Were Gerald Thompson's profit-based payments from construction companies partnership distributions or deductible construction-service receipts?

Subject

Gerald M. and Bernice Thompson (D&O 98-19)

Plain-English summary

Gerald Thompson met potential construction customers, estimated projects, and negotiated signed contract proposals for three Albuquerque construction businesses in 1993. Humberto Hernandez Construction paid him a straight 10-15% commission. Component Building Corporation and Superior Exteriors & Supplies paid him 55% of net profit on jobs he brought in.

The Thompsons reported all of that compensation as Schedule C business income. A federal-state data match led to an assessment of $2,344.44 gross receipts tax, $234.48 penalty, and $1,186.88 interest.

The first defense was that the profit-based payments made Thompson a partner. Hearing Officer Margaret B. Alcock found otherwise. Thompson had no partnership agreement, never discussed partnership status, filed no partnership return, had no access to company books, did not share company-wide profits, and was not required to bear losses. His share was simply a commission measured by net profit for the specific jobs he negotiated.

The second defense was the construction-services deduction in Section 7-9-52. The decision found it unnecessary to decide whether Thompson's estimating and contract work was a sales service or construction service. Even if it was construction, the deduction required an NTTC from each construction-business buyer, and Thompson had none. His belief that he was not engaged in business did not create the missing documentation.

There was no prohibited double taxation. Each construction company was taxed on its contract receipts from the property owner; Thompson was taxed on the separate compensation he received for negotiating the contract. Different taxpayers received payment for different services.

Penalty also stood. Thompson had previously owned three businesses, paid gross receipts tax, and used NTTCs. His longtime accountant prepared Schedule C, but Thompson never asked for advice about gross receipts tax and received none. His failure to investigate a familiar state-tax obligation was negligence. The protest was DENIED.

What this means for you

• Profit-based compensation does not by itself create a partnership. The full relationship — agreement, control, loss sharing, books, tax filings, and business-wide ownership — matters.
• Calling a service "construction" is not enough for the deduction. Section 7-9-52 also required the construction-business buyer to deliver an NTTC.
• Related project receipts can be separate taxable transactions. The general contractor's customer contract and the estimator's service compensation were distinct.
• Past business experience can undermine a no-negligence claim. Thompson already knew about gross receipts tax and NTTCs from earlier ventures.
• An accountant only helps the reliance defense when advice is actually sought and received. A long relationship and federal-return preparation did not substitute for a state-tax consultation.

Key questions answered

Why wasn't Thompson a partner?
He lacked any partnership agreement or discussion, filed no partnership returns, had no book access or control, and did not share losses or profits beyond his own jobs.

Did the Hearing Officer decide whether estimating was a construction service?
No. The classification could not change the outcome because Thompson had no NTTCs to satisfy the deduction's separate documentation requirement.

Why wasn't this double taxation?
The construction companies earned receipts from property owners. Thompson separately earned receipts from the companies for negotiating contracts.

Why didn't reliance on his accountant remove penalty?
Thompson never requested or received advice about gross receipts tax, despite prior experience paying the tax and using NTTCs.

Verbatim citations

The partnership definition:

A partnership is defined as "an association of two or more persons to carry on as co-owners a business for profit."

The decision on the actual relationship:

The evidence supports the finding that Mr. Thompson received a commission from net profits for services rendered as an independent contractor. The evidence does not support a finding of partnership.

The NTTC defect:

Even assuming that Mr. Thompson was engaged in selling a construction service, he could not claim the deduction provided in Section 7-9-52 because he did not receive a nontaxable transaction certificate (“NTTC”) from any of the businesses for which he performed those services.

The negligence conclusion:

Mr. Thompson was negligent in failing to report gross receipts tax on business income earned during 1993 and is liable for the negligence penalty imposed pursuant to Section 7-1-69 NMSA 1978.

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Gerald M. and Bernice Thompson
• Decision PDF: D&O 98-19

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
G. M. & BERNICE THOMPSON 98-19
ID. NO. 01-187010-00 9
ASSESSMENT NO. 2093538

DECISION AND ORDER

This matter came on for formal hearing on April 3, 1998 before Margaret B. Alcock, Hearing

Officer. G. M. and Bernice Thompson were represented by Dennis R. Francish, their attorney. The

Taxation and Revenue Department ("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. During the assessment period January-December 1993, G. M. Thompson performed

services for three different construction businesses located in Albuquerque, New Mexico: Component

Building Corporation, Superior Exteriors & Supplies, Inc. and Humberto Hernandez Construction.

2. When one of the three businesses received an inquiry concerning a construction job,

Mr. Thompson would meet with the potential customer at the site and then give the customer a contract

proposal setting out the specific work to be done and an estimate of the cost of the job. Work on the

project would commence after the customer agreed to and signed the proposal.

3. Mr. Thompson was not the only person performing these services for Component

Building Corporation, Superior Exteriors & Supplies, Inc. and Humberto Hernandez Construction.

4. Mr. Thompson received a straight commission of 10 to 15 percent of the total cost of

jobs for which he negotiated contracts for Humberto Hernandez Construction.

5. Mr. Thompson received 55 percent of the net profit of Component Building

Corporation and Superior Exteriors & Supplies, Inc. on each job for which Mr. Thompson negotiated

the contract.

6. For purposes of Mr. Thompson’s commission, net profit was calculated by taking the

total cost of the job and subtracting the cost of all materials, labor and overhead, including gross

receipts tax.

7. Each contract negotiated by Mr. Thompson included gross receipts tax as part of the

cost of the job.

8. Mr. Thompson assumes that the gross receipts tax was reported and paid to the state.

Mr. Thompson did not have access to the books of Component Building Corporation, Superior

Exteriors & Supplies, Inc. or Humberto Hernandez Construction and he cannot confirm that the tax was

actually paid.

9. Mr. Thompson did not have a formal partnership agreement with any of the businesses

for which he performed services.

10. Mr. Thompson never discussed a partnership with any of the businesses for which he

performed services.

11 Mr. Thompson never filed a partnership return with any of the businesses for which he

performed services.

12. None of the three businesses withheld income or social security taxes from the

payments made to Mr. Thompson.

13. The Thompsons reported all income from services performed on Schedule C of their

1993 federal income tax return.

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14. The Thompsons’ accountant of twenty years prepared their 1993 income tax returns.

The accountant did not tell Mr. Thompson he should be paying gross receipts tax on the business

income reported on Schedule C of his federal income tax return.

15. At various times prior to 1993, Mr. Thompson owned three different businesses:

Exterior Coatings of New Mexico, Universal Pools, and Jade Company. Mr. Thompson reported and

paid gross receipts tax on his receipts from each of these businesses.

16. When Mr. Thompson owned Exterior Coatings of New Mexico, he obtained non-

taxable transaction certificates from the Department to give to vendors from whom he purchased

supplies and materials.

17. It did not occur to Mr. Thompson that he was engaging in business when he performed

services for Component Building Corporation, Superior Exteriors & Supplies, Inc. and Humberto

Hernandez Construction.

18. It did not occur to Mr. Thompson that he should be paying gross receipts tax on the

payments he received for his services or that he should obtain nontaxable transaction certificates from

the businesses buying his services.

19. On December 18, 1996, as a result of information obtained from the Thompsons’

Schedule C to their 1993 federal income tax return, the Department issued Assessment No. 2093538

for the period January-December 1993 in the amount of $2,344.44 gross receipts tax, $234.48

penalty and $1,186.88 interest for a total assessment of $3,765.80.

20. On January 13, 1997, Dennis R. Francish filed a letter protesting the assessment on

the Thompsons’ behalf.

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DISCUSSION

The Thompsons raise the following arguments in support of their protest to the Department’s

assessment: (1) Mr. Thompson was in partnership with Component Building Corporation and Superior

Exteriors & Supplies, Inc., and the payments he received from these two companies represented

distributions of partnership profits rather than compensation for services; (2) Mr. Thompson was

performing construction services for Component Building Corporation, Superior Exteriors & Supplies,

Inc. and Humberto Hernandez Construction and was therefore entitled to the deduction provided in

Section 7-9-52 NMSA 1978; and (3) denying Mr. Thompson a deduction from gross receipts results in

unconstitutional double taxation. Mr. Thompson’s testimony concerning his reliance on the advice of

his accountant raises the additional issue of whether the negligence penalty was properly assessed under

Section 7-1-69 NMSA 1978.

I. EXISTENCE OF PARTNERSHIP.

The Uniform Partnership Act, Sections 54-1-1 to 43 NMSA 1978, applies to partnership

relationships during the period at issue.1 A partnership is defined as "an association of two or more

persons to carry on as co-owners a business for profit." Section 54-1-6. The Act also provides rules

for determining the existence of a partnership, Section 54-1-7, denotes the nature of a partner's

liability, Section 54-1-15, and sets forth rules determining rights and duties of partners, Section 54-1-

18. In Armstrong v. Reynolds, 102 N.M. 261, 262, 694 P.2d 517, 518 (1985), the New Mexico

Supreme Court stated that in the absence of a written partnership agreement, "a pattern of conduct,

such as the sharing of profits and expenses of the business, filing of partnership tax forms, previous

execution of contracts on behalf of the partnership, and control of a partnership bank account will

1
An amended version of the Uniform Partnership Act became effective on July 1, 1997, replacing the previous act
in its entirety. Sections 54-1A-101 to -1005 NMSA 1978 (1997 Supp.).

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suffice to show the creation of a partnership relationship." citing Dotson v. Grice, 98 N.M. 207, 209,

647 P.2d 409, 411 (1982) (emphasis in the original).

The Thompsons argue that Mr. Thompson’s commission was based on a sharing of profits,

which is prima facie evidence of a partnership under Section 54-1-7(D), which states:

D. the receipt by a person of a share of the profits of a business is prima facie
evidence that he is a partner in the business, but no such inference shall be drawn if
such profits were received in payment:
(1) as a debt by installments or otherwise;
(2) as wages of an employee or rent to a landlord;
(3) as an annuity to a widow or representative of a deceased partner;
(4) as interest on a loan, though the amount of payment vary with the
profits of the business;
(5) as the consideration for the sale of a good will of a business or other
property by installments or otherwise.

The presumption of partnership can be overcome by contrary evidence. Even circumstantial evidence

consisting of improbabilities and suspicious circumstances may be sufficient to overcome direct

evidence of the existence of a partnership. See, Vaughan v. Wolfe, 80 N.M. 141, 144, 452 P.2d 475,

478 (1969). In this case, the overall pattern of conduct indicates that a partnership relationship never

existed between Mr. Thompson and Component Building Corporation or between Mr. Thompson and

Superior Exteriors & Supplies, Inc. The facts against finding the existence of a partnership include the

following:

Mr. Thompson did not have a formal partnership agreement with Component Building
Corporation or Superior Exteriors & Supplies, Inc., nor did he ever discuss a partnership with
either of them.

Mr. Thompson never filed a partnership return with Component Building Corporation or
Superior Exteriors & Supplies, Inc. He treated the payments he received from these companies
in the same way he treated the payments he received as commissions from Humberto
Hernandez Construction, reporting them as business income on Schedule C of his federal
income tax returns.

Mr. Thompson was not the only person Component Building Corporation or Superior Exteriors
& Supplies, Inc. used to perform estimating services and negotiate contracts. Mr. Thompson’s
right to a share of profits was limited to the jobs on which he worked.

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Mr. Thompson testified that he would not have received payment for his work if a job which he
negotiated did not make a profit; there is no indication that Mr. Thompson would have been
required to share in any losses suffered.

Mr. Thompson did not have access to the books of Component Building Corporation or
Superior Exteriors & Supplies, Inc. and had no control over their payment of gross receipts
taxes.

The evidence supports the finding that Mr. Thompson received a commission from net profits for

services rendered as an independent contractor. The evidence does not support a finding of

partnership.

II DEDUCTION FOR SALE OF CONSTRUCTION SERVICES PROVIDED
IN SECTION 7-9-52 NMSA 1978.

The Thompsons maintain that Mr. Thompson was performing construction services. At the

hearing, Mr. Thompson took issue with statements made in a February 3, 1997 letter written by

Nancy Pagel, a tax auditor in the Department’s Protest Office. Ms. Pagel stated that Mr. Thompson

was not engaged in performing construction services but was engaged in promoting the sale of those

services.2 Mr. Thompson testified that he did not solicit customers for any of the businesses for

which he worked but simply provided cost estimates and negotiated contract proposals at their

request. The Thompsons argue that Mr. Thompson’s services qualified as construction services

under the New Mexico Court of Appeals’ decision in Miller v. Bureau of Revenue, 93 N.M. 252, 599

P.2d 1049 (Ct. App. 1979). The Thompsons further argue that to the extent Department Regulations

GR 3(C):1 (now 3 NMAC 2.1.11.1) and GR 52:1 (now 3 NMAC 2.52.8) would prevent Mr.

Thompson’s services from being characterized as construction services, the regulations are

inconsistent with the statutes and unconstitutionally vague.

2
Ms. Pagel’s conclusion was based on three affidavits from the owners or corporate officers of Component Building
Corporation, Superior Exteriors & Supplies, Inc. and Humberto Hernandez Construction which were attached to the
Thompsons’ protest. Each affidavit states that Mr. Thompson performed “sales” or “selling” services for which he was
paid a commission.

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There is no need to reach the constitutional issue raised by the Thompsons’ challenge to

Regulations GR 3(C):1 and GR 52:1. Characterizing the services rendered by Mr. Thompson as

construction services, rather than as sales services, would not change the outcome of this protest.

Under either scenario, Mr. Thompson is liable for gross receipts tax on his receipts from negotiating

contract proposals.

Section 7-9-4 NMSA 1978 imposes an excise tax on the gross receipts of any person

engaging in business in New Mexico. The definition of “engaging in business” includes “carrying on

or causing to be carried on any activity with the purpose of direct or indirect benefit.” Section 7-9-

3(E) NMSA 1978. The statute makes no distinction between activities engaged in by large

corporations and activities engaged in by small “mom and pop” operations or by individuals acting

as independent contractors. The term “gross receipts” is defined in Subsection F of Section 7-9-3

NMSA 1978 to include the total amount of money or the value of other consideration received from

performing services in New Mexico. Unless a specific statutory exemption or deduction applies, Mr.

Thompson is liable for gross receipts tax on his 1993 business income.

Mr. Thompson maintains that he is entitled to the deduction provided in Section 7-9-52 NMSA

1978. Subsection A states:

A. Receipts from selling a construction service may be deducted from gross
receipts if the sale is made to a person engaged in the construction business who
delivers a nontaxable transaction certificate to the person performing the construction
service. (Emphasis added).

Even assuming that Mr. Thompson was engaged in selling a construction service, he could not claim

the deduction provided in Section 7-9-52 because he did not receive a nontaxable transaction certificate

(“NTTC”) from any of the businesses for which he performed those services. Mr. Thompson testified

that although he had owned three businesses at various times in the past, it never occurred to him that

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he was engaging in business when he performed services for the three construction companies. Nor did

it occur to him to obtain NTTCs in order to deduct his receipts for purposes of the gross receipts tax.

Mr. Thompson’s oversight does not excuse him from payment of gross receipts tax. Nor does it

allow him to claim a deduction for which he does not qualify. There is a statutory presumption that the

Department’s assessment of gross receipts taxes is correct. Section 7-1-17 (C) NMSA 1978. Where an

exemption or deduction from tax is claimed, the statute must be construed strictly in favor of the taxing

authority, the right to the exemption or deduction must be clearly and unambiguously expressed in the

statute, and the right must be clearly established by the taxpayer. Wing Pawn Shop v. Taxation and

Revenue Department, 111 N.M. 735, 740, 809 P.2d 649, 654 (Ct. App. 1991). Where a party claiming

a right to a tax exemption or deduction fails to follow the method prescribed by statute or regulation, he

waives his right thereto. Proficient Food v. New Mexico Taxation & Revenue Department, 107 N.M.

392, 397, 758 P.2d 806, 811 (Ct. App. 1988).

In this case, Mr. Thompson would not be entitled to claim a deduction under Section 7-9-52 in

the absence of properly executed NTTCs. Accordingly, he is liable for gross receipts tax on his 1993

income from services regardless of whether he was performing a sales service or a construction service.

III. DOUBLE TAXATION.

The Thompsons argue that denying Mr. Thompson a deduction in this case results in double

taxation. It is a popular misconception that there is something inherently illegal or unconstitutional

with double taxation. Almost 80 years ago, in Ft. Smith Lumber Co. v. Arkansas, 251 U.S. 532 (1920),

the United States Supreme Court summarily disposed of the plaintiff's argument that Arkansas had

imposed a double tax on corporate stock in violation of the federal constitution. As stated by Justice

Oliver Wendell Holmes, writing for the majority:

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The objection to the taxation as double may be laid on one side. That is
a matter of State law alone. The Fourteenth Amendment no more
forbids double taxation than it does doubling the amount of a tax..."

251 U.S. at 533. New Mexico courts have also held, on numerous occasions, that there is no

constitutional prohibition against double taxation. New Mexico State Board of Public Accountancy v.

Grant, 61 N.M. 287, 299 P.2d 464 (1956); Amarillo-Pecos Valley Truck Line, Inc. v. Gallegos, 44 N.M.

120, 99 P.2d 447 (1940); State ex rel. Attorney General v. Tittmann, 42 N.M. 76, 75 P.2d 701 (1938).

It should also be noted that in construing the New Mexico Gross Receipts and Compensating

Tax Act, the New Mexico courts have held that there is no double taxation where the two taxes

complained of are imposed on the receipts of different taxpayers. See, e.g., House of Carpets, Inc. v.

Bureau of Revenue, 87 N.M. 747, 507 P.2d 1078 (Ct. App. 1973); New Mexico Sheriffs & Police

Association v. Bureau of Revenue, 85 N.M. 565, 514 P.2d 616 (Ct. App. 1973). That is the case here.

To illustrate, Taxpayer Exhibit No. 5 evidences a contract between Component Building

Corporation and Bruce G. to reroof Mr. G’s home. Under the contract, Component Building

Corporation received $8,326.00 for this work, plus an additional $483.95 representing the passed-on

gross receipts tax. The legal incidence of the gross receipts tax was on Component Building

Corporation. Mr. Thompson had no liability for reporting or paying gross receipts tax on Component

Building Corporation’s receipts from selling reroofing services to Mr. G.

The second page of Exhibit 5 is a set of figures showing how Component Building Corporation

calculated the fee it paid to Mr. Thompson for his services in drawing up the contract proposal. The

figures indicate that Mr. Thompson was paid $1,440.75. The legal incidence of the gross receipts tax

on this transaction was on Mr. Thompson. Component Building Corporation had no liability for

reporting or paying gross receipts tax on Mr. Thompson’s receipts from negotiating the contract

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between Component Building Corporation and Mr. G. Under the facts presented, there is no "double

taxation."

IV PENALTY.

The Thompsons’ 1993 federal income tax return was prepared by the same accountant who had

prepared their taxes for twenty years. Mr. Thompson testified that given the long-standing nature of the

relationship, he expected his accountant to advise him if additional taxes were due. This testimony

raises a question as to whether Mr. Thompson should be held liable for the 10 percent negligence

penalty imposed by under Section 7-1-69 NMSA 1978.

Section 7-1-69 NMSA 1978 (1993 Repl.Pamp.) governs the imposition of penalty during the

period at issue in this protest. Subsection A imposes a penalty of two percent per month, up to a

maximum of 10 percent:

[i]n the case of failure, due to negligence or disregard of rules and
regulations, but without intent to defraud, to pay when due any amount
of tax required to be paid...

Taxpayer "negligence" for purposes of assessing penalty is defined in Regulation GR 69:3 (now 3

NMAC 1.11.10) as:

1) failure to exercise that degree of ordinary business care
and prudence which reasonable taxpayers would exercise under
like circumstances;

2) inaction by taxpayers where action is required;

3) inadvertence, indifference, thoughtlessness, careless-
ness, erroneous belief or inattention.

Regulation GR 69:4 (now 3 NMAC 1.11.11) sets out several situations that may indicate a taxpayer has

not been negligent, including “reasonable reliance on the advice of competent tax counsel or accountant

as to the taxpayer’s liability after full disclosure of all relevant facts....”

10
The Thompsons' failure to report and pay gross receipts tax was not based on advice received

from their accountant, but on Mr. Thompson’s inattention to the requirements of New Mexico law. Mr.

Thompson was well aware of New Mexico’s gross receipts tax, having reported and paid the tax on

receipts from his previous businesses. Mr. Thompson was also aware of the use of NTTCs to support

deductions from gross receipts. He testified that he had obtained NTTCs to use in purchasing materials

and supplies for his stucco business. Although Mr. Thompson reported his receipts from services

performed during 1993 as business income on his federal tax returns and also paid self-employment

taxes to the government, he testified that it never occurred to him that his income was subject to New

Mexico gross receipts tax. This inattention to his state tax obligations meets the definition of

negligence.

Mr. Thompson believes his accountant should have advised him of his liability for gross

receipts tax on his 1993 income. Mr. Thompson acknowledges, however, that he never asked the

accountant whether there might be other taxes due in connection with the business income reported on

his 1993 federal income tax return. Nor did Mr. Thompson discuss the applicability of the gross

receipts tax or the use of NTTCs with his accountant at the time Mr. Thompson began performing

services for Component Building Corporation, Superior Exteriors & Supplies, Inc. and Humberto

Hernandez Construction. Although reliance on the advice of a competent tax advisor may be a defense

to the imposition of penalty under Regulation GR 69:4, there is no evidence that Mr. Thompson either

sought or received advice concerning his gross receipts tax liability on income earned during 1993.

The application of Regulation GR 69:4 has been addressed in at least two decisions of the New

Mexico Court of Appeals. In Vivigen, Inc. v. Minzner, 117 N.M. 224, 231-232, 870 P.2d 1382, 1389-

1390 (Ct. App. 1994), the court of appeals rejected Vivigen’s argument that it reasonably relied on the

11
accountants auditing its annual financial statements to alert Vivigen of its liability for payment of

compensating tax:

This response is not persuasive.... Vivigen offered no evidence that the outside auditors
reviewed Vivigen's monthly state tax returns and does not explain why the audit for the
annual reports should have uncovered failure to pay compensating tax, nor does it
explain why the failure of the auditors to discover the error would excuse Vivigen's
failure to comply with clear state law.

Similarly, in El Centro Villa Nursing Center v. Taxation and Revenue Department, 108 N.M. 795, 797,

779 P.2d 982, 984 (Ct. App. 1989) , the court found that the taxpayer could not have reasonably relied

on the erroneous gross receipts tax reports prepared by its accountant:

According to the accountant's testimony, taxpayer reviewed the monthly reports and
failed to inquire about the reporting of the payments as cost reimbursements. Taxpayer
should have known that it had received large payments, especially in November 1984,
no different in character than the Medicaid income received monthly throughout the
year and reported monthly as gross receipts,.... Given taxpayer's knowledge of the
character and size of the income payments in question, taxpayer cannot be said to have
reasonably relied on the incorrect reports as advice of its accountant.

In this case, Mr. Thompson should have realized that the income he earned from performing services as

an independent contractor was subject to gross receipts tax, just as the income he earned in his previous

businesses had been subject to tax. Under the circumstances, Mr. Thompson cannot argue that he

reasonably relied on his accountant, whose advice on gross receipts tax was never specifically solicited,

in failing to report and pay this tax. The negligence penalty was properly imposed.

CONCLUSIONS OF LAW

1. The Thompsons filed a timely written protest to Assessment No 2093538 pursuant to

Section 7-1-24 NMSA 1978, and jurisdiction lies over the parties and the subject matter of this protest.

2. Mr. Thompson did not have a partnership relationship with either Component Building

Corporation or Superior Exteriors & Supplies, Inc.

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3. During 1993, Mr. Thompson was engaging in business as defined in Section 7-9-3(E)

NMSA 1978 and is liable for gross receipts tax on his receipts from performing services in New

Mexico.

4. Mr. Thompson is not entitled to claim the deduction from gross receipts provided in

Section 7-9-52 NMSA 1978.

5. Mr. Thompson was negligent in failing to report gross receipts tax on business income

earned during 1993 and is liable for the negligence penalty imposed pursuant to Section 7-1-69 NMSA

1978.

For the foregoing reasons, the Thompsons’ protest IS DENIED.

DONE, this 14th day of April 1998.

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