Franchise

Agreement.” [Taxpayer’s Motion, Page 2, ¶2]

12. Section 1 of the Franchise Agreement, entitled “Grant of License” grants a

franchisee a limited license to use specific trademarks identified in an appendix to the Franchise

Agreement, subject to the terms and conditions of the Franchise Agreement. [Taxpayer’s Motion,

Page 2, ¶3]

13. The authority to utilize the trademarks is limited exclusively to use in connection

with sales from a single restaurant established under the Franchise Agreement. [Taxpayer’s

Motion, Page 2, ¶4]

14. Section 7 of the Franchise Agreement establishes the amounts that a franchisee is to

pay Taxpayer. The Franchise Agreement provides for the following:

a. An initial license fee paid concurrent with the execution of the Agreement;

b. A grand opening promotional deposit;

c. A continuing royalty fee equal to 5% of “gross sales” as consideration for the

limited trademark license; and

d. A continuing advertising fee equal to 4% of “gross sales” to be used for national

advertising.

[Taxpayer’s Motion, Page 3, ¶9]

15. The continuing royalty fee and the continuing advertising fee are paid on a monthly

basis and are calculated based on the prior month’s gross sales. [Taxpayer’s Motion, Page 3, ¶10]

In the Matter of A & W Restaurants, Inc., page 3 of 17.

16. The Department audited Taxpayer for gross receipts tax for the periods from

January 1, 2006 through December 31, 2011. [Taxpayer’s Motion, Page 3, ¶11]

17. The Department concluded that the continuing royalty fee was subject to gross

receipts tax because the payments by franchisees to Taxpayer represented receipts from “granting

a right to use a franchise employed in New Mexico.” [Taxpayer’s Motion, Page 4, ¶15]

18. As a result of a statutory modification effective June 15, 2007, the Department

limited its examination to royalty fees paid to Taxpayer after June 14, 2007. [Taxpayer’s Motion,

Page 4, ¶16]

DISCUSSION

The primary issue in this matter is whether the Department correctly determined that the

continuing royalty fee paid by franchisees to Taxpayer constituted “gross receipts” subjecting it to the

New Mexico Gross Receipts and Compensating Tax Act. Taxpayer asserts that the continuing royalty

fee is consideration for Taxpayer’s grant of a limited license to utilize its trademarks. It claims that

the fee is therefore exempt from gross receipts tax under the definition of “property” as provided in

NMSA 1978, Section 7-9-3 (J) (2007). In contrast, the Department asserts that the royalty fees paid

are taxable as gross receipts because they are receipts from granting the right to use a franchise

employed in New Mexico, subject to gross receipts tax under NMSA 1978, Section 7-9-3.5 (A) (1)

(2007), and that the bundle of rights that is part of a franchise includes the grant of a trademark.

Burden of Proof and Standard of Review.

Pursuant to NMSA 1978, Section 7-1-17 (C), the assessment issued in this case is

presumed correct. The Taxpayer has the burden to overcome the presumption of correctness that

attached to the assessment. See Archuleta v. O’Cheskey, 1972-NMCA-165, ¶11, 84 N.M. 428.

In the Matter of A & W Restaurants, Inc., page 4 of 17.
Unless otherwise specified, for the purpose of the Tax Administration Act, “tax” is defined to

include interest and civil penalty. See NMSA 1978, § 7-1-3 (X). Under Regulation 3.1.6.13

NMAC, the presumption of correctness under Section 7-1-17 (C) extends to the Department’s

assessment of penalty and interest. See Chevron U.S.A., Inc. v. State ex rel. Dep’t of Taxation &

Revenue, 2006-NMCA-50, ¶16, 139 N.M. 498, 503 (agency regulations interpreting a statute are

presumed proper and are to be given substantial weight).

Summary Judgment is appropriate when there is no genuine dispute as to any material fact

and the moving party is entitled to prevail as a matter of law. See Romero v. Philip Morris, Inc.,

2010-NMSC-035, ¶7, 148 N.M. 713. In controversies involving a question of law, or application

of law where there are no disputed facts, summary judgment is appropriate. See Koenig v. Perez,

1986-NMSC-066, ¶10-11, 104 N.M. 664. If the movant for summary judgment makes a prima

facie showing that it is entitled to a judgment as a matter of law, the burden shifts to the opposing

party to show evidentiary facts that would require a trial on the merits. See Roth v. Thompson,

1992-NMSC-011, ¶17, 113 N.M. 331. Even if the nonmoving party does not file their own motion

for summary judgment, summary judgment may be granted to the nonmoving party if there is no

genuine dispute of fact, they are entitled to judgment as a matter of law, and the moving party was

generally on notice of the nonmoving party’s counter-claim in its response to the moving party’s

summary judgment pleading. See Martinez v. Logsdon, 1986-NMSC-056, ¶12, 104 N.M. 479.

Despite the fact that Taxpayer only filed a motion for partial judgment rather than full summary

judgment and the Department only filed a cross-claim as part of its response against Taxpayer’s

motion for partial summary judgment, both parties agreed on the record during the motion hearing

that this case was ripe for a final decision and order on full summary judgment because there was

In the Matter of A & W Restaurants, Inc., page 5 of 17.
no genuine dispute of fact and resolution of the protest turned on a question of application of law.

Principals of Statutory Construction.

As will be discussed in more detail, resolving the issue at the protest involves statutory

construction of the definition and application of the terms “franchise” and “property” as used in the

Gross Receipts and Compensating Tax Act. At its simplest level, the Department argues that

Taxpayer must pay gross receipts tax on the granting of all rights to a New Mexico franchisee under

the Franchise Agreement given that the base definition of gross receipts includes receipts from sales

of a franchise employed in New Mexico while Taxpayer argues that trademark rights must be

unbundled from the Franchise Agreement because trademarks are excluded from the definition of

property subject to gross receipts tax.

Questions of statutory construction begin with the plain meaning rule. See Wood v. State

Educ. Ret. Bd., 2011-NMCA-20, ¶12. In Wood, ¶12 (internal quotations and citations omitted), the

Court of Appeals stated “that the guiding principle in statutory construction requires that we look

to the wording of the statute and attempt to apply the plain meaning rule, recognizing that when a

statute contains language which is clear and unambiguous, we must give effect to that language

and refrain from further statutory interpretation.” A statutory construction analysis begins by

examining the words chosen by the Legislature and the plain meaning of those words. State v.

Hubble, 2009-NMSC-014, ¶13, 206 P.3d 579, 584. Extra words should not be read into a statute

if the statute is plain on its face, especially if it makes sense as written. See, Johnson v. N.M. Oil

Conservation Comm'n, 1999-NMSC-21, ¶ 27, 127 N.M. 120, 126, 978 P.2d 327, 333. “Tax

statutes, like any other statutes, are to be interpreted in accordance with the legislative intent and

in a manner that will not render the statutes' application absurd, unreasonable, or unjust." City of

In the Matter of A & W Restaurants, Inc., page 6 of 17.
Eunice v. State Taxation & Revenue Dep't, 2014-NMCA-085, ¶8 (internal citations and quotations

emitted). It is a canon of statutory construction in New Mexico to adhere to the plain wording of a

statute except if there is ambiguity, error, an absurdity, or a conflict among statutory provisions.

See Regents of the Univ. of New Mexico v. New Mexico Fed'n of Teachers, 1998-NMSC-20, ¶28, 125

N.M. 401. Only if the plain language interpretation would lead to an absurd result not in accord

with the legislative intent and purpose is it necessary to look beyond the plain meaning of the

statute. See Bishop v. Evangelical Good Samaritan Soc'y, 2009-NMSC-036, ¶11, 146 N.M. 473.

When applying the plain meaning rule, the statutes should be read in harmony with the provisions of

the remaining statute or statutes dealing with the same subject matter. See State v. Trujillo, 2009-

NMSC-012, ¶22, 146 NM 14. See also Hayes v. Hagemeier, 1963-NMSC-095, ¶9, 75 N.M. 70 (“All

legislation is to be construed in connection with the general body of law.”).

Gross Receipts Tax, Franchise Agreements, and Franchise Royalties

For the privilege of engaging in business, New Mexico imposes a gross receipts tax on the

receipts of any person engaged in business. See NMSA 1978, § 7-9-4 (2002). Under NMSA 1978,

Section 7-9-3.5 (A) (1) (2007), the term “gross receipts” is broadly defined to mean

the total amount of money or the value of other consideration received from
selling property in New Mexico, from leasing or licensing property
employed in New Mexico, from granting a right to use a franchise employed
in New Mexico, from selling services performed outside New Mexico, the
product of which is initially used in New Mexico, or from performing
services in New Mexico.

There are numerous sub-clauses within this statutory definition of gross receipts. For instance, the

sale of a service is listed in its own clause, while the sale of property is listed in another clause. As

will be discussed in more detail, receipts related to licensing a franchise in New Mexico are listed

In the Matter of A & W Restaurants, Inc., page 7 of 17.
in their own clause while receipts from selling, leasing, or licensing property are listed in separate

clauses. Indeed, the entire franchise clause was added to the gross receipts definition by the

Legislature in 2007, after the New Mexico Supreme Court’s decision in Sonic Indus. v. State,

2006-NMSC-038, 140 N.M. 212.

“Engaging in business” is defined as “carrying on or causing to be carried on any activity

with the purpose of direct or indirect benefit.” NMSA 1978, § 7-9-3.3 (2003). Under the Gross

Receipts and Compensating Tax Act, there is a statutory presumption that all receipts of a person

engaged in business are taxable. See NMSA 1978, § 7-9-5 (2002). Since Taxpayer is an entity

engaged in the business of granting a right to use a franchise, all of Taxpayer’s receipts from granting

the right to use a franchise employed in New Mexico are presumed subject to gross receipts tax under

Section 7-9-5.

Nevertheless, despite this general presumption of taxability of an entity engaged in the

business of selling a license to use a franchise in New Mexico, Taxpayer argues that gross receipts tax

are not applicable to receipts associated with the sale of a trademark in light of the definition of

property under the Gross Receipts and Compensating Tax Act. In pertinent part and again as a result

of the Legislature’s 2007 post-Sonic amendments, the Legislature defines “property” under NMSA

1978, Section 7-9-3 (J) (2007), as “real property, tangible personal property, licenses other than the

licenses of copyrights, trademarks or patents and franchises.” Taxpayer asserts that the receipts from

fees received in consideration for granting a trademark license to a franchisee come within the

statutory exception for “licenses other than the licenses of copyrights, trademarks or patents” in

Section 7-9-3 (J). Consequently, Taxpayer avers that the Department must unbundle the various

components of its Franchise Agreement, consider the selling of a license for the use of Taxpayer’s

In the Matter of A & W Restaurants, Inc., page 8 of 17.
trademark a separate, stand-alone transaction distinct from other components of the Franchise

Agreement, and thus not impose gross receipts tax on that unbundled portion of the Franchise

Agreement. The Department, in contrast, asserts that the sale of the license to use Taxpayer’s

trademark is but one component of a bundled transaction for granting of a right to use a franchise

employed in New Mexico, which is subject to gross receipts tax under the franchise clause in Section

7-9-3.5 (A) (1).

As it relates to the Gross Receipts and Compensating Tax Act, the Legislature has not defined

the term “franchise.” In the absence of a specific definition of “franchise,” rules of statutory

construction require that the term “franchise” be given its plain meaning. Referring to Black’s Law

Dictionary (10th Edition, 2014), the term “franchise” is defined “[t]o grant (to another) the sole

right of engaging in a certain business or in a business using a particular trademark.” Moreover,

the term “franchise” has been the subject of discussion before the New Mexico Court of Appeals. In

Sonic Industs., Inc. v. State, 2000-NMCA-087, ¶23, 129 N.M. 657, rev’d on other grounds in Sonic

Indus. v. State, 2006-NMSC-038, 140 N.M. 212, the Court of Appeals set forth what it concluded to

be the traditional definition of a franchise:

In its simplest terms a franchise is a license from the owner of a
trademark or trade name permitting another to sell a product or service
under that name or mark. More broadly stated, the franchise has
evolved into an elaborate agreement under which the franchisee
undertakes to conduct a business or sell a product or service in
accordance with methods and procedures prescribed by the franchiser
and the franchiser undertakes to assist the franchisee through
advertising, promotion and other advisory services.

(internal citations omitted).

In the Matter of A & W Restaurants, Inc., page 9 of 17.
The Department has also promulgated a regulation defining “franchise.” Regulation 3.2.1.7

(E) NMAC states that

(1) A “franchise” is an agreement in which the franchisee agrees to
undertake certain business activities or to sell a particular type of
product or service in accordance with methods and procedures
prescribed by the franchisor, and the franchisor agrees to assist the
franchisee through advertising, promotion and other advisory services.
The franchise usually conveys to the franchisee a license to use the
franchisor's trademark or trade name in the operation of the
franchisee's business.

(2) Example: Y, a pie company of Cambridge, Massachusetts, grants
to X of Virden, New Mexico, the right to make pies according to their
exclusive recipe and to operate Y Pie shops throughout New Mexico.
The right to make the pies and operate the pie shops, whether granted
for a “one-time” payment or for a continuing percentage of the
proceeds of the shops, is a franchise. Therefore, the receipts of Y,
from its granting of the franchise are subject to gross receipts tax.

Under NMSA 1978, Section 9-11-6.2 (G), a Department regulation is presumed to be a proper

implementation of the provisions of the laws under the Department’s purview. See also Chevron

U.S.A., Inc., 2006-NMCA-50, ¶16.

The Department’s regulatory definition of that term under Regulation 3.2.1.7 (E) NMAC is

generally consistent with the Black’s Law Dictionary definition of the term “franchise” and the Court

of Appeals’ conception of that term in Sonic Industs. The commonality of these three conceptions of

the term “franchise” establish that the plain meaning of that term as used in Section 7-9-3.5 (A) (1)

includes a franchisees’ use of the franchisors’ trademark. There is simply nothing to indicate that the

Legislature has intended an interpretation of the term “franchise” that materially differs from the

traditional definition of the term, which includes the granting of a license to use a trademark as an

element of granting a franchise.

In the Matter of A & W Restaurants, Inc., page 10 of 17.
Presumably aware of the Department’s regulation defining “franchise” at Regulation 3.2.1.7

(E) NMAC and of the Court of Appeals’ conception in Sonic Industs, a reasonable inference may also

be drawn from the Legislature’s inaction in response to this administrative interpretation that the

definition promulgated by the Department is consistent with its intent for the term “franchise”. Sonic

at ¶25, citing State ex rel. Stratton v. Roswell Indep. Schs, 111 N.M. 495, 503.

This plain meaning reading of the term “franchise” is also consistent with the Legislature’s

2007 amendments to the Gross Receipts and Compensating Tax Act made after the Supreme

Court’s decision in Sonic Indus. v. State, 2006-NMSC-038, 140 N.M. 212. In Sonic Indus., the

New Mexico Supreme Court found that receipts under a franchise agreement were receipts from

selling property outside of New Mexico, not subject to gross receipts tax under the statutory

definitions applicable in 2006. See Sonic Indus. 2006-NMSC-038, ¶14. However, in an apparent

effort to subject receipts of licensing a franchise employed in New Mexico to gross receipts tax

despite the Sonic Indus. holding, the Legislature expressly added the franchise clause to the

definition of gross receipts tax under Section 7-9-3.5(A)(1). While Taxpayer argues that the 2007

definitional change to “property” meant that the Legislature did not intend to extend gross receipts

tax to the license of the trademark under a franchise agreement, this Legislative action of expressly

adding the distinct franchise clause to Section 7-9-3.5 (A)(1) separate from the property clauses of

that section clearly indicates its general intent to subject the licensing fees of a franchise employed

in New Mexico to gross receipts tax.

The remaining question is whether the Department erred in refusing to unbundle, for gross

receipts purposes, the grant of a license to use Taxpayer’s trademarks from other elements of the

Franchise Agreement. The Court of Appeals squarely addressed this unbundling issue in Sonic

In the Matter of A & W Restaurants, Inc., page 11 of 17.
Industs., Inc. v. State, 2000-NMCA-087, 129 N.M. 657. However, in overruling the Court of Appeals

on other grounds in Sonic Industs., Inc. v. State, 2006-NMSC-038, 141 P.3d 1266, the Supreme Court

determined it was unnecessary to address the issue of whether a franchisor’s licensing of its

trademarks to New Mexico franchisees were bundled elements of a taxable New Mexico grant of a

franchise. Consequently, the Supreme Court in Sonic, by neither affirming nor overruling the New

Mexico Court of Appeals on this specific question, the legal analysis of this particular issue by the

Court of Appeals remains undisturbed. See Sangre De Cristo Dev. Corp. v. City of Santa Fe, 84 N.M.

343, 348 (1972) (the general rule is that a case is not authority for a proposition it has not considered).

In Sonic Industs., Inc. v. State, 2000-NMCA-087, 129 N.M. 657, the Court of Appeals found

that the rights created by the subject franchise agreement consisted of a bundle of intangible,

intellectual property rights typically associated with franchises together with support services. Id. at

¶28. The Court of Appeals found that the rights and services transferred pursuant to the agreement

subject of that case were consistent with the traditional definition of a franchise.

In the protest at hand, Taxpayer is a business engaged in granting franchises employed in

New Mexico. According to the Franchise Agreement, it “has the exclusive right to operate and grant

licenses to others to operate, under the trademarks set forth in Appendix I (the “Trademarks”), a

system of restaurants that are uniform in their basic appearance and operation (the “A&W

Restaurants”)[.]” See Taxpayer’s Motion, Exhibit B, ¶A.

In addition to use of trademarks, the Franchise Agreement addresses numerous topics to

which a franchisee is required to adhere, including: the Taxpayer’s systems and procedures; the

purchases of equipment and supplies including food, paper products, furnishings, and fixtures;

adherence to building construction and maintenance standards; training; advertising and promotional

In the Matter of A & W Restaurants, Inc., page 12 of 17.
programs intended to enhance the collective success of all franchisees; record keeping and inspection

of the restaurant.

This arrangement clearly comes within the definition of “franchise” and is similar to the

agreement in Sonic in which the Court of Appeals determined that “a franchise is to be treated as a

compound or ‘bundled’ form of property, which typically includes a license to use franchiser’s

trademark[.]” Id. at ¶28. In that case, the Court of Appeals rejected claims that the Department was

required to break a franchise into its various components in order to determine the taxability of

franchise fees. Id. at ¶26. The Court of Appeals reasoning applies in this case as well. A “franchise” is

to be treated as a compound or “bundled” form of property which the Department is not required to

separate into various components to determine taxability of franchise fees.

In reviewing the entirety of the Franchise Agreement in this case, the effect of unbundling the

grant of a trademark from the remainder of the agreement is inconsistent with the purpose of the

Franchise Agreement. For example, the Franchise Agreement declares that the failure to pay any

royalty, including the continuing royalty fee at issue in this protest, is a breach and default which if

not cured, will result in the termination of the Franchise Agreement. See Taxpayer’s Motion, Exhibit

B, Sec. 17.1. If Taxpayer’s intended that the trademark license be unbundled from the rest of the

agreement, as it argued at the hearing on this matter, then the failure to pay the royalty fee would only

result in the revocation of the license to use the unbundled trademark while all other components of

the remaining bundle under the Franchise Agreement would remain undisturbed, largely to the

benefit of the defaulting franchisee. The result would be a restaurant operating as a franchise in every

way, but devoid of all trademarks of the franchisor and without having to pay for one of the essential

components of the agreements. This does not seem consistent with Taxpayer-franchisor’s intent in

In the Matter of A & W Restaurants, Inc., page 13 of 17.
entering into the agreement.

Taxpayer has engaged in the business of selling franchises employed in New Mexico. An

essential component of the franchise is a license to utilize the trademarks of the franchiser. The

trademarks provide a mechanism by which patrons will immediately recognize the service and goods

and associate those services and goods with the goodwill accompanying that trademark. As stated in

N.M. Taxation & Revenue Dep't v. Barnesandnoble.com LLC, 2012-NMCA-063, ¶29:

When a company acquires trademarks and goodwill, the essence of
what it obtains is the right to inform the public that it is in possession
of the special experience and skill symbolized by the name of the
original concern, and of the sole authority to market its products. The
value of what it obtains is tied to the underlying business that
generates the goodwill associated with the trademarks. If there is no
business and no good will, a trademark symbolizes nothing. Goodwill
is bound to the business with which it is associated, and can no more
be separated from a business than reputation from a person.

Contrast this with an alternative scenario which may be a better example of the intended

application of the exclusion for “licenses other than the licenses of copyrights, trademarks or patents”

from the definition of property in Section 7-9-3 (J) (2007). If Taxpayer sold a trademark license to a

manufacturer of t-shirts which then imprinted the trademark on a shirt which it sold, then use of that

trademark is not being conveyed as part of a franchise, but as a stand-alone transaction. Under

Section 7-9-3 (J), the exclusion for licenses of the trademark would apply and the Taxpayer receipts

from selling a trademark license would not be taxable as gross receipts because they are specifically

excluded from the definition of “property.” There is further support for this interpretation of Section

7-9-3 (J) (2007) when considering that this application harmonizes with NMSA 1978, Section 7-9-47

(1994), which provides a deduction for receipts from selling tangible personal property or licenses

when the buyer resells the tangible personal property or license either by itself or in combination with

In the Matter of A & W Restaurants, Inc., page 14 of 17.
other tangible personal property or licenses in the ordinary course of business.

In summary, returning to Section 7-9-3.5 (A) (1), there are separate clauses for the sale of a

service, the sale of property, and the sale of a license to use a franchise employed in New Mexico.

The application of the law described in the manner above is most consistent with the Legislature’s

use of the separate clauses contained in Section 7-9-3.5 (A) (1) of the sale of property and the sale of

a license to a franchise employed in New Mexico. While the definition of “property” under Section 7-

9-3 (J) certainly modifies that word for the sale of property clause under Section 7-9-3.5 (A) (1), it

does not modify the clause addressing franchise, as a trademark is an essential element of the bundle

of items that constitute a franchise. As the example above illustrates, the stand-alone sale of a

trademark does not constitute the sale of property under Section 7-9-3.5 (A) (1) in light of the

exclusion contained in Section 7-9-3 (J). But the sale of a license to use a franchise necessarily

includes the sale of the trademark, and thus the receipts from the license of the trademark under the

franchise agreement are subject to the gross receipts tax under Section 7-9-3.5 (A) (1)’s franchise

clause. This interpretation is not only consistent with the plain meaning of the term “franchise,” but

harmonizes the various provisions of the Gross Receipts and Compensating Tax Act, another favored

approach of statutory construction. Therefore, without any genuine dispute of material fact, the

Department is entitled to summary judgment as a matter of statutory construction and application of

law.

CONCLUSIONS OF LAW

A. Taxpayer filed a timely, written protest of the Department’s assessment and

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

In the Matter of A & W Restaurants, Inc., page 15 of 17.
B. Because, as the parties agreed during the summary judgment motion hearing, there

is no genuine dispute as to any material fact, summary judgment is appropriate in this matter. See

Romero v. Philip Morris, Inc., 2010-NMSC-035, ¶7, 148 NM 713.

C. Under NMSA 1978, Sec. 7-9-5 (2002), all of Taxpayer’s receipts in New Mexico

are presumed subject to New Mexico’s gross receipts tax.

D. Under NMSA 1978, Sec. 7-9-3.5 (2007), Taxpayer is obligated to pay gross

receipts on the total amount of money or value of other consideration received from granting a

right to use a franchise employed in New Mexico, including trademarks associated with the

franchise.

E. A franchise is to be treated as a compound or bundled form of property, which

includes a license to use Taxpayer’s trademarks. Sonic Industs., Inc. v. State, 2000-NMCA-087, 129

N.M. 657 (overruled on other grounds); Regulation 3.2.1.7 E NMAC.

F. The Department is not required to unbundle a franchise agreement for the purposes of

assessing gross receipt taxes.

For the foregoing reasons, Taxpayer’s protest is DENIED.

DATED: October 17, 2016

Brian VanDenzen
Chief Hearing Officer
Administrative Hearings Office
P.O. Box 6400
Santa Fe, NM 87502

In the Matter of A & W Restaurants, Inc., page 16 of 17.
NOTICE OF RIGHT TO APPEAL

Pursuant to NMSA 1978, Section 7-1-25 (2015), the parties have the right to appeal this

decision by filing a notice of appeal with the New Mexico Court of Appeals within 30 days of the

date shown above. See Rule 12-601 NMRA. If an appeal is not filed within 30 days, this Decision

and Order will become final. Either party filing an appeal shall file a courtesy copy of the appeal

with the Administrative Hearings Office contemporaneous with the Court of Appeals filing so that

the Administrative Hearings Office may being preparing the record proper.

In the Matter of A & W Restaurants, Inc., page 17 of 17.