Can a large retailer avoid the negligence penalty on underpaid New Mexico compensating (use) tax by pointing to its overall compliance, netting against overpayments, or the fact that it employs in-house CPAs?

Plain-English summary

Condev West, a multi-state retailer, had to pay the negligence penalty on compensating (use) tax it underpaid — its overall good compliance, its overpayments in other months, and its three in-house CPAs did not excuse it. Protest DENIED. The company conceded the tax and interest and fought only the penalty.

Compensating tax is New Mexico's use tax on tangible personal property brought into the state when gross receipts tax was not paid at purchase. Condev operates retail stores and had procedures to report compensating tax, but a Department audit of January 1997 through April 2000 found $38,708.72 of underpaid compensating tax (mostly on capital assets), plus $17,397.63 interest and a $3,882.09 penalty. The company agreed it owed the tax and interest, so the only question was the penalty.

Inadvertent error and improper prior-period fixes are both negligence

Section 7-1-69 imposes a penalty when a failure to pay is "due to negligence or disregard of rules and regulations," and Regulation 3.1.11.10 defines negligence to include inadvertence and carelessness. The company said its misses (like not paying compensating tax on glass display cases in a remodel) were unavoidable "human error." New Mexico law disagrees: the Court of Appeals held in El Centro Villa that Section 7-1-69(A) "is designed specifically to penalize unintentional failure to pay tax." Separately, Condev corrected past errors by adjusting the current month's return rather than amending the prior return or claiming a refund. That violates Regulation 3.1.9.13 (no offsetting a prior overpayment by understating a current return) and the rule that each payment must be identified to the month of the taxable event (Amoco Production; Sections 7-9-11, 7-1-26, 7-1-10(E)). Both problems were negligence.

No de minimis exception; penalty is on the gross underpayment

The company argued the shortfall was insignificant next to what it paid correctly. But Section 7-1-69 has no de minimis exception — paying 99 percent correctly does not excuse a negligent failure on the remaining 1 percent. It also argued the penalty should be figured on the net underpayment after crediting overpayments in other months. Under Amoco Production, New Mexico does not authorize offsetting one period's overpayment against another period's underpayment, and penalty is calculated on the gross "amount of tax due but not paid" assessed in the audit. (A later statute, Section 7-1-69(F) effective July 1, 2001, does not apply to this period — and would not have changed the result, because the full penalty had accrued before the refund claim.)

Sampling and in-house CPAs did not help

Condev argued the Department's sampling method was too imprecise to support a penalty. But it did not challenge the sampling for the tax itself, offered no evidence of inaccuracy, and — critically — most underpayments were found by a detailed invoice-by-invoice audit of capital assets, not by sampling. Finally, employing three in-house CPAs did not establish the "reasonable reliance on competent advice" defense in Regulation 3.1.11.11: that defense requires the taxpayer to have consulted its advisor and received erroneous advice about the specific liability after full disclosure. There was no evidence the CPAs advised on these transactions or approved the flawed reporting method; general tax staffing is not enough.

Result: protest DENIED. The negligence penalty stood.

What this means for you

"Human error" is negligence for New Mexico penalty purposes

Unintentional mistakes in reporting compensating (use) tax are exactly what Section 7-1-69(A) penalizes. Good intentions and generally solid procedures do not, by themselves, avoid the penalty.

Fix past errors the right way — amend or claim a refund

Do not correct an earlier underpayment (or overpayment) by adjusting the current month's return. Amend the prior return for underpayments and file a claim for refund for overpayments; each payment must be tied to the month of the taxable event.

There is no "close enough" and no automatic netting

Paying most of your tax correctly will not excuse a negligent shortfall, and the penalty is computed on the gross underpayment, not net of overpayments in other periods.

Having CPAs on staff is not a reliance defense

To avoid a penalty by relying on professional advice, you must show your advisor addressed the specific transaction after full disclosure and gave erroneous advice. Simply employing accountants does not prove you were not negligent on a particular item.

Common questions

Q: What tax was involved?
A: New Mexico compensating (use) tax — $38,708.72 underpaid for January 1997 through April 2000, with $17,397.63 interest and a $3,882.09 penalty. Only the penalty was disputed.

Q: Why was inadvertent error still penalized?
A: Under El Centro Villa, Section 7-1-69(A) is designed to penalize even unintentional failures to pay. Negligence includes inadvertence and carelessness.

Q: Why couldn't the penalty be netted against overpayments?
A: Amoco Production holds New Mexico does not offset one period's overpayment against another's underpayment; the penalty is based on the gross underpayment assessed.

Q: Didn't the overall small shortfall matter?
A: No. Section 7-1-69 has no de minimis exception — a negligent failure to pay part of the tax is penalized even if most of the tax was paid correctly.

Q: The company employs three CPAs — why wasn't that enough?
A: The reliance defense requires advice on the specific liability after full disclosure. There was no evidence the CPAs advised on these transactions or approved the reporting method, so merely employing them did not show a lack of negligence.

Citations and references

Statutes and regulations:

• NMSA 1978, § 7-1-69 — negligence penalty (2% per month, up to 10%; no de minimis exception; new Subsection F effective July 1, 2001 inapplicable here)
• NMSA 1978, § 7-9-11 — CRS taxes due on or before the 25th of the month following the taxable event
• NMSA 1978, § 7-1-26 — claim for refund of overpaid tax
• NMSA 1978, § 7-1-10(E) — limits on the use of estimated payments
• NMSA 1978, § 7-1-17 — a Department assessment is presumed correct
• Regulation 3.1.11.10 NMAC — definition of taxpayer negligence
• Regulation 3.1.11.11 NMAC — no-negligence situations, including reliance on competent advice about the specific liability
• Regulation 3.1.9.13 NMAC — a taxpayer may not offset a prior overpayment by understating a current return

Cases cited:

• El Centro Villa Nursing Center v. Taxation & Revenue Department, 108 N.M. 795, 779 P.2d 982 (Ct. App. 1989)
• Arco Materials, Inc. v. Taxation & Revenue Department, 118 N.M. 12, 878 P.2d 330 (Ct. App. 1994), rev'd on other grounds by Blaze Construction Co. v. Taxation & Revenue Department, 118 N.M. 647, 884 P.2d 803 (1994)
• Amoco Production Co. v. New Mexico Taxation & Revenue Department, 118 N.M. 72, 878 P.2d 1021 (Ct. App. 1994)

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Condev West, Inc.
• Decision PDF: D&O 02-19

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
CONDEV WEST, INC. No. 02-19
ID NO. 02-306845-00 0
ASSESSMENT NO. 2674606

DECISION AND ORDER

A formal hearing on the above-referenced protest was held August 19, 2002, before Margaret

B. Alcock, Hearing Officer. Condev West, Inc. (“Taxpayer”) was represented by Debbie Cornwell,

its Tax Audit Manager. The Taxation and Revenue Department ("Department") was represented by

Bridget A. Jacober, Special Assistant Attorney General. Based on the evidence and arguments

presented, IT IS DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. The Taxpayer owns and operates retail stores in 30 states. The Taxpayer has five

stores in New Mexico and is registered with the Department for payment of gross receipts,

compensating and withholding taxes, which are required to be paid monthly under the Department’s

combined reporting system (“CRS”).

2. During the audit period at issue, the Taxpayer had procedures in place to insure that

compensating tax was properly reported on its purchases of tangible personal property delivered in

New Mexico. In late 1998 or early 1999, the Taxpayer reviewed and enhanced these procedures.

3. When purchasing tangible personal property for its New Mexico stores, the Taxpayer

first determined whether the transaction was taxable or nontaxable.

4. When a sale was taxable and the property was purchased from a New Mexico vendor,

the Taxpayer checked to see whether the vendor had charged gross receipts tax on the sale. If the

vendor had not charged tax, the Taxpayer asked the vendor to do so.

5. When a sale was taxable and the property was purchased from a vendor outside New

Mexico, the Taxpayer consulted with the vendor to determine whether the vendor had nexus with

New Mexico and should be charging gross receipts tax.

6. Once the Taxpayer determined that a vendor did not have nexus with New Mexico,

the Taxpayer reported and paid compensating tax on its New Mexico purchases from that vendor.

7. When the Taxpayer discovered that a transaction had been underreported or

overreported, the Taxpayer did not amend its prior return, but simply adjusted the compensating tax

it reported for the current month.

8. The Taxpayer performed periodic reviews of its monthly reporting of CRS taxes. If

the Taxpayer believed that inadvertent errors had led to an underreporting of tax in earlier periods, it

did not go back and amend its prior returns, but added the estimated amount of the underpayment to

its CRS return for the current month.

9. On November 17, 1999, the Department sent the Taxpayer written notice that it had

been selected for a field audit.

10. After receiving the Department’s audit notice, the Taxpayer reviewed its reporting of

CRS taxes and determined that those taxes may have been underreported during the period subject to

audit. On its December 1999 CRS-1 return, which was filed January 25, 2000, the Taxpayer

reported an additional $15,000 of CRS taxes to cover the suspected underpayment during earlier

periods.

11. After the field audit began, the Department made a decision to limit the audit to the

Taxpayer’s reporting and payment of compensating tax.

12. The Department audited the Taxpayer’s payment of compensating tax on the

purchase of supplies, which included such items as pens, paper bags, receipts, gift wrapping, etc., by

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reviewing a sample of invoices and then applying the error rate found in that sample to the entire

audit period.

13. The Department audited the Taxpayer’s payment of compensating tax on the

purchase of capital assets by looking at each individual invoice related to these purchases.

14. The majority of underpayments found in the audit were related to the Taxpayer’s

purchase of capital assets.

15. Due to the Taxpayer’s practice of correcting past reporting errors by adjusting its

CRS reporting for the current month, rather than going back and amending its returns for the months

in which the errors occurred, the Department’s audit also determined that the Taxpayer had

underpaid compensating taxes for certain months of the audit period and overpaid taxes for other

months.

16. The Taxpayer had an outstanding compensating tax liability of $38,820.78 for the 40-

month period from January 1997 through April 2000. The Taxpayer’s overpayment of compensating

tax for the same period, including the $15,000 estimated payment made after the Taxpayer received

the Department’s audit notice, was $32,604.94.

17. On June 29, 2001, the Department issued Assessment No. 2674606 to the Taxpayer

in the total amount of $60,100.50, representing $38,820.78 of compensating tax, $17,397.63 of

interest, and $3,882.09 of penalty.

18. On September 27, 2001, pursuant to a written extension of time granted by the

Department, the Taxpayer filed a written protest to the Department’s assessment.

19. The Department subsequently agreed to make some minor adjustments that reduced

the amount of tax principal to $38,708.72.

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20. After the Taxpayer filed a written claim for refund of the taxes it overpaid during the

audit period, the Department applied the refund to the Taxpayer’s outstanding liability.

21. At the administrative hearing on the Taxpayer’s protest, the Taxpayer’s tax audit

manager stated that the Taxpayer was no longer disputing its liability for the tax principal and

interest assessed by the Department and that the only matter remaining to be decided was the

assessment of penalty.

DISCUSSION

The sole issue to be determined is whether the Taxpayer is liable for the penalty assessed on

its underpayment of compensating tax during the period January 1997 through April 2000. The

Taxpayer raises the following arguments in support of its position that penalty should be abated: (1)

the amount of underreported tax is insignificant when compared to the amount of tax paid during the

same period and does not provide grounds to conclude that the Taxpayer acted negligently or in

disregard of the Department’s rules and regulations; (2) the penalty should be based on the net

amount of tax due after application of the Taxpayer’s overpayments for the same period; (3) the

sampling method the Department used to determine the Taxpayer’s liability has a margin for error

and should not be the basis for determining penalty; and (4) the Taxpayer employs three in-house

CPAs to insure taxes are correctly reported and this establishes that the Taxpayer was not negligent

in failing to properly report compensating tax.

Section 7-1-17 NMSA 1978 provides that any assessment of taxes made by the Department

is presumed to be correct. Section 7-1-3 NMSA 1978 defines tax to include not only the amount of

tax principal imposed but also, unless the context otherwise requires, “the amount of any interest or

civil penalty relating thereto." See also, El Centro Villa Nursing Center v. Taxation and Revenue

Department, 108 N.M. 795, 779 P.2d 982 (Ct. App. 1989). Accordingly, the presumption of

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correctness applies to the assessment of penalty at issue in this case, and it is the Taxpayer’s burden

to present evidence and legal arguments to support an abatement.

Section 7-1-69 NMSA 1978 governs the imposition of penalty. Subsection A imposes a

penalty of two percent per month or any fraction of a month, up to a maximum of ten percent, that a

taxpayer fails “due to negligence or disregard of rules and regulations” to pay taxes or file required

tax reports in a timely manner. Taxpayer negligence for purposes of assessing penalty is defined in

Regulation 3.1.11.10 NMAC 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 Taxpayer maintains that its underpayment of compensating tax during the audit

period was not due to negligence or to a disregard of rules and regulations. The Taxpayer raises the

following arguments in support of its position:

(1) The amount of underreported tax is insignificant when compared to the amount of

tax paid during the same period and does not provide grounds for a penalty. This argument is

based on a misreading of Section 7-1-69(A) NMSA 1978, which imposes a ten percent penalty

whenever the failure “to pay the amount of tax required to be paid” is due to negligence or disregard

of rules and regulations. The focus is on the amount of tax not paid. The statute does not provide a

de minimis exception, and the fact that a taxpayer may have paid 99 percent of its tax correctly is

irrelevant. If the failure to pay the remaining one percent of tax can be attributed to the taxpayer’s

negligence, penalty is due on that one percent. Here, the Taxpayer’s underpayment of compensating

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tax was due to two factors: inadvertent or “human” error and erroneous reporting of prior period

adjustments. Both of these factors constitute negligence.

Inadvertent Error. At the administrative hearing, the Taxpayer’s tax audit manager

acknowledged that while the Taxpayer has instituted various procedures to insure proper payment of

its taxes, human errors still occur. She testified that the largest reporting errors found by the

Department’s auditor were related to the Taxpayer’s failure to pay compensating tax on the purchase

of fixed assets. She identified the purchase of glass display cases used in a store remodel as one of

the transactions the Taxpayer failed to report. She said this was an inadvertent error and may have

been due to the fact that high-dollar items require a higher level approval before tax can be paid.

The audit manager gave her opinion that such errors are inevitable and do not indicate negligence on

the part of the Taxpayer. New Mexico law holds differently.

In El Centro Villa Nursing Center v. Taxation & Revenue Department, 108 N.M. 795, 797,

779 P.2d 982, 984 (Ct. App. 1989), the New Mexico Court of Appeals rejected the argument that

inadvertent or human error does not constitute negligence, stating:

It is apparent from the taped proceedings that taxpayer's advocate, its
accountant, did not understand the meaning of the term "negligence," either
generally or as specifically defined in Regulation 69:3. He admitted that
taxpayer's accounting system failed in December 1983 and November 1984 ...
but stated that this was due to "human error," which he did not characterize as
negligence. Taxpayer continues the misconception about when failure to pay
tax can be penalized under Section 7-1-69(A) by disregarding any accepted
definition of negligence and asserting that it is unfair to penalize a taxpayer for
inadvertent error.

The court concluded that “Section 7-1-69(A) is designed specifically to penalize unintentional failure

to pay tax.” Id. See also, Arco Materials, Inc. v. Taxation & Revenue Department, 118 N.M. 12, 16,

878 P.2d 330, 334 (Ct. App. 1994) rev'd on other grounds by Blaze Construction Co. v. Taxation &

Revenue Department, 118 N.M. 647, 884 P.2d 803 (1994). The inadvertent errors that led to the

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Taxpayer’s failure to pay compensating tax on certain transactions come within this definition of

negligence.

Erroneous Reporting. The second factor contributing to the Taxpayer’s underpayment of

compensating tax was its erroneous method of reporting prior period adjustments. Section 7-9-11

NMSA 1978 requires CRS taxes to be paid “on or before the twenty-fifth day of the month following

the month in which the taxable event occurs.” If a taxpayer finds that compensating taxes for a

particular month were underpaid, the taxpayer should file an amended return to correct its earlier

reporting. If a taxpayer finds that taxes were overpaid, the taxpayer is required to file a claim for

refund with the Department. See, Section 7-1-26 NMSA 1978.

Taxpayers are not permitted to correct reporting errors in earlier months by adjusting the

compensating tax reported on the current month’s return. As stated in Department Regulation

3.1.9.13 NMAC: “A taxpayer may not create a credit for a discovered overpayment of tax by

understating the amount due on current tax returns to offset amounts paid on prior returns.” Nor may

a taxpayer guard against past underpayments by making additional estimated payments in a later

reporting period. See, Section 7-1-10(E) NMSA 1978, limiting the use of estimated payments to

taxpayers who meet specified requirements and enter into a written agreement with the Department.

As noted by the New Mexico Court of Appeals in Amoco Production Co. v. New Mexico

Taxation & Revenue Department, 118 N.M. 72, 75, 878 P.2d 1021, 1024 (Ct. App. 1994), “a tax is

not paid simply when monies are deposited with the state.” Each tax payment must be properly

identified to the month in which the taxable transaction occurred. This is the only way the

Department can determine whether tax on that transaction was paid correctly and on time. The

Taxpayer’s practice of adjusting the current month’s reporting to correct reports filed for prior

periods was not in accordance with New Mexico law and was in disregard of the Department’s rules

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and regulations. Accordingly, the compensating tax liability resulting from this incorrect reporting is

subject to the negligence penalty imposed by Section 7-1-69(A) NMSA 1978.

(2) The penalty should be based on the net amount of tax due after applying the

Taxpayer’s overpayments to the underpayments found in the audit. In Amoco Production Co.,

supra, the court of appeals held that New Mexico statutes do not authorize the Department to apply

overpayments of taxes for one reporting period as offsets against underpayments for another prior

reporting period. The Taxpayer has accepted this ruling with regard to the tax principal and interest

assessed by the Department, but argues that a different rule should apply to penalty. The Taxpayer

has not provided any authority to justify such a distinction.1 Pursuant to Section 7-1-69(A)(1)

NMSA 1978, penalty is calculated as follows:

two percent per month or any fraction of a month from the date the tax was
due multiplied by the amount of tax due but not paid, not to exceed ten
percent of the tax due but not paid.

The “amount of tax due” for purposes of calculating penalty is the amount of tax assessed by the

Department. This includes the total amount of the Taxpayer’s underpayments of compensating tax

during the audit period, without regard to any overpayments made during the same period.

(3) The sampling method the Department used to determine the Taxpayer’s liability

has a margin for error and should not be the basis for determining penalty. At the

administrative hearing, the Taxpayer’s audit manager affirmatively stated that the Taxpayer does not

challenge the Department’s use of sampling to determine the Taxpayer’s liability for tax. She then

argued that the sampling method used was not sufficiently accurate to justify the imposition of

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Effective July 1, 2001, a new Subsection F was added to Section 7-1-69 NMSA 1978, which states that no penalty shall be
imposed on “tax that is deemed paid by crediting overpayments found in an audit...pursuant to Section 7-1-29 NMSA 1978.”
This provision does not apply to the period at issue in this case. In addition, Section 7-1-29 NMSA 1978 requires a taxpayer to
file a claim for refund before credit can be given for an overpayment and further provides that a tax is “deemed paid in the period
in which the overpayment was made or the period in which the overpayment was credited against an underpayment, whichever
is later” (emphasis added). Here, the full ten percent penalty had accrued before the Taxpayer filed its claim for refund and the

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penalty. There is simply no logic to this argument. In addition, the Taxpayer failed to provide any

evidence to establish why or to what extent the Department’s sampling method was inaccurate.

As discussed in the previous section, the calculation of penalty is based on the amount of tax

established in the Department’s audit. Having withdrawn its challenge to the assessment of tax

principal, the Taxpayer has no grounds to complain when this same figure is used to determine the

amount of penalty due on the Taxpayer’s underpayment of tax.

I also note that while the Department audited the tax paid on supplies using a sampling

method, it conducted a detail audit of tax paid on capital assets. This means that the Department’s

auditor looked at each individual invoice to determine whether compensating tax was properly

reported and paid on the assets purchased. The Taxpayer’s audit manager acknowledged that most

of the underpayments found in the audit were related to capital assets. Clearly, the accuracy of the

Department’s sampling methods does not apply to these underpayments.

(4) The Taxpayer employs three in-house CPAs to insure taxes are correctly reported

and this establishes that the Taxpayer was not negligent in its failure to report compensating

tax. Department Regulation 3.1.11.11 NMAC sets out several situations that may indicate a taxpayer

has not been negligent, including proof that “the failure to pay tax or to file a return was caused by

reasonable reliance on the advice of competent tax counsel or accountant as to the taxpayer’s liability

after full disclosure of all relevant facts.” The Taxpayer argues that the fact it employs three CPAs to

research tax laws and regulations establishes that the Taxpayer was not negligent in failing to properly

report and pay the compensating tax assessed by the Department. There is no evidence, however, that

the Taxpayer’s CPAs advised the Taxpayer not to pay compensating tax on the transactions at issue in

this case. Nor is there any evidence that the CPAs approved or were even aware of the Taxpayer’s

Department credited the Taxpayer’s overpayments to the underpayments found in the audit. Accordingly, even if the 2001

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method of reporting adjustments to prior period returns. The fact that a taxpayer employs an attorney

or a CPA to provide general tax advice does not establish that the taxpayer was not negligent in failing

to pay tax on a particular transaction. The Department’s regulation applies only when a taxpayer has

consulted with its tax advisor and received erroneous advice concerning the specific liability at issue.

CONCLUSIONS OF LAW

1. The Taxpayer filed a timely, written protest to Assessment No. 2674606, and

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

2. The Taxpayer’s underpayment of compensating tax during the audit period was due to

negligence or disregard of rules and regulations, and penalty was properly imposed pursuant to Section

7-1-69 NMSA 1978.

For the foregoing reasons, the Taxpayer's protest IS DENIED.

DATED August 27, 2002.

legislative change were applied to this case, it would not affect the assessment of penalty to the Taxpayer.

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