When I bind books using my own labor and a customer's pages, am I selling goods to the government or performing a taxable service?

Plain-English summary

Bookbinders of New Mexico, an Albuquerque company, bound loose pages and magazines into books and rebound worn books. About 90–95% of its binding work was for government agencies — university and public libraries, public schools, the legislative council service, and other state and federal bodies. Customers supplied the pages or old bookblocks; the company added its own materials (averaging about $1.60 per book) and charged roughly $8.60 to bind pages/magazines and $5.85 to rebind.

For years the company did not charge, collect, or pay gross receipts tax on the government work, treating it as a sale of tangible personal property. That mattered because Section 7-9-54(A) allows a deduction for receipts from selling tangible personal property to the government — but there is no equivalent deduction for selling services to the government. After an audit, the Department issued two assessments (for 1988 and for 1989 through March 1994) totaling tens of thousands of dollars in gross receipts tax, plus some compensating tax, interest, and penalty. The company protested.

Hearing Officer Gerald B. Richardson denied the protest on both the main issue and a statute-of-limitations issue:

• Bookbinding is predominantly a service. Under the statutory definition of "service" in Section 7-9-3(K), and the EG&G decision, you don't look at the end product's value to the buyer — you compare the seller's relative investment of labor versus materials. Here materials were only about a fourth to a fifth of the charge, and labor was four to five times the materials, so the service clearly predominated.
• Charging more for bigger books didn't change that. The company argued that higher prices for larger books showed it was selling a tangible good. That might matter if labor and materials were close in value — but here labor overwhelmingly predominated.
• A Department example confirmed it. Regulation GR 47:3 (example 3) treats a dry cleaner who mends clothes as performing a service and using materials in that service, not selling thread and buttons. Department regulations are presumed a proper implementation of the law (Section 9-11-6.2(G)).
• No government-sales deduction for services. Because the company was performing a service, the Section 7-9-54 deduction for sales of tangible personal property to the government did not apply, and the receipts were taxable.
• The six-year audit period applied. The ordinary limit is three years (Section 7-1-18(A)), but Section 7-1-18(D) extends it to six years when a return understates tax liability by more than 25%. Even though the company reported its full gross receipts before claiming the (invalid) deduction, it still understated its gross receipts tax liability by more than 25%, so the older periods were properly assessed. (The taxpayer's analogy to federal IRC § 6501(e) failed because the New Mexico statute keys off understated liability, not omitted gross income.)

What this means for you

Working on a customer's goods is usually a service, even if you add materials

If your business transforms or repairs items a customer provides — binding, mending, cleaning, refinishing, repairing — you are likely performing a taxable service, not selling goods, even though you supply some materials. New Mexico compares the value of your labor to the value of your materials; when labor predominates, it's a service.

The government-sales deduction is only for tangible personal property

Section 7-9-54's deduction for sales to the United States, New Mexico, or their agencies applies to tangible personal property, not services. Selling to a government customer does not make your receipts deductible if what you're really providing is a service. Don't assume "we sell to the state, so it's exempt."

Don't rely on how a prior owner handled it

This company had followed a no-tax practice inherited from before the current owner bought it in 1985. That history didn't protect it. A long-standing internal practice — even one a predecessor used — is not a substitute for the statute, and it won't prevent an assessment when the treatment was wrong.

Claiming a deduction can still be a 25% understatement — and open a six-year audit

Reporting your full gross receipts and then taking a deduction you weren't entitled to can still understate your tax liability by more than 25%, which lets the Department reach back six years instead of three. Full disclosure of receipts on the return doesn't cap the audit period the way it might under some federal rules — New Mexico measures the understatement against your tax liability.

Common questions

Q: I use my own materials but work on the customer's property. Am I selling goods or performing a service?
A: Usually a service, if your labor predominates over your materials. New Mexico compares the relative value of skills/labor versus materials. Here labor was four to five times the materials, so it was a service — and services don't get the government-sales deduction.

Q: All my customers are government agencies. Aren't my receipts deductible under Section 7-9-54?
A: Only if you're selling tangible personal property to them. That deduction doesn't cover services. If what you provide is predominantly a service, selling to the government doesn't make the receipts deductible.

Q: Does charging more for a bigger job prove I'm selling a product?
A: Not by itself. The Hearing Officer said that could matter only where labor and materials are close in value. Where labor clearly predominates, price differences tied to size don't convert a service into a sale of goods.

Q: I disclosed all my gross receipts on the return. Doesn't that limit the audit to three years?
A: Not in New Mexico. Section 7-1-18(D) opens a six-year window whenever the return understates tax liability by more than 25%. Taking an improper deduction that understates your liability by that much triggers the longer period even if you reported your full receipts.

Citations and references

Statutes and regulation:

• § 7-9-54(A) NMSA 1978 — deduction for receipts from selling tangible personal property to the United States, New Mexico, or any governmental unit, subdivision, agency, department, or instrumentality; there is no corresponding deduction for selling services to government
• § 7-9-3(K) NMSA 1978 — "service" means activities engaged in for others for consideration that involve predominantly the performance of a service as distinguished from selling or leasing property; the intended use or ultimate objective of the parties is not controlling
• § 7-1-18(A) NMSA 1978 — ordinary three-year period to assess tax
• § 7-1-18(D) NMSA 1978 — six-year period to assess where a return understates tax liability by more than twenty-five percent
• § 9-11-6.2(G) NMSA 1978 — Department regulations are presumed a proper implementation of the laws the Department administers
• § 7-9-47 NMSA 1978 — deduction for sales of tangible personal property for resale (referenced in the regulation discussed)
• § 7-1-24 NMSA 1978 — timely written protest of an assessment
• Regulation GR 47:3, example 3 — a dry cleaner who mends clothing is performing a service and using materials in that service, not selling those materials

Case cited:

• EG&G, Inc. v. Director, Revenue Division, 94 N.M. 143, 607 P.2d 1161 (Ct. App.), cert. denied, 94 N.M. 628, 614 P.2d 545 (1979) — the 1976 definition of "service" focuses on the nature of the seller's activity and the relative investment of skills versus materials, not the end product's value to the purchaser

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Bookbinders of New Mexico, Inc.
• Decision PDF: D&O 96-17

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
BOOKBINDERS OF NEW MEXICO, INC.,
ID. NO. 02-024378-00 2, PROTEST TO
ASSESSMENT NOS. 1884844 and 1937973. No. 96-17

DECISION AND ORDER

This matter came on for formal hearing on June 5, 1996 before Gerald B. Richardson,

Hearing Officer. Bookbinders of New Mexico, Inc. (hereinafter "Taxpayer") was represented by

Matthew Urrea, Esq. The Taxation and Revenue Department (hereinafter "Department") was

represented by Frank D. Katz, Chief Counsel.

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

as follows:

FINDINGS OF FACT

1. The Taxpayer is a corporation located in Albuquerque, New Mexico which has

been wholly owned by Mr. James J. Salazar since 1985.

2. The Taxpayer is engaged in the business of bookbinding and selling custom three

ring binders.

3. The Taxpayer's bookbinding business falls into three categories. The first category

consists of binding loose pages provided by a customer into a bound book. The second category

consists of binding magazines provided by a customer into a bound book. The third category

consists of removing an old and worn out binding from a book and replacing it with a new

binding.

4. About ninety to ninety-five percent of the Taxpayer's bookbinding work is done
   for governmental agencies, such as University libraries, public libraries, the legislative council

service, public schools and other state and federal agencies. The Taxpayer's custom three ring

binding work is done for private entities.

5. The bookbinding process involves sewing the pages together, creating what is

known as a bookblock. The Taxpayer's customers supply either loose pages, magazines or old

bookblocks to the Taxpayer for binding into books. End sheets are added to the book block and

are glued so as to make a hinge. A spine is then glued to the bookblock and end pages to reinforce

the binding. Then a cover is made. The cover consists of binder's board, a heavy paperboard,

which is cut to size and a cloth cover is glued onto it. The cover is then glued onto the bookblock

and end sheets. Then the title of the book is embossed in gold lettering onto the end of the book.

6. The Taxpayer estimates that on average, the cost of materials it provides for the

bookbinding process is approximately $1.60, which can vary slightly, depending upon the size of

the book bound. On average, the Taxpayer charges its customers $8.60 to bind magazines and

loose pages and $5.85 to rebind old books.

7. After an audit by the Department, the Department issued two assessments to the

Taxpayer. Assessment No. 1884844 was mailed to the Taxpayer on June 15, 1995 and assessed

$15,264.62 gross receipts tax, $190 compensating tax, $15,962.29 interest and $1,545.47 penalty

for the reporting periods of January, 1988 through December, 1988. Assessment No. 1937973

was also mailed to the Taxpayer on June 15, 1995 and assessed $42,409.63 gross receipts tax,

$4,830.52 compensating tax, $4,724.01 penalty and $35,869.29 interest for the reporting periods

of January, 1989 through March, 1994.

8. On July 13, 1995, the Taxpayer filed a written protest to Assessment Nos.

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1884844 and 1937973.

9. Prior to 1991 the Taxpayer did not report and pay gross receipts tax upon its

receipts from bookbinding for its governmental clients and it did not charge those clients gross

receipts tax. This practice was based upon the practice which had been in place since before Mr.

Salazar acquired the company in 1985. The Taxpayer did charge, report and pay gross receipts tax

upon its other gross receipts from non-governmental clients.

10. The Department's audit determined that gross receipts taxes were owing upon the

Taxpayer's receipts from its governmental clients.

DISCUSSION

The primary issue to be determined herein is whether the Taxpayer is liable for gross

receipts tax upon its receipts from its governmental customers for whom it bound books. Key to

this determination is whether the Taxpayer's activities amount to the performance of a service for

the governmental customers or whether the Taxpayer is selling tangible personal property to its

governmental customers in the form of a bookbinding. This is because there is a deduction from

gross receipts tax, found at Section 7-9-54(A) NMSA 1978, for receipts from selling tangible

personal property to the United States, New Mexico, or any governmental unit, subdivision,

agency department or instrumentality thereof. There is, however, no corresponding deduction or

exemption for receipts from the sale of services to such governmental entities.

The Taxpayer contends that it is selling tangible personal property in the form of the

bookbinding1 to its governmental customers. The Department argues that the Taxpayer is

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Since the Taxpayer's customers provide the materials which, when sewn together, constitute the bookblock,
the Taxpayer argues that only the bookbinding it manufactures is the tangible personal property which it is selling
to governmental entities.

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performing bookbinding services to its governmental customers, rendering its receipts from its

governmental customers subject to gross receipts tax.

"Service" is defined at Section 7-9-3(K) NMSA 19782 in pertinent part as follows:

"service" means all activities engaged in for other persons for a
consideration, which activities involve predominantly the
performance of a service as distinguished from selling or leasing
property. "Service" includes activities performed by a person for
its members or shareholders. In determining what is a service, the
intended use, principal objective or ultimate objective of the
contracting parties shall not be controlling. (emphasis added).

This definition was adopted by the 1976 legislature in order to modify the body of caselaw which

had developed prior to the enactment of the 1976 amendments. EG&G, Inc. v. Director,

Revenue Division, 94 N.M. 143, 607 P.2d 1161 (Ct. App.), cert. denied, 94 N.M. 628, 614 P.2d

545 (1979). This definition requires that rather than focusing on the end product's value to the

purchaser, the focus is on the nature of the seller's activity, requiring an inquiry into the seller's

relative investment of skills and materials to determine which predominates, the services or the

tangibles. Id. at 146. In this case, that inquiry leads to the conclusion that the Taxpayer is

performing a service rather than selling bookbindings. Comparing the relative values of the

materials to the amount charged its customers, the materials represent only approximately one

quarter to one fifth of the total amount charged. This indicates that the materials are incidental to

the service being provided.

In this regard, the Taxpayer argues that since it charges more to bind larger books than

smaller ones, this is indicative of the fact that it is selling a tangible, since more materials are used

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The definition of "service" has remained unchanged during all periods pertinent to the assessments at issue, so

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to bind larger books but the relative amount of labor remains the same. This argument might be

persuasive in an instance where the relative values of the of materials and the labor are very close.

That is not the case in this matter, however, where the value of the labor is almost four or five

times that of the materials involved and the value of the labor clearly predominates.

The Department's regulation GR 47:3 (example 3) is instructive with respect to the facts of

this case and supports the Department's position that the Taxpayer is predominately performing a

service. The Department's regulations are presumed to be a proper implementation of the

provisions of the laws that are charged to the Department to apply. Section 9-11-6.2(G) NMSA

1978 (1995 Supp.). The regulation provides in pertinent part:

When a taxpayer uses tangible personal property in the
performance of an activity which is predominately the sale of a
service, the taxpayer must compute the tax liability based on total
receipts. Such receipts include the charge for the performance of
the service plus any other amounts such as the charge for material
used in the performance of the service. Where separate billing of
material and labor is the trade practice, and the taxpayer bills
separately, the taxpayer may give a nontaxable transaction
certificate (NTTC) for the purchases of the material.
Example 3: X, a dry cleaner, mends clothing that is brought to X
for cleaning. X uses thread, material and buttons to mend the
clothing. X maintains that they are selling these products. X does
not sell thread, buttons or material: rather X is engaged in
performing a service and uses the materials in the performance of
the service. Therefore, the sale of these products to X is not a sale
for resale.

Although this regulation is directed at determining whether the deduction from gross receipts for

selling tangible personal property for resale pursuant to Section 7-9-47 is available to a seller of

tangible personal property who receives a nontaxable transaction certificate from the purchaser, it

remains instructive on the issue of whether the purchaser is reselling a tangible or is using a

no particular supplement of pamphlet of the statutes is included in the statutory citation.

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tangible in the performance of a service.

Because the facts of this case indicate that the Taxpayer is predominately performing a

service for its governmental customers and there is no deduction available in such a case, the

Taxpayer's receipts from performing bookbinding services are subject to gross receipts tax and the

Department's assessments with respect to that issue are proper.

A secondary issue remains. The Taxpayer contends that both assessments, to the extent

that they assess taxes beyond the normal three year statute of limitations found at Section 7-1-

18(A) NMSA 1978 should be abated. Although Section 7-1-18(A) does limit assessment of taxes

to three years from the end of the calendar year in which payment of the tax was due, it recognizes

certain exceptions to this limitation on the assessment of tax. Specifically, Subsection D of

Section 7-1-18 provides as follows:

If a taxpayer in a return understates by more than twenty-five
percent of the amount of his liability for any tax for the period to
which the return relates, appropriate assessments may be made by
the department at any time within six years from the end of the
calendar year in which payment was due.

The Taxpayer argues that Section 7-1-18 is modelled on Section 6501(e) of the Internal

Revenue Code which also provides for a six year limitation on assessment of tax when there has

been an understatement in excess of twenty-five percent of a taxpayers gross income. The

Taxpayer argues that "understatement" has been interpreted under this section to not include

situations where the Internal Revenue Service could determine that a tax liability was understated

by an examination of the taxpayer's return because the basis for the tax calculation was disclosed

on the face of the taxpayer's return. The Taxpayer argues that Section 7-1-18(D) should be

interpreted similarly and that this would prohibit the assessment of tax beyond the three year

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limitation of Section 7-1-18(A) because the Taxpayer's returns disclosed its total receipts but then

claimed a deduction for its receipts from its governmental customers.

I have not examined the authority interpreting IRC Section 6501(e), but I would note a

significant difference in the wording of the state and federal provisions. While the federal

provision refers to the omission from gross income of amounts in excess of twenty-five percent of

gross income, Subsection D makes no reference to the underreporting of gross receipts. Rather, it

refers to the understatement by more than twenty-five percent of the amount of a taxpayer's

liability. In this case, while the Taxpayer reported the full amount of its gross receipts prior to

claiming the deduction for the sale of tangible personal property to governmental entities,

nonetheless, the Taxpayer's returns still underreported the Taxpayer's gross receipts tax liability by

more than twenty-five percent. Thus, I find that the Department's assessments were authorized by

Section 7-1-18(D).

CONCLUSIONS OF LAW

1. The Taxpayer filed a timely, written protest, pursuant to Section 7-1-24 NMSA

1978 to Assessment Nos. 1884844 and 1937973 and jurisdiction lies over both the parties and the

subject matter of the Taxpayer's protest.

2. The Taxpayer activities in binding books for governmental entities involved

predominately the performance of a service rather than the sale of tangible personal property and

thus the Taxpayer was not entitled to claim the deduction found at Section 7-9-54 NMSA 1978

for its receipts from its governmental customers.

3. Assessment Nos. 1884844 and 1937973 assess taxes within the limitations of

Section 7-1-18(D) NMSA 1978 and are therefore proper assessments of tax.

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For the foregoing reasons, the Taxpayer's protest IS HEREBY DENIED.

DONE, this 3rd day of July, 1996.

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