Could a copier company deduct the supply portion of bundled maintenance contracts with governments and nonprofits without separately invoicing supplies?

Plain-English summary

Southwest Copy Systems proved that the supply portion of its bundled copier-maintenance contracts was deductible when sold to governments and Section 501(c)(3) nonprofits, even though the monthly invoices did not separately price the supplies. Reliable transaction records overcame the Department's audit sample.

Southwest sold, leased, serviced, and repaired copiers, printers, and fax machines. Its maintenance agreements charged a monthly per-copy fee covering unlimited service, parts, and consumable supplies such as toner, developer, drums, rollers, and cleaning components.

The Department assessed $127,787.54 of gross receipts tax and $72,885.62 of interest. It also assessed $1,866.10 of compensating tax and $1,134.05 of interest, which Southwest did not contest.

The remaining dispute concerned tangible-property sales within the maintenance agreements for governmental and nonprofit customers that had supplied timely Type 9 NTTCs.

Separate invoicing was the clearest proof, not the only proof

Sections 7-9-54(A) and 7-9-60(A) allowed deductions for tangible personal property sold to qualifying governmental entities and Section 501(c)(3) organizations.

Regulation 3.2.1.29(E)(1) addressed a single transaction containing both services and tangible property. When each component exceeded 40 percent, receipts could be apportioned if the property or service value was readily ascertainable and the records adequately reflected the property portion.

The regulation called separate invoice charges the “clearest way” to carry that burden. The AHO held that neither the statutes nor the regulation made separate invoicing mandatory.

The OMD system reliably separated supplies from service

Southwest used copier-industry software known as OMD. When a technician returned from a service call, staff entered the hours worked and each supply item used. The system applied the technician rate, charged the supply cost to the customer's contract, and removed the item from inventory.

Service-ticket amounts were not combined with supply-ticket costs inside the system. The decision credited the owners' detailed testimony and found that the records were reliable, adequately reflected the charges, showed customers were charged the property costs, and did not overstate those costs.

The maintenance agreements contained conflicting boilerplate about whether consumables were included. The AHO used the contracts' “Special Terms” and the owners' credible testimony to find that parts and consumables such as toner were included in the monthly fee.

Detailed records displaced the audit sample

The auditor used percentage samples despite having access to Southwest's records. The Department's own Audit Manual allowed a taxpayer to present detailed information challenging a sample.

Southwest's CPA extracted the retail price of every relevant supply sale from the old and new OMD systems and revised the audit workpapers. Because the transaction-level evidence was more accurate and credible for the disputed government and nonprofit sales, the AHO set aside the sample for those deductions.

Southwest did not dispute that the service portion remained taxable or that other audit exceptions stayed disallowed.

Result: protest GRANTED IN PART and DENIED IN PART. Southwest proved that it owed $62,449.74 of gross receipts tax, plus interest. The assessed compensating tax and its interest also remained due.

What this means for you

Businesses selling bundled goods and services

Separately stated invoices are strong evidence, but this decision accepted another method when reliable records identified property and service amounts, showed the customer was charged the property cost, and did not overstate it.

Copier and equipment-maintenance companies

Track parts, consumables, technician time, customer contracts, and inventory by transaction. Southwest prevailed because its system tied each supply and service charge to a specific contract.

Taxpayers challenging an audit sample

Detailed transaction-level evidence can rebut a sampling result. Here, the taxpayer used the Department's workpapers and its complete internal data to establish the correct deductible supply amounts.

Common questions

Q: Were all maintenance-contract receipts deductible?
A: No. Only the proven tangible-property portion sold to qualifying governments and nonprofits was deductible; service receipts remained taxable.

Q: Did the invoices separately state toner and parts?
A: No. The AHO held that separate invoicing was not mandatory because the OMD records supplied the required proof.

Q: Why was the audit sample set aside?
A: Southwest provided detailed records for each disputed transaction, which more accurately showed the supply costs than the sampled percentages.

Q: What tax remained after the ruling?
A: $62,449.74 of gross receipts tax plus interest, along with the uncontested compensating tax and interest.

Citations and references

Statutes and regulation:

• NMSA 1978, §§ 7-1-17(C) and 7-9-5 — assessment and taxability presumptions
• NMSA 1978, § 7-9-54(A) — tangible-property sales to governmental entities
• NMSA 1978, § 7-9-60(A) — tangible-property sales to Section 501(c)(3) organizations
• NMSA 1978, § 7-1-67 — interest on unpaid tax
• Regulation 3.2.1.29(E)(1) NMAC — mixed service and tangible-property transactions

Cases cited:

• MPC Ltd. v. New Mexico Taxation and Revenue Department, 2003-NMCA-021 — burden shifts after sufficient rebuttal evidence
• Wing Pawn Shop v. Taxation and Revenue Department, 1991-NMCA-024 — burden to prove a deduction
• C.R. Anthony Co. v. Loretto Mall Partners, 1991-NMSC-070 — contextual interpretation of an ambiguous contract

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Southwest Copy Systems, Inc.
• Decision PDF: D&O 14-37

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
SOUTHWEST COPY SYSTEMS, Inc. No. 14-37
TO ASSESSMENT ISSUED UNDER LETTER
ID NO. L 1514601984

DECISION AND ORDER

A formal hearing on the above-referenced protest was held on October 22, 2014, before

Monica Ontiveros, Hearing Officer. The Taxation and Revenue Department (“Department”) was

represented by Elena Romero Morgan, Esq., attorney for the Department. Mr. Tom Dillon,

Protest Office Supervisor from the Department, appeared as a witness for the Department, along

with Shawn Marris, Senior Economist for the Department. Southwest Copy Systems, Inc.

(“Taxpayer”) appeared at the appointed time and was represented by Clinton Marrs, Esq. The

President of Southwest Copy Systems, Inc., Michael Contois, and the Vice President of

Southwest Copy Systems, Inc., Dorothy Contois, appeared as witnesses for Taxpayer. Brian

Rowe, certified public accountant, also appeared as a witness for Taxpayer.

Taxpayer introduced into the record Exhibits 1–16. Initially, the Department objected to

Exhibits 1-14 based on relevancy; specifically that the exhibits were not based on source

documents and not tied to the contracts. The objection was overruled because the workpapers

deal with the receipts within the audit period and relate to the transactions at issue. The

Department did not object to these same exhibits in the Joint Prehearing Statement. In addition,

the Department argued that Mr. Rowe did not indicate on the workpapers who had prepared the

documents. Exhibits 1-14 were initially prepared by the auditor, Ms. Cabrini Sanchez. Mr.
Rowe used the workpapers to arrive at his own calculations. The Department introduced into

the record Exhibits B-E. The Hearing Officer would like to acknowledge the hard work and

effort of both attorneys in this matter.

The record in this matter also contains the following filings: Notice of Telephonic

Scheduling Conference issued on November 8, 2013; Scheduling Order and Notice of

Administrative Hearing issued on November 21, 2103; Motion to Vacate Administrative Hearing

and Pre-Hearing Deadlines filed on January 16, 2014 by Taxpayer; Department’s Objection to

Taxpayer’s Motion to Vacate Administrative Hearing and Pre-Hearing Deadlines filed on

January 17, 2014; Continuance Order, Amended Scheduling Order, and Amended Notice of

Administrative Hearing issued on January 30, 2014; Joint Prehearing Statement filed by the

Department on April 2, 2014 (mislabeled); Motion to Extend Deadline for Filing Prehearing

Statement filed by Taxpayer on June 17, 2014; Order Extending Joint Prehearing Statement

Deadline issued on June 17, 2014; Notice of Telephonic Prehearing Status Conference issued on

June 27, 2014; Continuance Order, Amended Scheduling Order, and Amended Notice of

Administrative Hearing issued on July 1, 2014; Amended Continuance Order, Amended

Scheduling Order, and Amended Notice of Administrative Hearing issued on July 8, 2014;

Department’s Motion for Summary Judgment for the Denial of the Protest of Southwest Copy

Systems, Inc. filed on August 15, 2014; Protestant’s Motion for Summary Judgment filed on

August 18, 2014; Department’s Response to Taxpayer’s Motion for Summary Judgment filed on

August 27, 2014; Protestant’s Opposition to Department’s Motion for Summary Judgment filed

on September 22, 2014; Continuance Order, Amended Notice of Summary Judgment Hearing,

and Notice of Administrative Protest Hearing issued on September 24, 2014; Joint Prehearing

Statement filed on October 2, 2014; Amendment to Joint Prehearing Statement filed on October

Page 2 of 23
3, 2014; Order Denying Summary Judgment issued on October 8, 2014; and Notice of

Reassignment of Hearing Officer for Administrative Hearing issued on October 20, 2014. There

are also various e-mails contained in the administrative file.

There were three scheduling hearings that are also part of the record. Those hearings

occurred on November 21, 2013, June 27, 2014 and July 1, 2014.

At the conclusion of the hearing, the Department was offered an opportunity to present

legal argument, no more than five pages in length, responding to any issues raised at the hearing.

The Department’s legal counsel, Ms. Morgan, informed the Hearings Bureau that she intended to

file legal argument. An Order was issued on October 29, 2014 setting out the deadlines for the

legal argument. No legal argument was filed by the Department.

Based on the aforementioned pleadings, the testimony and evidence introduced at the

hearing, and the arguments presented, IT IS DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. On December 21, 2005, the Department assessed Taxpayer in the principal

amount of gross receipts tax of $127,787.54 and $72,885.62 in interest for the tax period of

January 31, 1998 through March 31, 2003. The relevant audit period for gross receipts tax is

April 2001-March 2003. Exhibit D, page C2a. (The gross receipts tax audit period is from

January 2000-March 2003; however, there were zero exceptions related to the issue in dispute

for the time period of January 2000-March 2001 and so this time period is not included.) The

Department also assessed Taxpayer $1,866.10 in the principal amount of compensating tax and

$1,134.05 in interest. Letter Id No. L1514601984. Taxpayer is not contesting the compensating

tax that is due.

2. Taxpayer filed a protest in this matter on January 18, 2006.

Page 3 of 23

3. On January 25, 2006, the Department acknowledged the protest filed by

Taxpayer.

4. The Department requested a hearing in this matter with the Hearings Bureau on

November 4, 2013.

5. The Department conducted an audit of Taxpayer beginning on October 23, 2002

and concluding on August 11, 2004. Exhibit D, page GN 1.

6. The auditor, Cabrini Sanchez, used the sampling method of audit even though

Taxpayer’s records were available to her. Exhibit D, page GN 3. Ms. Sanchez stated in the audit

that she used the sampling method because there was a high number of daily transactions.

Exhibit D, pages GN 3 and DN1.2. Ms. Sanchez derived the disallowed deductions by

multiplying a percentage of error of 34.1527% (old OMD system), 19.3824% (new OMD

system) and 76.5719% (disallowed deductions) against the total deductions per the filed returns

to arrive at a disallowed deduction amount. Exhibit D, pages DN1.3, DN2.2 and DN3.3.

7. The Department’s on-line Audit Manual provides that the sampling method is

used to review “less than 100% of the items within an account balance or class of transactions

for the purpose of evaluating some characteristic of all the items within the balance or class of

transactions.” Department’s Audit Manual, page 26. The purpose of audit sampling is to allow

the Department’s employees to be more efficient and to save time and money. Department’s

Audit Manual, page 26. The sampling method is an alternate method of sampling. [CD 2,

10/22/14, 4:50]. (At the hearing during the testimony of the Department’s witness, Shawn

Marris, he discussed the Department’s on-line Audit Manual. The Audit Manual can be found at

http://realfile.tax.newmexico.gov/general-audit-manual.pdf.) [CD 2, 10/22/14, 18:11-18:56].

Page 4 of 23

8. The Department’s Audit Manual states that “when sampling procedures have been

challenged by a taxpayer, we have allowed the taxpayer to present detailed information to refute

the results of the sample.” Department’s Audit Manual, page 26.

9. Taxpayer’s representatives provided detailed information to the Department

during the course of the Department’s audit, but the Department did not conduct a more detailed

audit. Exhibit D, pages DN.1.1-DN 1.3.

10. Taxpayer was incorporated in New Mexico in 1992. Its President is Michael

Contois, and its Vice President is Dorothy Contois. [CD 1, 10/22/14, 55:43-55:57].

11. Mr. Contois has been in the copier business since 1968. [CD 1, 10/22/14, 55:00-

57:00].

12. During the audit period, Taxpayer was in the business of selling, leasing and

servicing photocopier, printer and fax equipment to other businesses located in New Mexico.

[CD 1, 10/22/14, 57:00 and 1:16:15-1:16:30].

13. As part of its business practice, Taxpayer sold photocopier, printer and fax parts

and supplies (collectively known as “supplies”) to its customers. It also sold services to repair

and maintain the photocopiers, printers and fax machines (collectively known as “machines”).

[CD 1, 10/22/14, 1:16:53-1:17:04]. The charges for the supplies and the charges for the services

were included in a monthly fee charged to Taxpayer’s customers. Exhibit 15, pages 1-4.

14. Customers entered into Maintenance Agreements (Agreement) with Taxpayer for

the servicing of the machines and for providing supplies. The Agreement was a form contract

that all nonprofits and governmental agencies used during the audit period. [CD 1, 10/22/14,

2:08:46-57]. The Agreement provided that for a monthly fee, the fee changed depending on

several factors, Taxpayer provided unlimited service, drum and parts, and supplies: Toner,

Page 5 of 23
Developer, Waste Container. [CD 1, 10/22/14, 1:36:00-1:39:42]; Exhibit 15, pages 1-4. The

fee for the Agreement included a set number of copies, e.g., 15,000 copies per month. [CD 1,

10/22/14, 1:36:00-1:43:00]; Exhibit 15, page 1. The pricing cost of the Agreement was derived

by knowing the yields of copies per type of machine. [CD 1, 10/22/14, 1:38:00-1:39:58].

15. The customer could order and use as many supplies (drum and parts, and supplies:

Toner, Developer, Waste Container) so long as it did not exceed the per month number of copies

agreed upon. [CD 1, 10/22/14, 2:09:42-2:10:45]. If the number of agreed upon copies were

made, then there was an additional fee or overage charge was applied to the customer’s account.

Exhibit 15, pages 1-4.

16. The Agreement, however, also specifies that “(p)arts are included in your

Maintenance Agreement, excluding consumables such as toner, dispersant, and developer…” .

Exhibit 15, pages 1-4.

17. Taxpayer’s customers included 501(c)(3) organizations (“nonprofits”) and

governmental units or subdivisions, agencies, departments or instrumentalities (“entities”).

Exhibits 4 and 5.

18. Taxpayer’s business model was to sell business-to-business. [CD 1, 10/22/14,

1:04:30-1:04:40]. Taxpayer’s business slogan or motto was “to be responsive to the customer’s

needs quickly” and “to be competitive you need to supply the customer’s needs.” [CD 1,

10/22/14, 1:01-1:04:40]. The business model included not being a retail business for walk in

customers to purchase supplies. [CD 1, 10/22/14, 1:03:52]. Taxpayer’s business model included

being the “total solutions” for every business. [CD 1, 10/22/14, 1:51].

19. During the audit period, Mr. Contois testified that Taxpayer had approximately 40

employees. [CD 1, 10/22/14, 59:21-59:27]. (The Department’s audit stated that there were 28

Page 6 of 23
employees employed during the audit period. Neither party explained the discrepancy. ) Exhibit

D, page GN 1. The company was divided into administrative, service and sales departments.

[CD 1, 10/22/14, 59:27-59:39].

20. The supplies were kept on-site in Taxpayer’s warehouse. [CD 1, 10/22/14,

1:00:46-1:01:11].

21. The supplies included PM kits, rollers, computer boards, display panels, drums,

cleaning blades, developer and toner. [CD 1, 10/22/14, 1:06:11-1:07:02].

22. The photocopier machines serviced were high speed large copy machines costing

anywhere from $5,000 to $50,000. [CD 1, 10/22/14, 1:10:53-1:13:38].

23. The sales representatives for the company responded to sales calls outside of the

office. The sales representatives were not qualified to service the machines. [CD 1, 10/22/14,

1:05:00-1:30:00].

24. The service technicians were dispatched from the company’s main office to

service machines.

[CD 1, 10/22/14, 1:05:00-1:30:00].

25. Prior to the audit period, the cost for servicing a machine was around 66% percent

of the pricing cost of the Agreement, with the remaining 34% of the pricing cost of the

Agreement attributable to supplies for the machine. [CD 1, 10/22/14, 1:48:50-1:49:40]. Prior to

audit period, Taxpayer employed one service technician for every 76-100 machines. [CD 1,

10/22/14, 1:22:47-1:24:12].

26. During the audit period, Taxpayer employed one technician for every 400

machines. [CD 1, 10/22/14, 1:24:15-1:24:17].

Page 7 of 23

27. The computer program used to track supplies and service hours was referred to as

the “OMD” system. [CD 2, 10/22/14, 30:43-33:48].

28. The OMD system kept track of the number of service calls per customer, the

number of hours a technician serviced a machine and the hourly fee for each technician servicing

a machine. [CD 2, 10/22/14, 26:30-30:27].

29. When a service technician was dispatched to a customer’s office, a service ticket

and if necessary, a supply ticket were created. [CD 1, 10/22/14, 1:39:20-1:43:00; CD 2,

10/22/14, 30:43-32:43]. When the technician returned from a customer’s office, he added the

number of service hours to the ticket and the name and number of supplies. [CD 2, 10/22/14,

28:29-30:27].

30. A data entry clerk would, then, enter the information into the OMD system and

the OMD system would fill in the cost of the supply item to the customer’s contract number and

remove the item from inventory. [CD 1, 10/22/14, 1:39:20-1:43:00; CD 2, 10/22/14, 27:00-

30:03].

31. The service ticket indicated how many hours the technician worked on the

equipment and the cost per hour for his/her time. [CD 1, 10/22/14, 1:39:20-1:43:00; CD 2,

10/22/14, 27:00-30:03]. The OMD system would, then, calculate the service charge and charge

the customer’s contract number with the service fee. [CD 2, 10/22/14, 30:01-30:08].

32. The OMD system kept track of the inventory and charged each customer’s

contract number with the cost of each supply charged to the customer’s contract number. [CD 1,

10/22/14, 1:39:50-1:43; CD 2, 10/22/14, 26:30-30:27; CD 2, 10/22/14, 30:43-33:48].

33. The amount of service ticket was not combined in any way with the cost of

supplies listed on the supply ticket. [CD 2, 10/22/14, 31:52-32:18].

Page 8 of 23

34. The Department’s audit acknowledges that in Taxpayer’s computer software

system, Taxpayer separated the sale invoices by taxable sales and deductions. Exhibit D, page

DN 1.2.

35. Mrs. Contois was responsible for the administration of the office, of all the

internal financial and accounting functions. [CD 2, 10/22/14, 25:36-26:01].

36. The OMD system was a software system specifically designed for Taxpayer’s

copier business. [CD 2, 10/22/14, 30:51-31:18].

37. During the course of the audit, the computer program was changed, and the new

program worked almost identically to the old program. Exhibit D, pages GN3 and D2.2.

38. Taxpayer’s computer program was reliable and was able to keep track of the cost

of supplies charged to each customer’s contract number.

39. The Department’s audit states that “(t)he taxpayer said that to calculate

deductions an internal company specific formula of 64% taxable / 36% was invented and used

since the business start date.” Exhibit D, page DN2.2.

40. There is no evidence that either Taxpayer’s representative made this statement or

that the President or the Vice President invented the formula. Exhibit D, page DN 1.2.

41. Taxpayer does not dispute all of the audit exceptions in the audit. Taxpayer is

only protesting the audit findings that pertain to the sale of tangible personal property sold to

nonprofits and governmental agencies.

42. Mr. Dillon testified that he did not doubt that Taxpayer sold tangible personal

property as part of the Agreement. [CD 2, 10/22/14, 2:45:03-2:45:10]. Mr. Dillon testified that

the audit exceptions being disputed by Taxpayer are only being disallowed because there is no

Page 9 of 23
separate invoice detailing the price of the supplies. [CD 2, 10/22/14, 2:18:30 and 2:43:30-

2:43:37].

43. Ms. Sanchez did not testify in this matter even though she is still employed by the

Department.

44. Prior to the conclusion of the audit, Taxpayer’s representative, Brian Rowe, CPA,

disputed the audit findings and disputed the disallowance of the deductions as it applied to

nonprofits and governmental agencies. [CD 2, 10/22/14, 59:21-1:00:22].

45. Taxpayer was allowed a deduction for the sale of the supplies (i.e., toner) to

nonprofits or governmental agencies if the supply was separately invoiced. Exhibits 4 and 5.

46. The disallowed deductions in dispute relate to nonprofits and governmental

agencies who issued a timely Type 9 nontaxable transaction certificate (“nttc") to Taxpayer.

47. The nonprofits and governmental agencies in dispute are: Albuquerque Indian

Center, Albuquerque Little Theatre, Albuquerque Public Schools, Berean Baptist Church,

Catching the Dream, Catholic Social Services, Children Youth and Families, Christian

Fellowship Church, City of Albuquerque, Cornucopia, Inc., County of Valencia, EV Lutheran

Good Samaritan, Federal Aviation Administration Government Letter, Frederick H. Leonhard

Foundation, Immanuel Baptist Church, Los Lunas Schools, March of Dimes Birth Fund,

National Indian Youth Council, New Mexico Educational Assistance Foundation, New Mexico

Environment Department, New Mexico Coalition Against Domestic Violence, New Mexico

State Highway and Transportation Department, Office of the Special Trustee, Presbyterian

Medical Services, Pueblo of Laguna, City of Rio Rancho, Rio Rancho United Methodist, Sandia

View Elementary, Taxation and Revenue Department, Town of Edgewood, Tramway

Page 10 of 23
Community Church, University of New Mexico, Us District Court, US Postal Service, YMCA of

Albuquerque. Exhibit D, page C11.0.

48. The Department determined that from April 2001 through March 2003,

$101,510.44 in gross receipts were disallowed because the Agreement included a service

component. Exhibit D, pages C2a and C3.20a.

49. Mr. Rowe derived a percentage of the total receipts by reviewing the total receipts

received by Taxpayer from nonprofits and governmental agencies for the period of April 1, 2001

and ending March 2003 and, then, dividing the dollar amount or the “retail” price of the supplies

sold to the nonprofits and governmental agencies. Exhibit 3 and Exhibit 16, pages 3-4.

50. By accessing the old and new OMD systems, Mr. Rowe determined and provided

the retail price of all the supplies sold to nonprofits and governmental agencies during the audit

period. Exhibits 7-14.

51. Mr. Rowe calculated that the receipts for supplies were: 79.3731% for 2001;

83.4010% for 2002; and 70.4652%. Exhibits 3 and 16, page 4.; [CD 2, 10/22/14, 1:00:00-

1:44:00].

52. Based on the percentages, Mr. Rowe revised the workpapers provided to him by

Ms. Sanchez. Exhibits 1, 2, 4 and 5. (Mr. Rowe omitted his initials from his revised

workpapers.)

53. There were deductions that were disallowed by the Department, other than the

ones described herein. Taxpayer does not dispute the disallowance of these deductions.

54. Mr. Rowe determined that the allowable deductions based on sale of tangible

personal property sold under the Agreements was $374,172.63 with amount of tax due of

Page 11 of 23
$62,449.74. Exhibit 1, page C2a and Exhibit 16, pages 7-8. (Mr. Rowe used the auditor’s work

papers and carried over the headings into his workpapers.)

55. Taxpayer does not dispute that a portion of the receipts from the Agreements that

are services and therefore not deductible.

56. Taxpayer does not dispute the interest on the amount of tax it claims is due.

57. Mr. and Mrs. Contois were credible witnesses because they both had extensive

knowledge of the manner in which their business operated both structurally and financially.

They both exhibited ease in describing the details of the OMD system and how it operated which

was crucial in determining whether the OMD system was reliable and whether the cost of the

tangible personal property was entered into the system. In addition, they both seemed very

truthful.

DISCUSSION

The issue to be determined is whether Taxpayer is able to substantiate its sales of tangible

personal property if the sale included a service and the personal property was not invoiced

separately.

The Department contends that to substantiate the sale of tangible personal property at the

same time a service is provided by the same taxpayer, an invoice must be prepared indicating the

cost of the tangible personal property item to the customer. (The Department argued that in the

Agreement there was no “allocation” between the price of the tangible personal property and the

cost of the service.) [CD 1, 10/22/14, 29:00-35:33]. Taxpayer argued that there is no statutory

obligation that a taxpayer prepare an invoice detailing the sale of tangible personal property, so

long as there is sufficient record keeping and proof of the cost of the item.

Burden of Proof and Standard of Review.

Page 12 of 23
NMSA 1978, Section 7-1-17(C) (2007) provides that any assessment of taxes made by

the Department is presumed to be correct. See, TPL, Inc. v. Taxation and Revenue Dep’t, 2000-

NMCA-083, ¶8, 129 N.M. 539, 542, 10 P.2d 3d 863, 866, cert. granted, 129 N.M. 519, 10 P.3d

843, rev’d on other grounds, 2003-NMSC-7, 133 N.M. 447, 64 P.3d, 474. Accordingly, it is

Taxpayer’s burden to present evidence and legal argument to show that it is entitled to an

abatement, in full or in part, of the assessment issued against it. When a taxpayer presents

sufficient evidence to rebut the presumption, the burden shifts to the Department to show that the

assessment is correct. See, MPC LTD. v. N.M. Taxation and Revenue Dep’t., 2003-NMCA-021,

¶ 13, 133 N.M. 217, 219-220, 62 P.3d 308, 310-311; Grogan v. New Mexico Taxation and

Revenue Department, 2003-NMCA-033, ¶11, 133 N.M. 354, 357-58, 62 P.3d 1236, 1239-40.

Consequently, Taxpayer has the burden to show that the Department’s assessment is incorrect

and establish that it was entitled to the deduction for tangibles. See Archuleta v. O'Cheskey,

1972-NMCA-165, ¶7, 84 N.M. 428, 431, 504 P.2d 638, 641. The courts have held that “where an

exemption or deduction from tax is claimed, the statute must be construed strictly in favor of the

taxing authority, the right to the exemption or deduction must be clearly and unambiguously

expressed in the statute, and the right must be clearly established by the taxpayer.” Wing Pawn Shop

v. Taxation and Revenue Department, 1991-NMCA-024, ¶16, 111 N.M. 735, 740, 809 P.2d 649,

654.

In addition thereto, it is presumed that “all receipts of a person engaging in business are

subject to the gross receipts tax.” NMSA 1978, Section 7-9-5 (2002). Therefore, the notice of

assessment is not only presumed to be correct, but all of Taxpayer’s receipts are presumed to be

taxable. It is Taxpayer’s burden to rebut the presumptions.

Taxpayer’s Business.

Page 13 of 23
Taxpayer was in the business of selling, leasing and servicing machines to other

businesses located in New Mexico. Mr. Contois and his wife, Mrs. Contois, have owned and

operated the company since 1992. Both Mr. and Mrs. Contois were credible witnesses and both

witnesses spoke at length about the specific nature of the copier business. Mr. Contois

articulated that the business plan and model for his business was to meet the needs of New

Mexico businesses and to sell business-to-business in both the servicing and repairing of the

machines. Taxpayer’s business slogan or motto was “to be responsive to the customer’s needs

quickly” and “to be competitive you need to supply the customer’s needs.” The business model

included not being a retail business for walk in customers but to provide the necessary supplies

for each customer at the time the machines were serviced so that each customer could print and

make copies without much interruption. To accomplish this, Taxpayer sold or leased machines

to customers and then entered into formal written Agreements with customers wherein the

customer was charged a per copy fee per month, which included a service component to the

contract and a supply component. The agreed upon monthly fee was priced to include both

service charges and charges for supplies. Taxpayer used form contracts that were modified for

use with each individual customer. There is no issue that the service component of the

Agreement constituted gross receipts for which no deduction applies.

Sale of Tangible Personal Property.

The only inquiry is whether certain receipts from the supplies or the tangible personal

property when sold with the service component are deductible either pursuant to the deduction

for sales of tangible personal property to a governmental agency or the sales of tangible personal

property to a nonprofit. The applicable deductions at issue are Section 7-9-54 and Section 7-9-

60. Section 7-9-54(A) which provides that:

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(r)eceipts from selling tangible personal property to the United States or New
Mexico, or any governmental unit or subdivision, agency, department or
instrumentality thereof may be deducted from gross receipts or from governmental
gross receipts.

NMSA 1978, Section 7-9-54(A) (2001). The other germane deduction is Section 7-9-60(A) and

it provides that:

A.(r)eceipts from selling tangible personal property to organizations that have been
granted exemption from the federal income tax by the United States commissioner
of internal revenue as organizations described in Section 501(c)(3 of the United
States Internal Revenue Code of 1986, as amended for renumbered, may be
deducted from gross receipts…

NMSA 1978, Section 7-9-60(A) (2001).

In addition thereto, there are specific regulations providing instruction when there is a

sale of both a service and tangible personal property in a single transaction. The regulations

provide the use of either a “predominate” test, wherein the transaction is predominately a service,

or a test when neither the service or the sale of tangible personal property “predominate.”

In regulation 3.2.1.29(E)(1) NMAC (2001)1, the Department contemplates the possibility

that there are some transactions wherein either the performance of a service or the sale of

tangible personal property may not predominate but both the service and sale of property occur

in a transaction. The regulation provides that if the receipts attributable to each constitutes more

than 40% of the total receipts, then the receipts may be apportioned accordingly. However, the

market value or the cost of the tangible personal property or services must be “readily

ascertainable” and the taxpayer’s records must “adequately reflect” the portion of the receipts

derived from the sale of tangible personal property. The regulation goes on to provide that the

1
It should be noted that the example under regulation 3.2.1.29(E) NMAC (2001) is identical to Taxpayer’s situation
but for the manner in which Taxpayer X bills the customer. In the example, Taxpayer X bills the customer with an
invoice for the sale of the tangible personal property.

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taxpayer is responsible for providing the information and to justify the portion of the receipts

attributable to the sale of tangible personal property. Finally, the regulation provides that “(t)he

clearest way of carrying that burden is to specify separately on the invoice the charges for the

property and the charges for the services, and to retain sufficient records to allow a determination

that the relative value of either the property or the services is not overstated.” (Emphasis added).

The Department argued that the language in the regulation providing that the clearest way

to prove the cost of tangible personal property is to separately state on the invoice the charges for

the tangible personal property is a mandatory requirement. In reviewing both statutory

deductions, Section 7-9-54 and 7-9-60, there is no mandatory requirement that the invoice must

separately state the charges for the property and the charges for the services. Likewise, in

reviewing the regulation, there is no mandatory requirement that the taxpayer must separately

state the charges for the property and the charges for the services. The language in the regulation

only provides that “the clearest” manner in which the taxpayer, whose burden it is, may prove

the charges for the property and the charges for the services is to separately state those charges.

There is no doubt that the clearest and surest manner in which to prove the cost of tangible

personal property when there is a sale of both a service and property is to separately state the cost

of the property. There are going to be some businesses for which separately stating the cost of

the property is not in keeping with the type of business. Mr. Contois testified that the customers

would have been confused if they had received an invoice for the cost of supplies; especially

considering that the supplies were included within the per month fee.

Therefore, since the regulation does not require that the charges for the property be

separately stated, the inquiry then shifts focus to whether Taxpayer met its burden by showing

there were sufficient records to show the cost of the property and whether Taxpayer charged its

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customers that cost. There are four components to this inquiry. One component is whether the

record keeping is generally reliable. Another component is whether the record keeping

adequately reflects the charges. The third is whether Taxpayer charged its customers the cost of

the property. And finally, a taxpayer must show that charges are not “overstated.”

As for whether Taxpayer’s record keeping was reliable, Mr. Contois testified in great

detail about the operational nature of Taxpayer’s business. He testified that the machines that

were serviced under an Agreement were not desk top printers, but rather high speed large

machines costing anywhere from $5,000 to $50,000. Each machine was highly sophisticated and

if you compared the machines that were in use prior to the audit period to the machines used

during the audit period, the machines in use prior to the audit period needed more servicing than

the newer more efficient machines. He testified that there was a formula of one service

technician for every 76-100 machine prior to the audit period as compared to during the audit

period wherein the Taxpayer only needed one technician for every 400 machines. This is

evidence that the servicing part of the pricing of the Agreement was not as important as the

supply part of the pricing of the Agreement. It was the supplies that were more costly than the

servicing of a machine. The newer machines simply did not need to be serviced like the older

machines.

It was Mr. Contois' belief that to have a successful business, Taxpayer needed to be

readily available to service any machine at any time and provide the necessary supplies when

servicing the machines. Part of servicing the machines included routine service calls, which

included charging supplies, including PM kits, rollers, computer boards, display panels, drums,

cleaning blades, developer and toner to the customer’s contract.

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The sale of the supplies was accounted for on a daily basis in the OMD system. Mr. and

Mrs. Contois both testified that there was a software program, the OMD system, which kept

track of the inventory and charged each customer’s contract with the cost of each supply and the

number of service hours a technician work on a machine. The Agreements were priced to

include both the service and supply costs.

Mrs. Contois testified at length about how the cost of the supplies were tracked in the

OMD system. During the audit period, Mrs. Contois was responsible for the administration of

the office, of all the internal financial and accounting functions. The OMD system was a

software system specifically designed for the copier business. Mrs. Contois described in great

detail how the OMD kept track of the number of service calls per customer contract, the number

of hours a technician serviced a machine and the hourly fee for each technician servicing a

machine. Generally, when a service technician was dispatched to a customer’s office a service

ticket was created. When the technician returned from a customer’s office, the technician

completed the number of hours he serviced a machine and the supplies he used. The clerk

would, then, input the data into the OMD system, and the OMD system would populate the cost

of the supply item to the customer’s contract number and the per hour rate for the technician.

The OMD system would, then, tie the charges to the customer’s contract number. The charge for

the service ticket was not combined in any way with the cost of supplies listed on the supply

ticket. Taxpayer’s OMD system also kept track of the inventory and charged each customer’s

contract number with the cost of each supply item charged to a customer’s account.

Taxpayer disputes the sampling method as it was applied to the receipts and disallowed

deductions from nonprofits and governmental agencies. The Department used a percentage of

error of 34.1527% (old OMD system), 19.3824% (new OMD system) and 76.5719% (disallowed

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deductions) multiplied against the total deductions per the filed returns to arrive at a disallowed

deduction amount. Instead, Mr. Rowe gathered the cost of the supplies from the OMD systems,

which contain all of the original cost amounts, and prepared a spreadsheet indicating the cost of

all the items charged during the audit period to nonprofits and governmental agencies. Exhibits

7-14 and 16. The listing is detailed and there is no evidence to prove that any of the costs were

overstated. The auditor, Ms. Sanchez, noted in her audit that Taxpayer’s computer software

system separated the sale invoices by taxable sales and deductions. Exhibit D, page DN 1.2. It

is not clear if this is an acknowledgment that Taxpayer charged its customers the cost of the

supplies or if she meant something entirely different. Thus, since she was not available to

testify, this statement is not helpful. Ms. Sanchez also stated in the audit that “(t)he taxpayer said

that to calculate deductions an internal company specific formula of 64% taxable / 36% was

invented and used since the business start date.” There is no evidence that Taxpayer “invented”

a formula and since the auditor was unavailable to testify as to this statement, this statement is

not given any weight. Both Mr. Contois and Mrs. Contois were credible witnesses and did not

give any evidence that they would decide the pricing cost of an Agreement based on an invented

formula. Taxpayer has met its burden that the record keeping was reliable, that it accurately

reflected the charges, that the customers were charged the cost of the property and that the

charges were not overstated.

Sampling Method.

The Department argued that the method of sampling was accurate, so therefore, the

assessment should be upheld. Taxpayer argues that the sampling method is not the only method

for deriving the exceptions or the disallowed deductions. The Department’s own Audit Manual

provides that the sample method reviews “less than 100% of the items within an account balance

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or class of transactions for the purpose of evaluating some characteristic of all the items within

the balance or class of transactions.” Department’s Audit Manual, page 26. In fact, a more

accurate rendition of a taxpayer’s disallowed deductions is to review each transaction. In this

case, Taxpayer has provided the cost of each sale of tangible personal property sold to a

nonprofit or governmental agency. Exhibits 7-14. The Department’s Audit Manual states that

“when sampling procedures have been challenged by a taxpayer, we have allowed the taxpayer

to present detailed information to refute the results of the sample.” Department’s Audit Manual,

page 26. Therefore the sampling method as applied to the disallowed deductions (the portion

related to supplies under the Agreement) is set aside because Taxpayer met its burden to

overcome the presumption of correctness with detailed and credible evidence of the cost of each

sale of tangibles sold to nonprofits and governmental agencies.

Contradictory Language in Agreement.

There is the issue of the contradicting language in the Agreement concerning whether the

supplies, like toner, were included in the monthly fee. There is no question that the contract is

ambiguous since there are terms that contradict each other. The “Special Terms” language

contradicts the language in the Agreement. In C.R. Anthony Co. v. Loretto Mall Partners, 1991-

NMSC-070,¶¶12-19, 112 N.M. 504, 508-509, 817 P.2d 238, 242-243, the Court abandoned the

“plain-meaning” or “four-corners” standard to determine whether the context of the contract was

ambiguous. The Court went on to adopt the contextual approach to contract interpretation, in

recognition of the “difficulty of ascribing meaning and content to terms and expressions in the

absence of contextual understanding.” C.R. Anthony Co., 1991-NMSC-070, ¶14. See also, Mark

V, Inc. v. Mellekas, 1993-NMSC-001, 114 N.M. 778, 845 P.2d 1232. Thus, parol evidence is

admissible to explain or clarify an ambiguous term. C.R. Anthony Co., 1991-NMSC-070, ¶18.

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Mr. Contois testified that Taxpayer used a standard form agreement and amended the Agreement

with the notations under the section of the Agreement entitled “Special Terms.” Exhibit 15,

pages 1-4. Each example of an Agreement indicates that supplies included both the parts and

supplies like toner. The testimony is credible that the standard Agreement was amended by the

“Special Terms” section and that, not only were the parts included in the monthly fee, but the

supplies like toner were also included. Therefore, the standard form section related to supplies

of the Agreements is modified by the “Special Terms” section of the Agreement.

CONCLUSIONS OF LAW

A. Southwest Copy Systems, Inc. filed a timely written protest to the Department’s

Assessment issued under Letter Id No. L1514601984.

B. Jurisdiction lies over the parties and the subject matter of this protest.

C. The amount of assessed gross receipts tax is $127,787.54 in principal and

$72,885.62 in interest for the tax period of January 31, 1998 through March 31, 2003. The

Department also assessed Taxpayer $1,866.10 in the principal amount of compensating tax and

$1,134.05 in interest. Letter Id No. L1514601984.

D. Taxpayer owes the assessed compensating tax, including principal and interest.

E. Southwest Copy Systems, Inc. kept reliable records and its record keeping

adequately related the cost of the supplies charged to its customers.

F. Southwest Copy Systems, Inc. charged its customers the cost of the tangible

personal property and those costs were not overstated.

G. Southwest Copy Systems, Inc. was not legally required to separately state on an

invoice the charges to its customers for costs allocated to the sale of tangible personal property

because it utilized a record keeping system that was reliable; the record keeping adequately

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elected the charges; the pricing cost of the contract included the cost of the supplies; and the

charges were not overstated.

H. The receipts from the sale of tangible personal property to nonprofit organizations

and governmental agencies are deductible but the services are not.

I. Southwest Copy Systems, Inc., Inc. proved by a preponderance of the evidence

that it owes in gross receipts tax $62,449.74, plus interest.

J. Southwest Copy Systems, Inc., Inc. was able to rebut the presumption of

correctness as it applied only to the receipts set forth herein.

K. Interest should be applied to the principal amount of tax due in accordance with

NMSA 1978, Section 7-1-67 (2007).

For the foregoing reasons, the Taxpayer' protest IS GRANTED IN PART AND DENIED

IN PART.

DATED: November 20, 2014.

Monica Ontiveros
Hearing Officer
Taxation & Revenue Department
Post Office Box 630
Santa Fe, NM 87504-0630

NOTICE OF RIGHT TO APPEAL

Pursuant to NMSA 1978, §7-1-25 (1989), the Taxpayer have the right to appeal this

decision by filing a notice of appeal with the New Mexico Court of Appeals within 30 days of

the date shown above. See NMRA, 12-601 of the Rules of Appellate Procedure. If an appeal is

not filed within 30 days, this Decision and Order will become final. A party filing an appeal

shall file a courtesy copy of the appeal with the Hearings Bureau contemporaneously with the

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filing of the Notice with the Court of Appeals so that the Hearings Bureau may prepare the

record proper.

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