Is a signed tax settlement with the state binding if it was never approved by the Attorney General?

Plain-English summary

Johnson & Johnson, the New Jersey pharmaceutical parent, operated in New Mexico through subsidiaries. After a Multistate Tax Commission (MTC) audit of the 1980–82 years, the Department assessed about $40,000 against six J&J subsidiaries, claiming they had enough New Mexico activity ("nexus") to owe corporate income tax. J&J protested, arguing those subsidiaries only solicited sales and were protected by federal law (P.L. 86-272).

To settle, J&J's tax official (Mr. Robinson) and the Department's protest-office manager (Mr. Gallegos) agreed to a $25,000 payment and a "four-two" split of the nexus issue for later years. J&J drafted a Tax Settlement Agreement, and its paragraph 9 declared the agreement "final and conclusive for all periods prior to 1991." The Department's Secretary signed it in May 1992 — but no one sent it to the Attorney General for approval. The Department's chief counsel had never seen the final version and, because of the sweeping finality language, would not have approved it.

What made this important was something the negotiators never discussed: starting in 1987, J&J had switched to federal consolidated filing and was deducting more than half of its income as foreign-dividend "non-business" income the state couldn't tax. If New Mexico could treat that as apportionable business income, J&J owed roughly $2 million. When a Department auditor tried to examine 1987–1991 in late 1994, J&J said those years were closed by the agreement. The Department responded that the agreement was not binding because the Attorney General never approved it; the Attorney General then refused to sign (citing the two-year delay), and the Department issued Assessment No. 1885005 — $1,228,647 in corporate income tax, $122,864.70 penalty, and $836,033.18 interest for 1987–1991.

This decision resolved only one bifurcated issue: is the Tax Settlement Agreement enforceable? Hearing Officer Gerald B. Richardson said no, and denied J&J's protest on that point:

• Compromising assessed taxes requires the Attorney General's written approval. Section 7-1-20 makes a "closing agreement" the only way the Department may compromise assessed taxes, and subsection A requires the written approval of the Attorney General. The agreement compromised assessed taxes, the Attorney General expressly refused to approve it, so the binding protections of subsection D never attached. Without that approval the Department lacked legal capacity to make the deal, and a contract contrary to public policy is a nullity (State ex rel. Udall v. Colonial Penn). The agreement was void from the start.
• "Apparent authority" doesn't save it. J&J argued it could rely on the Secretary's authority to bind the Department (Ellingwood). But an unambiguous statute required the Attorney General's approval; J&J had constructive knowledge of it (it's in the published statutes), and as a large multinational with sophisticated tax staff — "not a mom and pop taxpayer" — it couldn't reasonably assume the Secretary could act for the separate office of the Attorney General.
• The mistake was mutual, not the Department's alone. Both sides treated this as a small-dollar matter and neither researched the required form of the agreement. A mutual mistake is grounds for rescission or reformation, not enforcement — and reformation was impossible once the Attorney General refused to approve.
• The state was not equitably estopped. Courts rarely estop the state, especially in tax cases (Bien Mur), and only when "right and justice demand it" (United States v. Bureau of Revenue). J&J had no reasonable reliance (constructive notice of Section 7-1-20; and Section 7-1-60 limits tax estoppel to reliance on a regulation or a written ruling addressed to the taxpayer) and showed no prejudicial change of position (Westerman). Critically, the parties had actually negotiated only the nexus issue, worth a few thousand dollars a year, and the Department never reneged on that — so J&J "got essentially what it was negotiating for," and the situation wasn't so "aggravated or shocking" that estoppel was required.

The Hearing Officer found J&J's negotiator credible (he wasn't scheming to "do" New Mexico) — but that only confirmed that the nexus issue was all the parties bargained over, and the broad paragraph-9 closure of unrelated issues wasn't the real subject of the deal. The separate "nexus filing agreements" J&J pointed to didn't help, because they don't compromise assessed taxes (so they aren't closing agreements) and J&J wasn't even aware of them.

What this means for you

A settlement with the Department isn't final until the Attorney General approves it

If you compromise assessed New Mexico taxes, the deal must be a closing agreement approved in writing by the Attorney General (Section 7-1-20). A settlement signed only by Department officials — even the Secretary — is not binding and can be treated as void. Before you rely on a tax settlement, confirm in writing that the Attorney General has approved it.

You're charged with knowing the legal requirements — especially if you're sophisticated

The Hearing Officer held J&J to constructive knowledge of the statute and stressed that a large company with professional tax staff can't claim it reasonably believed a Department official could bind the state without Attorney General approval. The more resources you have, the less likely a court is to excuse reliance on an official's apparent authority.

Broad "closes all years" language may not hold if it wasn't really negotiated

Paragraph 9 literally closed every pre-1991 year for all issues, but the decision looked at what the parties actually negotiated — only the narrow nexus question. Sweeping finality language bootstrapped onto a small settlement gave J&J no estoppel protection for unrelated, much larger issues. Don't assume boilerplate finality clauses will bind the state beyond the dispute you actually resolved.

Estoppel against the state in tax cases is very hard to win

New Mexico allows estoppel against the state only when "right and justice demand it," and Section 7-1-60 confines tax estoppel to reliance on a regulation or a written ruling addressed to you personally. Oral assurances, informal deals, or an official's signature on a non-conforming agreement generally won't estop the Department. Get binding positions in the proper statutory form.

Common questions

Q: A Department employee (even the Secretary) signed my settlement. Isn't that binding?
A: Not for a compromise of assessed taxes. Section 7-1-20 requires the Attorney General's written approval. Without it, the Department lacks the legal capacity to bind the state, and the agreement can be held void from the start.

Q: I didn't know the Attorney General had to approve it. Doesn't the Department's mistake bind it?
A: No. The requirement is in the published statutes, so you're charged with constructive knowledge of it. And here the mistake about the agreement's form was mutual — which points toward rescission, not enforcement — not a one-sided Department error you can hold it to.

Q: Can't I use equitable estoppel to hold the state to the deal?
A: Rarely. Courts are very reluctant to estop the state in tax matters and require "right and justice" plus reasonable reliance and a prejudicial change of position. Here J&J had constructive notice of the approval requirement and showed no change of position, so estoppel failed.

Q: The agreement said it 'closed all years before 1991.' Why didn't that stop the audit?
A: Because the agreement was void for lack of Attorney General approval, and because the parties had actually negotiated only the small nexus issue. The broad closure language didn't reflect a real bargain over the much larger foreign-dividend issue, so it gave no protection against auditing that issue for 1987–1990.

Q: Did this decide whether J&J actually owed the $2 million?
A: No. This was a partial decision on only the enforceability of the settlement. The underlying question — whether J&J's foreign-dividend income is taxable business income for New Mexico — was reserved for a later hearing.

Citations and references

Statutes and regulation:

• § 7-1-20 NMSA 1978 — after assessment, the Department may compromise a tax liability only by a written "closing agreement" entered with the written approval of the Attorney General; such an agreement is conclusive as to the periods covered, but a compromise lacking that approval is not effective
• § 7-1-60 NMSA 1978 — the state is estopped in tax matters only where the taxpayer relied on a regulation in effect when the liability arose, or on a written ruling addressed to the taxpayer personally by the Department
• § 7-2A-8.4 NMSA 1978 and Regulation CIT 9:2 — a corporate taxpayer elects among filing methods (separate accounting, separate corporate entity, combination of unitary corporations, or federal consolidated group)
• §§ 7-5-1 to 7-5-7 NMSA 1978 — the Multistate Tax Compact, under which the Multistate Tax Commission audited J&J on behalf of New Mexico and other states
• § 7-1-24 NMSA 1978 — timely written protest of an assessment
• P.L. 86-272 — federal statute barring a state from imposing a net income tax where the company's in-state activity is limited to solicitation of orders for tangible personal property

Cases cited:

• State ex rel. Udall v. Colonial Penn, 112 N.M. 123, 812 P.2d 777 (1991) — contracts made in violation of public policy are a nullity and unenforceable
• Ellingwood v. N.N. Life Ins., 111 N.M. 301, 805 P.2d 70 (1991) — apparent authority binds a party where a reasonably prudent person would suppose the actor to possess it, based on the trappings of actual authority
• Taxation and Revenue Department v. Bien Mur Indian Market, 108 N.M. 228, 770 P.2d 873 (1989) — courts are especially reluctant to estop the state in tax cases; reliance on informal Department advice is unreasonable given Section 7-1-60
• United States v. Bureau of Revenue, 87 N.M. 164, 531 P.2d 212 (Ct. App. 1975) — estoppel may be applied against the state only when "right and justice demand it"
• Westerman v. City of Carlsbad, 55 N.M. 550, 237 P.2d 356 (1951) — elements of equitable estoppel as to the party claiming it: lack of knowledge and of the means of knowledge, reliance on the other party's conduct, and a prejudicial change of position

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Johnson & Johnson and Affiliates
• Decision PDF: D&O 96-09

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
JOHNSON & JOHNSON AND AFFILIATED
SUBSIDIARIES, I.D. NO. 02-108895-00 0, NO. 96-09
PROTEST TO ASSESSMENT NOS. 1884894
AND 1885005

PARTIAL DECISION AND ORDER
MATTER ONE

This matter came on for formal hearing on February 6, 1996 before Gerald B. Richardson,

Hearing Officer. Johnson & Johnson and affiliated subsidiaries, hereinafter, "Johnson & Johnson",

was represented by Curtis W. Schwartz, Esq. of Modrall, Sperling, Roehl, Harris & Sisk, P.A. and by

Paul H. Frankel, Esq. of Morrison & Foerster, L.L.P. The Taxation and Revenue Department,

hereinafter, "Department", was represented by Bruce J. Fort, Special Assistant Attorney General.

The parties have stipulated that Assessment No. 1884894 should be abated and therefore only

Assessment No. 1885005 will be addressed. With respect to that assessment, by an Order of the

Hearing Officer dated August 18, 1996, the formal hearing of Johnson & Johnson's protest has been

bifurcated. The February 6, 1996 formal hearing addressed only the issues arising out of the May 1,

1992 Tax Settlement Agreement entered into between the Taxpayer and the Department.

Based upon the evidence and the arguments presented, IT IS DECIDED AND ORDERED

AS FOLLOWS:

FINDINGS OF FACT

1. Johnson & Johnson's corporate headquarters and its principal place of business are

located in New Brunswick, New Jersey. New Jersey is Johnson & Johnson's commercial domicile.

2. The tax years at issue herein are the tax years ending in 1987, 1988, 1989, 1990 and

1991.

3. Johnson & Johnson conducts business through domestic subsidiaries in the United

States and through foreign subsidiaries in foreign countries. As the parent corporation, Johnson &
Johnson never directly conducted business in New Mexico from 1980-1990. It did, however, have

subsidiaries which conducted business in New Mexico during those periods of time.

4. Ethicon, Inc., "Ethicon", is a directly or indirectly wholly-owned subsidiary of

Johnson & Johnson. Ethicon operates a manufacturing facility in New Mexico. Ethicon timely filed

New Mexico corporate income tax returns for 1981 and 1982. Ethicon elected the separate entity

reporting method and filed accordingly.

5. Ethicon's reported factors in New Mexico during years 1981 through 1991 inclusive

were:

Year Property Payroll Sales
1981 $14,855,236 $ 1,415,679 $ 299,624
1982 $18,130,553 not available not available
1983 $22,307,514 $ 5,063,380 $ 419,683
1984 $22,969,339 $ 5,741,312 $ 293,010
1985 $24,020,979 $ 7,587,690 $ 441,911
1986 $24,479,732 $10,350,272 $ 891,753
1987 $26,541,398 $11,213,525 $1,175,471
1988 *2-28-88 $25,822,889 $ 2,086,738 $ 189,776
12-31-88 $25,622,389 $10,188,190 $1,058,890
total N/A $12,274,928 $1,248,666
1989 $36,288,843 $13,860,277 $1,229,403
1990 $43,600,404 $16,631,091 $1,464,353
1991 $49,579,167 $23,305,153 $1,902,260

• On March 1, 1988, Ethicon merged into Technicare Corporation and the survivor's name

was changed to Ethicon. As a result of the merger, Ethicon had two tax years ending

in 1988.

6. Xanar, Inc., "Xanar", is a directly or indirectly wholly-owned subsidiary of Johnson &

Johnson. Xanar sold medical equipment in New Mexico. Xanar timely filed a New Mexico

corporate income tax return for 1982. Xanar elected the separate entity reporting method and filed

accordingly. Xanar's factors in New Mexico during years 1982 through 1989 inclusive were:

Year Property Payroll Sales
1981-1986 not available not available not available

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1987 0 0 $ 55,825
1988 0 0 0
1988 0 0 0
1989 0 0 0
post 1989--the company was sold

7. The Multistate Tax Commission, "MTC" is a commission formed pursuant to Article

VI of the Multistate Tax Compact, §§ 7-5-1 through 7-5-7 NMSA 1978 (1995 Repl. Pamp.). The

MTC conducted an audit of Johnson & Johnson and its subsidiaries. The audit was concluded in

1989. The MTC conducted the audit on behalf of New Mexico and ten other states. The focus of

the MTC's audit was corporate income tax. The audit related to the 1980, 1981 and 1982 tax years.

8. The MTC auditor concluded that Ethicon and Xanar had accurately filed their

respective New Mexico income tax returns.

9. The MTC auditor also concluded that six other directly or indirectly wholly-owned

subsidiaries of Johnson & Johnson had nexus with New Mexico. Those subsidiaries were Codman

and Shurtleff, Inc.; Johnson & Johnson Products, Inc.; Ortho Diagnostic Systems, Inc.; Ortho

Pharmaceutical Corporation; Personal Products Company and McNeilab, Inc.

10. As a result of the MTC audit, in September 1989, the Department issued separate

assessments of corporation income tax to the six Johnson & Johnson subsidiaries listed above for the

tax years 1980, 1981 and 1982. The aggregate amount of corporate income tax, penalty and interest

assessed under these assessments was $40,410.60.

11. On November 29, 1989, Johnson & Johnson, on behalf of its subsidiaries, timely

protested all of the Department's assessments. In its protests, Johnson & Johnson asserted that

because the activities of its six subsidiaries in New Mexico were limited to the solicitation of sales,

they were protected from having to file New Mexico corporate income tax returns by the provisions

of P.L. 86-272.

12. The only issue raised by the MTC audit with respect to New Mexico for tax years

1980-1982 pertained to the issue of whether nexus to tax existed with respect to certain Johnson &

Johnson subsidiaries. This is because for those tax years, Johnson & Johnson had elected to file with

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New Mexico on a separate corporate entity basis. With respect to other states for whom the MTC

conducted the audit, the audit concluded that Johnson & Johnson conducted a world-wide unitary

business through its domestic and foreign subsidiaries. Depending upon the statutory provisions of

the other states, the effect of this conclusion was to combine all or a portion of either the income of

the foreign subsidiaries, or all or a portion of the income Johnson & Johnson received from its foreign

subsidiaries in the form of dividends with Johnson & Johnson's other income for purposes of

calculating corporate income taxes due in those other states. The effect of this conclusion was to

increase (and in some cases, increase very substantially) Johnson & Johnson's assessed liability for

taxes to the other states.

13. From 1987 through June of 1992, Manuel F. Gallegos was employed by the

department as manager of its Protest Office.

14. In his capacity as the manager of the Department's Protest Office Mr. Gallegos had

frequent contact with taxpayers who had formally protested various department actions.

15. Often, Mr. Gallegos was the only department employee with whom taxpayers had

contact regarding protested matters.

16. Mr. Gallegos' responsibilities included negotiating protested matters with taxpayers.

17. In his capacity as manager of the Department's Protest Office Mr. Gallegos

communicated both by telephone and in writing with Mr. Joseph F. Robinson, Assistant Director of

Domestic Taxation for Johnson & Johnson concerning Johnson & Johnson's protests. Sometime in

December of 1991, the Department had written Johnson & Johnson proposing an informal conference

concerning Johnson & Johnson's protests in January of 1992. Mr. Robinson called Mr. Gallegos in

response to the letter and said that it would be difficult to attend a hearing in January, but perhaps the

matter could be compromised on some basis. An agreement to compromise the assessed liabilities

for $25,000 was proposed and Mr. Robinson also suggested carrying the settlement forward through

the 1990 tax year.

18. As a result of the settlement discussions between Mr. Gallegos and Mr. Robinson,

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Johnson & Johnson proposed a settlement which was put into the form of a Tax Settlement

Agreement. This first draft of the Tax Settlement Agreement was written by Mr. Robinson and was

mailed to Mr. Gallegos on February 27, 1992.

19. Following receipt of Johnson & Johnson's draft Tax Settlement Agreement, Mr.

Gallegos sent a memo dated March 30, 1992 to both Frank Katz, the Department's Chief Counsel, and

Steve Keene, the Director of the Department's Audit & Compliance Division. Mr. Gallegos' memo

asked whether the Tax Settlement Agreement was sufficient or whether a standard closing agreement

needed to be prepared. By "sufficient", Mr. Gallegos intended to ask whether the form of the

agreement was sufficient to effectuate a binding settlement of the matter between the Department and

Johnson & Johnson. The memo indicated that the only issue involved was the issue of nexus with

respect to certain Johnson & Johnson subsidiaries.

20. In the course of his duties as chief counsel Mr. Katz is familiar with closing

agreements, including the drafting and review of such.

21. Mr. Katz had no familiarity with the Johnson & Johnson protests other than to see the

draft Tax Settlement Agreement and Mr. Gallegos' March 30, 1992 memo when he responded to the

memo in writing. Mr. Katz agreed that the matter could be settled by the Tax Settlement Agreement

and he agreed with settling the matter for the dollar amount proposed, but he found some portions of

the agreement ambiguous and confusing. He questioned why the nexus of Johnson & Johnson

subsidiaries would be an issue after Johnson & Johnson began filing on a federal consolidated basis

with the Department and he questioned the provisions of paragraph 9 concerning the finality of the

agreement for certain tax periods. Mr. Katz found the reference to the time periods ambiguous and

he did not believe that periods through 1990 should be closed out.

22. Mr. Gallegos did not fully understand what Mr. Katz intended to convey by his

written comments concerning paragraph 9.

23. Mr. Keene never responded to Mr. Gallegos' memo of March 30, 1992.

24. Subsequent to Mr. Gallegos receiving Mr. Katz' comments, Mr. Gallegos and Mr.

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Robinson discussed changes to the proposed settlement agreement.

25. The specific changes that Mr. Gallegos requested were to paragraphs 3, 8 and 9.

26. Mr. Robinson prepared a revised Tax Settlement Agreement which reflected the

changes which he and Mr. Gallegos discussed. Mr. Stanley Stern, Director of Domestic Taxation for

Johnson & Johnson executed the revised Tax Settlement Agreement on behalf of Johnson & Johnson.

Mr. Robinson then forwarded the Tax Settlement Agreement to Mr. Gallegos by letter, dated April

24, 1992, for execution by the Department. Accompanying the Tax Settlement Agreement and Mr.

Robinson's transmittal letter was a check for $25,000 in payment of the settlement amount with

respect to the 1980 through 1982 tax years.

27. Between the first draft Tax Settlement Agreement and the revised Tax Settlement

Agreement, paragraph 9 was changed to delete the phrase "as to the previously identified periods" and

in lieu thereof, the phrase "for all tax periods prior to 1991" was inserted.

28. The correspondence and settlement discussions between Mr. Gallegos and Mr.

Robinson related to all open tax years prior to 1991, not just 1980 -1982, the years related to the

protested assessments.

29. The revised Tax Settlement Agreement, transmitted by Mr. Robinson's letter of April

24, 1992 was executed on behalf of the Department on May 15, 1992 by Steve Keene and by Dick

Minzner, then Secretary of the Department, the highest ranking official of the Department.

30. It was the intention of both Mr. Gallegos and Mr. Robinson that the Tax Settlement

Agreement be binding and enforceable on all parties thereto.

31. Under the terms of the executed Tax Settlement Agreement, Johnson & Johnson

agreed to pay the Department $25,000 in settlement of the issue of the nexus of the six subsidiary

corporations for the 1980-1982 audit period. The parties also agreed to a four-two split of the nexus

issue for tax years 1983 through 1990, with Johnson & Johnson conceding nexus for four of the

subsidiaries and the Department agreeing not to argue or assert nexus for the other two subsidiaries.

The agreement provides that the agreement shall be final and conclusive for all periods prior to 1991

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and prohibits the Department from reopening these periods for purposes of determining, assessing or

collecting any tax not provided for in the agreement absent any adjustments to Johnson & Johnson's

federal returns.

32. Mr. Gallegos understood that the Tax Settlement Agreement would close all tax years

prior to 1991 to the Department for purposes of auditing or assessing corporate income tax, unless

there were future adjustments made by the Internal Revenue Service affecting Johnson & Johnson's

federal taxable income.

33. It was Mr. Robinson's intention in negotiating the Tax Settlement Agreement to close

all tax years prior to 1991 to future audit or assessment of corporate income tax by the Department,

unless there were future adjustments made by the Internal Revenue Service affecting Johnson &

Johnson's federal taxable income.

34. The Tax Settlement Agreement is not limited in scope to just the assessments issued

to six Johnson & Johnson subsidiaries, but relates to corporate income tax of Johnson & Johnson and

its subsidiaries for all tax years prior to 1991.

35. At the time the Tax Settlement Agreement was negotiated, the parties knew that the

issue of nexus for all subsidiaries was worth only a few thousand dollars per year.

36. A reasonable estimate of the total tax effect of excluding the factors for the four

subsidiaries for whom Johnson & Johnson conceded nexus under the terms of the Tax Settlement

Agreement for the 1987-1990 tax years was $3,646. Johnson & Johnson gave this up when it entered

into the Tax Settlement Agreement.

37. A reasonable estimate of the total tax effect of considering the factors of the two

subsidiaries for whom the Department conceded it lacked nexus under the terms of the Tax

Settlement Agreement for the 1987-1990 tax years was $2,087. The Department gave this up when it

entered into the Tax Settlement Agreement.

38. Mr. Katz never saw or reviewed the terms of the revised Tax Settlement Agreement

prior to its execution by the Department. If he had, he would not have approved it. Because Mr.

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Katz had no further involvement with the Tax Settlement Agreement and did not receive or review

the revised Tax Settlement Agreement, he took no action to submit the Tax Settlement Agreement to

the Attorney General.

39. Johnson & Johnson relied on the Department to obtain all necessary approvals and

signatures to be obtained to render the Tax Settlement Agreement binding and enforceable.

40. As a matter of administrative practice, the Department does not impose upon any

taxpayer the obligation to see to it that the Department has obtained all necessary approvals with

respect to closing agreements compromising assessed taxes.

41. By letter dated June 16, 1992, Mr. Gallegos transmitted a copy of the executed Tax

Settlement Agreement to Mr. Robinson.

42. Mr. Gallegos was the only Department employee with whom Johnson & Johnson had

substantive contact during the time period of 1992 through November of 1994 regarding the protested

assessments and the Tax Settlement Agreement by which those protested assessments were settled

between the parties.

43. By letter dated August 13, 1992, to Mr. Gallegos, Mr. Robinson transmitted the

schedule required by paragraph 5 of the Tax Settlement Agreement and a check in the amount of

$8,621 in payment of the additional income tax liability shown thereon plus applicable interest.

44. Mr. Robinson's August 13, 1992 transmittal letter noted that the adjustment to the

numerators of the apportionment factors required by paragraph 6 of the Tax Settlement Agreement

was not necessary because Johnson & Johnson had already included the apportionment factors of the

four companies treated as having nexus with New Mexico in Johnson & Johnson's apportionment

factors.

45. In 1987, Johnson & Johnson elected to change its filing method for reporting and

filing corporation income taxes with New Mexico pursuant to Regulation CIT 9:2 and in accordance

with Section 7-2A-8.4 NMSA 1978. Johnson & Johnson had elected to no longer file separate

corporate income tax returns for each of its subsidiaries doing business in New Mexico on a separate

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corporate entity basis, but, instead, to file on a federal consolidated basis. Under the federal

consolidated reporting methodology the income, losses and the factors of all of the corporations

included in Johnson & Johnson's federal consolidated return are considered in calculating Johnson &

Johnson's New Mexico income tax liability.

46. Mr. Robinson made the decision to change Johnson & Johnson's filing method from

separate corporate entity filing to the federal consolidated basis in the summer or fall of 1988. This

decision was made because Mr. Robinson believed that it would reduce the amount of corporate

income tax due to New Mexico from Johnson & Johnson's subsidiaries filing in New Mexico because

it would allow losses of other Johnson & Johnson subsidiaries to be taken into account as well as the

income of Johnson & Johnson's subsidiaries operating in New Mexico in calculating New Mexico

corporate income taxes for Johnson & Johnson.

47. At the time that Mr. Robinson made the decision to change Johnson & Johnson's

filing methodology, and consequently, at the time that Mr. Robinson was negotiating the Tax

Settlement Agreement with Mr. Gallegos, Mr. Robinson knew that New Mexico included

foreign-source dividends from corporations with a unitary relationship to the taxpayer in the

taxpayer's apportionable tax base in calculating New Mexico corporate income taxes.

48. Neither Mr. Robinson or Johnson & Johnson believe that Johnson & Johnson is

engaged in a unitary world-wide business which includes its foreign subsidiaries.

49. At the time that Mr. Robinson was negotiating the Tax Settlement Agreement with

the Department, Mr. Robinson was aware of the MTC audit conclusion that Johnson & Johnson was

engaged in a world-wide unitary business.

50. Within the year prior to the finalization of the Tax Settlement Agreement with the

Department, and in some instances, during the same time in which the Tax Settlement Agreement

was being negotiated with the Department, Mr. Robinson was involved in negotiating settlements

with several of the other states involved in the MTC audit who were claiming additional income taxes

from Johnson & Johnson based upon the MTC audit conclusion that Johnson & Johnson operated a

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unitary world-wide business. In negotiating these settlements, Mr. Robinson negotiated to have the

settlements extend beyond the MTC audit period to cover all open tax years, usually through 1989 or

1990. Those settlements resulted in Johnson & Johnson agreeing to terms which included all or part

of the income or dividends from Johnson & Johnson's foreign subsidiaries in Johnson & Johnson's

apportionable tax base for purposes of calculating income taxes owed to those states for the audit

years. These settlements resulted in Johnson & Johnson paying the various states more than five

million dollars.

51. Johnson & Johnson timely filed New Mexico income tax returns using the federal

consolidated group reporting method for the 1987 through 1990 tax years and those returns were

available for Mr. Gallegos to review at the time he was negotiating the Tax Settlement Agreement

with Mr. Robinson. Johnson & Johnson's 1991 New Mexico income tax return was not available

because it was not yet due.

52. Mr. Gallegos did not review Johnson & Johnson's 1987 through 1990 corporate

income tax returns during the period of time he was negotiating the Tax Settlement Agreement with

Mr. Robinson. Had he done so, his review would have revealed that Johnson & Johnson was

consistently deducting as allocated income dividend income representing more than half of its federal

taxable income in arriving at New Mexico taxable income. If Mr. Gallegos had reviewed those

returns, he would not have agreed to the terms proposed by Mr. Robinson in the Tax Settlement

Agreement without making further inquiry into the deductions being taken by Johnson & Johnson.

53. Had the dividends received by Johnson & Johnson's consolidated groups from

Johnson & Johnson's foreign subsidiaries during the 1987 through 1990 tax years been considered

business income subject to apportionment by New Mexico, Johnson & Johnson would have owed

approximately two million dollars in additional corporate income tax, penalty and interest to the state

of New Mexico.

54. During their settlement discussions, the only issue discussed between Mr. Gallegos

and Mr. Robinson was the question of nexus for the six disputed corporations and how the terms of

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  the settlement of that issue would be handled for years subsequent to the audit years. Mr. Gallegos

and Mr. Robinson never discussed the fact that Johnson & Johnson allocated all of its foreign source

dividend income, excluding it from consideration by New Mexico in calculating Johnson & Johnson's

corporation income taxes payable to the Department.

55. Prior to executing the Tax Settlement Agreement no employee of the Department

requested or reviewed copies of Johnson & Johnson's New Mexico corporate income tax returns for

tax years 1987 through 1990.

56. The Tax Settlement Agreement as prepared by Johnson & Johnson and executed by

them and the Department contains no signature line or any other notation to indicate that the

agreement would be reviewed or approved by the Attorney General.

57. The Tax Settlement Agreement entered into between the Department and Johnson &

Johnson represented a compromise of assessed taxes assessed against six subsidiaries of Johnson &

Johnson.

58. The Department has never had a policy or practice of compromising assessed taxes

without a closing agreement, signed by the Attorney General.

59. Normally, the Department's attorney handling the protest of assessed taxes would be

involved in drafting any closing agreement compromising those assessed taxes. It would be the

responsibility of that attorney to forward the closing agreement to the Attorney General to obtain the

necessary approval of the closing agreement. In this case, because no Department attorney was

handling the protests by Johnson & Johnson's subsidiary corporations and because no attorney was

involved in determining the final terms of the Tax Settlement Agreement, the Tax Settlement

Agreement was not forwarded to the Attorney General's Office for signature at the time the agreement

was executed by the Department.

60. The Attorney General's Office reviews proposed closing agreements for form,

propriety and content.

61. The Attorney General's Office review of proposed closing agreements may involve a

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  discussion between the Department's attorney and the Attorney General's Office representative about

the agreement. On occasion, the Attorney General's Office has rejected closing agreements proposed

by the Department and/or sent them back to the Department for rewriting.

62. The Attorney General has not delegated authority to anyone in the Department to

execute or approve closing agreements on behalf of the Attorney General.

63. The Attorney General's Office and the Taxation and Revenue Department are entirely

separate agencies of state government.

64. On October 4, 1994 the Department sent the Tax Settlement Agreement to the

Attorney General with a cover letter requesting that the Attorney General review and approve the

agreement. The Attorney General declined to sign or approve the agreement on the basis that more

than two years had elapsed since the Department had executed the agreement before it was

transmitted to the Attorney General for approval. Thereafter, the Department took no further action

to obtain the Attorney General's approval of the agreement.

65. Between 1990 and 1994, the Tax Settlement Agreement was the only agreement

between the Department and a taxpayer compromising assessed taxes which was not signed or

approved by the Attorney General. All tax settlement agreements in the standard form of a closing

agreement which settle taxes between the Department and a taxpayer during that time frame were

ultimately approved by the Attorney General although they may have been altered from their original

form as a result of the review process in the Attorney General's Office.

66. In late 1994, Rex Foutz, a corporate income tax auditor with the Department

contacted Johnson & Johnson and informed them that he intended to conduct an audit of New Mexico

corporate income tax for 1987 and subsequent tax years.

67. Mr. Foutz was informed by Johnson & Johnson that it would allow Mr. Foutz access

to records for an audit of 1991 and subsequent tax years but that tax years prior to 1991 were closed

pursuant to the terms of the Tax Settlement Agreement.

68. In late December, 1994 Johnson & Johnson was advised over the telephone by Mr.

• 12 -
  Foutz that the Department did not consider itself bound by the Tax Settlement Agreement because it

was not signed by the Attorney General of the State of New Mexico. Therefore, Mr. Foutz informed

Johnson & Johnson that the Department would assert a corporate income tax deficiency for 1987 and

subsequent tax years.

69. The first time any Department employee communicated to Johnson & Johnson that

the Department did not consider itself bound by the Tax Settlement Agreement was Mr. Foutz'

telephone call in late 1994. At no time prior thereto did any Department employee communicate in

any way to any employee or agent of Johnson & Johnson (i) any issue of enforceability of the Tax

Settlement Agreement, (ii) the necessity to obtain either the Attorney General's signature on or

approval of the Tax Settlement Agreement or (iii) any effort by the Department to obtain the signature

or approval of the Attorney General for the Tax Settlement Agreement.

70. The Department issued two provisional assessments to Johnson & Johnson,

Assessment Nos. 1885005 and 1884894.

71. Assessment No. 1885005 bears an assessment date of December 29, 1994 and a

stamped mailing date for purposes of application of Section 7-1-24(B) NMSA 1978 of December 28,

1994. It assessed $1,228,647 of corporate income tax, $122,864.70 of penalty and $836,033.18

interest through January 15, 1995 for the 1987 through 1991 tax years.

72. Assessment No. 1884894 bears an assessment date of December 25, 1994 and a

stamped mailing date for purposes of application of Section 7-1-24(B) NMSA 1978 of December 29,

1994. It assessed $64,790.12 of penalty and $65,340.10 in interest computed through January 15,

1995 for the 1988 through 1991 tax years.

73. The Department has agreed to abate Assessment No. 1884894.

74. The "nexus filing agreements" comprising Exhibit S-21 do not compromise or settle

assessed taxes nor do they reflect approval by the Attorney General.

75. Johnson & Johnson was not aware of the nexus filing agreements at the time it

negotiated the terms of and prepared the Tax Settlement Agreement with the Department.

• 13 -
  DISCUSSION

The only issues to be determined at this juncture relate to the enforceability of the Tax

Settlement Agreement entered into between Johnson & Johnson and the Department and whether

equitable estoppel would operate to estop the Department from disregarding the terms of the Tax

Settlement Agreement in the event it is concluded that the agreement is not binding upon the

Department. The remaining issues concerning the taxes, penalty and interest assessed by Assessment

No. 1885005 have been bifurcated and will be determined in a subsequent hearing.

Johnson & Johnson was audited by the Multistate Tax Commission ("MTC") on behalf of a

number of states, including New Mexico, for tax years 1980-1982. Johnson & Johnson (the parent

corporation1) did not directly engage in business in New Mexico. Its subsidiaries, Ethicon, Inc. and

Xanar, Inc. did engage in business in New Mexico and they elected to report to the Department for

corporate income tax purposes using the separate corporate entity filing methodology.2 The MTC

audit concluded that six other Johnson & Johnson subsidiaries were engaged in activities in New

Mexico sufficient to establish nexus and in 1989 the Department issued assessments totalling

approximately $40,000 against those subsidiaries for corporation income tax for the audit years.

Johnson & Johnson protested those assessments on the basis that the six subsidiaries did nothing more

than to solicit sales in New Mexico and as such, they were protected by the provisions of P.L. 86-272

from filing corporate income taxes in New Mexico. The MTC audit also concluded, with respect to

other states for whom the MTC conducted the audit, that Johnson & Johnson conducted a world-wide

unitary business through its domestic and foreign subsidiaries. This audit finding was irrelevant for

1
Throughout this decision "Johnson & Johnson" is used to mean Johnson & Johnson, the parent
corporation, as well as its subsidiaries and affiliates. When only the parent corporation is intended to
be referenced, it will be specifically noted as the parent corporation.
2
Regulation CIT 9:2 allows a taxpayer to elect any one of four reporting methods when filing its
initial corporate income tax return. There are provisions, not pertinent herein, which impose
conditions for changing the filing methodology once one is elected, for subsequent years. The four
filing methodologies are:
separate accounting
separate corporate entity
combination of unitary corporations
federal consolidated group

• 14 -
  purposes of New Mexico taxes because of Johnson & Johnson's election to file on a separate

corporate entity basis for its subsidiaries engaging in business in New Mexico. For the other states,

however, if they require unitary businesses to file on a water's edge or world-wide unitary basis, the

effect of this finding was to include either the income of Johnson & Johnson's foreign subsidiaries or

the dividends those foreign subsidiaries paid to Johnson & Johnson to be included in Johnson &

Johnson's income subject to apportionment among the states. As a consequence of this MTC audit

finding, the other states issued substantial assessments of additional corporate income taxes to

Johnson & Johnson. Johnson & Johnson acted to dispute the conclusion that it conducted a

world-wide unitary business in those other states, and negotiated settlements to resolve those disputes.

In negotiating those settlements, Johnson & Johnson negotiated settlements to settle those matters for

all open years, not just the years covered by the MTC audit. Johnson & Johnson ultimately paid over

five million dollars to settle those cases.

Sometime in December of 1991, Mr. Manuel Gallegos, the manager of the Department's

protest office, wrote to Johnson & Johnson proposing a meeting in January of 1992 to discuss the

issues raised by Johnson & Johnson in its protests of the six assessments issued to Johnson &

Johnson's subsidiaries. In response to Mr. Gallegos' letter, Mr. Joseph Robinson, Assistant Director

of Domestic Taxation for Johnson & Johnson telephoned Mr. Gallegos. Mr. Robinson explained that

it would be difficult for Johnson & Johnson to meet with the Department in January and asked if it

would be possible to discuss settling the disputed assessments in some manner. There ensued

settlement discussions between Mr. Gallegos and Mr. Robinson in which the general terms of a

settlement were worked out. Essentially, the parties agreed to a four/two split on the nexus issue,

with Johnson & Johnson conceding nexus on four of the subsidiaries and the Department conceding

no nexus on the other two and they agreed on a payment of $25,000 to settle the issue for the

1980-1982 audit years. Mr. Robinson also proposed that the settlement be carried forward through

the 1990 tax year and that he would draw up a draft of the settlement agreement and send it to Mr.

Gallegos for review by the appropriate parties at the Department.

• 15 -
  When Mr. Gallegos received the draft Tax Settlement Agreement from Mr. Robinson, he sent

it, along with the cover memo, to Mr. Frank Katz, the Department's chief counsel, for review. Mr.

Katz was not familiar with the Johnson & Johnson assessments or protests. Mr. Gallegos' memo

asked whether the draft Tax Settlement Agreement was sufficient to effectuate a binding settlement of

the Johnson & Johnson protests or whether a standard closing agreement was needed. His memo

also explained that the Johnson & Johnson protests involved only the question of nexus with respect

to Johnson & Johnson subsidiaries. Mr. Katz reviewed the matter briefly and responded that he

agreed with settling the matter for the dollars indicated and by the form of agreement proposed, but he

raised several questions concerning the agreement. With respect to paragraph 9 which accorded

finality to the agreement as to "all previously identified periods", Mr. Katz commented that he found

the agreement confusing and raised the concern that the agreement talks about every period up to

1990. Mr. Katz testified that he did not agree with closing the tax years through 1990. His written

comments, however, do not clearly convey that opposition. Mr. Gallegos did not understand from

Mr. Katz' comments that he disagreed with closing all tax years through 1990, but only understood

that the ambiguity in the draft agreement needed to be clarified as to which years would be closed.

When Mr. Gallegos next spoke with Mr. Robinson, he proposed language which explicitly provided

that the agreement be final and conclusive for "all periods prior to 1991" to clarify the ambiguity as to

which years would be closed. That language was incorporated into the final Tax Settlement

Agreement which was executed by both the Department and Johnson & Johnson.

The Tax Settlement Agreement was not sent to the Attorney General for approval at the time

the agreement was executed by the Department. Closing agreements, which are provided for at

Section 7-1-20 NMSA 1978 as the means by which assessed taxes may be compromised by the

Department, are required to be approved by the Attorney General. The Department's legal division

handles the coordination of the process of sending closing agreements to the Attorney General and

tracking those closing agreements once they are sent there. In this case, Mr. Katz never saw the final

version of the Tax Settlement Agreement, nor would he have approved it because of the finality

• 16 -
  provision to which he objected. Since nobody in the Department's legal division was involved in

finalizing the Tax Settlement Agreement, nobody at the Department took any action to have it

approved by the Attorney General at the time it was executed. Only in 1994, apparently after the

Department determined that it wanted to audit some of the years which it was prohibited from

auditing under the terms of the Tax Settlement Agreement, was the agreement sent to the Attorney

General's Office. The Attorney General's Office refused to approve the Tax Settlement Agreement,

noting the two year delay between the execution of the agreement by the parties and its submission for

approval by the Attorney General.

The discussions between Mr. Gallegos and Mr. Robinson addressed only the nexus issue

concerning the six Johnson & Johnson subsidiaries and how the settlement of that issue for the audit

years would be carried forward to the open years beyond the audit years. Although Johnson &

Johnson had filed its 1987-1990 tax returns with the Department and they would have been available

for Mr. Gallegos to review in the context of his settlement negotiations with Mr. Robinson, Mr.

Gallegos did not review those returns. In retrospect, that was a mistake, for that review would have

revealed under its new filing methodology, Johnson & Johnson was consistently deducting more than

half of its federal taxable income as non-business income not taxable in New Mexico. If Mr.

Gallegos had discovered this, he would have made further inquiry into what type of income was being

treated as non-business income and whether the Department agreed with that characterization before

agreeing to the terms of the proposed Tax Settlement Agreement.

The deductions Johnson & Johnson claimed as non-business income only become an issue

because in 1987, Johnson & Johnson had changed its filing with the Department, electing to report on

the federal consolidated basis. This means that Johnson & Johnson would no longer file separate

returns under the separate corporate entity filing method in New Mexico for each of its subsidiaries

doing business here. Rather, one return would be filed using the same consolidated filing group of

corporations which Johnson & Johnson used when filing with the Internal Revenue Service. Johnson

& Johnson believed this to be advantageous in New Mexico because the losses of some of its other

• 17 -
  subsidiaries would be combined to offset the income of its subsidiaries operating in New Mexico,

reducing its New Mexico corporate income tax liability. This election of filing methods also brought

Johnson & Johnson (the parent corporation) into the group of corporations filing in New Mexico.

Johnson & Johnson received more than half of its federal taxable income in the form of dividends

from its foreign subsidiaries, and the Department considers that this foreign dividend income would

also be included in the pot of income New Mexico looks to in determining its proportionate share of

taxable income. Johnson & Johnson was aware of the Department's view but it deducted all of its

foreign dividend income on the basis that it qualifies to be classified non-business income because

Johnson & Johnson contends that no unitary relationship exists between it and its foreign

subsidiaries.3 Within the year prior to, and in some cases, at the same time, that Mr. Robinson was

negotiating the terms of the Tax Settlement Agreement with Mr. Gallegos, Johnson & Johnson had

negotiated and settled its protests with some of the other states involved in the MTC audit in which

the taxability of Johnson & Johnson's foreign source income was an issue.

It is in this context that the enforceability of paragraph 9 of the Tax Settlement Agreement is

to be decided. It provides as follows:
This agreement shall be final and conclusive for all periods prior to 1991, and these periods
shall not be reopened by the Department, nor shall any suit, action or proceeding for
determination, assessment, collection, refund or credit be brought by either party;
provided, however, that adjustments to J&J's federal return by the Internal Revenue
Service shall be subject to adjustment for New Mexico tax purposes. For the limited
purpose of reflecting such limited adjustments only, J&J may file an amended return
or the Department may issue an adjustment.

The language of paragraph 9 is unambiguous and clearly prohibits the Department from

auditing or assessing additional tax for 1990 and prior years. Since the assessment at issue herein,

assesses tax for the 1987-1991 tax years, the terms of paragraph 9 would prohibit the Department

from assessing for all but the 1991 tax year.

3
Whether a unitary relationship exists between Johnson & Johnson and its foreign subsidiaries
who paid the foreign dividend income and the business or non-business nature of that foreign
dividend income will be addressed, for at least the 1991 tax year, when a formal hearing is held to
address the remaining issues raised by Johnson & Johnson's protest.

• 18 -
  The Department contends, however, that the Tax Settlement Agreement is unenforceable

because it was not approved by the Attorney General. The Department's argument is based upon the

provisions of Section 7-1-20 NMSA 1978 (1990 Repl. Pamp.) 4 , the provision of the Tax

Administration Act5 which authorizes closing agreements as the means by which assessments of tax

may be compromised and sets forth the conditions governing closing agreements. The provisions of

Section 7-1-20 are as follows:
A. At any time after the assessment of any tax, if the director in good faith is in
doubt of the liability for the payment thereof, he may, with the written approval of the
attorney general, compromise the asserted liability for taxes by entering, with the
taxpayer, into a written agreement that adequately protects the interests of the state.

B. The agreement provided for in this section is to be known as a "closing
agreement". If entered into after any court acquires jurisdiction of the matter, the
agreement shall be part of a stipulated order or judgment disposing of the case.

C. As a condition for entering into a closing agreement, the director may require
the taxpayer to furnish security for payment of any taxes due according to the terms of
the agreement.

D. A closing agreement is conclusive as to liability or nonliability for payment of
assessed taxes relating to the periods referred to in the agreement and, except upon a
showing of fraud or malfeasance, or the misrepresentation or concealment of a
material fact:
(1) the agreement shall not be modified by any officer, employee or agent of the state;
and
(2) in any suit, action or proceeding, the agreement or any determination, assessment
collection, payment, abatement, refund or credit made in accordance therewith shall
not be annulled, modified, set aside or disregarded.
(Emphasis added)

There is no other provision in the Tax Administration Act, nor elsewhere, such as the

Taxation and Revenue Department Act6 where the secretary's power to compromise assessments of

tax is addressed. The Tax Settlement Agreement, by its very terms, purports to compromise the taxes

4
The version of Section 7-1-20 contained in the 1990 Replacement Pamphlet is referred to because
it is the version in effect when the parties entered into the Tax Settlement Agreement. The only
changes between it and the version in the 1995 Replacement Pamphlet is that the references to
"director" in subsections A and C have been amended to "secretary".
5
Chapter 7, Article 1, NMSA 1978
6
Chapter 9, Article 11, NMSA 1978

• 19 -
  which had been assessed by the Department for the 1980-1982 tax years, as well as providing terms to

carry the settlement forward to additional years. Section 7-1-20 is the statutory provision which

addresses the conditions upon which an assessment of taxes may be compromised. Subsection A

unambiguously requires the written approval of the Attorney General to any agreement to

compromise the assessment of any tax. Thus, the legislature has stated the public policy in New

Mexico that agreements which compromise assessed taxes must, in addition to meeting with the

Secretary's approval, receive the scrutiny and written approval of the Attorney General. The reasons

for such a provisions should be obvious. Protection of the public fisc is of great importance to the

functioning of government. Providing for review and approval by the Attorney General not only

protects the state against the potential for corrupt acts by its public officials, it also provides protection

against innocent mistakes and careless or complacent enforcement of the state's tax laws by the state's

taxing officials. In short, it provides additional assurance that the agreement "adequately protects the

interest of the state", as required by Subsection A.

In this case, the Attorney General expressly refused to grant approval to the Tax Settlement

Agreement. Since the Tax Settlement Agreement fails to meet the express statutory provisions of

Section 7-1-20 because it lacks the written approval of the Attorney General, none of the protections

of Subsection D binding the state to the terms of the agreement can be invoked by Johnson &

Johnson. In fact, absent the approval of the Attorney General, the Department lacks the legal

capacity to enter into an agreement, such as the Tax Settlement Agreement, which compromises

assessed taxes. Because the Tax Settlement Agreement lacks the written approval of the Attorney

General, it is contrary to the express public policy requiring such approval found in Section 7-1-20.

Contracts in violation of public policy are a nullity and unenforceable. State ex rel. Udall v.

Colonial Penn, 112 N.M. 123, 130, 812 P.2d 777 (1991). Thus, Johnson & Johnson may not rely

upon the Tax Settlement Agreement to bar the Department from auditing or assessing tax for the years

at issue herein.

Johnson & Johnson attempts to avoid the fatal consequence of the absence of the Attorney

• 20 -
  General's approval by asserting that such approval is not necessary under the doctrine of apparent

authority. Under this doctrine, the exercise of authority flowing from one's position which a

reasonably prudent person naturally would suppose the other to possess by virtue of the trappings of

actual authority acts to bind the party exercising the authority. Ellingwood v. N.N. Life Ins., 111

N.M. 301, 805 P.2d 70 (1991). Johnson & Johnson argues that it should reasonably be able to rely

upon the authority of the Secretary of the Department to contractually bind the Department to the

terms of the Tax Settlement Agreement. While it might seem reasonable under most circumstances

for Johnson & Johnson to believe that the Secretary can act to bind the Department, under the

circumstances of this case, such a belief is not reasonable. In the first place, there is an express

statutory provision which unambiguously requires the written approval of the Attorney General to

effectuate the compromise of taxes. Although Johnson & Johnson may not have had actual

knowledge of the requirement, it had constructive knowledge, since it was codified in the statutes

which are available for any taxpayer to consult. In this regard, it is noteworthy that in this instance

we are not dealing with a mom and pop taxpayer without the resources or sophistication to consult a

statute or a tax service. Johnson & Johnson is a large, multinational company which possesses a staff

of competent tax professionals who handle highly complex federal and state tax matters.

Additionally, the Secretary of the Department and the Attorney General are obviously separate

governmental officials with separate statutory and constitutional duties and obligations. There is no

basis for Johnson & Johnson to conclude that the Secretary of the Department had the apparent

authority to act for the Attorney General.

Johnson & Johnson also argues that the failure to obtain the approval of the Attorney General

was a unilateral mistake of law on the part of the Department which should not relieve the

Department from the binding effect of a contract. There was a mistake of law on the Department's

behalf in this instance, but it was a mistake shared by Johnson & Johnson. As noted above, Johnson

& Johnson is a sophisticated taxpayer with the professional staff and resources necessary to know the

legal requirements for compromising taxes. The truth of the matter is that both the Department and

• 21 -
  Johnson & Johnson regarded the matter which was the subject of the Tax Settlement Agreement to be

a small dollar issue of no significant legal importance. The Department's chief counsel admitted that

he gave little thought to the issue of the form of the agreement. He devoted far more attention to the

substance of the terms of the agreement. Mr. Robinson, who prepared the draft and final form of the

agreement apparently took a similar approach. He gave no attention to the form of the agreement.

He made no effort to research New Mexico law on what such agreements require and he had no

discussions with Mr. Gallegos about the form of the agreement in their negotiating process. Thus,

the mistake about the form of the agreement was a mutual mistake for which Johnson & Johnson also

shares some responsibility. Such a mutual mistake is more appropriately grounds for rescission or

reformation of the contract, rather than its enforcement. With respect to the particular mutual

mistake in this case, reformation is not even a consideration to remedy the mistake where the

Attorney General has refused to approve the agreement.

Even though the Tax Settlement Agreement is unenforceable due to its failure to meet the

conditions of Section 7-1-20, the issue remains as to whether the Department should be equitably

estopped from denying the binding effect of the agreement. As a general rule, courts are reluctant to

apply the doctrine of equitable estoppel against the state. This general rule is given even greater

weight in cases involving the assessment and collection of taxes. Taxation and Revenue

Department v. Bien Mur Indian Market, 108 N.M. 228, 231, 770 P.2d 873, 876 (1989). However,

estoppel may be applied against the state when "right and justice demand it". United States v.

Bureau of Revenue, 87 N.M. 164, 166, 531 P.2d. 212, 214 (Ct. App. 1975).

Although I as a decision maker must admit a great deal of discomfort in general with the

concept of not holding parties to the agreements they have made, upon analysis of the full context of

this matter, I must conclude that this matter is not so aggravated or shocking that right and justice

require the Department be estopped.

At the hearing, the Department presented a great deal of evidence which would indicate a

strong possibility that Johnson & Johnson had knowingly put one over on the Department. Mr.

• 22 -
  Robinson negotiated and drafted the Tax Settlement Agreement on behalf of Johnson & Johnson. It

was at his suggestion that tax years through 1990 be included in the terms of the settlement. At the

time he was negotiating the terms of the Tax Settlement Agreement, Mr. Robinson knew that New

Mexico considered foreign source dividends to be includible in a taxpayer's apportionable tax base

where a unitary relationship exists between the dividend payor and a taxpayer. Mr. Robinson was

also aware that Johnson & Johnson had deducted its foreign dividend income in determining its

apportionable tax base for New Mexico commencing with tax year 1987, when it changed its tax

filing methodology in New Mexico. Although Mr. Robinson testified that he did not believe that

Johnson & Johnson was engaged in a unitary business with its foreign dividend paying subsidiaries,

he was aware that the same Multistate Tax Commission audit which gave rise to the liability he was

negotiating to settle with New Mexico had concluded that Johnson & Johnson operated a unitary

world-wide business with its foreign dividend paying subsidiaries. With respect to other states

involved in the MTC audit, this conclusion resulted in the assessment of millions of dollars of

additional income tax. Within the year in which the Tax Settlement Agreement was negotiated with

New Mexico, Mr. Robinson was also involved in negotiating settlements over these other states'

assessments which required Johnson & Johnson to pay more than five million dollars of additional

income taxes.

In spite of this evidence, Mr. Robinson testified passionately that at the time he was

negotiating the Tax Settlement Agreement with New Mexico that he was not thinking about Johnson

& Johnson's potential exposure on its treatment of its foreign dividend income in New Mexico, but

was only trying to settle the assessments at issue in New Mexico and to obtain closure through all

open tax years. In response to cross examination by the Department's counsel in which counsel

asked Mr. Robinson why he wasn't surprised that in negotiating the agreement Mr. Gallegos did not

mention the foreign dividend issue Mr. Robinson testified:
We don't spend our time worrying about New Mexico and the tax department. We've got 39
other states. We've got the federal tax return. I was changing jobs. I'm not sitting
there scheming about how we can do the state of New Mexico. I'm closing an issue.
I'm closing through 1990. I want closure. And I'm not sitting there thinking, well,
what might New Mexico come back and say?

• 23 -
  Transcript of Proceedings, pp. 234-235. (Emphasis added.)

Frankly, in spite of the evidence that Mr. Robinson might have been trying to "do" the state of

New Mexico, I found Mr. Robinson to be credible. I believe that he wasn't really thinking about

Johnson & Johnson's exposure on its treatment of its foreign dividend income when he negotiated the

Tax Settlement Agreement with Mr. Gallegos. His testimony is also revealing, however, of what I

believe to be the crux of this matter concerning estoppel. It reveals that in Mr. Robinson's view, the

only issue that he and Mr. Gallegos were negotiating and settling was the issue of nexus involving the

Johnson & Johnson subsidiaries which the MTC audit had concluded were taxable by New Mexico.

That this is what was in Mr. Gallegos' mind when negotiating the agreement is confirmed by the

language of his memorandum to Mr. Katz transmitting the draft Tax Settlement Agreement to Mr.

Katz to review. The memorandum indicated that "it involves only the question of nexus on four

subsidiaries of Johnson and Johnson for the audit period of 1980, 1981 and 1982." Exhibit S-10.

The language of the Tax Settlement Agreement itself provides further confirmation that the nexus

issue is what the parties were negotiating. It details not only how the nexus issue will be settled for

the audit years, but it also addresses in some detail how the terms of that settlement will be carried

forward to the years beyond the audit. In spite of the more general language of paragraph 9, which

closes all tax years through 1990 and does not limit the closure to only the nexus issue, it is clear that

Mr. Gallegos and Mr. Robinson were focusing on the nexus issue in all of their discussions. This

context also explains why Mr. Gallegos did not take the precautionary measure of examining Johnson

& Johnson's tax returns for 1987 through 1990 which would have revealed that Johnson & Johnson

was deducting the majority of its income prior to determining its New Mexico taxable income.

Because the nexus issue was worth only a few thousand dollars per year in taxes, both Johnson &

Johnson and the Department considered the settlement to be a rather small potatoes issue. This

context was most likely a significant factor as to why neither Mr. Katz, or Mr. Robinson devoted any

time or attention to the issue of legal requirements of the form of the agreement to effectuate a

binding compromise of taxes. This is not a practice which should be condoned or approved, but it

• 24 -
  does indicate the state of mind of the parties when the agreement was negotiated and entered into.

This context thus demonstrates that, in spite of its protestations to the contrary, Johnson &

Johnson has gotten essentially what it was negotiating for when it negotiated the agreement. It got

settlement of the nexus issue and it got closure on that issue through the open tax years. The

Department has not reneged on any aspect of the nexus issue settlement. If it had, a far more

compelling case for equitable estoppel would be presented. But that is not this case. It is for this

reason that this case is not one in which "right and justice" demand that the Department be estopped.

The supreme court's decision in the Bien Mur case is also instructive on the issue of estoppel.

In that case, a taxpayer was claiming estoppel against the tax department on the basis of oral

representations made by a Department employee. The court found that the element of reasonable

reliance by the party seeking to assert estoppel was missing in that case. The basis for the court's

conclusion was that there exists a statutory provision of the Tax Administration Act, Section 7-1-60

NMSA 1978, which expressly provides for estoppel against the state in taxation matters in only two

circumstances. Those are where the taxpayer relies upon a regulation which was in effect during the

time the tax liability arose, or where the taxpayer acts in reliance upon a written ruling addressed to

him personally and in writing by the director of the Department. The court concluded that Bien Mur

could not have reasonably relied upon the oral advice given by the Department employee because of

the existence of Section 7-1-60, a provision of which the taxpayer had constructive notice. Id., 108

N.M. at 231. In this case it would be equally unreasonable for Johnson & Johnson to rely upon the

Tax Settlement Agreement to effectuate a binding compromise of taxes where there was no evidence

of compliance with the requirements of Section 7-1-20 with regard to the need for written approval of

the compromise by the Attorney General.

In addition to a lack of reasonable reliance, the other elements of equitable estoppel also

appear to be lacking. As related to the party claiming estoppel, the elements are: (1) lack of

knowledge and of the means of knowledge of the truth as to the facts in question; (2) reliance upon

the conduct of the party estopped; and (3) action based thereon of such a character as to change his

• 25 -
  position prejudicially. Westerman v. City of Carlsbad, 55 N.M. 550, 555-56, 237 P.2d 356, 359

(1951). With respect to the first element, lack of knowledge as to the fact that the agreement may not

be enforceable because of the lack of approval by the Attorney General, Johnson & Johnson fails to

meet this requirement due to the fact that it was well within its means to obtain this knowledge since

it had only to consult the statutes or a tax service to learn of the requirements of Section 7-1-20.

Even the third element appears to be lacking in this case. Johnson & Johnson presented no evidence

that it had taken any actions based upon the closure of tax years 1987-1990 which had changed its

position prejudicially. It only presented testimony as to its reliance upon the Tax Settlement

Agreement. At the hearing, Mr. Stanley Stern, Johnson & Johnson's Director of Domestic Taxation

testified that Johnson & Johnson always pays its fair share of taxes. Transcript of Proceedings, p.

253, pp. 258-260. If that is the case, then there should be no prejudice to letting the matter of

Johnson & Johnson's income tax liability for tax years 1987-1990 proceed to a determination through

the administrative and judicial process to determine whether it, in fact, paid its fair share of taxes.

A few other matters raised by the parties also deserve comment. It was stipulated by the

parties that the Department had entered into numerous "nexus filing agreements". See, Exhibit S-21.

These agreements were entered into in situations where there were substantial questions as to

whether a taxpayer had sufficient nexus with New Mexico to be subject to tax and a taxpayer agrees

to come forward and commence reporting and paying tax in return for the Department agreeing not to

audit for prior periods. See Exhibits S-18 and S-19 for the Department's policy regarding these

agreements. These agreements were not reviewed or approved by the Attorney General. Johnson &

Johnson points to these agreements as evidence that the Department entered into numerous

agreements without the approval of the Attorney General. While the validity of these agreements is

not an issue herein and will not be addressed herein, two things are notable with respect to these

agreements. First, by their terms, they do not compromise assessed taxes. At most, under their

terms the Department may only agree not to conduct audits of past periods to determine if taxes

should be assessed. Since by its very terms, a closing agreement may be entered only "after the

• 26 -
  assessment of any tax" to "compromise the asserted tax liability", the nexus filing agreements do not

amount to a closing agreement. Section 7-1-20(A). (Emphasis added.) Secondly, Johnson &

Johnson presented no evidence that it was even aware of the existence of this type of agreement at the

time it was negotiating the Tax Settlement Agreement. Thus, it could not have relied upon them as

an indication that the Attorney General's approval was not necessary for the Tax Settlement

Agreement.

The Department argued that there was no additional consideration given by Johnson &

Johnson for the Department's agreement to close tax years 1987-1990 when the Tax Settlement

Agreement was negotiated. Johnson & Johnson argues that the agreement is a single, indivisible

agreement for which adequate consideration was given. Thus, there need be no analysis of the

consideration given for each element of the agreement. I agree the agreement is a single, indivisible

agreement and I have no reason to second guess the Department's judgement that adequate

consideration was given at the time the agreement was negotiated and entered into.

In conclusion, this case amply illustrates the wisdom of the public policy of New Mexico, as

expressed in Section 7-1-20, which requires the review and approval of the Attorney General to any

agreements which compromise assessed taxes to assure that the interests of the state are adequately

protected. In this case, Mr. Gallegos, a well meaning employee with the responsibility to oversee and

resolve thousands of administrative tax protests thought he was settling a relatively small dollar tax

protest involving only the issue of nexus for six of Johnson & Johnson's subsidiaries and carrying the

substance of that settlement forward to the open tax years beyond the years covered by the

assessments in protest. Mr. Gallegos understood that the terms of paragraph 9 were broader than just

the nexus issue, but he mistakenly failed to review Johnson & Johnson's tax returns to determine if

there were any other obvious problems with closing out those years as to all issues. Mr. Katz, the

Department's Chief Counsel, in reviewing the draft agreement did not focus on the form of the

agreement, but on its substance, and he did not approve of the provision, which due to its ambiguous

nature, might close out tax years 1987-1990 as issues going beyond the nexus issue being negotiated.

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  Unfortunately, there was a failure of communication between Mr. Katz and Mr. Gallegos and the

agreement was rewritten only to clarify the ambiguity as to the tax years being closed. These were

inadvertent mistakes by well intentioned public servants. The effect of these mistakes, however,

have the potential to compromise up to several million dollars of public tax monies for less than

$40,000. Obviously, this result would not have adequately protected the fiscal interests of the state.

The public policy of this state, however, is that agreements which compromise taxes must receive a

second and independent review and approval by the Attorney General. This provides an additional

assurance that inadvertent mistakes or oversights by public employees do not operate to the prejudice

the public fisc. Because the Tax Settlement Agreement was in clear contravention of the public

policy of the state, it is unenforceable. Additionally, because the Johnson & Johnson had

constructive notice of the requirement of Attorney General approval, and the parties negotiations

focused solely on the nexus issue, right and justice do not demand that the Department be estopped

from examining issues other than the nexus issue for the 1987-1990 tax years. For these reasons,

Johnson & Johnson's protest with respect to the issue of the enforceability of the Tax Settlement

Agreement must be denied.

CONCLUSIONS OF LAW

1. Johnson & Johnson filed timely, written protests to Assessment Nos. 1884894 and

1885005, pursuant to Section 7-1-24 NMSA 1978 and jurisdiction lies over both the parties and the

subject matter of this protest.

2. The Tax Settlement Agreement compromised assessed taxes of six subsidiary

corporations of Johnson & Johnson.

3. Any compromise of assessed taxes requires the written approval of the Attorney

General in order to be effective. Section 7-1-20 NMSA 1978.

4. The Tax Settlement Agreement was not approved by the Attorney General and is

therefore unenforceable and void ab initio.

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  5. The Attorney General's office and the Department are separate governmental agencies

and no agency relationship or delegation of authority exists by which the Department can act on

behalf of or with the apparent authority for the Attorney General with respect to the compromise of

taxes by closing agreements.

6. The Taxpayer had constructive knowledge of the requirement of Section 7-1-20

NMSA 1978 that any compromise of assessed taxes must have the written approval of the Attorney

General.

7. Because Johnson & Johnson had constructive knowledge of the requirements of

Section 7-1-20, it could not have reasonably relied upon the binding effect of the terms of the Tax

Settlement Agreement.

8. Johnson & Johnson did not take any actions to its prejudice in reliance upon the terms

of the Tax Settlement Agreement which closed tax years 1987-1990.

9. The Department has never had a policy of compromising assessed taxes without the

Attorney General's approval.

10. The "nexus filing agreements" do not compromise assessed taxes.

11. Johnson & Johnson did not rely upon the "nexus filing agreements" when negotiating

the terms or determining the form the Tax Settlement Agreement.

12. The intent of the parties when negotiating the Tax Settlement Agreement was to

compromise the taxes assessed for tax years 1980-1982 concerning the nexus issue with respect to six

Johnson & Johnson subsidiaries and to carry the effect of the terms of that settlement forward through

the 1990 tax year.

13. Right and justice do not require that the Department be estopped from denying the

binding effect of the provision of the Tax Settlement Agreement which closed tax years 1987-1990

for issues other than the nexus issue.

14. The Tax Settlement Agreement was negotiated and entered into as a single,

indivisible agreement, for which adequate consideration exists.

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  For the foregoing reasons, Johnson & Johnson's protest with respect to the issue of the

enforceability of the Tax Settlement Agreement IS HEREBY DENIED.

DONE, this 26th day of March, 1996.

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