Modrall Sperling New Mexico Tax Newsletter/January 2004

January 01, 2004

Summary
Governor Bill Richardson has put numerous tax issues on his call to the 2004 New Mexico Legislature. In an effort to offset the projected 31% increase in Medicaid costs, the Governor has called for a 1% increase in the premiums tax on health care insurers. That tax is already one of the highest in the country. In addition, he has called for a substantial increase in the liquor taxes. Of significance to business, the Governor and various business advocacy groups are calling for a reduction in tax pyramiding in the context of the gross receipts tax as it affects businesses. The Governor has temporarily abandoned his call for a total repeal of the gross receipts tax on the purchase of food and on medical services. He now suggests that such reductions be phased in.

Governor Calls For Numerous Tax Changes

Governor Bill Richardson has put numerous tax issues on his call to the 2004 New Mexico Legislature. In an effort to offset the projected 31% increase in Medicaid costs, the Governor has called for a 1% increase in the premiums tax on health care insurers. That tax is already one of the highest in the country. In addition, he has called for a substantial increase in the liquor taxes. Of significance to business, the Governor and various business advocacy groups are calling for a reduction in tax pyramiding in the context of the gross receipts tax as it affects businesses. The Governor has temporarily abandoned his call for a total repeal of the gross receipts tax on the purchase of food and on medical services. He now suggests that such reductions be phased in.

The Governor has also outlined a series of additional tax changes for economic development purposes. Those include a three year tax holiday for qualifying start up businesses, a "high wage" jobs tax credit, tax changes to attract professional sports events, participation in the streamlined Sales Tax Project, and a reduction in the punitive 15% interest rate on tax underpayments.

About the only major change the Taxation & Revenue Department has proposed are changes to the Tax Administration Act. Several of the proposed changes were worked out in cooperation with the Association of Commerce & Industry, the equivalent of a state chamber of commerce. Modrall Sperling tax attorney Timothy R. Van Valen heads that group's tax committee. Among the changes agreed to with ACI is the removal of some of the "gottchas" in administration of the non-taxable transaction certificate system for the gross receipts tax. The Department also proposes a significant increase in funding to expand the Department's fraud unit. The biggest administrative change recommended by the Blue Ribbon Tax Reform Commission, abandoning the Department's current system of internal administrative hearing officers in favor of a system of independent hearing officers, will likely not come before this legislative session. While the Department does not oppose independent hearing officers, will likely not come before this legislative session. While the Department does not oppose independent hearing officers, it has not reached internal or external agreement regarding the form of such a system.

Blue Ribbon Tax Reform Commission Makes Recommendations

After nearly six months of intensive study, the Blue Ribbon Tax Reform Commission made its final recommendations. The twenty-three member Commission consisting of representatives of business, health care, Indian and local governments and legislators, concluded its studies with a series of recommendations at their last meeting in late October 2003.

Facing what appears to be a fiscal crisis on the horizon, probably a year from now, the Commission recommended many tax cuts, many tax increases and many measures to eliminate special interest legislation that would result in tax increases. The recommended tax increases exceeded the tax cuts by almost $200 million. The Republican legislative members of the Commission voted unanimously against most all direct tax increases.

Included in the recommended tax increases were the following:

1. Fuel Taxes. Increase the diesel fuel tax by 3 cents per gallon and increase the gasoline tax by 2 cents per gallon. These measures were intended to pay for increased maintenance and construction of New Mexico's highways.

2. Real Property Transfer Tax. Impose a new graduated real property transfer tax on home sales with homes selling for less than $100,000 being exempt. The rates were set at 1% to 2% and would be imposed upon the buyer.

3. Compensating Use Tax. Change the compensating use tax to impose it on services performed outside of New Mexico but used in New Mexico and increasing the rate from the statewide base of 5% to include all local option taxes. The rate could thereby increase to over 7% depending on the user's locality.

4. Corporate Income Tax. Require mandatory combined filing for all unitary corporations.

5. Gross Receipts Tax. Eliminate many exemptions and deductions that are too numerous to mention in this Newsletter. The Commission also recommended converting many exemptions to deductions so that the true tax cost of that benefit could be better measured. The Commission further recommended elimination of a 0.5% credit against state gross receipts tax when paid within a municipality imposing local option gross receipts tax, which would result in a 0.5% gross receipts tax increase for most sales in New Mexico.

6. Motor Vehicle Excise Tax. Increase the motor Vehicle Excise Tax, paid on the sales of most motor vehicles in New Mexico, from 3% to 4%.

The Commission also recommended tax reductions in the following areas:

1. Personal Income Tax. Increase the low-income comprehensive tax rebate (LICTR) by changing the eligibility standards to benefit many more low-income families. LICTR is in effect a negative income tax. It creates refundable credits. The Commission also made recommendations intended to benefit middle income New Mexicans and single parents.

2. Corporate Income Tax. Decrease the top tax rate from 7.6% to 6.4%.

3. Gross Receipts Tax. Expand the deduction for sales of services for resale by eliminating the current requirement that the next sale be subject to the gross receipts tax. Also, eliminating the gross receipts tax on hospital services.

Much to the Governor's chagrin, the Commission rejected his call for elimination of the gross receipts tax on food and medical services. In both cases, the measures were in part deemed too costly. With regard to both, the Commission felt a more targeted and less costly approach was to increase LICTR eligibility.

2003 Special Session Deals With Highways & Sex Offenders; Not Tax Reform

The Governor's long-touted Special Session of the legislature to deal with tax reform on the heels of the Blue Ribbon Tax Reform Commission did not deal with tax reform. Due to disagreement between the executive and legislative branches of government, no agreement could be reached with regard to any tax reform issues. Instead, the two-week session in late October and early November dealt with funding for highways and the Governor's initiatives with regard to sex offenders.

Raising additional revenues for highway construction and maintenance had been one of the Governor's goals for the Blue Ribbon Tax Reform Commission. When the Commission suggested raising the gasoline tax, the Governor balked. The Governor had wanted at least $100 million per annum in additional revenues for the Transportation Department.

In the 2003 Special Session, the Governor and the legislators were able to compromise somewhat on additional funding for the Transportation Department. The tax on diesel fuel was increased. The legislature, however, gave the Transportation Department authority to issue up to $1.6 billion in highway improvements and for the study and implementation of light rail in the Rio Grande corridor from south of Albuquerque north to Santa Fe. Disputes arising out of an attempt by the Governor to fund tax reductions in other areas with an increase in liquor excise taxes was largely responsible for the special session concluding without any other tax changes.

ACI Honors Van Valen

Tim Van Valen, a partner in Modrall Sperling's State and Local Tax Group, has received the New Mexico Association of Commerce and Industry's Exemplary Service Award. Tim, a member of the ACI Board and chair of that group's Taxation Committee was honored at that organization's annual banquet. This is the first time in memory that ACI has presented such an award. ACI is New Mexico's equivalent of a state chamber of commerce.

Tim worked tirelessly on behalf of ACI developing and commenting on legislative proposals before the Blue Ribbon Tax Reform Commission. He made various personal and written presentations to the Blue Ribbon Tax Reform Commission on behalf of ACI and authored numerous editorials on tax refom which appeared in such notable publications as the Albuquerque Journal and the New Mexico Business Weekly. Tim also coordinated drafting of ACI's legislative positions on tax issues for the 2004 New Mexico Legislature.

Modrall Sperling joins ACI in recognizing and thanking Tim for his excellent work on behalf of the business community.

,v>TRD Adopts a New Policy Regarding Non-Taxable Transaction Certificates

Over the years the New Mexico Taxation & Revenue Department has unfavorably distinguished itself by its strict adherence to the view that a taxpayer claiming a gross receipts tax deduction must have the appropriate "type" of Department issued non-taxable transaction certificate ("NTTC") in its possession at a specific point in time in order to qualify for the deduction claimed. That was so even if it was clear that the substance of the transaction otherwise entitled the taxpayer to the deduction.

Valid criticism has been made of the Department's very rigid form over substance policy. Curtis Schwartz of Modrall Sperling's State and Local Tax Group participated in a legislatively mandated study conducted by the Department to review its NTTC policies. The Department's new administration has taken the criticism of its NTTC requirements to heart. As of January 1, 2004 the Department made regulatory changes regarding the number of types of NTTC's. The Department has also agreed to additional legislative changes. It is hoped that the legislative changes will ultimately lead to properly taxing the substance of the transactions in question.

Administratively, the Department has reduced the number of NTTCs from 15 to 7. Taxpayers and their representatives can find a list of the specific changes on the Department's website, www.state.nm.us/tax/ under the heading Publications. In addition, the Department, in conjunction with the Association of Commerce and Industry, intends to introduce a bill in this legislative session that will permit alternative evidence of deductibility to be presented in certain circumtances in lieu of an NTTC in order to prove the taxpayer's entitlement to a deduction. The Department has also agreed with ACI on a legislative proposal to reduce the current timing requirements for possession of NTTCs that have historically caused unnecessary problems for taxpayers. Tim Van Valen of Modrall Sperling's State and Local Tax Group, in his role as chair of ACI's Taxation Committee, was instrumental in negotiating the package of legislative NTTC reforms with the Department.

Guest Column: New Tax Policy Organization

by Jim Eads, Executive Director, New Mexico Tax Research Institute

There is a new tax policy organization in New Mexico that is quietly making news and having a positive impact on the tax policy making process. The New Mexico Tax Research Institute (NMTRI) is a non-partisan, non-profit, member-supported tax policy organization dedicated to research, education and analysis of taxes in the Land of Enchantment.

NMTRI seeks to inform taxpayers, tax collectors and tax policy makers based on factual and principled analysis of existing and proposed taxes in our state. It was organized in late 2002 as a result of a recommendation from a town-hall meeting on taxes held by New Mexico First. Membership is open to any and all individuals and businesses with interests in New Mexico.

NMTRI just concluded its First Annual New Mexico Tax Conference. The Conference was attended by approximately 120 people who had the opportunity to hear and interact with a truly outstanding roster of speakers including Curtis Schwartz of Modrall, Sperling; Walter Hellerstein of the University of Georgia; Prentiss Willson of Ernst & Young; Doug Lindholm of the Council on State Taxation; Steve Keene of KPMG and many others. The topics discussed included corporate income taxes, the Streamlined Sales Tax Project, tax reform and tax politics.

Jim Eads, who is new to New Mexico, but not new to state and local taxation, is the President and Executive Director of NMTRI. Eads has an extensive background in the area having been Chief Counsel for the state revenue agency in Arkansas, a tax attorney for Sears and AT&T Corp. and a partner with Ernst & Young. He is also a former President of the National Tax Association. Anyone interested in information about the New Mexico Tax Research Institute should contact Jim Eads at 505-228-7129, jimeads@nmtri.org or visit its website at www.nmtri.org.

Kmart On Hold Again

The widely anticipated decision by the New Mexico Supreme Court in Kmart Corp. v. Taxation & Revenue Dept. is on hold again. Shortly after Kmart's petition for certiorari was granted by the New Mexico Supreme Court in January 2002, Kmart went into a Chapter 11 bankruptcy proceeding. The company exited bankruptcy in May 2003. The New Mexico Supreme Court proceeding had been stayed during the pendency of the bankruptcy proceeding. The case involves gross receipts and corporate income taxation of an intangible property subsidiary. Modrall Sperling represents Kmart.

In the summer of 2003, the Supreme Court established a briefing schedule. On its own motion it later stayed briefing because it wanted to issue its opinion in Sonic Industries, Inc. v. Taxation & Revenue Dept. and Long John Silver's Restaurants Inc. v. Taxation & Revenue Dept. prior to briefing in Kmart. Sonic and Long John Silver's raise the issue of where the sale of intangible property takes place for New Mexico gross receipts tax purposes. That same issue presents itself in Kmart if the Court finds that New Mexico has taxing jurisdiction over the intangible property subsidiary. Assuming that is so, Kmart argued that its subsidiary licensed (a sale of property for gross receipts tax purpose) its tangible property to Kmart Corporation in Michigan and, therefore, because the sale did not occur in New Mexico, the subsidiary's royalties therefrom were not subject to the gross receipts tax. Modrall Sperling also represents Long John Silver's.

Kmart, Sonic and Long John Silver's all desire that the Kmart case be fully briefed and considered by the Court prior to issuing its opinion in any of these cases so that the gross receipts tax issue of first impression can be given its fullest possible exposition in different factual contexts. Accordingly, Modrall Sperling filed a motion in Kmart requesting that the Court reconsider the issuance of its stay on briefing. Similarly, Modrall Sperling filed a motion in Long John Silver's requesting that the Court consider Kmart prior to issuing its opinion in Long John Silver's.

These motions were filed in August of 2003. As of press time, the Court has yet to rule on those motions and the Kmart case remains stalled.

Xerox Loses Claim of Unconstitutional Discrimination Against Foreign Commerce

A recent administrative decision by the New Mexico Taxation & Revenue Department Hearing Officer handed Xerox Corporation a loss with respect to its claim that New Mexico's corporate income tax scheme unconstitutionally discriminates against foreign commerce in the tax base in the context of unitary combined filing by including foreign dividends but not domestic dividends. See, Xerox Corporation, D&O No. 03-22, decided December 3, 2003.

Xerox filed its New Mexico corporate income tax returns using the unitary combined filing method. Xerox had two domestic subsidiaries that were not unitary with the group that filed in New Mexico. Those subsidiaries paid dividends to Xerox. Xerox included those dividends in its apportionable income and then excluded them pursuant to the dividends received deduction of IRC Sec. 243. At the same time, its dividends from its foreign subsidiaries were included in the combined group's income.

The Hearing Officer concluded that there was no unconstitutional discrimination because New Mexico could not tax the domestic dividends of a non-unitary corporation. She reasoned that those domestic dividends were not subject to New Mexico's taxing jurisdiction in the first instance and were accordingly never in the combined group's New Mexico tax base. The Hearing Officer, therefore, concluded that one could not compare the domestic dividends received to the foreign dividends received which were included in the unitary group's tax base to prove discrimination.

The Hearing Officer's analysis was, however, not complete. Allied Signal teaches that certain dividends paid by non-unitary corporations are apportionable. Xerox had included the dividends in apportionable income and had then deducted those dividends pursuant to the dividends received deduction of IRC Sec. 243. The Hearing Officer simply did not deal with the issue of whether the domestic dividends at issue were apportionable in spite of the fact that the payor was not unitary with the combined group. The failure to consider the issue of whether the dividends were apportionable despite the fact that the payor was not unitary with the payee was a crucial flaw in the analysis. Whether that fact would have made a difference in the ultimate outcome of the case is unclear; however, what is clear is that the issue presented in this case is not foreclosed in New Mexico.

Modrall Sperling's State & Local Tax Services

Modrall Sperling's state and local tax lawyers have long handled some of the most significant state and local tax matters in New Mexico. Those matters include contested tax matters, revenue ruling requests for and participation in Department rule making efforts on behalf of our clients. Our state and local tax attorneys are also called upon to provide advice with respect to New Mexico tax consequences of mergers, acquisitions and other commercial transactions. In addition, we analyze proposed legislation on behalf of clients and offer testimony as tax experts before various legislative committees. We also assist clients in managing the audit process.

All areas of state and local tax are covered with our unique expertise in this area including corporate income tax, gross receipts tax, property tax and industry specific taxes such as severance, premiums, tobacco, gasoline, motor fuel and transportation. Over the years we have worked with major businesses inside and outside of New Mexico including those in retailing, manufacturing, high tech, mining, oil & gas and other industries.

Our state and local tax attorneys work closely with other Modrall Sperling practice groups and departments, particularly our Governmental Affairs Group and our Natural Resources Department.