If a New Mexico contractor builds roads for federal agencies that insist the work is tax-exempt, does the contractor still owe gross receipts tax on that income?

Subject

Storm Construction and Don & Sara Hetter (D&O 99-12)

Plain-English summary

Don and Sara Hetter operated Storm Construction, a sole proprietorship that built roads, streets, and earth-moving projects — most of them for governmental entities, chiefly the National Park Service and the U.S. Forest Service. After a 1995 audit, the Department assessed Storm Construction $103,071.55 in gross receipts tax (plus compensating tax, withholding tax, penalty, and interest) for January 1992 through December 1995, and filed a tax lien to secure it. The Hetters protested.

The trouble started because the federal agencies told Storm Construction the work was not taxable and even provided a copy of a Department letter to the U.S. Department of Agriculture. But that letter said a vendor selling tangible personal property to a federal agency does not need a nontaxable transaction certificate — it was about selling goods, not building roads. The Hearing Officer held that Storm Construction was not selling gravel and base course; it was selling a construction service. Under the Gross Receipts and Compensating Tax Act, "construction" is a taxable service, the building materials become part of that service, and there is no deduction or exemption for services sold to governmental entities. So the receipts were fully taxable.

The Hetters did win one adjustment: for subcontracting work for Big J Enterprises, they produced a proper nontaxable transaction certificate, and the Department agreed to reduce the assessment (with penalty and interest) for those receipts. On two other points they lost:

• Land value. The Hetters had bought land, subdivided it, installed utilities and foundations, affixed manufactured homes, and sold the packages. Sales of real property are deductible under Section 7-9-53, so the record was held open for them to document the land value — but they never provided the records, so no further adjustment was allowed.
• Spousal liability. Mr. Hetter asked that his former wife be released from the tax debt based on a divorce order assigning post-separation debts to whoever incurred them. The Hearing Officer held the Department was not bound by the divorce order because it was not a party to that proceeding.

The gross receipts tax lien (No. 91761) was upheld; the lien tied to the personal income tax assessments (No. 91764) was released after those assessments were abated. The protests were denied.

What this means for you

• Building something for the government is usually taxable in New Mexico, even though selling goods to the government can be exempt. The line is service vs. sale of tangible personal property. Construction is a service, and services sold to governmental entities have no gross receipts tax deduction.
• Materials folded into a construction job are not a separate tax-free sale. Gravel, base course, and similar materials become part of the taxable construction service, not an exempt sale of goods.
• A federal agency telling you the work is tax-exempt does not make it so. Storm Construction relied on assurances (and a real Department letter) that turned out to address a different situation. The taxpayer, not the customer, bears the gross receipts tax.
• If you claim a deduction, keep the paperwork and meet the deadline. The one win here came from producing a valid nontaxable transaction certificate; the land-value claim failed only because the records were never provided within the time allowed.
• A divorce decree does not bind the tax authority. Splitting debts in a divorce controls the spouses' rights against each other, not the Department's ability to collect from either of them.

Key questions answered

Why did construction for the National Park Service and Forest Service get taxed when sales to the federal government can be exempt?
Because building a road is a service, not a sale of tangible personal property. The deduction the agencies pointed to (Section 7-9-54) applies to selling goods to the United States. New Mexico taxes construction as a service, and there is no deduction or exemption for services sold to governmental entities.

Weren't the gravel and base course "goods" sold to the government?
No. Under the Act, construction materials that become part of a construction project are part of the taxable construction service. Storm Construction was selling completed road work, not separately selling materials.

Did anything help the taxpayers?
Yes — for the Big J Enterprises subcontract work they produced a valid nontaxable transaction certificate, so the Department agreed to adjust that portion of the assessment (with related penalty and interest).

Why didn't the land sales reduce the tax?
Sales of real property are deductible under Section 7-9-53, and the Hearing Officer gave the Hetters sixty days to document the land's value so it could be separated from taxable receipts. They never provided the records, so no additional deduction was allowed.

Could the divorce order shift the tax to just one spouse?
No. The Department was not a party to the divorce, so the order could not bind it. It governs only the rights and liabilities of the people who were in that proceeding.

Verbatim citations

The Department letter the taxpayers relied on — which covered sales of goods, not construction:

This will also confirm that a vendor selling tangible personal property to an agency or instrumentality of the United States is not required to obtain an NTTC in order to prove that the transaction is not subject to the New Mexico gross receipts tax. The vendor is required to obtain an invoice or other documentation to establish that the federal government is the entity making the purchase.

Why construction is a taxable service, not an exempt sale:

"Service" includes construction activities and all tangible personal property that will become an ingredient or component part of a construction project in New Mexico.

The result on the governmental-entity receipts:

Because there is no deduction or exemption in the Gross Receipts and Compensating Tax Act for services sold to governmental entities, the Taxpayers were subject to gross receipts tax on all of their receipts from performing construction services for such entities.

Why the divorce order did not bind the Department:

This is because the Department is not bound to follow the Order. The Department was not a party to the divorce proceedings between Mr. and Mrs. Hetter. The Order can only apply to establish the rights and liabilities of the parties to the proceeding in which it was entered.

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Storm Construction and Don & Sara Hetter
• Decision PDF: D&O 99-12

Original ruling text

BEFORE THE HEARING OFFICER
OF THE TAXATION AND REVENUE DEPARTMENT
OF THE STATE OF NEW MEXICO

IN THE MATTER OF THE PROTESTS OF
DON AND SARA HETTER NO. 99-12
PROTEST TO ASSESSMENT NOS. 664932, 664933
AND 664934;
STORM CONSTRUCTION
ID. NO. 02-179419-00 7, PROTEST TO
ASSESSMENT NO. 2037464; AND
PROTEST TO LIEN NOS 91761 AND 91764

DECISION AND ORDER

This matter comes on for decision following a formal hearing conducted on October 7,

1998 before Gerald B. Richardson. Don and Sara Hetter and Storm Construction, hereinafter,

“Taxpayers”, were represented by Don Hetter. The Taxation and Revenue Department,

hereinafter, “Department”, was represented by Monica M. Ontiveros, Special Assistant Attorney

General. At the close of the formal hearing, the record was held open until December 7, 1998

to allow the Taxpayers to submit additional information for review by the Department and for the

Department to make any adjustments it felt appropriate. Some of the matters in dispute have

now been resolved between the parties, as will be more fully set forth below.

FINDINGS OF FACT

1. Taxpayers are New Mexico residents and were owners of a business, known as

Storm Construction, a sole proprietorship.

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2. Storm Construction was a construction contractor which specialized in building

roads, streets or construction projects which required earth moving. The majority of the

construction projects were performed for governmental entities. The Taxpayers also sold some

mobile homes which were sold with the lots on which they were placed.

3. In 1995, the Department audited the Taxpayers.

4. As a result of the audit, on June 10, 1996, the Department issued Assessment No.

2037463, hereinafter, “the gross receipts tax assessment”, to Storm Construction, assessing

$103,071.55 in gross receipts tax, $1,950 in compensating tax, $1,800 in withholding tax,

$10,682.26 in penalty and $35,032.91 in interest for the reporting periods of January, 1992

through December, 1995.

5. On July 5, 1996, the Taxpayers filed a written request with the Department for a

sixty day extension of time to protest the gross receipts tax assessment.

6. On July 19, 1996, the Department granted the Taxpayers an extension of time

until September 8, 1996 to file a protest to the gross receipts tax assessment.

7. On September 6, 1996, the Taxpayers filed a written protest to the gross receipts

tax assessment.

8. At the time of the Department’s audit, the Taxpayers had not filed personal

income tax returns with the Department for tax years 1992, 1993 and 1994. The Department’s

auditors estimated the Taxpayers’ income tax liability treating the gross receipts of Storm

Construction as income for the years involved and giving the Taxpayers the benefit of the

standard deduction.

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9. As a result of the Department’s audit, on June 19, 1996 the Department issued to

the Taxpayers Assessment Nos. 664932, 664933 and 664934, hereinafter, “the personal income

tax assessments” for tax years 1992, 1993, and 1994, respectively.

10. On July 6, 1996, the Taxpayers filed a request for an additional sixty days to file a

protest to the personal income tax assessments.

11. On July 19, 1996 the Department granted the Taxpayers an extension of time,

until September 16, 1996, to file protests to the personal income tax assessments.

12. As a result of information the Taxpayers provided to the Department through the

administrative protest procedure, the Department has abated the personal income tax assessments

and those assessments are no longer in issue.

13. On December 24, 1996, the Department filed Notice of Claim of Lien No. 91761

against the Taxpayers to secure the payment of the gross receipts tax assessment.

14. On December 24, 1996, the Department filed Notice of Claim of Lien No. 91764

against the Taxpayers to secure the payment of the personal income tax assessments.

15. On January 3, 1997, the Taxpayers filed a protest to the filing of Lien Nos 91761

and 91764.

16. As a result of the abatement of the personal income tax assessments, the

Department has relieased Lien No. 91764.

DISCUSSION

The Taxpayers were assessed gross receipts tax based upon the failure of Storm

Construction to report receipts from performing construction services for governmental entities

and upon its claim of deduction for receipts from performing construction services which it was

not able to substantiate by providing the nontaxable transaction certificates required to support

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its claim of deduction. During the audit years, Storm Construction derived a substantial amount

of its gross receipts from performing road construction services for the National Park Service and

the United States Forest Service. These entities represented to the Taxpayers that they were not

subject to tax and informed the Taxpayers that it would be iimproper to charge them tax. In fact,

these entities provided Mr. Hetter with a copy of letter from the Department’s counsel to the

General Counsel for the United States Department of Agriculture, which addresses whether

nontaxable transaction certificates are needed to support claims of deduction when tangible

personal property is sold to the United States or its instrumentalities. In pertinent part the letter

states:

This will also confirm that a vendor selling tangible personal
property to an agency or instrumentality of the United States is not
required to obtain an NTTC in order to prove that the transaction is
not subject to the New Mexico gross receipts tax. The vendor is
required to obtain an invoice or other documentation to establish
that the federal government is the entity making the purchase. In
the event of audit, the vendor may use this documentation to prove
the non-taxability of the transaction. (emphasis added).

The Taxpayer relied upon this letter in not charging its governmental clients gross receipts tax.

Unfortunately, the Taxpayer was misled by the governmental entities it contracted with. While

the statements above are true, because there is a deduction found at Section 7-9-54 NMSA 1978

for receipts from selling tangible personal property to the United States and other governmental

entities, the deduction has no applicability to the Taxpayers’ activities. This is because the

Taxpayers were building roads, which activity is defined as “construction”. Section 7-9-3 (C)(1).

The Gross Receipts and Compensating Tax Act defines construction to be a service.

Specifically, “service” is defined in pertinent part as follows:

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“Service” includes construction activities and all tangible personal
property that will become an ingredient or component part of a
construction project in New Mexico. (emphasis added).

Thus, the Taxpayers were not selling gravel and base course to their governmental clients when

they contracted to build roads. Those construction materials became part of the construction

service they was selling to their governmental clients. Because there is no deduction or

exemption in the Gross Receipts and Compensating Tax Act for services sold to governmental

entities, the Taxpayers were subject to gross receipts tax on all of their receipts from performing

construction services for such entities.

The Taxpayers were able to produce a nontaxable transaction certificate for some

subcontracting work done for Big J Enterprises. The Taxpayers’ receipts from Big J Enterprises

had been included in the Department’s assessment because the Taxpayers had not produced a

nontaxable transaction certificate to support a claim of deduction for those receipts when audited

by the Department. Subsequently, the Taxpayers were able to demonstrate to the Department

that they had a proper certificate in a timely manner from Big J Enterprises and the Department

has agreed to adjust the gross receipts tax assessment, together with applicable penalty and

interest, accordingly.

During the audit period, the Taxpayers had also bought some land, subdivided it, put in

utilities, put in foundations and permanently affixed manufactured homes to the land, which they

then sold. The Taxpayers’ total receipts from the sale of the homes and the land to which they

were attached were included in the gross receipts upon which tax was assessed. Because there is

a deduction provided at Section 7-9-53 NMSA 1978 for receipts from the sale of real property,

the hearing record was left open for the Taxpayers to provide records to substantiate the value of

the land so that it could be segregated from taxable gross receipts and the assessment adjusted

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accordingly. Although Mr. Hetter said he could provide the records within thirty days of the

hearing, the Hearing Officer granted Mr. Hetter sixty days to ensure that adequate time to locate

and provide the records was given. No records were provided the Department. Because of this,

the Taxpayers have lost their opportunity to present additional evidence on this issue. There

being no evidence to substantiate further adjustments to the gross receipts tax assessment, the

assessment, as adjusted by the Department, is upheld.

The last issue the Taxpayers raised with respect to the gross receipts tax assessment is

that Mr. Hetter asked that his former wife, Sara Hetter, be absolved from any personal liability

resulting from the gross receipts tax assessment. Mr. and Mrs. Hetter separated in September,

1991. A petition for a divorce, however, was not filed until December 3, 1996. In an Order filed

in the divorce proceeding on September 9. 1997, Judge Kass ordered that all debts incurred by

either party after September, 1991 be the sole and separate debt of the party incurring the debt.

Mr. Hetter’s request that Mrs. Hetter be absolved from any liability for the gross receipts tax

assessment is based upon the language of the Order.

I find the Order to be less than clear with respect to how it would apply to the tax

liability at issue. In addition to the language about debts incurred after the parties separated, the

Order recites that the parties have acquired community property and obligated themselves to

community debt and it further declares that assets acquired by either party after September, 1991,

are the sole and separate property of the party acquiring the assets. It is not clear whether the

Order’s separate reference to the parties’ community property and debts means to treat them

separately from other debts and assets arising or acquired after September, 1991. Storm

Construction Company was community property and the debts attributable to it would be

community debts. In any event, it is not necessary to determine what the Court meant by the

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Order. This is because the Department is not bound to follow the Order. The Department was

not a party to the divorce proceedings between Mr. and Mrs. Hetter. The Order can only apply to

establish the rights and liabilities of the parties to the proceeding in which it was entered.

The Taxpayers also protested the Department’s liens which it filed to secure the taxes it

assessed. Because the personal income tax assessment has been abated, the lien securing it,

Notice of lien number 91764, has also been released. Lien number 91761 remains in place to

secure the gross receipts tax assessment, as adjusted by the Department. The Taxpayers have

presented no arguments as to why the lien is improper or invalid.1 Having failed to carry their

burden of proving the Department’s lien to be defective or invalid in any manner, the

Department’s lien is upheld.

CONCLUSIONS OF LAW

1. The Taxpayers filed timely, written protests pursuant to Section 7-1-24 NMSA

1978, to the gross receipts tax assessment, the personal income tax assessments and Lien Nos.

91761 and 91764, and jurisdiction lies over both the parties and the subject matter of these

protests.

2. The personal income tax assessments have been abated and the lien securing

them, Lien No. 91764, has been released rendering the protests to those matters moot.

3. The Taxpayers have failed to carry their burden of proving the Department’s gross

receipts tax assessment to be invalid or incorrect.

4. The Taxpayers have failed to carry their burden of proving the Department’s Lien

No. 91761 to be invalid or incorrect.

For the foregoing reasons, the Taxpayers’ protests ARE HEREBY DENIED.

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DONE, this 9th day of February, 1999.

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Of course, the adjustments made in the gross receipts tax assessment as a result of the information the Taxpayer
provided the Department have the effect of reducing the amount of liability the Department’s lien secures.

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