A contractor bought materials for a New Mexico State Library project and was reimbursed. Did the reimbursements owe gross receipts tax, or were they tax-free agency pass-throughs?

Subject

Ellen Berkovitch (D&O 00-09)

Plain-English summary

In 1995 Ellen Berkovitch signed a professional-services contract with the New Mexico State Library to be "materials manager" for the Statewide Reading Program. Her job was to produce a program manual for librarians: she selected and hired printers and artists, bought the needed materials and services, handled the money, and shipped the finished manuals. The contract said all expenses were her responsibility and that she was an independent contractor. She paid the vendors (who charged her gross receipts tax on their bills), and the State Library reimbursed her for those purchases as part of her pay — $9,174.64 of materials and services that year. Because she reported her contract income on a federal Schedule C, the Department later assessed gross receipts tax on it.

Berkovitch conceded she owed tax on her fee but argued the $9,174.64 of reimbursements should not be taxed — she said she was buying as a disclosed agent for the State Library, and that taxing her on top of the tax the vendors already charged was illegal double taxation.

The Hearing Officer denied the protest on both points:

• No agency relationship. Under Regulation 3 NMAC 19.3.1, reimbursed expenses are taxable gross receipts unless incurred "as agency on behalf of a principal" — and an agency relationship exists only where the person "has the power to bind a principal" so the vendor could enforce the bill against the principal. Even though the vendors knew the purchases were for a State Library project (so disclosure was not an issue), the contract made the expenses Berkovitch's own responsibility, let her choose the vendors, and labeled her an independent contractor. She could not bind the State Library. The situation matched Brim Healthcare (a manager reimbursed for its own employees' costs was taxable because it spent for its own account) and was unlike the law-firm photocopying in Francis & Starzynski, where the attorney-client relationship gave the firm implied authority to bind clients.
• Double taxation is not illegal. Citing Justice Holmes in Ft. Smith Lumber Co. v. Arkansas, the Hearing Officer explained there is nothing unconstitutional about double taxation, and there is no double taxation at all where the two taxes fall on different taxpayers — here the vendor was taxed on its receipts and Berkovitch on hers, separate taxpayers and separate transactions. She could have avoided the stacking by giving the vendors nontaxable transaction certificates for resale (Sections 7-9-47 and 7-9-48), but, new to the state, she did not know to.

What this means for you

• Getting reimbursed for expenses does not make the money tax-free in New Mexico. Reimbursements are gross receipts by default. The only escape is a genuine disclosed-agency purchase — and that takes more than the customer knowing what the money is for.
• "Disclosed agency" requires the power to bind your customer. The test is whether the vendor could have sued your customer for the bill. If you pick the vendors, the contract makes the costs your responsibility, and you're an independent contractor, you are buying for your own account — and your reimbursements are taxable.
• Double taxation is not a winning argument. New Mexico and federal courts have repeatedly held double taxation is not unconstitutional, and there is no double tax where the two charges land on different taxpayers. The vendor's tax and your tax are separate.
• Use resale certificates to stop tax from stacking. If you buy tangible property or services to resell (or pass through) to your customer, give the vendor the right nontaxable transaction certificate so it doesn't build gross receipts tax into your cost. Berkovitch's real loss was not knowing to do this.

Key questions answered

Why were the reimbursements taxable when they were just pass-through costs?
Because they were not incurred in a disclosed-agency capacity. Regulation 3 NMAC 19.3.1 makes reimbursements gross receipts unless the person had the power to bind a principal. Berkovitch's contract made the expenses her own responsibility and let her choose the vendors, so she bought for her own account.

The vendors knew it was for the State Library — wasn't that enough for agency?
No. Disclosure was not the problem; the missing element was the power to bind. Knowing the ultimate user of the goods does not, by itself, make the buyer an agent who can obligate the principal to the vendor.

Why did the law-firm case (Francis & Starzynski) not help her?
That case turned on the attorney-client relationship, where an attorney has implied authority to bind a client for litigation expenses, and the clients controlled the photocopying. Berkovitch had no comparable relationship and kept control over choosing and paying the vendors, so her case followed Brim Healthcare instead.

Wasn't it double taxation to tax her after the vendors already charged tax?
No. Double taxation is not illegal, and there was no double taxation here in any event because the vendor and Berkovitch were separate taxpayers taxed on separate transactions. She could have avoided the stacking with resale certificates under Sections 7-9-47 and 7-9-48.

Verbatim citations

The disclosed-agency test:

The receipts of any person received as a reimbursement of expenditures incurred in connection with the performance of a service or the sale or lease of property are gross receipts as defined by Subsection F of Section 7-9-3, unless that person incurs such expense as agency on behalf of a principal while acting in a disclosed agency capacity. An agency relationship exists if a person has the power to bind a principal in a contract with a third party so that the third party can enforce the contractual obligation against the principal.

Why there was no agency (following Brim Healthcare):

Although the Taxpayer received reimbursement of the expenses she incurred in purchasing materials and services in performance of her contract, the vendors were of her own choosing and as the contract specified, the expenses incurred were her responsibility.

On double taxation:

It is a popular misconception that there is something inherently illegal or unconstitutional with double taxation. ... New Mexico courts have also held, on numerous occasions, that there is no constitutional prohibition against double taxation. ... [T]he 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.

The holding:

The expenses incurred by the Taxpayer under her contract with the State Library were not expenses incurred in an agency capacity pursuant to Regulation 3 NMAC 19.3.1. They are gross receipts from engaging in business and are thus subject to gross receipts tax. ... For the foregoing reasons, the Taxpayer's protest IS HEREBY DENIED.

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Ellen Berkovitch
• Decision PDF: D&O 00-09

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
ELLEN BERKOVITCH NO. 00-09
ID. NO. 02-154452-00 2, PROTEST TO
ASSESSMENT NO. 2308883

DECISION AND ORDER

This matter came on for formal hearing on February 7, 2000 before Gerald B.

Richardson, Hearing Officer. Ellen Berkovitch, hereinafter, “Taxpayer”, represented herself at

the hearing. The Taxation and Revenue Department, hereinafter, “Department”, was represented

by Bridget A. Jacober, Special Assistant Attorney General. Based upon the evidence and

arguments presented, IT IS DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. In 1995, the Taxpayer entered into a professional services contract with the New Mexico

State Library to be a “materials manager” for the Statewide Reading Program. Among the

Taxpayer’s duties under this contract are to coordinate the research, production and editing of a

program manual for librarians as part of the Statewide Reading Program.

2. The Taxpayer’s duties under the contract were selecting, hiring and overseeing a printer

to print the program manual, the purchase of various materials and services to be used in the

production of the manual, distributing and shipping the manual.

3. The contract required that the Taxpayer handle all financial matters related to the services

provided and to submit to the State Library the invoices, statements and evidences of payment

related to the materials and services provided. The contract specified that all expenses incurred

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by the Taxpayer in performing the services were the responsibility of the Taxpayer and that the

Taxpayer was an independent contractor.

4. The Taxpayer paid for the purchase of materials and services used to produce the

program manual and received reimbursement for those purchases from the State Library as part

of her compensation under the terms of the contract with the State Library.

5. When the Taxpayer made those purchases of materials and services, the vendor of those

materials and services charged the Taxpayer the cost of passed on gross receipts tax.

6. In 1995, the Taxpayer purchased $9,174.64 in materials and services as part of her

contract with the State Library. The invoices for those materials and services, even though they

were issued to the Taxpayer, listed the purchases as for the State Library or the State Library

project. The Taxpayer was reimbursed by the State Library for the purchases she made.

7. For tax year 1995, the Taxpayer reported $14,127 in gross receipts from a business or

profession on Schedule C of her 1995 Federal income tax return.

8. The Taxpayer was new to the state in 1995 and did not understand that she would be

subject to gross receipts tax on the performance of services under her contract with the State

Library.

9. The Department, through its information sharing agreement with the Internal Revenue

Service (“IRS”), obtained information about the Taxpayer’s 1995 Federal Schedule C and

determined that the Taxpayer had not reported or paid gross receipts taxes in 1995 on the amount

reported on her Federal Schedule C.

10. On October 26, 1998, the Department issued Assessment No. 2308883 to the Taxpayer,

assessing $738.00 in gross receipts tax, $73.80 in penalty and $364.40 in interest for reporting

periods, January, 1995 through December, 1995.

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11. On November 11, 1998 the Taxpayer filed a written protest to Assessment No. 2308883.

DISCUSSION

The issue to be determined is whether the Taxpayer is liable for gross receipts tax upon

the $9,174.64 in reimbursements for expenditures she made as part of her contract with the State

Library1. In making this argument, the Taxpayer relies upon Regulation 3 NMAC 19.3.1 which

provides:

The receipts of any person received as a reimbursement of
expenditures incurred in connection with the performance of a
service or the sale or lease of property are gross receipts as defined
by Subsection F of Section 7-9-3, unless that person incurs such
expense as agency on behalf of a principal while acting in a
disclosed agency capacity. An agency relationship exists if a
person has the power to bind a principal in a contract with a third
party so that the third party can enforce the contractual obligation
against the principal.

In this case it appears that the vendors were aware that the materials and services were being

purchased for use in a State Library project, and thus, there is no issue with the disclosure of the

Taxpayer’s relationship with the State Library. It must then be determined whether the

relationship between the State Library and the Taxpayer created an agency relationship such that

the vendors would have the right to enforce payment against the State Library if they had not

been paid by the Taxpayer. This requires an examination of the contractual relationship between

the State Library and the Taxpayer to determine whether the contract establishes an agency

relationship such that the Taxpayer is empowered to bind the State Library in its transactions

with the third-party vendors. The Scope of Work portion of the contract enumerates the

responsibilities of the Taxpayer. With respect to the vendors, the contract requires that the

Taxpayer select, hire and oversee printers and artists in the development and printing of program

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The Taxpayer does not dispute her liability for gross receipts tax on the remainder of her receipts from the State
Library contract.

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materials, to arrange for the printing of program materials, to select and obtain materials, as

needed, to arrange for and oversee the distribution and shipment of program materials and to

handle all financial matters related to those services and submit to the State Library all invoices,

statements and evidences of payment related to the services the Taxpayer renders. The contract

further provides that “all expenses shall be the responsibility of the Contractor” and that the

Contractor is an independent contractor.

These terms do not establish an agency relationship. This case is analogous to that in

Brim Healthcare v. State, Taxation and Revenue Department, 119 N.M. 818, 498 P.2d 498 (Ct.

App. 1995). In that case, Brim contracted with hospitals to manage them and also to provide key

management personnel who were employees of Brim. Under its contracts with hospitals, Brim

received compensation for its management services and also reimbursement for the salaries,

fringe benefits and expenses for Brim’s management employees working at the hospitals. Brim

had claimed that its receipts for the reimbursement of the salaries, benefits and expenses of its

employees should not be considered gross receipts subject to tax because it was acting as an

agent for the hospitals in paying these expenses. The Court of Appeals rejected this argument,

noting that when it received the expense reimbursements under its contract with the hospitals, it

was receiving them for its own account and expended them to meet its own responsibilities to its

own employees. The same holds true in the instant matter. Although the Taxpayer received

reimbursement of the expenses she incurred in purchasing materials and services in performance

of her contract, the vendors were of her own choosing and as the contract specified, the expenses

incurred were her responsibility.

The Taxpayer relies upon a Dispositional Order of Reversal issued by the New Mexico

Supreme Court in the matter of Taxation and Revenue Department v. Francis & Starzynski,

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P.A., No. 24,440, Nov. 9, 1998. That matter involved the reimbursement receipts of a law firm

for photocopying expenses incurred on behalf of its clients. The Order reversed an

administrative decision of the Department which had found that those reimbursements were not

reimbursements of expenses incurred in an agency capacity. In determining to reverse the

Department, the Supreme Court found that the clients of the law firm had ultimate control over

the photocopying. It distinguished Brim Healthcare on the basis of the attorney-client

relationship, where it is well established that it is within the implied authority of an attorney to

bind his client for expenses incurred in representing the client. Francis & Starzynski is thus

distinguishable from this case, which does not involve an attorney-client relationship and where

the control over the selection and payment of the vendors remained with the Taxpayer.

The Taxpayer also argues that she should not be subject to gross receipts tax upon her

reimbursed expenses because when she made those purchases, the vendors included in their

billing the cost of gross receipts taxes. The Taxpayer thus argues that this amounts to double

taxation which she believes to be improper and illegal. It is a popular misconception that there is

something inherently illegal or unconstitutional with double taxation. Eighty 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:

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

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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.

In this case there are separate taxpayers and separate taxable transactions. The vendor is subject to gross

receipts tax upon its receipts from performing services or selling materials and the Taxpayer is subject to

gross receipts tax upon her receipts from performing services under her contract with the State Library.

There are deductions provided in the Gross Receipts and Compensating Tax Act which would have been

available to avoid the stacking of taxes which occurred in this case. If the Taxpayer had obtained and

issued the appropriate non-taxable transaction certificates to its vendors, the vendors could have claimed

the deduction for the sale of tangible personal property for resale or for the sale of services for resale

pursuant to §§ 7-9-47 and 7-9-48 and would not have included tax in their charges to the Taxpayer.

Unfortunately, apparently because she was new to the state and unfamiliar with the operation of the

gross receipts tax, the Taxpayer did not know to take advantage of these provisions.

For the reasons stated herein, the Taxpayer is subject to gross receipts on the amounts she

was paid under her contract with the State Library which amounted to reimbursement of the

expenses she incurred under her contract.

CONCLUSIONS OF LAW

1. The Taxpayer filed a timely, written protest to Assessment No. 230883, and jurisdiction

lies over both the parties and the subject matter of this protest.

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2. The expenses incurred by the Taxpayer under her contract with the State Library were not

expenses incurred in an agency capacity pursuant to Regulation 3 NMAC 19.3.1. They are gross

receipts from engaging in business and are thus subject to gross receipts tax.

3. The transactions where the Taxpayer purchased materials and services and the transaction

where the Taxpayer was compensated for the performance of services under her contract with the

State Library were separate transactions which were each subject to gross receipts tax.

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

DONE, this 15th day of March, 2000.

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