Could a New Mexico manufacturer substantiate R&D wage allocations with drafting logs and engineer interviews instead of a formal project-timekeeping system?

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Plain-English summary

Process Equipment & Service Company proved its New Mexico R&D tax credits without a formal project-timekeeping system. Contemporaneous drafting logs, engineer interviews, and payroll data reasonably allocated wages to qualified research and also served the company's real business decision-making.

The Farmington manufacturer designed and built oil-and-gas production equipment, including separators, dehydrators, treaters, combustors, and heaters. Customers brought unique wellsite problems, and the company used engineering, simulations, design meetings, drafting, and prototypes to develop custom solutions.

It applied for Technology Jobs and Research and Development Tax Credits of $88,014 for 2014 and $79,827.50 for 2016. The Department agreed that the company performed qualified research at a qualified facility. The dispute was whether it adequately proved the amount of qualified expenditures.

The allocation method used real operational records

The company did not track every employee's time by project. Its products were priced using direct labor, materials, and administrative costs, and customers were not separately billed for R&D time. Management considered a dedicated R&D time system burdensome and unnecessary except for claiming the credit.

Its accounting adviser, CliftonLarsonAllen, instead used a two-part method:

• review contemporaneous drafting logs and project change codes to identify drafting work tied to research projects; and
• interview engineers to determine the percentage of projects and wages attributable to qualified R&D, then apply those percentages to payroll data.

The method counted only projects that reached drafting and produced some product. It omitted unsuccessful early-stage work with no viable result. The record identified 16 qualifying projects for 2014 and 11 for 2016.

New Mexico required more than federal approval

The company argued that the method had repeatedly supported its federal research credit and should therefore satisfy New Mexico. The AHO rejected that as a complete answer.

New Mexico's statute differed from 26 U.S.C. § 41. When a qualified expenditure was allocated, Section 7-9F-3(G) required the same cost-accounting methodology the taxpayer used in other business activities. Federal acceptance alone could not erase that distinct state requirement.

Using the same method for the federal credit supported the methodology's credibility and consistency, but did not independently satisfy New Mexico law.

A formal time system was not required

The Department read the statute as requiring contemporaneous and reliable time tracking and questioned whether the adviser-created method was a true cost-accounting method.

The statutory language did not require a particular timekeeping system. The drafting-log method systematically recorded and analyzed labor costs incident to R&D projects, bringing it within the ordinary meaning of cost accounting.

The credit's stated purpose was to create a favorable tax climate for technology businesses and promote New Mexico employment and higher wages. Requiring small local businesses to build an onerous project-management system solely for the credit would conflict with that purpose when reliable existing records could establish qualified expenditures.

The company used the method outside tax preparation

The company's engineering executive credibly explained that he used drafting time and the same review process to decide whether R&D projects remained viable. That was an “other business activity” under Section 7-9F-3(G), not merely tax-credit preparation.

The accounting firm's arrangement also did not invalidate the evidence. It billed hourly, with billing delayed until the credit outcome, rather than charging a fixed percentage of the credit. No New Mexico prohibition on that hybrid arrangement was identified, and the methodology remained grounded in actual development work.

Result: protest GRANTED. The Department had to approve the 2014 and 2016 credit claims, modified by the company's concession that it could not apply the federal 80% wage rule to the New Mexico credit.

What this means for you

New Mexico does not mandate one R&D tracking system

A formal employee-by-employee project-time system may be useful, but D&O 20-02 held that the statute did not make it the exclusive proof method.

Use contemporaneous operational evidence

Drafting logs, change codes, payroll data, technical records, and credible employee interviews can work together to support a reasonable wage allocation.

Show a genuine non-tax business use

If the expenditure is allocated, the methodology must also be used in another business activity. Here, management used the drafting-log review to evaluate project viability.

Do not simply copy the federal calculation

New Mexico's qualified-expenditure rules differ from the federal research credit. Federal acceptance adds credibility but does not prove state eligibility by itself.

Avoid importing the federal 80% wage rule

The company conceded that the federal shortcut did not apply, and the approved state claims had to be modified accordingly.

Common questions

Q: Was qualified R&D itself disputed?
A: No. The Department conceded that the company conducted qualified research at a qualified facility. Only substantiation of expenditures was contested.

Q: What records supported the allocation?
A: Contemporaneous drafting logs and change codes, employee interviews, identified projects, and payroll data.

Q: Why did the method count as another business activity?
A: The engineering executive used drafting-log information to judge whether continuing an R&D project was viable.

Q: Did prior federal credit acceptance control?
A: No. The state credit has its own statutory allocation language, though consistent federal use supported the method's credibility.

Q: Were the originally requested dollar amounts automatically granted unchanged?
A: No. Both years were approved subject to removing the federal 80% wage treatment the company had conceded was unavailable.

Citations and references

Statutes:

• NMSA 1978, §§ 7-9F-1 through 7-9F-13 — Technology Jobs and Research and Development Tax Credit Act
• NMSA 1978, § 7-9F-2 — favorable-tax-climate, employment, and wage purpose
• NMSA 1978, § 7-9F-3(G) and (I) — qualified expenditures, allocation methodology, and qualified research
• NMSA 1978, §§ 7-9F-5 and 7-9F-6(B) — credit calculation and eligibility requirements
• 26 U.S.C. § 41(b) and (c)(5) — federal qualified research expenses, consistency, and anti-distortion comparison

Cases:

• Team Specialty Products v. New Mexico Taxation and Revenue Department, 2005-NMCA-020 — tax credits as legislative grace and taxpayer's burden
• Security Escrow Corp. v. State Taxation and Revenue Department, 1988-NMCA-068 — narrow but reasonable construction
• United States v. McFerrin, 570 F.3d 672 (5th Cir. 2009) — federal R&D expense estimates based on testimony and other evidence
• Chavez v. Commissioner of Revenue, 1970-NMCA-116 — fair construction consistent with legislative purpose

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Process Equipment & Service Company Inc
• Decision PDF: D&O 20-02

Original ruling text

1 STATE OF NEW MEXICO
2 ADMINISTRATIVE HEARINGS OFFICE
3 TAX ADMINISTRATION ACT

4 IN THE MATTER OF THE PROTEST OF
5 PROCESS EQUIPMENT & SERVICE COMPANY INC.
6 TO THE TAXATION AND REVENUE DEPARTMENT’S
7 DENIAL OF REFUND ISSUED UNDER LETTER
8 ID NO. L0040880432

9 &

10 IN THE MATTER OF THE PROTEST OF
11 PROCESS EQUIPMENT & SERVICE COMPANY INC.
12 TO DENIAL OF TECHNOLOGY JOB R & D TAX CREDIT ISSUED UNDER
13 LETTER ID NO. L0049360688

14 v. AHO Case No. 18.10-270R, D&O No. 20-02

15 NEW MEXICO TAXATION AND REVENUE DEPARTMENT

16 DECISION AND ORDER

17 On April 11, 2019, Chief Hearing Officer Brian VanDenzen, Esq., conducted a merits

18 administrative hearing in the matter of the tax protest of Process Equipment & Service Company,

19 Inc. (Taxpayer) pursuant to the Tax Administration Act and the Administrative Hearings Office

20 Act. At the hearing, Attorneys Gene Creely and Frank Crociata appeared representing Taxpayer.

21 Taxpayer called Jim Rhodes, Marcus Mims, C.P.A., and Michael DePrima as witnesses in this

22 matter. Staff Attorney David Mittle appeared, representing the opposing party in the protest, the

23 Taxation and Revenue Department (Department). Department protest auditor Milagros Bernardo

24 appeared as a witness for the Department.

25 Taxpayer presented duplicate exhibit numbers by each relevant year, resulting in Exhibits

26 #1-17 for 2014 and Exhibits #1-15 for 2016. The hearing officer erred in allowing such

27 confusing, duplicative numbering, as in retrospect the exhibit numbering system needlessly

28 complicated the record. In order to minimize this confusion, the year in parenthesis will be added

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 1 of 30.
1 to Taxpayer exhibits e.g. Taxpayer Exhibit (2014) #1, Taxpayer Exhibit (2016) #1. Taxpayer

2 Exhibits (2014) #1-17 and Exhibits (2016) #1-15 were admitted into the record. Department

3 Exhibit A was admitted into the record.

4 In quick summary, this protest involves the Department’s denial of Taxpayer’s 2014 and

5 2016 claims for technology jobs and research and development tax credits. The Department denied

6 the claims because it determined that Taxpayer’s methodology of demonstrating qualified

7 expenditures was inadequate under the statutory language and evidence presented. Ultimately, after

8 making findings of fact and discussing the issue in more detail throughout this decision, the hearing

9 officer finds that Taxpayer did adequately demonstrate entitlement to the claimed credits and

10 therefore Taxpayers’ protest must be granted. IT IS DECIDED AND ORDERED AS FOLLOWS:

11 FINDINGS OF FACT

12 Jurisdictional Background

13 1. On December 31, 2015, Taxpayer applied for a technology jobs tax credit totaling

14 $88,014.00 from the period of January 1, 2014 to December 31, 2014, hereinafter referred to as

15 the 2014 credit. [Taxpayer Exhibit (2014) #1; Administrative Record, hearing request packet].

16 2. On February 3, 2017, the Department denied Taxpayer’s claim for 2014 credit.

17 [Taxpayer Exhibit (2014) #11; Administrative Record, hearing request packet].

18 3. On May 4, 2017, Taxpayer protested the Department’s denial of the 2014 credit.

19 [Taxpayer Exhibit (2014) #16; Administrative Record, hearing request packet].

20 4. On June 1, 2017, the Department acknowledged receipt of Taxpayer’s protest of

21 the denial of the 2014 credit. [Administrative Record, hearing request packet].

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 2 of 30.
1 5. On July 14, 2017, the Department requested a hearing with the Administrative

2 Hearings Office on Taxpayer’s protest of the 2014 claim. [Administrative Record, hearing

3 request packet].

4 6. On December 29, 2017, Taxpayer applied for a technology jobs tax credit totaling

5 $79,827.500 from the period encompassing 2016, hereinafter referred to as the 2016 credit.

6 [Taxpayer Exhibit (2016) #1; Administrative Record, hearing request packet].

7 7. On May 31, 2018, the Department denied Taxpayer’s claim for 2016 credit.

8 [Taxpayer Exhibit (2016) #10; Administrative Record, hearing request packet].

9 8. On August 29, 2018, Taxpayer protested the Department’s denial of the 2016

10 credit. [Taxpayer Exhibit (2016) #15; Administrative Record, hearing request packet].

11 9. On September 11, 2018, the Department acknowledged receipt of Taxpayer’s

12 protest of the denial of the 2016 credit. [Administrative Record, hearing request packet].

13 10. On October 26, 2018, the Department requested a hearing with the Administrative

14 Hearings Office for Taxpayer’s protest of the denial of the 2016 credit. [Administrative Record,

15 hearing request packet].

16 Substantive Findings

17 11. Jim Rhodes is chairman of the board of Taxpayer and Vice President of

18 Engineering, Research and Development, and Quality Management Systems. Mr. Rhodes has an

19 engineering degree from New Mexico State University and has worked for Taxpayer for some

20 40-plus years. [04-11-19 CD 00:34:30-00:36:50].

21 12. Taxpayer has 415 employees at its office in Farmington. [04-11-19 CD 00:37:10-

22 25].

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 3 of 30.
1 13. Taxpayer designs and manufactures oil and gas production equipment, separators,

2 dehydrators, treaters, sand separators, combustors, and indirect heaters. Taxpayer is a problem-

3 solver for oil and gas companies. [04-11-19 CD 00:37:26-00:38:20; Taxpayer Ex. (2014) #8.2;

4 Taxpayer Ex. (2016) #7.2; Taxpayer (2014) Ex. #12].

5 14. Taxpayer has three mechanical engineers, two civil engineers, a chemical

6 engineer, industrial engineer, electrical engineer, a master electrician, IT staffing, and six

7 fulltime drafters that work on research and development. [04-11-19 CD 00:38:21-47].

8 15. Research and development is the life-blood of Taxpayer’s business. [04-11-19 CD

9 0:38:48-0:40:10].

10 16. Taxpayer’s customers will contact Taxpayer seeking Taxpayer’s research and

11 development expertise in designing specific equipment necessary to work under specific

12 conditions at the customer’s unique wellsite. [04-11-19 CD 0:43:40-0:44:08].

13 17. On a custom project, Taxpayer begins with a predesign process involving

14 simulations, the engineering team, design team meeting, and leading to development of a

15 prototype at Taxpayer’s expense. [04-11-19 CD 0:44:08-0:45:10].

16 18. If the customer accepts Taxpayer’s prototype custom-engineered solution, the

17 customer will typically purchase many units of that product and Taxpayer will market those units

18 to other customers. [04-11-19 CD 0:45:10-0:45:52].

19 19. These custom-designed and engineered products generally form the basis of

20 Taxpayer’s research and development credit at issue in this protest. [04-11-19 CD 0:45:52-

21 0:46:11].

22 20. Taxpayer engaged CliftonLarsonAllen (CLA) as its accounting firm for the

23 purposes of seeking the research and development credit based on the recommendation of its

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 4 of 30.
1 local accounting firm, which had informed Taxpayer it believed it might be entitled to such a

2 credit. [04-11-19 CD 0:46:12-0:47:42].

3 21. CLA sent numerous staff to review Taxpayer’s records and interview Taxpayer’s

4 staff and business in order to develop a methodology to quantify Taxpayer’s time and wages

5 related to Taxpayer’s research and development activities. [04-11-19 CD 0:47:43-0:48:55].

6 22. CLA reviewed drafting logs, interviewed staff, and relying on known drafting

7 time of drawings per drafter, determined a percentage of projects that qualify as a research and

8 development project and a percentage of projects that were not qualified as research and

9 development project. [04-11-19 CD 0:48:55-0:51:00; 1:50:00-1:55:32; 3:29:53-3:34:00].

10 23. Mr. Rhodes walked through the methodology in detail using drafting logs.

11 [Taxpayer Ex. (2014) #2; 04-11-19 CD 1:50:00-1:55:32].

12 24. Taxpayer used drafting logs that were created contemporaneously during the time

13 period where the work was performed. [04-11-19 CD 0:51:00-0:54:29; Taxpayer Ex. (2014) #2].

14 25. Taxpayer has consistently used the methodology both in its federal and state tax

15 filings related to research and development credits since 2011. [04-11-19 CD 0:56:42-0:57:12;

16 1:01:24-1:02:05].

17 26. Taxpayer’s methodology only accounts for research and development projects

18 that made it to the drafting stage and excludes research and development projects where no

19 viable product resulted from development. [04-11-19 CD 0:57:13-0:58:30].

20 27. In 2014, Taxpayer was engaged in sixteen identified research and development

21 projects resulting in some sort of product, with each project more fully identified and described

22 in the evidentiary record 1. [Taxpayer (2014) #4; 04-11-19 CD 0:59:07-1:00:01].

1
Although the hearing officer considered listing out all 16 of the 2014 projects in this finding of fact (as well as the
11 2016 projects referenced in the next finding of fact), the hearing officer choose not to in order avoid any potential

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 5 of 30.
1 28. In 2016, Taxpayer was engaged in eleven identified research and development

2 projects resulting in some sort of product, with each project more fully identified and described

3 in the evidentiary record. [Taxpayer (2016) Ex. #5; 04-11-19 CD 1:00:02-1:01:23].

4 29. Taxpayer conducted qualified research in 2014 and 2016. [Taxpayer (2014) Ex.

5 #10.6; Taxpayer (2016) Ex. 9; Taxpayer (2015) Ex. #5].

6 30. Taxpayer did not employ a project time keeping system in 2014 or 2015. [04-11-

7 19 CD 1:05:52-1:06:00; Taxpayer does not maintain a detailed project time-keeping system,

8 which while ideal, is burdensome to implement simply for research and development tracking, as

9 it is time-consuming and burdensome to implement for Taxpayer’s research and development

10 process. [04-11-19 CD 2:40:06-2:41:19].

11 31. Taxpayer builds the price of the product based on the cost of direct labor, the cost

12 of materials, and administrative costs and does not bill the customer for the research and

13 development time, and thus does not use a project time keeping system. [04-11-19 CD 1:06:00-

14 1:07:21].

15 32. A project time keeping system would have little use to Taxpayer’s actual business

16 operational needs and Taxpayer would only use a project time keeping system for the purpose of

17 the tax credit. [04-11-19 CD 1:06:00-1:08:42; 04:09:45-04:09:56].

18 33. As a small business, Taxpayer would likely not have the resources, personnel, or

19 desire to employ a project time keeping system for the limited purpose of substantiating a small

20 research and development tax credit. [04-11-19 CD 1:05:52-1:11:49].

21 34. Taxpayer uses a cost accounting method for the purposes of the research and

22 development tax credit. [04-11-19 CD 1:13:00-17].

issue with trade secrets given that the names of the identified project does not add significant import to the analysis
of the issues in this protest.

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 6 of 30.
1 35. Taxpayer informally uses that same methodology as CLA used for the tax credit

2 to determine the continuing viability of a research and development project by comparing the

3 drafting time shown on the drafting logs against the potential results/outcome/viability of the

4 project. [04-11-19 CD 1:13:17-1:16:48].

5 36. Taxpayer is developing a process system and has a time keeping system for direct

6 labor charged to a customer, just not for research and development. [04-11-19 CD 1:18:07-

7 1:18:34].

8 37. Mr. Rhodes was unaware of how Taxpayer compensated CLA. [04-11-19 CD

9 1:25:10-35].

10 38. Mr. DePrima is an employee and principle of CLA. Mr. DePrima is an attorney

11 with an LLM in taxation practicing in the area of specialty tax services, primarily research and

12 development credits since 2009. Mr. DePrima has been regional head of CLA’s research and

13 development practice for the Mountain West since 2018. [04-11-19 CD 2:20:43-2:21:40].

14 39. CLA has used a consistent methodology to apply for the credit, both at the state

15 and federal level, for Taxpayers over the years it has been engaged by Taxpayer. [04-11-19 CD

16 2:22:20-2:23:10; 2:29:39-2:30:20; 2:36:00-2:39:25; 3:40:00-3:40:44; 4:28:41-4:29:58].

17 40. The instructions on the technology jobs tax credit do not provide specific

18 guidance on how to prove the credit. [04-11-19 CD 2:29:30-39; Taxpayer Ex (2014) #13;

19 Taxpayer (2016) Ex. #12].

20 41. CLA uses a two-prong approach in preparing the credit application for Taxpayer

21 where it looks at change codes on the drafting logs from the drafting group and then interviews

22 engineers to determine the research and development project percentages. Based on those

23 percentages, CLA uses the wages data to determine the amount of the credit application in the

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 7 of 30.
1 taxable year [04-11-19 CD 2:33:00-2:36:04; 3:29:53-3:40:44; 3:49:37-3:50:44; 04:05:26-

2 4:06:55; Taxpayer Ex (2014) #8; Taxpayer Ex. (2014) #3; Taxpayer (2016) Ex. #6.24; Taxpayer

3 (2016) Ex. #7].

4 42. In 2014, CLA used this methodology to determine the percentage of Taxpayer’s

5 wages that were related to research and development. [04-11-19 CD 3:48:37-3:49:35; 3:51:08-

6 3:54:26; Taxpayer Ex. (2014) #1; Taxpayer Ex. (2014) #2; Taxpayer Ex. (2014) #3; Taxpayer

7 Ex. (2014) #17].

8 43. In 2016, CLA used this methodology to determine the percentage of Taxpayer’s

9 wages related to research and development. [04-11-19 CD 3:49:35-3:50:44; Taxpayer Ex. (2016)

10 #1; Taxpayer Ex. (2016) #4].

11 44. A majority to CLA’s clients do not use a research and development project time-

12 keeping system and that has not been an impediment to claiming a federal research and

13 development credit. [04-11-19 CD 2:40:06-2:42:40].

14 45. Taxpayer does not allocate indirect general and administrative costs (referred to in

15 testimony as “G & A costs”) for either the state or federal research and development credit. [04-

16 11-19 CD 2:45:50-2:47:25].

17 46. CLA’s method for the research and development credit is not designed as a

18 formal cost accounting methodology nor is it designed to aid Taxpayer in measuring financial

19 performance. [04-11-19 CD 3:08:00-3:10:03; 4:04:57-4:05:27].

20 47. CLA is paid hourly for its work with Taxpayer on the research and development

21 credit work. CLA generally includes a cap in its fees under a particular engagement letter. CLA

22 does not charge a contingency fee to any client. [04-11-19 CD 3:10:25-3:12:09].

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 8 of 30.
1 48. CLA does not receive a contingency fee as fixed percentage of the amount of

2 credit granted, however the billing of Taxpayer’s hourly rate is reserved until the outcome of the

3 credit application is known. [04-11-19 CD 4:24:27-4:28:09].

4 49. Marcus Mims is a certified public accountant employed at CLA as a principal in

5 State and Local Tax. Mr. Mims has an accounting degree and has around 30-years of experience

6 in accounting. [04-11-19 CD 3:28:23-3:29:53].

7 50. Mr. Mims is the account manager for Taxpayer and has been since 2011. [04-11-

8 19 CD 3:29:53-3:30:20].

9 51. Taxpayer is not seeking an additional technology jobs credit in 2014 but is

10 seeking that additional credit in 2016. [04-11-19 CD 3:58:23-4:03:16; Taxpayer Ex. (2016) #1].

11 52. In developing a methodology for the research and development credit, CLA

12 focused only on wages. [04-11-19 CD 3:34:06-16].

13 53. CLA believes that the methodology it developed was fair, reasonable, true, and

14 correct. [04-11-19 CD 4:08:25-4:08:53].

15 54. Taxpayer initially applied the 80% federal rule to the wages but no longer seeks

16 the application of that rule.

17 55. Milagros Bernardo is protest auditor with the Department and was familiar with

18 Taxpayer’s protest. [04-11-19 CD 4:36:30-4:36:50].

19 56. The Department does not require a taxpayer to use an expensive time keeping

20 system to grant a credit but it does require a contemporaneous and reliable time tracking system.

21 [04-11-19 CD 4:36:50-4:37:20].

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 9 of 30.
1 57. The Department requires Taxpayer to use a cost-accounting methodology used for

2 allocation of expenditure be the same as the accounting methodology used by Taxpayer in other

3 business activities. [04-11-19 CD 4:37:20-4:38:10].

4 58. Protest Auditor Bernardo acknowledged that Taxpayer’s accounting activities,

5 processing tax returns, the submission of tax credit applications, and using the methodology to

6 make business decisions about the viability of a project all constitute part of Taxpayer’s other

7 business activities. [04-11-19 CD 4:49:11-4:50:05; 4:57:38-4:58:32].

8 59. While the Department approved previous credit claims substantiated by the same

9 methodology at issue here, the Department previously advised Taxpayer during a review of the

10 credit in a previous period that relying on drafting logs was not an acceptable method for

11 allocation of wages, as it assumes that all drawings require the same amount of work. [04-11-19

12 CD 4:54:00-4:56:48; Taxpayer Ex. (2014) #10.6-7; Taxpayer Ex. (2016) #9.8].

13 DISCUSSION

14 This protest involves Taxpayer’s application for the research and development tax credit

15 in 2014 and 2016, which the Department denied because it determined that Taxpayer failed to

16 substantiate its qualified expenditures using a method it also employed for other business

17 purposes, which the Department asserts is required under the applicable statutory definition.

18 Resolution of this protest turns both on a question of statutory construction and related question

19 of proof.

20 Burden of Proof and Principles of Statutory Construction

21 Although in some respects similar to deductions and exemptions, credits generally

22 involve more favorable tax treatment than either a deduction or an exemption. “Where an

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

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 10 of 30.
1 taxing authority, the right to the exemption or deduction must be clearly and unambiguously

2 expressed in the statute, and the right must be clearly established by the taxpayer.” See Sec.

3 Escrow Corp. v. State Taxation & Revenue Dep't, 1988-NMCA-068, ¶8, 107 N.M. 540, 760 P.2d

4 1306. See also Wing Pawn Shop v. Taxation & Revenue Dep't, 1991-NMCA-024, ¶16, 111 N.M.

5 735, 809 P.2d 649. See also Chavez v. Comm'r of Revenue, 1970-NMCA-116, ¶7, 82 N.M. 97,

6 476 P.2d 67. Because of the more favorable tax treatment of a credit over a deduction or

7 exemption, the New Mexico Court of Appeals has found that tax credits are legislative grants of

8 grace to a taxpayer that must be narrowly interpreted and construed against a taxpayer. See Team

9 Specialty Prods. v. N.M. Taxation & Revenue Dep't, 2005-NMCA-020, ¶9, 137 N.M. 50 (internal

10 citations omitted). Under the rationale of Team Specialty Prods, Taxpayer carries the burden of

11 proving that it is entitled to the claimed credit.

12 Nevertheless, although a credit must be narrowly interpreted and construed against a

13 taxpayer, it still should be construed in a reasonable manner consistent with legislative language.

14 See Sec. Escrow Corp., 1988-NMCA-068, ¶9, 107 N.M. 540 (although construed narrowly

15 against a taxpayer, deductions and exemptions—similar to credits—are still to be construed in a

16 reasonable manner). The “main goal of statutory construction is to give effect to the intent of the

17 legislature.” Dell Catalog Sales L.P. v. Taxation & Revenue Dep't, 2009-NMCA-0001, ¶ 19,

18 145 N.M. 419, 199 P.3d 863 (internal citations omitted). Questions of statutory construction

19 begin with the plain meaning rule. See Wood v. State Educ. Ret. Bd., 2011-NMCA-20, ¶12. In

20 Wood, ¶12 (internal quotations and citations omitted), the Court of Appeals stated “that the

21 guiding principle in statutory construction requires that we look to the wording of the statute and

22 attempt to apply the plain meaning rule, recognizing that when a statute contains language which

23 is clear and unambiguous, we must give effect to that language and refrain from further statutory

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 11 of 30.
1 interpretation.” A statutory construction analysis begins by examining the words chosen by the

2 Legislature and the plain meaning of those words. State v. Hubble, 2009-NMSC-014, ¶13, 206

3 P.3d 579, 584. Extra words should not be read into a statute if the statute is plain on its face,

4 especially if it makes sense as written. See Johnson v. N.M. Oil Conservation Comm'n, 1999-

5 NMSC-21, ¶ 27, 127 N.M. 120, 126, 978 P.2d 327, 333.

6 It is a canon of statutory construction in New Mexico to adhere to the plain wording of a

7 statute except if there is ambiguity, error, an absurdity, or a conflict among statutory provisions.

8 See Regents of the Univ. of New Mexico v. New Mexico Fed'n of Teachers, 1998-NMSC-20, ¶28,

9 125 N.M. 401. “Tax statutes, like any other statutes, are to be interpreted in accordance with the

10 legislative intent and in a manner that will not render the statutes' application absurd,

11 unreasonable, or unjust." City of Eunice v. State Taxation & Revenue Dep't, 2014-NMCA-085,

12 ¶8 (internal citations and quotations emitted). If the plain language interpretation would lead to

13 an absurd result not in accord with the legislative intent and purpose it is necessary to look

14 beyond the plain meaning of the statute. See Bishop v. Evangelical Good Samaritan Soc'y, 2009-

15 NMSC-036, ¶11, 146 N.M. 473. The purpose of interpreting statutes is to “give effect to the

16 Legislature’s intent, and in determining intent [the courts] look to the language used and consider

17 the statute’s history and background. Valenzuela v. Snyder, 2014-NMCA-061, ¶16, 326 P.3d

18 1120. See also Peabody Coalsales Co. v. N.M. Taxation & Revenue Dep't, No. A-1-CA-36632,

19 2019 N.M. App. Unpub. LEXIS 230, at ¶9 (Ct. App. June 12, 2019, non- precedential).

20 Provisions must be read in “a fair, unbiased, and reasonable construction, without favor or

21 prejudice to either the taxpayer or the State, to the end that the legislative intent is effectuated

22 and the public interests to be subserved thereby are furthered.” Chavez v. Comm'r of Revenue,

23 1970-NMCA-116, ¶ 7, 82 N.M. 97, 476 P.2d 67 (internal citations omitted). In searching for

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 12 of 30.
1 legislative intent, reviewing a legislative purpose statement provides guidance for interpreting

2 the plain statutory language that exist in the statute. In re Jade G., 2001-NMCA-058, ¶¶ 17-20,

3 130 N.M. 687 (Court looked at Legislative purpose statement for guidance in interpreting the

4 disputed plain language of the statute, though court found that the purpose statement itself cannot

5 confer powers beyond what is contained in the statutory language).

6 It is also a principle of statutory construction that statutes should be read in harmony with

7 other statutory provisions dealing with the same subject matter. See State v. Trujillo, 2009-NMSC-

8 012, ¶22, 146 NM 14. See also Hayes v. Hagemeier, 1963-NMSC-095, ¶9, 75 N.M. 70 (“All

9 legislation is to be construed in connection with the general body of law.”). See also N.M. Indus.

10 Energy Consumers v. N.M. Pub. Regulation Comm'n, 2007-NMSC-053, ¶ 20, 142 N.M. 533

11 (Legislature presumed to be aware of knowledge of relevant statutes and the common law and

12 thus statutes must be read in harmony with other statutes in pari materia). Statutes are also

13 interpreted with the assumption that the Legislature was in full knowledge of relevant statutory

14 and common law. State ex rel. Quintana v. Schnedar, 1993-NMSC-033, ¶ 4, 115 N.M. 573

15 (internal citations omitted).

16 Overview of the Technology Jobs and Research and Development Credit.

17 At issue in this protest is Taxpayer’s application for research and development tax credits in

18 2014 and 2016 under the Technology Jobs and Research and Development Credit, NMSA 1978,

19 Section 7-9F-1 through 13 (2015) 2. According to NMSA 1978, Section 7-9F-2 (2015), the purpose

20 of the Technology Jobs and Research Development Credit is “to provide a favorable tax climate for

21 technology-based businesses engaging in research, development and experimentation and to

22 promote increased employment and higher wages in those fields in New Mexico.” The Technology

2
The act was amended in 2015 and that version of the statute will be expressly referenced unless there is a material
difference in the previous version that would apply to the 2014 application for the credit.

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 13 of 30.
1 Jobs and Research Development Credit establishes a basic credit of 4% in 2014 and 5% in 2015 of

2 the amount of qualified expenditures made by a taxpayer at a qualified facility. See §7-9F-5. The

3 credit also provides an additional credit of 4% in 2014 and 5% in 2015 of the amount of qualified

4 expenditures made by a taxpayer at a qualified facility. See §7-9F-5.

5 NMSA 1978, Section 7-9F-6 (B) establishes the eligibility requirements for the credit.

6 Basically, a taxpayer conducting qualified research at a qualified facility is eligible for the credit if

7 they have an increase in annual payroll expense by $75,000.00 not previously used to support the

8 increase and there is $75,000.00 increase in annual payroll expense for every $1,000,000.00 in

9 qualified expenditures. In pertinent part, under Section 7-9F-3 (I), qualified research is research with

10 the purpose of discovering information that is technological in nature, the application of which is

11 intended to be useful in the development of a new or improved business component of the taxpayer,

12 and substantially all the activities focus on new or improved functionality, performance, reliability,

13 or quality than style, taste, or cosmetic design. There is no real dispute in this protest that Taxpayer

14 engaged in qualified research and development activities at a qualified facility 3.

15 Competing Interpretations of Qualified Expenditures under the Credit.

16 The issue in this case primarily relates to the meaning of the qualified expenditure portion of

17 the credit, how much overlap between qualified expenditures for purposes of the state credit and

18 qualified research expenses under the federal credit codified under 26 U.S.C.S. § 41, and whether

19 Taxpayer adequately demonstrated proof of qualified expenditures. Section 7-9F-3 (G) (emphasis

20 added) defines “qualified expenditure” as

21 an expenditure or an allocated portion of an expenditure by a taxpayer in
22 connection with qualified research at a qualified facility, including
23 expenditures for depletable land and rent paid or incurred for land,
24 improvements, the allowable amount paid or incurred to operate or maintain
25 a facility, buildings, equipment, computer software, computer software

3
The Department conceded these points in its prehearing statement, p.2.

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 14 of 30.
1 upgrades, consultants and contractors performing work in New Mexico,
2 payroll, technical books and manuals and test materials… []. If a “qualified
3 expenditure” is an allocation of an expenditure, the cost accounting
4 methodology used for the allocation of the expenditure shall be the same cost
5 accounting methodology used by the taxpayer in its other business activities.

6 The parties dispute both the statutory construction of the last sentence in terms of what evidence is

7 required to substantiate a qualified expenditure and whether the evidence presented by Taxpayer in

8 this matter was sufficient.

9 Taxpayer contends that because New Mexico’s Technology Jobs and Research

10 Development Credit is similar to federal law, 26 U.S.C.S. § 41, the proof needed to substantiate

11 qualified expenditures should be the same as under federal law, which permits the use of allocations

12 of time based on testimony and documents. Moreover, Taxpayer argued that since its federal R&D

13 credit application, which was supported by the same methodology at issue in this protest, has

14 routinely been accepted by the IRS since 2012, its state R&D credit based on a similar federal law

15 should be accepted by the Department. Thus, Taxpayer contends that there is no requirement for

16 project timekeeping system in order to claim the state credit, as that is not a requirement of federal

17 law. Further, Taxpayer avers that New Mexico apply the federal “standard of proof” in determining

18 credit eligibility and that testimony and documentation is sufficient for Taxpayer to establish

19 entitlement to the credit.

20 The Department contends that if the New Mexico Legislature wanted to adopt the 1980

21 federal credit wholesale, it could have done so by adopting the federal statute as Maine4 and New

22 Jersey (See N.J. Stat. §54:10A-5.24) did. Instead, the Department contends that the Legislature

23 chose to add the specific, different language requiring that a cost accounting method must be the

4
While the Department did not provide a citation to Maine law, Maine’s research expense tax credit is found at Me.
Rev. Stat. tit. 36, § 5219-K (2007), presumably the provision the Department seeks to reference which adopts the
federal definitions under IRS Code §41.

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 15 of 30.
1 same as a methodology relied on in Taxpayer’s other business activities, meaning the Legislature

2 intended something other than what is required federally to substantiate the credit claim. The

3 Department contends that Taxpayer’s chosen methodology, which involves allocating time based on

4 approximation of hours worked from drafting logs and interviews with employees is not a cost-

5 accounting method used in Taxpayer’s other business activities. The Department contends that

6 Taxpayer’s method cannot even be categorized as a cost-accounting method when Taxpayer’s two

7 witnesses from CLA could not agree that it amounted to that. The Department contends that the

8 methodology does not actually assist with Taxpayer’s other business activities, that the

9 methodology is something that CLA develops to get the credit, and the cost accounting system is

10 not the driver of Taxpayer’s business.

11 Taxpayer counters that the portion of the statute requiring that cost accounting method be

12 used in other business activities is simply an anti-distortion provision, and that Taxpayer is in no

13 way seeking to distort its activities or game the system in that it is consistently employing the same

14 method to demonstrate the research and development credit under federal law. In the alternative,

15 Taxpayer asserts that even if the cost accounting methodology must be used in Taxpayer’s other

16 business activities, the evidence supported that Taxpayer did in fact use the methodology for other

17 business purposes. Taxpayer contends that granting Taxpayer the credit in this case serves the

18 Legislature’s intended purpose of the credit in this case.

19 Comparing the State Credit to the Federal Credit

20 In comparing Section 7-9F-3 (G) to 26 U.S.C.S. § 41 (b), the operational equivalent

21 provision, while there are similarities between the New Mexico and federal credit but there are also

22 some notable differences. What New Mexico law refers to as “qualified expenditures” under

23 Section 7-9F-3 (G) are called “qualified research expenses” under 26 U.S.C.S. § 41(b). “Qualified

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 16 of 30.
1 research expenses” under 26 U.S.C.S. § 41(B) include in-house research expenses and contract

2 research expenses. Like Section 7-9F-3 (G), 26 U.S.C.S. § 41(b)(2) includes employee wages paid

3 or incurred as part of the qualified research expenses 5. Under the permitted “in-house research

4 expenses,” 26 U.S.C.S. § 41(b)(2) includes the costs of supplies. There is some overlap between

5 permitted supply costs under 26 U.S.C.S. § 41(b)(2) and the definition of “qualified expenditures”

6 under Section 7-9F-3 (G): both permit credit for payment/license to use computer software and

7 software upgrades. However, there is a difference in this area: Section 7-9F-3 (G) includes as a

8 qualified expenditure depletable land and rent paid or incurred for land permits, while in contrast,

9 26 U.S.C.S. § 41(b)(2)(C) excludes land, improvements to land, or property subject to allowance for

10 depreciation. In New Mexico, payment for consultants or contracts performing work in New

11 Mexico is fully includable as a qualified expenditure for purposes of Section 7-9F-3 (G), while

12 under federal law, generally only 65% of contract research expenses are includable. See 26 U.S.C.S.

13 § 41(b)(3)(A).

14 The most salient difference between the definition of “qualified expenditures” under Section

15 7-9F-3 (G) and the definition “qualified research expenses” under 26 U.S.C.S. § 41(b) is the one

16 identified by the Department: the federal “qualified research expenses” under 26 U.S.C.S. § 41(b)

17 contains no provision mandating that a cost accounting allocation methodology must also be

18 employed by a taxpayer in their other business activities. Yet, although not part of the definition of

19 “qualified research expenses,” the federal credit still contains a requirement for consistent treatment

20 of expenses: “…the qualified research expenses taken into account in computing such percentage

21 [for purposes of determining the base amount] shall be determined on a basis consistent with the

22 determination of qualified research expenses for the credit year.” 26 U.S.C.S. § 41(c)(5)(a).

5
Section 7-9F-3 (G) uses the word “payroll” rather than the synonymous word “wages” referred to by 26 U.S.C.S. §
41(b)(2), but these are substantively identical in this context.

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 17 of 30.
1 Moreover, the federal credit has a related anti-distortion provision: “[t]he Secretary may prescribe

2 regulations to prevent distortions in calculating a taxpayer’s qualified research expenses…” 26

3 U.S.C.S. § 41(c)(5)(b).

4 Under the federal credit, “taxpayers are required to retain records necessary to substantiate a

5 claimed credit. If the taxpayer can establish that qualified expenses occurred, however, then the

6 court should estimate the allowable tax credit.” See United States v. McFerrin, 570 F.3d 672, 675

7 (5th Cir. 2009) (internal citations omitted). The estimate of the allowable tax credit may be based on

8 testimony and other evidence in the record. See id. (internal citations omitted). Taxpayer argues that

9 in light of the similarities between the state and federal credit, its presentation of the methodology

10 supported by testimony is sufficient to satisfy the anti-distortion portion of the definition of

11 “qualified expenditures” under Section 7-9F-3 (G).

12 Substantiation of State Qualified Expenditures distinct from Federal Law.

13 Again, the main disputed statutory provision is the meaning of the “qualified expenditure”

14 definition under Section 7-9F-3 (G) as it relates to an allocation: “the cost accounting methodology

15 used for the allocation of the expenditure shall be the same cost accounting methodology used by

16 the taxpayer in its other business activities.” Taxpayer’s position is that this provision is generally

17 equivalent to the anti-distortion provisions contained under 26 U.S.C.S. § 41(c)(5)(b), while the

18 Department contends that the Legislature meant something different than the federal credit by

19 employing this specific language not included in the federal credit.

20 In applying the principles of statutory construction discussed at the outset, the hearing

21 officer agrees with the Department’s assertion that by choosing different words than the federal

22 credit, the New Mexico Legislature intended a credit unique to New Mexico rather than simply a

23 carbon copy of federal law. The Legislature was presumed to be aware of the terms of 26 U.S.C.S. §

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 18 of 30.
1 41, a statute dating to the early 1980’s, when it first passed the state credit in 2000. See Schnedar,

2 1993-NMSC-033, ¶ 4, 115 N.M. 573 (internal citations omitted). Moreover, the Department cited

3 two states that simply referred to the federal definitions as the basis of substantiating qualifying

4 expenditures. If the Legislature wished to mimic the federal credit, it could have adopted a similar

5 approach as these other states but it instead chose a different path

6 Despite Taxpayer’s somewhat persuasive argument that simply applying the federal credit’s

7 standard of proof for expenditures would be the most efficient administrative and policy outcome,

8 the hearing officer is not at liberty to read out the statutory difference between the state credit and

9 federal law. See NMSA 1978, Section 7-1B-7 (prohibiting hearing officer from formulating tax

10 policy other than adjudicating hearings). It is clear from the statutory language that the Legislature

11 did in fact intend that a taxpayer’s allocation methodology must be a method that is used for other

12 business purposes. And to that extent, it is not good enough for a taxpayer to simply state that since

13 the credit was approved federally, the methodology employed for the state credit is suffice.

14 Taxpayer Substantiated its Qualified Expenditures.

15 But despite agreeing with the Department that the Legislature intended the state tax credit to

16 be distinct from the federal credit, the hearing officer finds that the Department’s reading of the

17 other business purpose provision is too narrow as applied to this taxpayer given the clear stated

18 purpose of the act. Although Department’s counsel disavowed that any formal project management

19 system was required, based on the testimony of Ms. Bernardo, the Department protest auditor, the

20 Department seemed to impose a requirement that the only way to satisfy Section 7-9F-3 (G)’s cost

21 allocation method was by the use of a contemporaneous and reliable time recoding system.

22 However, the language of Section 7-9F-3 (G) does not require a specific type of time recording

23 system in order to demonstrate qualified expenditures.

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 19 of 30.
1 Instead, Section 7-9F-3 (G) imposes a requirement that when a taxpayer seeks to allocate its

2 expenditures, it use the same cost accounting methodology it uses for other business activities. In

3 this case, there is conflicting evidence as to whether the methodology used by Taxpayer amounted

4 to a formal cost accounting method, as Mr. DePrima and Mr. Mims of CLA had different views of

5 that term. Their difference appeared to be largely to whether the methodology might meet the

6 formal definition of a cost accounting method from the differing perspectives of a tax attorney (Mr.

7 DePrima) versus how a certified public account (Mr. Mims) would understand that term. Whether it

8 amounted a formalized cost accounting method from an accountancy perspective or not, CLA

9 believed that the methodology employed was a fair, true, and reasonable accounting to Taxpayer’s

10 labor costs for the research and development costs.

11 Although the hearing officer has some basic understanding of what is meant by cost

12 accounting, it is helpful to review some definitions of that concept. Black’s Law Dictionary defines

13 the “cost accounting method” as “[t]he practice of recording the value of assets in terms of their

14 historical cost.” Accounting method, Black’s Law Dictionary (9th ed. 2009). Merriam-Webster’s

15 formal definition of cost accounting is “the systematic recording and analysis of the costs of

16 materials, labor, and overhead incident to production.” Cost Accounting, Merriam-Webster.com

17 (January 30, 2019), https://www.merriam-webster.com/dictionary/cost%20accounting. In its

18 prehearing briefing, Taxpayer cited an online Investopedia term definition to provide an overview

19 of the concept of cost accounting: “Cost accounting is an accounting method that aims to capture a

20 company’s costs, such as depreciation of capital equipment. Cost accounting will first measure and

21 record these costs individually, then compare input results to output or actual results to aid company

22 management in measuring financial performance.” See Taxpayer’s March 21, 2019 Pre-Hearing

23 Brief on “Standard of Proof Issue”, p. 9, citing https://www/investopedia.com/terms/c/cost-

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 20 of 30.
1 accounting.sp. For the purposes of Section 7-9F-3 (G), it is clear that the method Taxpayer used was

2 designed to record and analyze Taxpayer’s labor costs incident to the research and development

3 projects it was engaged in, and to that extent it constituted a cost accounting method consistent with

4 the plain language meaning of that term, as shown by the dictionary definitions.

5 The Legislature stated that the purpose of research and development credit is “to provide a

6 favorable tax climate for technology-based businesses engaging in research, development and

7 experimentation and to promote increased employment and higher wages in those fields in New

8 Mexico.” § 7-9F-3 (emphasis added). In order to effectuate that stated purpose, statutory

9 interpretation must be done in a manner that results in a favorable tax climate for companies that

10 engage in specified research, development, and experimentation. As Mr. Mims and Mr. DePrima

11 indicated, most of their small business clients engaged in research and development projects do not

12 use either a project management system or a project time keeping system because of the cost burden

13 of developing, maintaining, and using such systems. It is highly unlikely that the Legislature would

14 require a rigid project management system or a project time keeping system if the Legislature

15 sought to create a favorable tax climate for technology-based businesses engaging in research and

16 development in New Mexico. The Legislature would not include such a purpose statement if it

17 intended the statute to be read so narrowly that a small, local company clearly engaged in research

18 and development activities could not qualify because it did not devote its limited resources to an

19 onerous, record-keeping or time management system beyond what it needs to actually conduct its

20 research and development activities. The Legislature would not want to create an incentive where

21 small and local New Mexico businesses engaged in research and development could not qualify for

22 the credit, while larger companies with vast resources could deploy and manage an onerous system.

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 21 of 30.
1 Here, Taxpayer had a system based on drafting logs, where it tracked how much work was

2 being committed to new research and development projects. That is a system that Taxpayer uses for

3 research and development business purposes. And that is the system that Mr. Rhodes testified he

4 also used to determine the continuing viability of research and development projects. [F.O.F #35]6.

5 Using the drafting log review process, which is also part of Taxpayer’s credit methodology, is part

6 of Taxpayer’s other business activities, satisfying both the plain meaning of the words “used by the

7 taxpayer in its other business activities” language under Section 7-9F-3 (G) and the Legislature’s

8 intent of fostering a favorable tax climate for business engaged in research and development in New

9 Mexico.

10 The Department argued in closing argument that one single sentence uttered by Mr. Rhodes

11 over the course of a five-hour hearing is insufficient to establish that Taxpayer used the

12 methodology for other business purposes. The hearing officer disagrees. Credible witness testimony

13 can have as much weight as documentary exhibits, as both testimonial and documentary exhibits

14 constitute the evidentiary record. In this case, the hearing officer found Mr. Rhodes to be highly

15 credible and straightforward. Mr. Rhodes also walked through the drafting logs and his review

16 process, noticing and volunteering that one of Taxpayer’s exhibits was not the correct log he would

17 have reviewed, which further bolstered his credibility [04-11-19 CD 1:49:30-1:54:22].

18 The Department also challenged the legitimacy of the credit claims because it claimed that

19 CLA had a contingency fee arrangement for payment from Taxpayer depending on the amount of

6
Based on their respective closings, both parties appeared to suggest that it was the hearing officer who raised, brought
up or somehow solicited the testimony of Mr. Rhodes that he employed the drafting log methodology to consider the
continuing viability of the research and development projects. [04-11-19 CD 5:07:58-5:08:25; 5:11:45-5:12:02].
However, a careful review of the audio shows that Mr. Rhodes’ assertion first came in response to the Department’s
cross-examination of Mr. Rhodes on whether the methodology has any other business purpose. [04-11-19 CD 1:13:17-
1:16:48]. The hearing officer did ask a follow up question about Mr. Rhodes statement to Department Protest Auditor
Milagros Bernardo [04-11-19 CD 4:57:25-4:58:34], essentially asking her to respond to Mr. Rhodes’ earlier testimony,
but Mr. Rhodes initial testimony came in response to a Department question on cross-examination.

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 22 of 30.
1 credit granted. It is not entirely clear that CLA in fact had a purely contingency fee arrangement in

2 this case. Instead, it appeared that CLA had a hybrid arrangement where it had an hourly billable

3 rate for the work it did but agreed not to bill the client until the amount of the credit approved was

4 granted. While the delay in billing until credit approval is similar to a contingency fee, the hourly

5 billing rate portion of the arrangement does not amount to a contingent percentage of the total

6 amount of the credit granted, which is different than a typical contingency fee arrangement seen in

7 the legal context. The Department cited no express state prohibition against hybrid delayed hourly

8 billing arrangements for accounting firms, and instead focused more on attacking the reliability and

9 legitimacy of the methodology. However, the methodology CLA developed was based on the actual

10 research and development work that Taxpayer performed. And the credible, straightforward

11 testimony of Mr. Rhodes alleviated any concerns that the method was not legitimate.

12 Taxpayer further argued that its use of the same methodology for claiming the federal credit

13 constituted another business purpose under the language of Section 7-9F-3 (G). The hearing officer

14 does not necessarily agree that using the methodology to claim another federal credit alone is

15 sufficient to constitute another business purpose, especially in light of the above discussion about

16 the differences between the state and federal credit. But while not dispositive, the fact that Taxpayer

17 also uses the same methodology for federal credit purposes certainly adds credibility that

18 Taxpayer’s methodology is not distortive. In other words, while not by itself satisfying the statutory

19 language, the fact that Taxpayer employs the same methodology to claim the federal credit is

20 reassuring that the methodology legitimately reflects the nature of Taxpayer’s research and

21 development expenditures. The hearing officer is satisfied that Taxpayer met its burden to establish

22 it was entitled to the technology jobs and research and development tax credit. Accordingly,

23 Taxpayer’s protest is granted and it is ordered that the Department approve the credit claim at issue

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 23 of 30.
1 in this matter with the modification that Taxpayer may not use the federal 80% rule on wages, as

2 Taxpayer acknowledged at hearing.

3 Invocation of the Witness Exclusion Rule.

4 Although not critical to the ruling, one other point of contention between the parties merits a

5 brief discussion. The Department properly invoked the witness exclusion rule in this proceeding. In

6 questioning, the Department established that Taxpayers’ witnesses had discussed over the lunch

7 hour a portion of Mr. Rhodes’ morning testimony regarding an exhibit where there was a pagination

8 discrepancy between Taxpayer’s copy and the copy of that exhibit provided to the Department and

9 the need to get a 2014 MOC Log admitted into the record. [04-11-19 CD 2:56:03-2:58:54; 4:03:30-

10 4:04:22].

11 Under NMSA 1978, Section 7-1B-6 (D) (2019), the formal rules of evidence and civil

12 procedure do not apply to tax protest hearings. Nevertheless, under the Administrative Hearings

13 Office’s general rules of practice, a party may invoke the exclusionary rule for non-testifying

14 witnesses. See Regulation 22.600.1.19 (E) NMAC. That regulation reads that

15 [a]t the hearing, either party can invoke the exclusionary rule, excluding all
16 witnesses other than the real party in interest, their representative, one main
17 case agent, and any designated expert witness from the proceeding until the
18 time of their testimony. If the rule has been invoked, the witnesses shall not
19 discuss their testimony with each other until the conclusion of the
20 proceeding. When the rule has been invoked, any witness who remains in the
21 hearing after conclusion of their testimony may not be recalled as a witness
22 in the proceeding, except that any witness may observe the testimony of an
23 expert witness and be recalled to provide any subsequent rebuttal testimony.

24 Regulation 22.600.1.19 (E) NMAC.

25 As the drafter of this regulation pursuant to authority under NMSA 1978, Section 7-1B-5 (A)(1)

26 (2015), the undersigned hearing officer intended to codify long-standing practice procedures of the

27 Administrative Hearings Officer and its predecessor, the Hearings Bureau of the Taxation and

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 24 of 30.
1 Revenue Department 7, and to loosely model Rule 11-615 NMRA of the Rules of Evidence. In turn,

2 Rule 11-615 NMRA is modeled on the Federal Rules of Evidence.

3 Cases interpreting Rule 11-615 NMRA thus are helpful in considering a violation of the

4 witness exclusion rule. “The purpose of the rule excluding witnesses is to give the adverse party

5 an opportunity to expose inconsistencies in the testimony and to prevent the possibility of one

6 witness shaping his testimony to match that given by the other witnesses.” State v. Ortiz, 1975-

7 NMCA-112, ¶ 33, 88 N.M. 370 (internal quotes and citations omitted). Testimony regarding

8 “simple objective facts” is “ordinarily not subject to tailoring, and if it were, it could have been

9 exposed easily.” United States v. Prichard, 781 F.2d 179, 183 (10th Cir. 1986). If there is a

10 violation of the rule, the remedy is within the discretion of the judge and the controlling

11 consideration is prejudice to the complaining party. Id. at ¶ 31.

12 In this case, the violation of the rule appeared to be limited to figuring out why there was a

13 pagination discrepancy between copies of the same exhibit and the need to enter another exhibit into

14 the record over the lunch hour. Mr. DePrima testified that there was no additional discussion of the

15 methodology. Other than the pagination discrepancy, there was no allegation in this case of a

16 substantive difference between the copies of the exhibit and no allegation that the discrepancy was

17 material to resolving this protest. Addressing the reason for a page discrepancy in copies of exhibits

18 is the type of a simple, objective fact not conducive to testimony tailoring. Moreover, despite

19 careful, prudent, and effective cross-examination by the Department’s counsel, there was no

20 evidence of tailoring testimony between witnesses on the material, disputed issues in dispute or any

21 allegation of prejudice. In fact, Mr. DePrima and Mr. Mims had differing testimony about whether

22 Taxpayer’s methodology amounted to a formal cost accounting method. Other than raising the issue

7
Under the Administrative Hearings Office Act of 2015, the Hearings Bureau was removed from the Taxation and
Revenue Department and became the independent Administrative Hearings Office.

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 25 of 30.
1 through questioning of multiple witnesses, the Department did not ask for or propose a remedy for

2 the violation of the exclusionary rule. As such, the hearing officer did not find any prejudice from

3 the violation of the exclusionary rule in discussing the exhibits and that there was no violation of the

4 broader anti-tailoring of testimony purpose of the rule.

5 CONCLUSIONS OF LAW

6 A. Taxpayer filed timely, written protests of the Department’s denials of the

7 Technology Jobs and Research and Development Credit.

8 B. The hearing was timely set and held within 90-days of protest under NMSA 1978,

9 Section 7-1B-8 (2015).

10 C. Taxpayer bears the burden of proving entitlement to the claimed credit, as a credit is

11 an act of Legislative grace. See Team Specialty Prods. v. N.M. Taxation & Revenue Dep't, 2005-

12 NMCA-020, ¶9, 137 N.M. 50 (internal citations omitted). Although a credit must be narrowly

13 interpreted and construed against the taxpayer, it still should be construed in a reasonable manner

14 consistent with legislative intent. See Sec. Escrow Corp., 1988-NMCA-068, ¶9, 107 N.M. 540.

15 D. The “main goal of statutory construction is to give effect to the intent of the

16 legislature.” Dell Catalog Sales L.P. v. Taxation & Revenue Dep't, 2009-NMCA-0001, ¶ 19,

17 145 N.M. 419, 199 P.3d 863 (internal citations omitted). Provisions must be read in “a fair,

18 unbiased, and reasonable construction, without favor or prejudice to either the taxpayer or the

19 State, to the end that the legislative intent is effectuated and the public interests to be subserved

20 thereby are furthered.” Chavez v. Comm'r of Revenue, 1970-NMCA-116, ¶ 7, 82 N.M. 97, 476

21 P.2d 67 (internal citations omitted).

22 E. For the purposes of the requirements of the Technology Jobs and Research and

23 Development Credit, there is no dispute at protest that Taxpayer satisfies the requirement of

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 26 of 30.
1 being engaged in qualified research and development activities and that such activities occurred

2 at a qualified facility. The only dispute is in the interpretation of the term “qualified expenditure”

3 under NMSA 1978, Section 7-9F-3 (G) and whether Taxpayer presented sufficient evidence to

4 demonstrate its qualified expenditures.

5 F. The Legislative purpose of the Technology Jobs and Research Development

6 Credit is “to provide a favorable tax climate for technology-based businesses engaging in

7 research, development and experimentation and to promote increased employment and higher

8 wages in those fields in New Mexico.” NMSA 1978, Section 7-9F-2 (2015).

9 G. Despite Taxpayer’s argument that New Mexico should simply accept and adopt

10 the proof required to establish entitlement to the similar the federal credit found under 26

11 U.S.C.S. § 41, New Mexico’s Technology Jobs and Research and Development Credit is a

12 distinct credit from the federal credit and thus a taxpayer may not simply assume that the

13 methodology employed to claim the federal credit satisfies the requirements for New Mexico’s

14 credit.

15 H. The Department’s argument that a taxpayer must employ a formal cost accounting

16 method or time management system as part of an allocation of the credit is too narrow of a

17 reading of Section 7-9F-3 (G)’s statutory language given the Legislature’s stated purpose of

18 creating a favorable tax climate for technology-based businesses like Taxpayer, a small, local

19 company that specializes in researching and developing custom engineered solutions for its

20 customers.

21 I. In seeking the credit, Taxpayer relied on an allocation of its qualified expenditure,

22 requiring that under NMSA 1978, Section 7-9F-3 (G), Taxpayer’s “cost accounting method used

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 27 of 30.
1 for the allocation of the expenditure shall be the same cost accounting methodology used by the

2 taxpayer in its other business activities.”

3 J. Taxpayer established that it relied on its credit methodology for other business

4 activities, satisfying the requirements of Section 7-9F-3 (G).

5 K. Taxpayer established entitlement to its claimed Technology Jobs and Research and

6 Development Credit.

7 For the foregoing reasons, the Taxpayer’s protest IS GRANTED. IT IS ORDERED that

8 the Department grant Taxpayer the claimed 2014 and 2016 Technology Jobs and Research and

9 Development Credit, as modified by Taxpayer’s concessions during the protest process that it could

10 not apply the federal 80% rule on wages.

11 DATED: January 31, 2020.

12
13 Brian VanDenzen
14 Chief Hearing Officer
15 Administrative Hearings Office
16 P.O. Box 6400
17 Santa Fe, NM 87502

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 28 of 30.
1 NOTICE OF RIGHT TO APPEAL

2 Pursuant to NMSA 1978, Section 7-1-25 (2015), the parties have the right to appeal this

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

4 date shown above. If an appeal is not timely filed with the Court of Appeals within 30 days, this

5 Decision and Order will become final. Rule of Appellate Procedure 12-601 NMRA articulates

6 the requirements of perfecting an appeal of an administrative decision with the Court of Appeals.

7 Either party filing an appeal shall file a courtesy copy of the appeal with the Administrative

8 Hearings Office contemporaneous with the Court of Appeals filing so that the Administrative

9 Hearings Office may begin preparing the record proper. The parties will each be provided with a

10 copy of the record proper at the time of the filing of the record proper with the Court of Appeals,

11 which occurs within 14 days of the Administrative Hearings Office receipt of the docketing

12 statement from the appealing party. See Rule 12-209 NMRA.

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 29 of 30.
1 CERTIFICATE OF SERVICE

2 On January 31, 2020, a copy of the foregoing Decision and Order was submitted to the

3 parties listed below in the following manner:

4 First Class Mail Interdepartmental Mail

5 INTENTIONALLY BLANK ON DIGITAL COPY
6
7 John Griego
8 Legal Assistant
9 Administrative Hearings Office
10 P.O. Box 6400
11 Santa Fe, NM 87502

In the Matter of the Protest of Process Equipment & Service Company, Inc., page 30 of 30.