My law firm bills clients for out-of-pocket costs like copying at cost with no markup — do I owe gross receipts tax on those reimbursements?

Plain-English summary

Francis & Starzynski, P.A., a New Mexico law firm, billed its clients for out-of-pocket costs — including photocopying — and did not treat those reimbursements as taxable gross receipts. The firm doesn't own a copier; it sends work to an independent shop, PC Services, which bills the firm monthly (charging the firm gross receipts tax). Under its Attorney-Client Agreement, the firm re-bills clients for copying at cost, with no markup, and doesn't charge them tax. On audit, the Department said those reimbursements were taxable and assessed gross receipts tax, penalty, and interest. (The parties had already settled the other categories: reimbursed court reporter, expert witness, and outside research fees were not taxable, while faxes, FedEx, travel, and long-distance charges were — leaving only photocopying in dispute.)

Hearing Officer Gerald Richardson ruled the reimbursed photocopying was taxable, but abated the penalty:

• Reimbursed expenses are gross receipts unless received as an agent. There's no statutory exclusion for reimbursed business costs, but courts recognize an agency exception (Regulation GR 3(F):75; Westland, Carlsberg): money received as a true agent/trustee on a principal's behalf isn't gross receipts.
• The agency test has two factors (Carlsberg Management and Brim Healthcare): (1) whose obligation does the expense really represent, and (2) how much control does the purported principal (client) retain over the agent as to that cost?
• No agency here. The obligation to pay PC Services was the firm's, not the client's — PC Services only received a client last name (it couldn't tell which "Smith"), had no dealings with the client, and nothing showed clients even knew copying was outsourced. Nor did clients control how many copies were made or their cost. Clients contracted for legal services, and the firm exercised its professional judgment on necessary copying. The firm was not a mere conduit, so the reimbursements were taxable. (That PC Services might be a third-party beneficiary of the fee agreement didn't matter — Carlsberg cared about control, not third-party liability.)
• Interest was mandatory despite the delay. The firm complained about roughly 17 months between assessment and hearing. But Section 7-1-67 requires interest with no relevant exception, and Section 7-1-24(D) only says a hearing date must be set "promptly." Under Ranchers-Tufco, the tardiness of public officers is not a defense to the State enforcing a public right (collecting interest), so no relief.
• Penalty abated for reliance on competent counsel. Under Section 7-1-69(A) a penalty needs negligence, and Regulation TA 69:4 excuses a taxpayer who reasonably relied on competent tax counsel after full disclosure. The firm's founder — an attorney — reached a reasoned conclusion on a genuinely complex question with full knowledge of the facts. That defeated negligence, so the penalty was abated. (The hearing officer reserved jurisdiction to fix the exact copying-tax amount if the parties couldn't agree.)

What this means for you

Any service business that re-bills clients for outside costs

Charging a client for a cost you incurred — even at cost with no markup — is generally taxable gross receipts unless you truly incurred it as the client's agent. The label "reimbursement" doesn't decide it. Ask the two questions the hearing officer asked: Whose bill was it really? and Did the client control that cost? If you ordered and owed the outside service on your own account and the client had no say, expect the reimbursement to be taxable.

How to structure a genuine pass-through

To fall within the agency exception, make the client the real principal: the client should be obligated to the third party (not just to you), should know and control the arrangement, and you should have no discretion to handle it outside the agency terms. A vendor that only knows a client's last name, deals solely with you, and is paid on your account is your cost, not the client's.

On penalties and interest

Even when you lose on the tax, a penalty can be abated if your position rested on reasonable reliance on competent tax counsel or an accountant after full disclosure — a strong reason to get, and document, professional advice on doubtful questions. Interest, though, is mandatory: it runs regardless of how long the Department takes to hear your protest, so paying the disputed tax (and protesting) is the only way to stop it.

Common questions

Q: I bill outside costs to clients at cost with no profit. Why is that taxable?
A: Because the tax turns on agency, not markup. If you (not the client) were obligated to pay the vendor and the client didn't control the cost, the reimbursement is your gross receipts — no markup needed for it to be taxable.

Q: What would make a reimbursed cost non-taxable?
A: A true agency pass-through: the client is the party actually obligated to the third party, is aware of and controls the arrangement, and you have no independent discretion over it. The firm's court reporter, expert witness, and outside research charges qualified; its outsourced copying did not.

Q: The Department took over a year to hear my protest. Can I get the interest reduced?
A: No. Interest is mandatory and a hearing delay isn't a defense — Section 7-1-24(D) only requires that a hearing date be set promptly, and public-officer tardiness doesn't excuse a public right like collecting interest.

Citations and references

Statutes and regulations:

• Regulation GR 3(F):75 — the common-law agency exception for reimbursed expenses
• § 7-1-67 NMSA 1978 — interest is imposed whenever tax is not paid when due
• § 7-1-24(D) NMSA 1978 — the Department or hearing officer shall promptly set a date for hearing
• § 7-1-69(A) NMSA 1978 — civil penalty for negligence or disregard of rules
• Regulation TA 69:4 — no negligence where the failure resulted from reasonable reliance on competent tax counsel or an accountant after full disclosure
• § 36-2-11 NMSA 1978 — an attorney's authority to bind a client within the scope of the representation

Cases cited:

• Carlsberg Management Co. v. New Mexico Taxation and Revenue Department, 116 N.M. 247, 861 P.2d 288 (Ct. App. 1993) — agency-exception analysis focusing on obligation and control
• Brim Healthcare, Inc. v. Taxation and Revenue Department, Ct. App. No. 15,658 (May 1, 1995) — no agency where the principal did not assume the obligation or control
• Westland Corp. v. Commissioner of Revenue, 83 N.M. 29, 487 P.2d 1099 (Ct. App. 1971) — amounts received as agent or trustee are excluded from gross receipts
• Ranchers-Tufco Limestone Project Joint Venture v. Revenue Division, 100 N.M. 632, 674 P.2d 522 (Ct. App. 1983) — public-officer tardiness is not a defense to enforcing a public right

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Francis & Starzynski, P.A.
• Decision PDF: D&O 95-07

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
FRANCIS & STARZYNSKI, P.A., No. 95-07
I.D. NO. 02-138376-00 6, PROTEST
TO ASSESSMENT NO. 1753028.

DECISION AND ORDER

This matter came on for hearing on July 10, 1995 before Gerald B. Richardson, Hearing

Officer. Francis & Starzynski, P.A. (hereinafter "Taxpayer") was represented by Douglas T.

Francis, Esq., President. The Taxation and Revenue Department (hereinafter "Department") was

represented by Bruce J. Fort Special Assistant Attorney General.

Based upon the evidence and the arguments presented, it is hereby DECIDED AND

ORDERED as follows:

FINDINGS OF FACT

1. The Taxpayer is a law firm which has been in operation in New Mexico since

January, 1990.

2. As the result of an audit of the Taxpayer by the Department, on February 5, 1994
   the Department issued Assessment No. 1753028 to the Taxpayer assessing $6,275.96 in gross

receipts tax, $627.60 in penalty and $1,681.66 in interest for the reporting period of January 1,
1990 through June 30, 1993.

3. On February 11, 1994, the Taxpayer filed a timely, written protest with the
   Department protesting Assessment No. 1753028.

4. The only discrepancy in how the Taxpayer handled the reporting of gross receipts
   tax noted by the Department's auditors concerned the Taxpayer's treatment of expenses which it

incurred and which were reimbursed to the Taxpayer by the Taxpayer's clients. The Taxpayer did
not treat the reimbursed expenses as gross receipts subject to tax.

5. Prior to the formal hearing in this matter the Taxpayer and the Department agreed

upon the tax treatment of various categories of reimbursed expenses. It was agreed that the

reimbursement of court reporter fees, expert witness fees and fees for research performed by third

parties were not subject to gross receipts tax. It was further agreed that the reimbursement of

costs for faxes, federal express, travel expenditures and long distance telephone charges were

receipts subject to gross receipts tax.

6. The only issue remaining to be resolved is whether the charges which the

Taxpayer incurs on behalf of clients for photo copying performed by an independent third party

and which costs are reimbursed to the Taxpayer by its clients are receipts subject to the gross

receipts tax.

7. The Taxpayer does not own its own copying machine. Instead, it has its copying

performed by PC Services, which has an office the building in which the Taxpayer's office is

located and also in the Bankruptcy Court, where the Taxpayer performs a substantial portion of its

law practice.

8. When the Taxpayer needs copies made, the documents to be copied are delivered

to PC Services with a notation of either a client's last name, if the copying is being done for a

specific client, or "office" if the copying is not going to be charged to a specific client.

9. PC Services bills the Taxpayer for its copying charges on a monthly basis. The

monthly bill contains a breakdown between the copies charged to "office" and those earmarked by

client last name. PC Services charges the Taxpayer gross receipts tax on the total charges for

copying.

10. Under the terms of the "Attorney-Client Agreement" entered into between the

Taxpayer and its clients the "Client agrees to pay all out-of-pocket costs of Attorneys [the

Taxpayer] (including . . . photocopy costs . . ., etc.) spent by Attorneys in the representation of

Client. . . ."

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11. When the Taxpayer bills the client for photocopying costs pursuant to the

Attorney-Client Agreement, the Taxpayer only bills for its actual costs and adds not mark up to

the actual costs incurred. Additionally, the Taxpayer does not charge the client for gross receipts

tax upon the amount it charges the client for photocopying costs.

12. In determining its billing policy not to charge gross receipts tax upon

photocopying charges, Mr. Francis, who is an attorney, determined that such charges should not

be subject to gross receipts tax on the basis that these charges are incurred as agents of the client

and were subject to tax when the services were purchased from PC Services. In making this

determination, Mr. Francis did not consider regulation GR 3(F):75 which addresses the taxability

of reimbursed costs.

DISCUSSION
The primary issue to be determined is whether the Taxpayer is subject to gross receipts tax

for its receipts from reimbursed photocopying costs. If that issue is resolved in favor of the

Department, then the issues of the Taxpayer's liability for penalty and interest also must be

determined.

There is no statutory exclusion in the Gross Receipts and Compensating Tax Act, Chapter

7, Article 9, NMSA 1978 for money received as reimbursement for business expenses. However,

the courts, over the years have interpreted the Act to exclude from gross receipts amounts received
as a trustee or agent. See, Westland Corp. v. Commissioner of Revenue, 83 N.M. 29, 33, 487

P.2d 1099, 1103 (Ct. App.), cert. denied, 83 N.M. 22, 487 P.2d 1092 (1971), and more recently,
Carlsberg Management Co. v. New Mexico Taxation and Revenue Department, 116 N.M. 247,

861 P.2d 288 (Ct. App. 1993). In 1988, the Department adopted regulation GR 3(F):75 which
recognizes the common law agency exception where the reimbursement of the expenditure

represents the reimbursement of an expense incurred as an agent on behalf of a principal. It is

upon this basis that the Taxpayer claims it is not subject to gross receipts tax.

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The issue of determining when a taxpayer's reimbursed expenses qualify for the agency

exception to the imposition of tax is a difficult one which has been the subject of extensive

discussion by our courts in recent years. The Carlsberg case involved a determination of whether

a property management company which managed apartments in a federally subsidized rent

program on behalf of the apartment owner was liable for gross receipts tax upon its

reimbursements of employment expenses incurred with respect to employees retained to manage

and operate the apartments. The rule adopted by the Court of Appeals in its decision is if a party

only receives money either as an advance for future payment of or reimbursement for past

payment of another's employment-related obligations, then an agency relationship exists sufficient

to avoid taxation of those funds as gross receipts. Id. at 251, 861 P.2d at 292. In that case, the

court then went on to examine the contractual agreement between the owner and the taxpayer,

looking at the degree of control retained by the apartment owner with respect to the taxpayer's

payment of the employee related expenses. Under the facts of that case, the court concluded that

the taxpayer was left with no discretion concerning when and how much to pay the employees.

The Court also found that the indemnification clause in the agreement between the taxpayer and

the owner requiring the owner to pay the Taxpayer for employment expenses indicated that the

payment of wages to employees was ultimately the duty of the owner. Based on these

considerations, the court concluded that an agency relationship existed and that the taxpayer was

not subject to gross receipts taxes upon its reimbursements of employee related expenses.

In the Carlsberg decision, the Court of Appeals was careful to limit its holding based upon

the facts of that case and left for another day its ruling on a "less-pervasive agency relationship."

Id. at 252, 862 P.2d at 293. That day arrived on May 1, 1995 when the Court of Appeals issued

its decision in Brim Healthcare, Inc. v. State of New Mexico, Taxation and Revenue

Department, Court of Appeals No. 15,658. That case also involved the reimbursement of

employee related expenses, but the taxpayer was a business providing hospital management

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services and key hospital employees to hospitals in New Mexico. The court concluded in Brim,

however, that an agency relationship did not exist under the facts of that case. As in the

Carlsberg case, the court focused on two areas in determining whether an agency relationship

existed. It focused on whose obligation was it for which the taxpayer was reimbursed and it

looked to the degree of control which the alleged principal had over the alleged agent with respect

to the reimbursed costs at issue. In Brim, the court concluded that there was no broad

indemnification clause which had the effect of shifting the obligation from the nominal employer

to the purported principal and that the other terms of the agreement established that the employees

were the taxpayer's and not the hospital's employees. Thus, the reimbursement of the taxpayer's

employee related expenses by the hospital was not a reimbursement of an expense incurred as an

agent of the hospital and was subject to gross receipts tax.

Brim and Carlsberg establish that in determining whether a reimbursed expense was

incurred in an agency capacity turns on the analysis of two factors: first, the relationship between

the parties must be analyzed to determine whose obligation to pay does the expense represent, and

secondly, to what extent does the purported principal retain control over the purported agent with

respect to the cost at issue?

With respect to the first issue, the Taxpayer relies upon the fact that the copy company has

a client name and thus knows that the copying job is being purchased by the Taxpayer on behalf

of its client. The Taxpayer also relies upon Section 36-2-11 NMSA 1978 which establishes an

attorney's authority to bind its client to any agreement within the scope of his duties and powers

and that an oral statement of such authority is sufficient. The facts as conveyed by the Taxpayer

do not establish that the obligation to pay the copying costs truly lies with the client, however.

While it is true, the Attorney-Client agreement establishes that the Client is required to reimburse

the Attorney for the cost incurred, the obligation at issue is the obligation to pay PC Services.

Mr. Francis could not recall any discussion between his firm and PC Services where it was

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discussed that the names given were names of clients or that under his Attorney-Client agreements

that the clients were obligated to reimburse his firm for the copying costs. Additionally, the only

name that PC Services was given was the last name of a client. This would hardly inform PC

Services which "Smith" or "Gallegos" could be looked to pay for any copying costs associated

with that billing appellation. The reality of the copying transaction is that the Taxpayer's clients

do not deal with the copying company and the copying company has no dealings with the client.

There is nothing in the record to indicate that the client knows who the copying company is or

even that the client is aware that the Taxpayer contracts out its photocopying services. The

client's bill only reflects a cost listed as "photocopy expense" which is not broken down by

number of copies or cost per copy and makes no reference to the name of any third party provider.

This leads us to the second inquiry, the degree of control exercised by the purported principal

over the purported agent with respect to the transaction at issue. The only thing in the record

pertinent to this issue is that the Attorney-Client agreement requires the client to reimburse the

Taxpayer for its photocopy costs. As noted above, there is nothing to indicate that clients are

even aware that photocopying is contracted out by the Taxpayer. Additionally, there is nothing to

indicate that the number or cost of copies are limited or controlled in any way by the clients. The

reality is that the clients are contracting for professional legal services from the Taxpayer and the

Taxpayer is rendering professional legal services, which include, such reasonable and necessary

photocopying expenses as, in the professional judgment of the Taxpayer, are appropriate to the

legal services being rendered. This does not arise to the level of control exercised by the

principal which the Court of Appeals found so persuasive in the Carlsberg case. The Taxpayer

in this case is not a mere conduit of funds between the Taxpayer's clients and the copying

company where there is no evidence that the clients are even aware of the existence of a third

party, and they do not control when the copying company is paid, the cost of the copies, or any of

the other terms of the arrangement between the Taxpayer and PC Services.

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The Taxpayer also argues that under the standard in New Mexico for determining whether

PC Services would be a third-party beneficiary of the Attorney-Client agreement and that this also

establishes that a sufficient agency relationship exists to shield the Taxpayer from gross receipts

tax on the reimbursement it receives for photocopying. It appears to be undisputed that PC

Services would qualify as a third party beneficiary under New Mexico law, but that is not

dispositive of the issue of agency. In the Carlsberg decision the court had this to say with respect

to third party liability:
We are not so much concerned with who is required to pay the employees, as that is but
one indicia of agency. We are more concerned with whether Taxpayer had the
discretion to pay the employees in a manner other than by the terms of the agency
relationship.

Id. at 252, 862 P.2d at 293. Thus, the court was more concerned with the degree of control

exercised by the purported principal than by whether third party liability is conclusively

established. As noted above, the evidence does not establish the existence of the level of control

necessary to establish that a sufficient agency relationship exists with respect to the incurring or

payment of photocopying charges.

The Taxpayer has also protested the imposition of interest on the grounds that there has

been too long a delay in resolving the matter in protest. Approximately seventeen months

elapsed between the date of the assessment and the hearing in this matter. The two operative

statutes relevant to this issue are Section 7-1-24 and Section 7-1-67. Section 7-1-67 provides for

the imposition of interest and provides in pertinent part:
If any tax imposed is not paid on or before the day on which it becomes due, interest shall
be paid to the state on such amount from the first day following the day on which
the tax becomes due, without regard to any extension of time or installment
agreement, until it is paid . . . . (emphasis added)

Thus, the statute mandates that interest is payable during the time from when the tax was due,

until it is paid, with no exceptions which are relevant to the issue herein.

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Section 7-1-24(D) governs administrative hearings under the Tax Administration Act and

provides that:
Upon timely receipt of a protest, the department or hearing officer shall promptly set a
date for hearing and on that date hear the protest or claim.

The administrative record in this case provides no clues as to what transpired between the

Taxpayer and the Department in the months between the tax assessment and the hearing, except

that the parties did hold an informal conference at some point prior to the hearing at which some

of the issues were resolved between the parties. If the Taxpayer made any efforts to have this

matter scheduled sooner, or if the Department failed to respond to any such requests, there was no

evidence presented by either party which would provide more of a factual context in which to

decide this issue. In any event, there is a case construing Section 7-1-24(D) which governs the

determination of this issue. In Ranchers-Tufco Limestone Project Joint Venture v. Revenue

Division, Taxation and Revenue Department, 100 N.M 632, 674 P.2d 522, cert. denied 100

N.M. 505, 672 P.2d 1136 (1983), the taxpayer challenged an approximately two year delay in

hearing its protests as violating Section 7-1-24(D). The court noted the ambiguity in the statute,

which requires that a date for a hearing be set promptly, and would require interpretation of the

statute to conclude that this required that the hearing itself be held promptly. The court did not

resolve this ambiguity. In analyzing this issue, the court assumed, but did not decide that Section

7-1-24 had been violated, but it granted no relief to the taxpayer. Instead, it applied the general

rule that tardiness of public officers in the performance of statutory duties is not a defense to an

action by the state to enforce a public right or to protect public interests. Id. 100 N.M. at 635.

Since the collection of interest on tax deficiencies is a public right, this rule is applicable to this

case as well and the Taxpayer is entitled to no relief from the imposition of interest.

The final issue to be determined is whether penalty may properly be imposed for failing to

timely report and pay taxes upon those reimbursed expenses which the Taxpayer has now agreed

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are taxable and upon the reimbursed photocopying expenses. Penalty is imposed, pursuant to

Section 7-1-69(A) NMSA where the failure to report or timely pay taxes is "due to negligence or

disregard of rules and regulations." Regulation TA 69:4 sets forth a number of situations which

may indicate that a taxpayer has not been negligent or in disregard of rules and regulations for

purposes of the imposition of penalty pursuant to Section 7-1-69(A). Pertinent to our discussion

is the fourth situation , which provides in pertinent part:
the taxpayer proves that the failure to pay tax or to file a return was caused by reasonable
reliance on the advice of competent tax counsel or accountant as to the taxpayer's
liability after full disclosure of all relevant facts; . . .

In this case, at the time the firm was established and billing practices were determined,

Mr. Francis made the determination that the firm's reimbursed expenses were not subject to gross

receipts tax. He based his conclusion upon his analysis that these expenses were incurred as

agents for the firm's clients and the fact that these costs had already been subjected to gross

receipts tax when they were incurred by the firm. Although the Taxpayer has now agreed that not

all of the reimbursed expenses would qualify for tax exclusion, this is a complex area and

reasonable minds could differ on the tax treatment of these various reimbursed costs. I have no

doubt of Mr. Francis' competency to analyze these matters and he certainly had full knowledge of

all of the facts relevant to the legal analysis of this issue. Thus, the conditions of Regulation TA

69:4 have been met and the penalty assessed should be abated.

A final matter to be discussed is that at the formal hearing, it was agreed that the Hearing
Officer would reserve jurisdiction to determine the amount of gross receipts tax attributable to the

photocopying expense issue if it was determined to be taxable. This is because at the time of the

hearing, the parties had not yet been able to extract this amount from the amounts attributable to

other issues which were agreed upon by the parties. Jurisdiction has been reserved to resolve this

issue should the parties be unable to arrive at consensus on this matter.

CONCLUSIONS OF LAW

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1. The Taxpayer filed a timely, written protest to the assessment of tax and

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

2. The Taxpayer did not incur photocopying expenses in the capacity of an agent for

its clients and therefore when it received reimbursement of those expenses from its clients, the

reimbursements are included in the Taxpayer's gross receipts and are subject to gross receipts tax.

3. The delay in resolving the Taxpayer's protest is not a basis for abating the

imposition of interest.

4. The Taxpayer's failure to pay gross receipts tax on its reimbursed expenses was

based upon its consultation with its own tax counsel and therefore the Taxpayer was not negligent

in failing to pay tax. For this reason the penalty imposed should be abated.

For the foregoing reasons, the Taxpayer's protest to the imposition of tax and interest IS

HEREBY DENIED. The Taxpayer's protest to the imposition of penalty IS HEREBY

GRANTED. The Department IS HEREBY ORDERED to abate the penalty assessed.

DONE, this 15th day of September, 1995.

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