Must a New Mexico medical-cannabis producer apply federal Section 280E when computing state corporate income tax for pre-2021 years?

Plain-English summary

New Mexicann Natural Medicine won full abatement of a $401,126.50 corporate income tax assessment based entirely on federal Internal Revenue Code Section 280E. The licensed New Mexico producer grew and sold medical cannabis and derivatives to qualified patients under the Lynn and Erin Compassionate Use Act.

For 2010–2016, the Department assessed:

• $313,315 corporate income tax;
• $58,242.70 penalty; and
• $29,568.80 interest.

The audit had no significant adjustment other than Section 280E. At the federal level, Section 280E bars deductions and credits for expenses incurred in a business trafficking in Schedule I or II controlled substances. Cannabis businesses may account for cost of goods sold, but expenses such as rent, utilities, payroll, depreciation, losses, and many other ordinary business costs are generally disallowed federally.

The Department argued that New Mexico corporate tax began with federal “taxable income,” so the federal 280E disallowance necessarily increased the taxpayer's New Mexico base income. Hearing Officer Chris Romero disagreed.

New Mexico's cannabis policy supplied a different context

The Compassionate Use Act made the production, packaging, and dispensing of medical cannabis lawful and regulated in New Mexico. It was intended to allow beneficial use for debilitating medical conditions. The Court of Appeals' Sacred Garden decision had also described affordability and access to treatment as part of that legislative purpose when applying a medical-cannabis gross-receipts deduction.

The hearing officer reasoned that denying ordinary business deductions at the state level solely because federal law treated cannabis differently would increase producers' costs, disadvantage them against other lawful medical businesses, and undermine the state Legislature's accessibility policy.

“Unless the context requires otherwise” allowed flexibility

Section 7-2A-2 defined corporate base income by reference to federal taxable income, but its definitions were introduced with “unless the context requires otherwise.” The decision treated licensed medical-cannabis activity as the unusual context in which a mechanical federal starting point would frustrate New Mexico legislative intent and produce an incoherent result.

The 2021 amendment made the state rule explicit

The Cannabis Regulation Act amended Section 7-2A-2(C) to exclude from base income an amount equal to otherwise federally deductible expenditures disallowed by Section 280E. Although enacted after the audited periods, the hearing officer viewed this as a clarification consistent with the policy already recognized in Sacred Garden, rather than a new reversal of policy.

Accordingly, the Department should omit Section 280E from the New Mexico base-income computation for this taxpayer and these periods. Because the 280E adjustment was the only significant audit basis, the entire assessment fell.

Result: protest GRANTED; tax, penalty, and interest fully ABATED; amounts paid ordered REFUNDED.

What this means for you

Federal 280E and New Mexico corporate income tax were not treated identically

D&O 22-07 rejected automatic adoption of the federal expense disallowance for the pre-2021 medical-cannabis periods before it. The decision relied on New Mexico-specific statutory context and policy.

The federal rule still affected the federal return

The decision did not invalidate Section 280E or allow federal deductions. It concerned how New Mexico calculated state base income after the federal computation.

Cost of goods sold is different from a deduction under 280E

Even federal 280E generally permits cannabis businesses to reduce gross receipts by cost of goods sold. The disputed assessment arose from disallowing ordinary and necessary expenses beyond COGS.

State-law purpose can matter when a definition imports federal tax concepts

The hearing officer used the phrase “unless the context requires otherwise” to reconcile the corporate tax statute with the Compassionate Use Act instead of treating federal taxable income as inflexible.

Later legislation expressly addressed the issue

The 2021 statute quoted in the decision explicitly removed otherwise federally deductible 280E expenses from New Mexico base income. For any current or later period, verify the operative version and its application rather than relying only on this 2010–2016 administrative decision.

Common questions

Q: Did the taxpayer have to apply Section 280E on its federal return?
A: The decision recognized the federal rule. The win concerned New Mexico corporate base income, not federal tax liability.

Q: What expenses had the Department disallowed?
A: It disallowed ordinary and necessary business expenses beyond cost of goods sold solely because of Section 280E. The audit identified no other significant adjustment.

Q: Why did the hearing officer reject the federal starting point?
A: He found that strict adoption would conflict with New Mexico's policy of lawful, regulated, accessible medical cannabis and that Section 7-2A-2 allowed context-sensitive application.

Q: What did Sacred Garden contribute?
A: It interpreted New Mexico's medical-cannabis and tax statutes harmoniously and recognized affordability and access to treatment as legislative objectives. D&O 22-07 applied that reasoning to corporate income tax.

Q: What happened to the $401,126.50 assessment?
A: It was abated in full, including tax, penalty, and interest, and the decision ordered any amounts already paid toward it refunded.

Q: Can another cannabis business rely on D&O 22-07?
A: No. This is an administrative decision for one taxpayer and 2010–2016 periods. Later statutory language may govern another taxpayer's years directly.

Citations and references

Statutes:

• 26 U.S.C. § 280E — federal disallowance of deductions and credits for a business trafficking in Schedule I or II controlled substances
• 26 U.S.C. § 162(a) — ordinary and necessary business expenses discussed as subject to the federal disallowance
• NMSA 1978, § 7-2A-2(C) (2017, amended 2021) — corporate base income and the “unless the context requires otherwise” language
• NMSA 1978, § 7-2A-2(C)(4) (2021) — exclusion for otherwise federally deductible expenditures disallowed by Section 280E
• NMSA 1978, §§ 26-2A-2 and 26-2B-4(F) — Compassionate Use Act purpose and protection of licensed producers
• NMSA 1978, § 7-9-73.1(A) (2021) — medical-cannabis gross-receipts deduction discussed through Sacred Garden
• NMSA 1978, §§ 7-1-17 and 7-1-3(X) — assessment presumed correct; “tax” includes penalty and interest
• NMSA 1978, §§ 7-1B-6 and 7-1B-8 — hearing procedure and timing
• NMSA 1978, § 7-1-25 — right to appeal the decision

Cases:

• Sacred Garden, Inc. v. New Mexico Taxation & Revenue Department, 2021-NMCA-038, 495 P.3d 576, certiorari quashed Feb. 23, 2022 — harmonized medical-cannabis and tax statutes and discussed accessibility and affordability
• Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. 173 (2007) — federal Section 280E and “trafficking” through regular commercial activity
• Holt v. New Mexico Department of Taxation & Revenue, 2002-NMSC-034 — federal taxable income as a starting point and Department authority to examine the proper state liability
• Chavez v. Commissioner of Revenue, 1970-NMCA-116 — fair construction that furthers legislative intent and public interests
• Sutin, Thayer & Browne v. Revenue Division, 1985-NMCA-047 — deductions as legislative grace used to achieve policy objectives

Source

• Listing: New Mexico Decisions & Orders
• Decision post: New Mexican Natural Medicine Inc
• Decision PDF: D&O 22-07

Original ruling text

1 STATE OF NEW MEXICO
2 ADMINISTRATIVE HEARINGS OFFICE
3 TAX ADMINISTRATION ACT

4 IN THE MATTER OF THE PROTEST OF
5 NEW MEXICANN NATURAL MEDICINE INC.
6 TO ASSESSMENT ISSUED UNDER
7 LETTER ID NO. L0228859696

8 v. AHO Case Number 18.12-327A, D&O 22-07

9 NEW MEXICO TAXATION AND REVENUE DEPARTMENT

10 DECISION AND ORDER
11 GRANTING SUMMARY JUDGMENT FOR TAXPAYER

12 This matter came before the Administrative Hearings Office, Hearing Officer Chris

13 Romero, Esq., upon the competing motions for summary judgment in the protest of New

14 Mexicann Natural Medicine, Inc (“Taxpayer”) pursuant to the Tax Administration Act and the

15 Administrative Hearings Office Act. Taxpayer is represented by Mr. Lewis Terr, Esq. The

16 Taxation and Revenue Department (“Department”) is represented by Mr. Richard Pener, Esq.

17 Taxpayer filed Taxpayer’s Motion for Summary Judgment (“Motion”) on February 25,

18 2019. The Department filed New Mexico Department of Taxation and Revenue’s Response to

19 New Mexicann Natural Medicine, Inc.’s Motion for Summary Judgment and Cross Motion and

20 Memorandum in Support of Cross Motion for Summary Judgment on March 1, 2019.

21 Although a hearing on the motion was held on April 30, 2019, the Hearing Officer

22 delayed issuing this decision anticipating that a final decision in Sacred Garden, Inc. v. New

23 Mexico Taxation & Revenue Dep't, 2021-NMCA-038, ¶17, 495 P.3d 576, 580, cert. quashed

24 Sacred Garden v. Taxation, No. S-1-SC-38164 (Feb. 23, 2022) would be valuable to the issues

25 now under consideration. The New Mexico Court of Appeals published its formal opinion in

26 Sacred Garden, Inc. v. New Mexico Taxation & Revenue Dep't, 2021-NMCA-038, 495 P.3d 576

27 on January 28, 2020. The New Mexico Supreme Court granted a writ of certiorari on March 29,

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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1 2021 in No. S-1-SC-38164. However, on February 23, 2022, the New Mexico Supreme

2 Court quashed its writ of certiorari as improvidently granted and ordered that a mandate

3 immediately issue.

4 The legal issue presented concentrates on whether New Mexico is either required or

5 permitted to apply 26 U.S.C. Section 280E (hereafter “Section 280E”) in disallowing

6 certain business deductions in the computation of New Mexico income tax. Because the

7 Hearing Officer concludes that application of Section 280E contradicts the intentions of

8 the Legislature under New Mexico law, Taxpayer’s motion and protest should be granted.

9 The Department’s motion should be denied. IT IS DECIDED AND ORDERED AS

10 FOLLOWS:

11 FINDINGS OF FACT

12 1. Taxpayer was incorporated in New Mexico on August 31, 2009 and began

13 business in New Mexico the same year. Taxpayer produces cannabis for medical use in New

14 Mexico and sells it as well as various derivatives to qualified patients. [Cross Motion and

15 Response (Affidavit of Theresa Root, Para. 5 (a))]

16 2. Taxpayer operates its business under the authority of the Lynn and Erin

17 Compassionate Use Act, NMSA 1978, Chapter 26, Article 2B (“Compassionate Use Act”). [Cross

18 Motion and Response]

19 3. On July 19, 2018, the Department issued a Notice of Assessment of Taxes and

20 Demand for Payment in the amount of $401,126.50 comprised of corporate income taxes in the

21 amount of $313,315.00, penalty in the amount of $58,242.70, and interest in the amount of

22 $29,568.80 for the corporate income tax periods from December 31, 2010 to December 31, 2016

23 (“Assessment”). [Administrative File]

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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1 4. The Assessment derived from an audit of the Taxpayer conducted by the

2 Department. [Cross Motion and Response (Affidavit of Theresa Root, Para. 5 (b)]

3 5. The Department’s audit concluded that Taxpayer understated its taxable income

4 because it had deducted from its gross income ordinary and necessary business expenses which

5 should have been disallowed under 26 U.S.C. 280E. [Motion (Undisputed Fact No. 3)]

6 6. The audit report noted no other bases for adjustments to Taxpayer’s reported

7 taxable income other than those resulting from its deduction of business expenses that would

8 have been allowable but for the Department’s application of 26 U.S.C. Section 280E. [Motion

9 (Undisputed Fact No. 4)]

10 7. If the auditor had not disallowed deductions from gross income for all ordinary

11 and necessary business expenses taken by the taxpayer in arriving at its taxable income, the audit

12 would not have resulted in any significant adjustments to the tax due for the tax periods covered

13 by the audit. [Motion (Undisputed Fact No. 22)]

14 8. The Department concluded: “For the tax year 2010, Taxpayer reported a New

15 Mexico Net Operation Loss (‘NOL’) carryforward from the previous year. It was found in the

16 review of the tax year 2009 lookback period that Taxpayer’s reported loss consisted solely of

17 business expenses other than cost of goods sold (‘COGS’). COGS is the only allowable expense

18 deduction that can be taken by a business in the cannabis industry as mandated by Title 26

19 Federal Revenue Code (‘IRC’) § 280E. Taxpayer’s misreported NOL deduction in tax year 2009

20 affected the subsequent years’ NOL carryover amounts. Taxpayer also understated its Federal

21 Taxable Income (CIT-1 line 1, Fed 1120, line 28 for the tax years 2010 through 2016 as a result

22 of deducting business expenses [other than COGS].” [Cross Motion and Response (Affidavit of

23 Theresa Root, Para. 5(d))]

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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1 9. The Department concluded: “For the tax years 2010, 2011, 2012, 2013, 2014,

2 2015, and 2016, Taxpayer took a combined deduction for COGS on its federal tax returns of

3 $6,217,794 and the Department, after adjustments, allowed a combined deduction for COGS on

4 Taxpayer’s New Mexico corporate tax returns of $6,447,470.” [Cross Motion and Response

5 (Affidavit of Theresa Root, Para. 5(e))]

6 10. The Department concluded: “For the tax years 2010, 2011, 2012, 2013, 2014,

7 2015, and 2016, Taxpayer deducted the following amounts of business expenses (in excess of

8 COGS) on its federal [corporate income tax] returns to arrive at its taxable income: 2010:

9 $296,480; 2011: $488,190; 2012: $309,491; 2013: $469,375; 2014: $720,661; 2015: $1,383,798;

10 2016: $1,838,823. [Cross Motion and Response (Affidavit of Theresa Root, Para. 5(g))]

11 11. The Department disallowed all of Taxpayer’s claimed ordinary and necessary

12 business expense deductions for the tax years 2010, 2011, 2012, 2013, 2014, 2015, and 2016,

13 finding that they should not have been permitted pursuant to 26 U.S.C. Section 280E. [Cross

14 Motion and Response (Affidavit of Theresa Root, Para. 5(h))]

15 12. On October 12, 2018, Taxpayer filed a timely protest of the Assessment with the

16 Department’s Protest Office, which was accompanied by a Tax Information Authorization (TIA)

17 form. [Administrative File]

18 13. On November 7, 2018, the Department acknowledged Taxpayer’s protest under

19 Letter ID No. L1698541744. [Administrative File]

20 14. On December 20, 2018, the Department submitted a Hearing Request to the

21 Administrative Hearings Office in which it requested that the protest be set for a hearing.

22 [Administrative File]

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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1 15. On December 21, 2018, the Administrative Hearings Office entered a Notice of

2 Telephonic Scheduling Hearing that set an initial scheduling hearing on January 11, 2019.

3 [Administrative File]

4 16. On January 11, 2019, the Administrative Hearings Office entered an Order

5 Allowing Withdrawal [and Substitution] of Counsel, permitting Taxpayer’s current counsel of

6 record to substitute for its previous attorney. The Administrative Hearings Office also entered a

7 Scheduling Order and Notice of Administrative Hearing which set a hearing on the merits of

8 Taxpayer’s protest for August 27, 2019 and a hearing on any dispositive motion for April 30,

9 2019. [Administrative File]

10 17. On February 25, 2019, Taxpayer filed Taxpayer’s Motion for Summary Judgment

11 which was accompanied by a Memorandum in Support of Motion for Summary Judgement

12 (“Motion”). [Administrative File]

13 18. On March 1, 2019, the Department filed New Mexico Department of Taxation

14 and Revenue’s Response to New Mexicann Natural Medicine, Inc.’s Motion for Summary

15 Judgment and Cross Motion and Memorandum in Support of Cross Motion for Summary

16 Judgment (“Cross Motion and Response”). [Administrative File]

17 19. On March 6, 2019, Taxpayer filed a Stipulated Motion to Extend Time for Reply

18 to Department’s Response to Motion for Summary Judgment and to Respond to Cross Motion

19 for Summary Judgment. [Administrative File]

20 20. On March 27, 2019, Taxpayer filed its Reply to Response to Summary Judgment

21 and Response to Cross Motion for Summary Judgment. [Administrative File]

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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1 21. On April 5, 2019, the Administrative Hearings Office entered a Notice of

2 Reassignment of Hearing Officer which reassigned the matter from the Chief Hearing Officer of

3 the Administrative Hearings Office to the undersigned. [Administrative File]

4 22. A hearing on the Motion and Cross Motion and Response was held on April 30,

5 2019. [Administrative File; Record of Hearing 4/30/2019]

6 23. On August 1, 2019, the parties filed a Joint Motion to Continuance in which they

7 requested that the merits hearing be continued pending any determination regarding their

8 motions. [Administrative File]

9 24. On August 6, 2019, the Administrative Hearings Office entered an Order

10 Vacating Merits Hearing Pending Determination of Pending Motions for Summary Judgment.

11 [Administrative File]

12 DISCUSSION

13 Because the issue presented centers on a question of law, and there are no disputed material

14 facts, both parties moved for summary judgment. In controversies involving a question of law, or

15 application of law where there are no disputed facts, summary judgment is appropriate. See

16 Koenig v. Perez, 1986-NMSC-066, ¶10-11, 104 N.M. 664. If the movant for summary judgment

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

18 to the opposing party to show evidentiary facts that would require a trial on the merits. See Roth

19 v. Thompson, 1992-NMSC-011, ¶17, 113 N.M. 331.

20 The material facts presented by this protest are not in dispute. Taxpayer is engaged in the

21 business of producing, packaging, and dispensing medical cannabis, an activity that during all times

22 relevant to the protest has been legal under the Lynn and Erin Compassionate Use Act, NMSA

23 1978, Chapter 26, Article 2B (“Compassionate Use Act”), the purpose of which “is to allow the

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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1 beneficial use of medical cannabis in a regulated system for alleviating symptoms caused by

2 debilitating medical conditions and their medical treatments.” See NMSA 1978, Section 26-2A-2

3 (2007)

4 Presumption of Correctness

5 Pursuant to NMSA 1978, Section 7-1-17 (C) (2007), the Assessment of tax issued in this

6 case is presumed correct and unless otherwise specified, for the purposes of the Tax

7 Administration Act, “tax” includes interest and civil penalty. See NMSA 1978, Section 7-1-3 (X)

8 (2013). Therefore, under Regulation 3.1.6.13 NMAC, the presumption of correctness under

9 Section 7-1-17 (C) also extends to the Department’s assessment of penalty and interest. See

10 Chevron U.S.A., Inc. v. State ex rel. Dep’t of Taxation & Revenue, 2006-NMCA-050, ¶16, 139

11 N.M. 498, 134 P.3d 785 (agency regulations interpreting a statute are presumed proper and are to be

12 given substantial weight).

13 As a result, the presumption of correctness in favor of the Department requires that

14 Taxpayer carry the burden of presenting countervailing evidence or legal argument to establish

15 entitlement to abatement of the Assessment. See N.M. Taxation & Revenue Dep’t v. Casias

16 Trucking, 2014-NMCA-099, ¶8, 336 P.3d 436. “Unsubstantiated statements that [an] assessment

17 is incorrect cannot overcome the presumption of correctness.” See MPC Ltd. v. N.M. Taxation &

18 Revenue Dep’t, 2003-NMCA-021, ¶13, 133 N.M. 217, 62 P.3d 308; See also Regulation 3.1.6.12

19 NMAC. If a taxpayer presents sufficient evidence to rebut the presumption, then the burden

20 shifts to the Department to re-establish the correctness of the assessment. See MPC, 2003-

21 NMCA-021, ¶13.

22 Since the central issue in dispute relates to the claim for business deductions, Taxpayer

23 bears the burden of establishing entitlement to a clearly and unambiguously expressed statutory

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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1 deduction. See TPL, Inc. v. N.M. Taxation & Revenue Dep't, 2003-NMSC-007, ¶9, 133 N.M.

2 447, 64 P.3d 474. Tax statutes must also be given “fair, unbiased, and reasonable construction,

3 without favor or prejudice to either the taxpayer or the [s]tate, to the end that the legislative

4 intent is effectuated and the public interests to be subserved thereby are furthered.” See Chavez v.

5 Comm'r of Revenue, 1970-NMCA-116, ¶7, 82 N.M. 97, 476 P.2d 67.

6 Application of 26 U.S.C. Section 280E

7 The central issue of this protest is the application of Section 280E in the computation of

8 Taxpayer’s New Mexico income tax liability.

9 At the federal level, Section 280E prohibits a Taxpayer and other similarly situated

10 businesses from taking deductions and claiming credits on their federal income taxes for any

11 amounts paid or incurred in “trafficking1” in controlled substances. See Californians Helping to

12 Alleviate Med. Problems, Inc. v. Comm’r, 128 T.C. 173, 182 (2007) (“Section 280E and its

13 legislative history express a congressional intent to disallow deductions attributable to a trade or

14 business of trafficking in controlled substances.”). Although Section 280E does not define

15 “trafficking,” courts in this context have interpreted the term to mean “engaging in a commercial

16 activity—that is, to buy and sell regularly.” Id.

17 A sampling of the categories of deductions precluded include “ordinary and necessary”

18 business expenses under IRC Section 162(a), state and local taxes under IRC Section 164, losses

19 under IRC Section 165, and depreciation under IRC Section 167. Even charitable contributions

20 incurred “in carrying on” the business of trafficking marijuana have been held nondeductible.

21 See Wellness v. Comm'r of Internal Revenue, 156 T.C. 62 (2021). As a result, businesses

1
The Hearing Officer acknowledges that the term, “trafficking,” may be perceived as suggesting criminal activities.
The Hearing Officer does not intend for use of that term in this Decision and Order to imply such meaning with
respect to Taxpayer (or any other similarly situated business). Use of the term, “trafficking,” is merely intended to
correspond with the language used in Section 280E.

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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1 lawfully engaged in the commercial activity at the state level of regularly buying or selling

2 cannabis are prohibited from “writing off” many of their operating expenses and overhead costs

3 including rent, utilities, and payroll expenses for federal income tax purposes because of their

4 status under federal law.

5 In this protest, Taxpayer perceives the Department as improperly applying Section 280E

6 in the computation of Taxpayer’s “base income” as defined by Section 7-2A-2 (C) (2017,

7 Amended 2021). In other words, the Department assumes the same position as the Internal

8 Revenue Service under Section 280E regarding taxation of businesses in the medical cannabis

9 sector despite the fact that New Mexico law and federal law view the activity in stark contrast to

10 one another.

11 Understandably, the Department does not see the issue through the same lens. The

12 Department asserts that it is required by statute to determine “base income” with reference to

13 “taxable income” as determined by a taxpayer’s federal corporate income tax return. It cites

14 NMSA 1978, Section 7-2A-2 (C) (2017, Amended 2021) which explains in relevant part:

15 C. “base income” means that part of the taxpayer’s income defined
16 as taxable income and upon which the federal income tax is
17 calculated in the Internal Revenue Code for income tax purposes
18 plus [other enumerated items.]

19 [Emphasis Added]

20 As such, the Department relies on the longstanding method of calculating state income

21 tax by beginning with the income upon which a taxpayer must pay tax to the federal government.

22 See Holt v. New Mexico Dept. of Taxation & Revenue, 2002-NMSC-034, ¶9, 133 N.M. 11, 13,

23 59 P.3d 491, 493; Champion Int'l Corp. v. Bureau of Revenue, 1975-NMCA-106, ¶39, 88 N.M.

24 411, 416, 540 P.2d 1300, 1305.

25 It asserts that the starting point for state taxation begins with “base income,” as calculated

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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1 under the requirements of the Internal Revenue Code. For that reason, “base income” will

2 incorporate applicable deductions for “all the ordinary and necessary expenses paid or incurred

3 during the taxable year in carrying on any trade or business” under 26 U.S.C Section 162 (a) with

4 adjustment for the application of Section 280E when deemed to apply.

5 Despite the broad prohibitions established by Section 280E, it does not prevent cannabis

6 businesses from reducing gross receipts by the cost of goods sold (“COGS”) when computing

7 their federal income tax liability.2 COGS generally refers to “expenditures necessary to acquire,

8 construct or extract a physical product which is to be sold.” See Reading v. Comm’r, 70 T.C.

9 730, 733 (1978), aff’d, 614 F.2d 159 (8th Cir. 1980). “A taxpayer derives COGS using the

10 following formula: beginning inventories plus current-year production costs (in the case of a

11 producer) or current-year purchases (in the case of a reseller) less ending inventories.” See FN2

12 It is within this setting that the Department rejected Taxpayer’s claim for deductions for

13 ordinary and necessary business expenses explaining that the New Mexico Legislature had not

14 provided for such deductions, and for that reason, it was obligated to strictly adhere to Section

15 280E in the same manner as the IRS. The Department’s audit narrative (attached as Exhibit A,

16 Page 3, to the Affidavit of Theresa Root) explained:

17 NM Corporate Income Tax statutes and regulations follow the
18 Federal Internal Revenue Code (IRC) set by the Federal Treasury
19 Department, Internal Revenue Service (IRS). No deviations from
20 the IRC have been made in the Department statutes or regulations
21 relative to the treatment of the deductions for illegal activities that
22 would affect the treatment of the facts in this audit.

23 Therefore, the Department concluded, “[Taxpayer] failed to appropriately apply Title 26

24 IRC §280 (E) to all years included under audit” by deducting from its gross income expenses that

25 should have been excluded by Section 280E. Therefore, the Department asserts that Taxpayer’s

2
https://www.irs.gov/businesses/small-businesses-self-employed/marijuana-industry-frequently-asked-questions

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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1 “base income” should be adjusted to reflect the disallowance of deductions for ordinary and

2 necessary business expenses prohibited by Section 280E, along with other expenses which it

3 determined were inappropriately included in the computation of costs of goods sold. The result

4 of the disallowance increases Taxpayer’s “base income” and associated income tax, leading to

5 the disputed Assessment at issue in this protest.

6 The referenced provision of the Internal Revenue Code, Section 280E, specifies:

7 No deduction or credit shall be allowed for any amount paid or
8 incurred during the taxable year in carrying on any trade or
9 business if such trade or business (or the activities which comprise
10 such trade or business) consists of trafficking in controlled
11 substances (within the meaning of schedule I and II of the
12 Controlled Substances Act) which is prohibited by Federal law or
13 the law of any State in which such trade or business is conducted.

14 Notwithstanding the prohibition of medical cannabis under federal law, New Mexico has

15 legislatively legalized and legitimized the production, packaging, and dispensing of medical

16 cannabis under the Compassionate Use Act. Yet, the Department claims, “[t]he fact that

17 Taxpayer produces and sells medical marijuana is irrelevant for purposes of I.R.C. § 280E.”

18 In light of direction from the New Mexico Court of Appeals and the New Mexico

19 Supreme Court’s recent quashing of its writ of certiorari in Sacred Garden, the Hearing Officer

20 does not agree that the legalization (or decriminalization) of medical cannabis in New Mexico is

21 irrelevant for the purposes of Section 280E because to do so disregards the intentions of the

22 Legislature when it enacted the Compassionate Use Act.

23 Well-established principles of statutory construction guide the interpretation of state tax

24 laws in which the primary goal is “to give effect to the intent of the [L]egislature.” See Dell

25 Catalog Sales L.P. v. N.M. Taxation & Revenue Dep't, 2009-NMCA-001, ¶19, 145 N.M. 419,

26 199 P.3d 863. Legislative intent is fulfilled “by first looking at the plain meaning of the language

27 of the statute, reading the provisions ... together to produce a harmonious whole.” Id.; Sundance

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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1 Mech. & Util. Corp. v. Armijo, 1987-NMSC-078, ¶5, 106 N.M. 249, 250, 741 P.2d 1370, 1371.

2 Despite its status under federal law, Taxpayer engages in a permissible business activity

3 under the authority of the Compassionate Use Act which “was expressly intended ‘to allow the

4 beneficial use of medical cannabis in a regulated system for alleviating the symptoms caused by

5 debilitating medical conditions and their medical treatments.’” See NMSA 1978, Section 26-2A-2

6 (2007); Sacred Garden, Inc. v. New Mexico Taxation & Revenue Dep't, 2021-NMCA-038, ¶17,

7 495 P.3d 576, 580, cert. quashed Sacred Garden v. Taxation, No. S-1-SC-38164 (Feb. 23, 2022).

8 In Sacred Garden, the Court of Appeals said, “the Compassionate Use Act was intended

9 to make medical marijuana accessible to those with debilitating medical conditions who might

10 benefit from the use thereof.” Id. In evaluating whether a similarly situated taxpayer could obtain

11 the benefit of a gross receipts tax deduction reserved for prescription drugs, the Court of Appeals

12 observed that, “[i]t is reasonably self-evident that the deduction from gross receipts for

13 prescription drugs was similarly intended to make medical treatment more accessible, by

14 lessening the expense to those who require it. These statutes should be read harmoniously, to

15 give effect to their commonality of purpose.” Id. Although this observation was directed to a

16 deduction from gross receipts under the Gross Receipts and Compensating Tax Act, the same

17 logic applies in the present case. Sacred Garden observed that affordability was a key

18 component of the Legislature’s intentions, emphasizing, “it is noteworthy that the financial

19 impact report issued in association with the Compassionate Use Act did not contemplate that any

20 tax revenue would be generated thereby.” See Sacred Garden, Inc., 2021-NMCA-038, ¶16.

21 If pursuant to the observation made in Sacred Garden that affordability was a key

22 component of the Legislature’s intent, then the Department’s proposed application of Section

23 280E to prohibit deduction of medical cannabis business expenses simply because of its status

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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1 under federal law surely contradicts those intentions. Refusing Taxpayer the benefits of income

2 tax deductions commonly allowed for other, “traditional” forms of business increase Taxpayer’s

3 costs which ultimately get passed on to the consumer in the form of a higher price, which is the

4 result the Legislature, according to Sacred Garden, wanted to avoid.

5 Despite the Department’s perception that the application of Section 280E is unyielding, a

6 close review of the introductory paragraphs of NMSA 1978, Sections 7-2-2 and 7-2A-2 (defining

7 “base income” for purposes of the Income Tax Act and the Corporate Income and Franchise Tax

8 Act) reveal that the Legislature intended to allow some reasonable flexibility and discretion

9 depending on the circumstances presented. Both sections state with concern for all the defined

10 terms that follow, including the definitions of “base income” that:

11 For the purpose of the [Income Tax Act and Corporate Income and
12 Franchise Tax Act] and unless the context requires otherwise[…]

13 [Emphasis Added]

14 This simple phrase, clear and unambiguous, and perhaps easily overlooked, exemplifies

15 the Legislature’s intention to avoid absurd results. Conversely stated, it signifies the desire that

16 none of the terms be inflexibly construed when a literal construction under some circumstances

17 would contradict the Legislature’s intentions. See Quintero v. N.M. Dept. of Transp., 2010-

18 NMCA-081, ¶13, 148 N.M. 903, 906, 242 P.3d 470, 473 (observing that a similar phrase,

19 “unless the context otherwise requires,” is used to acknowledge that certain factual situations

20 will not come within the literal language of a statute.)

21 Continuing with the analysis, it would be clearly contradictory to the Legislature’s

22 intention to permit a deduction from gross receipts on one hand, for the reasons the Court of

23 Appeals found reasonably self-evident in Sacred Garden, yet deny Taxpayer and other similarly

24 situated businesses the benefits of deducting ordinary and necessary business expenses for

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
Page 13 of 22
1 income tax purposes on the other. The results would be that the increased tax burden on one end

2 would consume the benefits provided on the other. This construction fails to produce a

3 “harmonious whole” and leads to absurd results whereby the Legislature’s intentions, as

4 recognized in Sacred Garden, are not effectuated, but instead trampled; where the public

5 interests to be subserved thereby are not furthered (evoking Chavez, 1970-NMCA-116, ¶7).

6 Instead, the scenario now at hand represents the sort of unique circumstances the

7 Legislature contemplated when it permitted the Department to deviate from its definitions by use

8 of the exception, “unless the context requires otherwise” to regard Taxpayer as it would other

9 traditional forms of businesses, such as, for example, pharmacies as seen in Sacred Garden.

10 In another example illustrative of the Legislature’s intent, the Compassionate Use Act, at

11 NMSA 1978, Section 26-2B-4 (F) (2007, amended 2019, 2021) provides that, “A licensed

12 producer shall not be subject to … penalty, in any manner, for the production, possession,

13 distribution or dispensing of cannabis pursuant to the Lynn and Erin Compassionate Use Act.”

14 This language not only embodies the intentions of the Legislature that no criminal or civil

15 penalties be imposed on licensed producers engaging in business under the Compassionate Use

16 Act, but that they be viewed analogous with any other “traditional” business.

17 Although strict application of Section 280E may not technically be perceived as a penalty

18 as seen in cases such as N. California Small Bus. Assistants Inc. v. Comm'r of Internal Revenue,

19 153 T.C. 65, 68 (2019), its strict application to Taxpayer under New Mexico law sets it apart

20 from other businesses engaged in lawful business activity. Indeed, application of Section 280E

21 places Taxpayer at a disadvantage to the extent it denies the benefit of common tax deductions

22 which will increase its state income tax liability based solely on how it is perceived under federal

23 law despite engaging in “the production, possession, distribution or dispensing of cannabis,”

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
Page 14 of 22
1 activities that have long been permissible under the Compassionate Use Act in New Mexico. Id.

2 As previously observed, federal law and state law view Taxpayer’s business activities in

3 stark contrast to one another. However, the fact that the IRS views the activity contrarily does

4 not circumvent the will of the New Mexico Legislature which is entitled to establish a different

5 policy for New Mexico, “to make medical marijuana accessible to those with debilitating

6 medical conditions who might benefit from the use thereof.”

7 “Federal or state deductions are a matter of legislative grace and a way of achieving

8 policy objectives.” See Sutin, Thayer & Browne v. Revenue Div. of Taxation & Revenue Dept.,

9 1985-NMCA-047, ¶17, 104 N.M. 633, 636, 725 P.2d 833. As observed by the Court of Appeals

10 in Sacred Garden, the policy objective of the Compassionate Use Act is readily apparent and

11 encompasses the intent to minimize costs to those who could benefit from the use of medical

12 cannabis. Omitting Section 280E from the computation of Taxpayer’s New Mexico state income

13 tax liability promotes the Legislature’s objective and is consistent with the discretion afforded to

14 the Department to consider its definitions within the context of the given circumstances. For this

15 reason, Taxpayer’s protest should be granted.

16 At this time, it is notable that the New Mexico Legislature passed the Cannabis

17 Regulation Act during its first special session3 of 2021. It was signed by the governor of the State

18 of New Mexico on April 12, 2021 and became effective on June 29, 2021. Among various other

19 enactments, including the legalization of recreational adult-use cannabis, it amended the

20 definition of “base income” in NMSA 1978, Sections 7-2-2 and 7-2A-2 to explicitly exclude “an

21 amount equal to any expenditure that is eligible to be claimed as a federal income tax deduction

22 but is disallowed pursuant to Section 280E of the Internal Revenue Code[.]” See NMSA 1978,

3
See https://www.governor.state.nm.us/wp-content/uploads/2021/12/House-Executive-Message-1-Proclamation.pdf

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
Page 15 of 22
1 Section 7-2-2 (B) (5) (2021); NMSA 1978, Section 7-2A-2 (C) (4) (2021); 2021 New Mexico

2 Laws 1st Sp. Sess. Ch. 4 (H.B. 2).

3 Given that the same bill clarified the application of NMSA 1978, Section 7-9-73.24

4 consistent with the court’s ruling in Sacred Garden, the Hearing Officer perceives the

5 amendment to “base income” in a similar light – that is, to clarify the existing law consistent

6 with the purpose expounded by Sacred Garden, rather than change it. See Aguilera v. Bd. of

7 Educ. of Hatch Valley Sch., 2006-NMSC-015, ¶ 20, 139 N.M. 330, 335, 132 P.3d 587, 592

8 (Changing a definition is “[s]uch a modest step [that it] is not usually a harbinger of radical

9 change.”)

10 The Hearing Officer will emphasize that “base income” is the figure from which the

11 computation of New Mexico income tax begins. The various mathematical processes for

12 computing that figure may vary from taxpayer to taxpayer but should always result in a

13 computation that accurately reflects the taxpayer’s federal tax obligation, but from which the

14 Department possesses the latitude to deviate when necessary. See Holt, 2002-NMSC-034, ¶22

15 (“Department has the authority to examine records in order to determine the extent of the

16 taxpayers’ liability[.]”). Under the facts of this protest, that authority to deviate derives from the

17 discretion provided by Section 7-2A-2, the Compassionate Use Act, as well as Holt which

18 recognized the Department’s authority to make an independent evaluation of a taxpayer’s

19 liability despite whatever information the taxpayer reported to the federal tax authorities.

20 For the reasons stated, Taxpayer’s protest is GRANTED.

4
The 2021 enactment of the Cannabis Regulation Act codified the ruling of the New Mexico Court of Appeals in
Sacred Garden by inserting the italicized language in the following quotation which was not previously explicit in
the statute. See NMSA 1978, Section 7-9-73.1 (2007). It now reads, “Receipts from the sale of prescription drugs
and oxygen and oxygen services provided by a licensed medicare durable medical equipment provider and cannabis
products that are sold in accordance with the Lynn and Erin Compassionate Use Act may be deducted from gross
receipts and governmental gross receipts.” See NMSA 1978, Section 7-9-73.1 (A) (2021) (italics in quotation
emphasizing new material)

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
Page 16 of 22
1 CONCLUSIONS OF LAW

2 A. Taxpayer filed a timely, written protest to the Assessment. Jurisdiction lies over the

3 parties and the subject matter of this protest.

4 B. The Department made a timely request for hearing and the Administrative Hearings

5 Office conducted a timely hearing within 90 days of Taxpayer’s protest under NMSA 1978, Section

6 7-1B-8 (2019).

7 C. The parties did not object that conducting the scheduling hearing satisfied the 90-

8 day hearing requirements of Section 7-1B-8 (A) while still allowing meaningful time for

9 completion of the other statutory requirements under Section 7-1B-6 (D). See also Regulation

10 22.600.3.8 (E) NMAC.

11 D. Taxpayer carries the burden to present countervailing evidence or legal argument

12 to show entitlement to an abatement of an assessment. See Casias Trucking, 2014-NMCA-099,

13 ¶8.

14 E. If Taxpayer presents sufficient evidence to rebut the presumption, then the burden

15 shifts to the Department to re-establish the correctness of the assessment. See MPC Ltd., 2003-

16 NMCA-021, ¶13.

17 F. Taxpayer overcame the presumption of correctness with respect to the computation

18 of its income tax liability. See Section 7-1-17(C).

19 G. Taxpayer bears the burden of establishing entitlement to a clearly and

20 unambiguously expressed statutory deduction. See TPL, Inc. v. N.M. Taxation & Revenue Dep't,

21 2003-NMSC-007, ¶9, 133 N.M. 447, 64 P.3d 474.

22 H. “Federal or state deductions are a matter of legislative grace and a way of

23 achieving policy objectives.” See Sutin, Thayer & Browne v. Revenue Div. of Taxation &

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
Page 17 of 22
1 Revenue Dept., 1985-NMCA-047, ¶17, 104 N.M. 633, 636, 725 P.2d 833.

2 I. Statutory provisions must be given “fair, unbiased, and reasonable construction,

3 without favor or prejudice to either the taxpayer or the [s]tate, to the end that the legislative

4 intent is effectuated and the public interests to be subserved thereby are furthered.” See Chavez v.

5 Comm'r of Revenue, 1970-NMCA-116, ¶7, 82 N.M. 97, 476 P.2d 67.

6 J. The primary goal of statutory interpretation is “to give effect to the intent of the

7 [L]egislature.” See Dell Catalog Sales L.P. v. N.M. Taxation & Revenue Dep't, 2009-NMCA-

8 001, ¶19, 145 N.M. 419, 199 P.3d 863.

9 K. Legislative intent is fulfilled “by first looking at the plain meaning of the

10 language of the statute, reading the provisions ... together to produce a harmonious whole.” See

11 Dell Catalog Sales L.P. v. N.M. Taxation & Revenue Dep't, 2009-NMCA-001, ¶19, 145 N.M.

12 419, 199 P.3d 863; Sundance Mech. & Util. Corp. v. Armijo, 1987-NMSC-078, ¶5, 106 N.M.

13 249, 250, 741 P.2d 1370, 1371.

14 L. 26 U.S.C. Section 280E prohibits businesses engaged in trafficking cannabis from

15 taking deductions and claiming credits on their federal income taxes for any amounts paid or

16 incurred in such business activity. See Californians Helping to Alleviate Med. Problems, Inc. v.

17 Comm’r, 128 T.C. 173, 182 (2007) (“Section 280E and its legislative history express a

18 congressional intent to disallow deductions attributable to a trade or business of trafficking in

19 controlled substances.”).

20 M. “Trafficking” for the purpose of 26 U.S.C. Section 280E means “engaging in a

21 commercial activity—that is, to buy and sell regularly.” See Californians Helping to Alleviate

22 Med. Problems, Inc. v. Comm’r, 128 T.C. 173, 182 (2007)

23 N. The business of producing, packaging, and dispensing medical cannabis is legal in

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
Page 18 of 22
1 New Mexico under the Lynn and Erin Compassionate Use Act, NMSA 1978, Chapter 26, Article

2 2B.

3 O. The business of producing, packaging, and dispensing medical cannabis, although

4 legal in New Mexico under the Lynn and Erin Compassionate Use Act, NMSA 1978, Chapter 26,

5 Article 2B, constitutes “trafficking” for the purpose of 26 U.S.C. Section 280E. See Californians

6 Helping to Alleviate Med. Problems, Inc. v. Comm’r, 128 T.C. 173, 182 (2007).

7 P. The Lynn and Erin Compassionate Use Act, NMSA 1978, Chapter 26, Article 2B

8 “was expressly intended ‘to allow the beneficial use of medical cannabis in a regulated system

9 for alleviating the symptoms caused by debilitating medical conditions and their medical

10 treatments.’” See NMSA 1978, Section 26-2A-2 (2007); Sacred Garden, Inc. v. New Mexico

11 Taxation & Revenue Dep't, 2021-NMCA-038, ¶17, 495 P.3d 576, 580, cert. quashed Sacred

12 Garden v. Taxation, No. S-1-SC-38164 (Feb. 23, 2022).

13 Q. “A licensed producer shall not be subject to … penalty, in any manner, for the

14 production, possession, distribution or dispensing of cannabis pursuant to the Lynn and Erin

15 Compassionate Use Act.” See NMSA 1978, Section 26-2B-4 (F) (2007, amended 2019, 2021)

16 R. The computation of New Mexico income tax begins with “base income” as

17 defined by NMSA 1978, Section 7-2A-2 (C) (2017, Amended 2021); See Holt v. New Mexico

18 Dept. of Taxation & Revenue, 2002-NMSC-034, ¶9, 133 N.M. 11, 13, 59 P.3d 491, 493;

19 Champion Int'l Corp. v. Bureau of Revenue, 1975-NMCA-106, ¶39, 88 N.M. 411, 416, 540 P.2d

20 1300, 1305.

21 S. “‘[B]ase income’ means that part of the taxpayer’s income defined as taxable

22 income and upon which the federal income tax is calculated in the Internal Revenue Code for

23 income tax purposes plus [other enumerated items.]” See NMSA 1978, Section 7-2A-2 (C) (2017,

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
Page 19 of 22
1 Amended 2021)

2 T. NMSA 1978, Section 7-2A-2 (2017, Amended 2021) permits the Department to

3 exercise discretion with regard for the definitions provided therein, including the definition of

4 “base income” (NMSA 1978, Section 7-2A-2 (C) (2017, Amended 2021)) by allowing flexibility

5 in circumstances where “the context requires otherwise” consistent with the intentions of the

6 Legislature.

7 U. Omitting 26 U.S.C. Section 280E from the computation of “base income” reflects

8 a “fair, unbiased, and reasonable construction, without favor or prejudice to either the taxpayer

9 or the [s]tate, to the end that the legislative intent is effectuated and the public interests to be

10 subserved thereby are furthered.” See Chavez v. Comm'r of Revenue, 1970-NMCA-116, ¶7, 82

11 N.M. 97, 476 P.2d 67.

12 V. By applying Section 280E to Taxpayer merely because of federal law treatment of

13 medical cannabis, the Department’s proposed construction of the statute inflates the cost of the

14 otherwise legal production of medical cannabis in New Mexico compared to any other non-

15 cannabis medical businesses in the state permitted to claim all applicable deductions, not limited

16 to COGS. The Legislature did not intend for state taxes to inflate the cost of products for those

17 requiring them, but intended “to make medical treatment more accessible.” See NMSA 1978,

18 Section 26-2A-2 (2007); Sacred Garden, Inc. v. New Mexico Taxation & Revenue Dep't, 2021-

19 NMCA-038, ¶17, 495 P.3d 576, 580, cert. quashed Sacred Garden v. Taxation, No. S-1-SC-

20 38164 (Feb. 23, 2022).

21 W. Omitting 26 U.S.C. Section 280E from the computation of “base income” is

22 consistent with legislative intent with respect for taxation of Taxpayer’s business under the

23 Compassionate Use Act. See Sacred Garden, Inc. v. New Mexico Taxation & Revenue Dep't,

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
Page 20 of 22
1 2021-NMCA-038, ¶17, 495 P.3d 576, 580, cert. quashed Sacred Garden v. Taxation, No. S-1-

2 SC-38164 (Feb. 23, 2022).

3 X. The Cannabis Regulation Act clarified that “base income” explicitly excludes “an

4 amount equal to any expenditure that is eligible to be claimed as a federal income tax deduction

5 but is disallowed pursuant to Section 280E of the Internal Revenue Code[.]” See NMSA 1978,

6 Section 7-2-2 (B) (5) (2021); NMSA 1978, Section 7-2A-2 (C) (4) (2021); 2021 New Mexico

7 Laws 1st Sp. Sess. Ch. 4 (H.B. 2).

8 For the reasons stated, Taxpayer’s protest is GRANTED. Assessed tax, penalty and

9 interest shall be abated, and any amounts paid to satisfy the Assessment from which this protest

10 arose shall be refunded.

11 DATED: April 1, 2022

12
13 Chris Romero
14 Hearing Officer
15 Administrative Hearings Office
16 P.O. Box 6400
17 Santa Fe, NM 87502

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
Page 21 of 22
1 NOTICE OF RIGHT TO APPEAL

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

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

4 date shown above. If an appeal is not timely filed with the Court of Appeals within 30 days, this

5 Decision and Order will become final. Rule of Appellate Procedure 12-601 NMRA articulates

6 the requirements of perfecting an appeal of an administrative decision with the Court of Appeals.

7 Either party filing an appeal shall file a courtesy copy of the appeal with the Administrative

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

9 Hearings Office may begin preparing the record proper. The parties will each be provided with a

10 copy of the record proper at the time of the filing of the record proper with the Court of Appeals,

11 which occurs within 14 days of the Administrative Hearings Office receipt of the docketing

12 statement from the appealing party. See Rule 12-209 NMRA.

13 CERTIFICATE OF SERVICE
14 I hereby certify that I served the foregoing on the parties listed below this 1st day of April

15 2022 in the following manner:

16 E-Mail E-Mail

17 INTENTIONALLY BLANK

In the Matter of the Protest of New Mexicann Natural Medicine, Inc.
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