If I cut and haul timber I don't own as a subcontractor, is my work exempt from gross receipts tax because timber severance is taxed under the Resources Excise Tax Act?

Plain-English summary

A logging subcontractor who cut and hauled timber he did not own owed gross receipts tax on his services; the natural-resources exemption, rewritten years earlier, no longer reached that kind of work. Protest DENIED.

Ernest Rose worked in 1996 as a subcontractor for Rose Wood Products, cutting, skidding, loading, and delivering logs to a sawmill in Cimarron, New Mexico, and cleaning up the logging sites afterward. He did not own the timber. Believing his timber work was exempt, he never registered for gross receipts tax. A limited-scope audit comparing his federal Schedule C income to his (nonexistent) gross receipts filings led to a June 2000 assessment of $6,688.08 in tax, plus penalty and interest.

How the two tax acts fit together

New Mexico taxes the severing and processing of natural resources — including timber — under the Resources Excise Tax Act, at rates far below the gross receipts tax. That Act has three related taxes: a "resources tax" on severers who own the resource (or owners who hire someone to sever it); a "processors tax" on processing in a mill or plant; and a "service tax" on severing or processing resources owned by others that are not otherwise covered. The scheme is comprehensive — everything severed or processed is subject to exactly one of these taxes. To avoid stacking, the gross receipts tax has long included an exemption (now Section 7-9-35) for activities taxed under the Resources Excise Tax Act.

The old case that would have helped Rose

In Carter & Sons (1979), on nearly identical facts — a business severing timber owned by someone else — the Court of Appeals held the severing business was exempt from gross receipts tax under the earlier version of Section 7-9-35, which broadly said that when the Resources Excise Tax Act imposed a privilege tax, no provision of the gross receipts tax act would apply to that privilege. The court noted the Act's purpose was to encourage extractive industries by taxing them at a fraction of the gross receipts rate.

Why the rewritten exemption no longer applies

The problem for Rose is that Section 7-9-35 was completely rewritten in 1989. It now exempts only "receipts from the sale or processing of natural resources" subject to the Resources Excise Tax Act. Rose did neither: he did not own the timber, so he did not sell it, and processing by definition happens in a mill or plant, which he did not operate. He sold services — cutting, skidding, loading, hauling, and brushwork. Although the gross receipts act defines "selling" broadly to include services, that does not transform his services into the "sale of natural resources" the exemption requires. Because exemptions are strictly construed in favor of the taxing authority and must be clearly established by the taxpayer (Security Escrow), the plain, unambiguous language of Section 7-9-35 simply did not cover his work.

The hearing officer acknowledged that both taxes end up applying by the time the logs become lumber, but explained that this results from how Rose Wood Products and Rose structured the job — using a subcontractor rather than an employee — much like any business that subcontracts part of its work (for example, hiring an outside bookkeeper who then owes gross receipts tax on those services). If this is an unintended consequence of the 1989 amendment, the remedy lies with the legislature, not the hearing officer.

The negligence penalty — even the Department missed the change

The penalty under Section 7-1-69(A) stood. In New Mexico's self-reporting system, everyone must ascertain the tax consequences of their activities (Tiffany Construction), and the duty to keep up with changes in the tax law is an ongoing, affirmative one (Arco Materials). Rose's mistaken belief that Section 7-9-35 still worked the way it had in Carter & Sons was exactly that kind of negligence. Notably, Rose showed that even the Department had agreed to abate the assessment until one of its own attorneys caught the outdated reliance on Carter & Sons and stopped the abatement — but the hearing officer held that a Department employee's own lapse does not excuse the taxpayer's duty to self-report correctly.

Result: protest DENIED; tax and penalty upheld.

What this means for you

Selling logging (or similar) services is taxed differently from selling the resource

The gross receipts exemption for natural resources reaches the sale or processing of the resource, not the services of severing it for someone else. If you cut, haul, or otherwise work timber (or minerals) you do not own, your service receipts are generally subject to gross receipts tax even though the resource itself is taxed under the Resources Excise Tax Act.

An old favorable case may no longer be good law

Carter & Sons once exempted work like Rose's, but the statute was rewritten in 1989. Relying on a decision without checking whether the underlying statute still reads the same way is risky. Confirm the current statutory language, not just the case.

Subcontracting instead of employing can add a layer of tax

Because a subcontractor owes gross receipts tax on its services (usually passed on to the customer), structuring work as subcontracting rather than employment can create tax that an in-house employee arrangement would not. Weigh that when you decide how to staff a job.

Keeping up with tax-law changes is your responsibility

The duty to track changes in the law is affirmative and ongoing. A good-faith but outdated belief about an exemption is treated as negligence and will support a penalty — even in the unusual situation where a Department employee made the same mistake.

Common questions

Q: The timber is already taxed under the Resources Excise Tax Act — why am I taxed too?
A: That Act taxes severing and processing of the resource. Your receipts for services of cutting and hauling timber you do not own are separate and are subject to gross receipts tax, because the Section 7-9-35 exemption only covers the sale or processing of the resource.

Q: Didn't a court exempt this exact kind of work?
A: Carter & Sons did, but under an older, broader version of Section 7-9-35. The Legislature rewrote the exemption in 1989 so it now covers only the sale or processing of natural resources, which does not include a subcontractor's severing services.

Q: Would it have been different if I were an employee?
A: Yes. Only one Resources Excise Tax Act tax would have applied had Rose Wood Products used Mr. Rose as an employee. The extra gross receipts tax arises because the work was done through an independent contractor.

Q: A Department employee agreed to cancel my assessment — why do I still owe a penalty?
A: The near-abatement was stopped when a Department attorney caught the outdated reliance on Carter & Sons. The hearing officer held that the Department's own lapse does not relieve a taxpayer's duty to self-report correctly, so the negligence penalty stood.

Citations and references

Statutes:

• NMSA 1978, § 7-9-35 — exempts from gross receipts tax receipts from the sale or processing of natural resources whose severance or processing is subject to the Resources Excise Tax Act (rewritten by Laws 1989, ch. 115, § 3)
• NMSA 1978, §§ 7-25-1 through 7-25-9 — the Resources Excise Tax Act: resources tax (§ 7-25-4), processors tax (§ 7-25-5), service tax (§ 7-25-6), and exemption where processors tax is paid (§ 7-25-7)
• NMSA 1978, § 7-9-3(B) — defines "selling" to include the transfer of property or the performance of a service for consideration
• NMSA 1978, § 7-1-69(A) — negligence penalty (2% per month, up to 10%)

Cases cited:

• Carter & Sons, Inc. v. New Mexico Bureau of Revenue, 92 N.M. 591, 592 P.2d 191 (Ct. App. 1979) — under the earlier exemption, a business severing another's timber was exempt from gross receipts tax
• Security Escrow Corp. v. State Taxation and Revenue Department, 107 N.M. 540, 760 P.2d 1306 (Ct. App. 1988) — exemptions are strictly construed in favor of the taxing authority and must be clearly established by the taxpayer
• Tiffany Construction Co. v. Bureau of Revenue, 90 N.M. 16, 558 P.2d 1155 (Ct. App. 1976), cert. denied, 90 N.M. 255, 561 P.2d 1348 (1977) — failing to ascertain one's tax consequences is negligence
• Arco Materials, Inc. v. State Taxation and Revenue Department, 118 N.M. 12, 878 P.2d 330 (Ct. App. 1994) — a taxpayer has an affirmative duty to keep informed about changes in the tax law

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Ernest J. & Jean Marie Rose
• Decision PDF: D&O 01-14

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
ERNEST J. AND JEAN MARIE ROSE NO. 01-14
ID NO. 02-432209-00 1, PROTEST TO
ASSESSMENT NO. 2540943

DECISION AND ORDER

This matter came on for formal hearing on June 20, 2001 before Gerald B. Richardson,

Hearing Officer. Mr. and Mrs. Rose, hereinafter, “Taxpayers”, were represented by Gary D.

Alsup, Esquire. The Taxation and Revenue Department, hereinafter, “Department”, was

represented by Bruce J. Fort, Special Assistant Attorney General. On June 27, 2001, Taxpayers

filed a Motion to Supplement the record in this matter and on June 28, 2001, an order was

entered granting the Taxpayers’ motion, and the matter was considered submitted at that time.

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

FOLLOWS:

FINDINGS OF FACT

1. Mr. Rose worked as a subcontractor for Rose Wood Products during 1996. His work

involved the cutting, skidding, loading and delivery of logs to the sawmill in Cimarron, New

Mexico as well as the brushwork or cleaning up of the logging site after the logging had been

completed.

2. Mr. Rose did not own the timber which he was harvesting.

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3. Taxpayers were not registered with the Department for purposes of the gross receipts

tax because they believed that Mr. Rose’s compensation for his work involving the severing of

timber was exempt from gross receipts tax.

4. On March 7, 2000, the Department notified the Taxpayers of a limited scope audit

based upon the discrepancy between the gross receipts which Taxpayers had reported on

Schedule C of their 1996 federal income tax return and the fact that the Taxpayers had not

reported gross receipts for purposes of reporting and paying gross receipts taxes during 1996.

5. As a result of the Department’s limited scope audit, on June 14, 2000, the Department

issued Assessment No. 2540943 to the Taxpayers, assessing $6,688.08 in gross receipts tax,

$668.76 in penalty and $3,887.44 in interest for the January 1996 through December 1996

reporting period.

6. On July 10, 2000, the Taxpayers filed a written protest to Assessment No. 2540943.

DISCUSSION

The primary issue to be determined herein is whether Mr. Rose’s activities involving the

severing or harvesting of timber are subject to the gross receipts tax. The determination of this

issue involves an analysis and interpretation of the interactions between the Gross Receipts and

Compensating Tax Act, Sections 7-9-1 through 7-9-89 NMSA 1978, and the Resources Excise

Tax Act, Sections 7-1-25 through 7-25-9 NMSA 1978.

The taxes imposed under the Resources Excise Tax Act are imposed on the privilege of

severing and processing natural resources within New Mexico. Section 7-25-2. Natural

resources include timber and any product thereof. Section 7-25-3(B). There are actually three

different taxes which may be imposed under the Resources Excise Tax Act, depending upon who

owns the natural resource and what activity is being performed. The “resources tax” is imposed

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on severers of natural resources. Section 7-25-4. Severers are defined to be persons who sever

natural resources that they own or owners of natural resources who have another person perform

the severing of the resources. Section 7-25-3(G). The “processors tax” is imposed on processors

of natural resources. Section 7-25-5. Processing is defined as “smelting, leaching, refining,

reducing, compounding or otherwise preparing for sale or commercial use any natural resource

so that its character or condition is materially changed in mills or plants located in New Mexico.”

Section 7-25-3(D). Thus, in the case of timber, processing would be what happens when the

timber is taken to a mill in New Mexico and is turned into lumber. Processors are defined to be

persons engaged in the business of processing natural resources owned by that person, or owners

of natural resources who have others perform the processing of the natural resources. Section 7-

25-3(E). Finally, there is the “service tax”, which is imposed on the privilege of severing or

processing New Mexico natural resources owned by others and which are not otherwise subject

to the processors tax or resources tax. Section 7-25-6. There is also an exemption provided at

Section 7-25-7 from resources tax if the processors tax has been paid with respect to those

natural resources. As outlined above, the taxes imposed under the Resources Excise Tax Act

operate in a comprehensive manner such that all natural resources severed or processed in New

Mexico are subject to one of the taxes imposed under the act, but only one of the taxes will

apply.

The Resources Excise Tax Act was first enacted by Laws 1966, ch. 48, § 1. Almost since

its enactment, there has been an exemption in the Gross Receipts and Compensating Tax Act for

activities which were subject to tax under the Resources Excise Tax Act. The exemption is

presently found at Section 7-9-35 NMSA 1978, and was previously found at Section 72-16(A)-4

NMSA 1953. The rates of tax for the taxes imposed under the Resources Excise Tax Act have

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always been significantly lower than the rate of tax imposed under the Gross Receipts and

Compensating Tax Act. In a case involving strikingly similar facts to the instant case, the Court

of Appeals found that “[T]he primary purpose of the Resources Excise Tax Act is obviously to

encourage the development of the extractive industries of the state because the rates imposed are

a fraction of the Gross Receipts Tax.” Carter & Sons, Inc. v. New Mexico Bureau of Revenue,

92 N.M. 591, 594, 592 P.2d 191 (Ct. App. 1979). That case also involved the interaction of the

two tax acts as they applied to a business which severed timber which was owned by another

person, which is essentially an identical situation to the one presented for determination herein.

Applying an earlier version of the exemption from gross receipts tax found at Section 7-9-35, the

Court of Appeals found that the business under contract to sever the timber was exempt from the

imposition of gross receipts tax on its activities. That earlier version of Section 7-9-35 had

provided:

When a privilege tax is imposed by the Resources Excise Tax Act,
the provisions of the act shall apply and determine the full measure
of tax liability for the privilege of engaging in the business stated
in the act and no provision of the Gross Receipts and
Compensating Tax Act shall apply to or create a tax liability for
such privilege, except as is provided in Section 72-16A-27 NMSA
1953.

Section 72-16A-12.23 NMSA 1953.

We are now faced with determining whether the later version of that exemption applies

to exempt the Taxpayers from the imposition of gross receipts tax upon the severing activities

performed by Mr. Rose. Section 72-16(A)-12.23 NMSA 1953 was recodified as Section 7-9-35

in the 1978 statutory compilation. It was completely rewritten by Laws 1989, ch. 115, § 3. It

now provides as follows:

Exempted from the gross receipts tax are receipts from the sale or
processing of natural resources the severance or processing of

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which are subject to the taxes imposed by the Resources Excise tax
Act except as otherwise provided in Section 7-25-8 NMSA 1978.
(emphasis added).

The Taxpayers argue that this provision must be construed broadly to cover the severing

activities performed by Mr. Rose in order to effectuate the legislative intent as expressed in

Carter & Sons to encourage the development of the timber extraction industry by exempting his

activities from the imposition of the gross receipts tax. The Taxpayers are correct in their

assertion that either the processors tax or the resources tax would be imposed on either the

severing or processing of the timber Mr. Rose cut, depending upon whether Rose Wood Products

or the Cimarron saw mill paid the tax. Thus, if the exemption at Section 7-9-35 is not applied,

the process of getting that timber into a final saleable form as lumber would be subject to a

higher cumulative tax burden than if the gross receipts tax exemption applies to Mr. Rose’s

activities.

The problem with the Taxpayers’ argument is that Section 7-9-35 has been completely

rewritten since Carter & Sons was decided and the express language of the exemption does not

apply to Mr. Rose’s activities. This is because Section 7-9-35 only exempts “receipts from the

sale or processing of natural resources”. Mr. Rose does neither of those activities. He does not

own the timber, so he does not sell it. The definition of processing makes it clear that processing

activities are those which occur in a mill or plant. Thus, Mr. Rose does not process the timber.

Taxpayers argue that because the definition of “selling” in Section 7-9-3(B) of the Gross

Receipts and Compensating Tax Act includes both the transfer of property for consideration or

any performance of service for consideration, that in order to effectuate the legislative intent of

the Resources Excise Tax Act to encourage the extractive industries of New Mexico, Mr. Rose

should be considered to be selling natural resources for purposes of the exemption at Section 7-

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9-35. The definition of selling is written broadly in Section 7-9-3(B) because it should be

obvious that a person can sell both property or services, and the Gross Receipts and

Compensating Tax Act imposes gross receipts tax upon both activities. See, Section 7-9-3(F),

the definition of “gross receipts”. The fact that Mr. Rose is selling his services of cutting,

skidding, loading and hauling timber, as well as doing brushwork to clean up the logging site

does not transform the services he performs into the sale “of natural resources the severance or

processing of which are subject to the taxes imposed by the Resources Excise Tax Act” as

provided in Section 7-9-35. Where an exemption or deduction from tax is claimed, the statute

must be strictly construed in favor of the taxing authority and the right to the exemption or

deduction must be clearly established by the taxpayer. Security Escrow Corp., v. State of New

Mexico Taxation and Revenue Department, 107 N.M. 540, 760 P.2d 1306 (Ct. App. 1988).

The language of Section 7-9-35 is unambiguous and clear that it applies only to the sale or

processing of natural resources. There is simply no way to read Section 7-9-35 to cover the

services performed by Mr. Rose.

Admittedly, the operation of the Resources Excise Tax Act and the Gross Receipts and

Compensating Tax Act to the activities at issue under the facts of this case results in the

imposition of both taxes by the time the severed timber has been cut into lumber. That result,

however, is more the result of the manner that Rose Wood Products and Mr. Rose structured

their business arrangement than a failure of the statutes to ensure the competitiveness of timber

extraction in New Mexico. Only one of the taxes imposed under the Resources Excise Tax Act

would have been imposed had Rose Wood Products engaged Mr. Rose’s services as an

employee, rather than an independent contractor. Thus, the situation is really no different than

that which results in other situations when a taxpayer decides to subcontract out some of the

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activities which are part of their business. For example, if a plumbing business hires an

independent contractor as a bookkeeper to maintain its business records, the bookkeeper would

be subject to gross receipts tax upon its receipts from performing bookkeeping services for the

plumbing business. Because it is common business practice for taxpayers to pass the cost of the

gross receipts tax on to their customers, it would likely cost the plumbing company the additional

cost of the gross receipts tax. If the plumbing business had an in-house employee keeping its

books, there would be no cost associated with passed on gross receipts tax.1 This difference in

tax burden, however, is not necessarily a failure of the tax system to tax all activities equally, but

is a result of the manner by which taxpayers structure their business arrangements. If, indeed,

the imposition of gross receipts tax upon Mr. Rose’s activities is an unintended consequence of

the amendment of Section 7-9-35, Mr. Rose’s remedy lies with the legislature, since the

language of the exemption at present is not broad enough to encompass Mr. Rose’s activities.

The final issue to be determined is whether the imposition of penalty was proper in this
case. The imposition of penalty is governed by the provisions of NMSA 1978, Section 7-1-69(A)
NMSA 1978 (1996), which imposes a penalty of two percent per month, up to a maximum of ten
percent:
in 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 or
to file by the date required a return regardless of whether any tax is due,....

This statute imposes penalty based upon negligence (as opposed to a willful or fraudulent intent) for

failure to timely pay tax. Thus, there is no contention that the failure to report and pay taxes was

based upon any conscious attempt by the Taxpayers to underreport taxes. What remains to be

determined is whether the Taxpayers were negligent in failing to report their taxes properly.

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There would, however, be other tax consequences, since the wages of the employee would be subject to other taxes
such as income withholding tax, social security and medicare (fica) withholding, etc,

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Taxpayer "negligence" for purposes of assessing penalty is defined in Regulation NMAC 3.1.11.10

(formerly TA 69:3) as:

A) failure to exercise that degree of ordinary business care and prudence which
reasonable taxpayers would exercise under like circumstances;
B) inaction by taxpayers where action is required;
C) inadvertence, indifference, thoughtlessness, carelessness, erroneous belief or
inattention.

In this case, the Taxpayers were simply not aware that the gross receipts tax would apply to

them even though taxes imposed under the Resources Excise Tax Act also applied to either the

severing or processing of the same timber Mr. Rose was cutting and hauling. Because Mr. Rose’s

family has been in the logging business for a long time, I suspect that both he and Rose Wood

Products were under the impression that the exemption found at Section 7-9-35 still operated in the

manner it did in the Carter & Sons case. The legislature amended that provision substantially,

however, and as explained above, it no longer operated in the same manner.

New Mexico has a self-reporting tax system which requires that taxpayers voluntarily report

and pay their tax liabilities to the state. Because of this, the case law is well settled that every

person is charged with the reasonable duty to ascertain the possible tax consequences of his actions,

and the failure to do so has been held to amount to negligence for purposes of the imposition of

penalty pursuant to Section 7-1-69 NMSA 1978. Tiffany Construction Co. v. Bureau of Revenue,

90 N.M. 16, 558 P.2d 1155 (Ct. App. 1976), cert. denied, 90 N.M. 255, 561 P.2d 1348 (1977).

The duty to understand how the tax laws apply to a taxpayer’s activities is an ongoing duty,

requiring taxpayers to keep abreast of changes in the tax laws. Arco Materials, Inc., v. State of New

Mexico, Taxation and Revenue Department, 118 N.M. 12, 15, 878 P.2d 330 (Ct. App. 1994) (A

taxpayer has an affirmative duty to keep informed about changes in the tax law that might affect its

liability). Thus, a negligence penalty is properly imposed when the failure to pay tax is based upon

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a taxpayer’s erroneous belief that no tax was due because there had been a change in the applicable

law.

The Taxpayers also point to the fact that even a Department employee apparently was not

aware of the change in law subsequent to Carter & Sons, because the Taxpayers produced evidence

that the Department agreed to abate the assessment at issue, but that in the review process for the

abatement, a Department attorney noticed the erroneous reliance on the Carter & Sons decision and

the abatement was apparently stopped before it was put into effect. While it is regrettable that even

some Department employees apparently do not keep abreast of changes to the tax laws, nonetheless,

it does not amount to a defense to the imposition of penalties, given the nature of the state’s self-

reporting tax system and the clear mandates of the court’s decision in Arco Materials.

CONCLUSIONS OF LAW

1. The Taxpayers filed a timely, written protest to Assessment No. 2540943 and

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

2. The provisions of Section 7-9-35 NMSA 1978 do not apply to exempt from gross

receipts tax the timber severing activities performed by Mr. Rose because Mr. Rose is not selling

natural resources or processing them.

3. The Taxpayers were negligent in failing to keep up with changes in Section 7-9-35

NMSA 1978 which had previously operated to provide an exemption from gross receipts tax for the

timber severing activities of Mr. Rose and penalty was properly imposed pursuant to Section 7-1-69

NMSA 1978.

For the foregoing reasons, the Taxpayers’ protest IS HEREBY DENIED.

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DONE, this 30th day of July, 2001.

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