If the state takes more than a year to finish an audit, can you escape the interest and penalty on the tax you underpaid?

Subject

Walter Burke Catering (D&O 99-05)

Plain-English summary

Walter Burke ran a catering business. He had accepted nontaxable transaction certificates (NTTCs) from various government and non-profit customers and deducted his catering receipts from those sales. The problem: the deductions those certificates support (Sections 7-9-54 and 7-9-60) cover sales of tangible personal property to such entities — not services like catering. A Department audit that began in February 1997 (and took over a year to finish, though Burke made his books available from the start) produced three assessments totaling several thousand dollars in gross receipts tax, penalty, and interest. (A tiny $50 franchise-tax assessment was also issued; Burke withdrew that protest at the hearing.)

Burke agreed he owed the tax and paid it. He protested only the penalty and interest, arguing it was unfair to charge him for the Department's slow audit. Hearing Officer Gerald B. Richardson denied the protest:

• Interest is mandatory and audit delay is no defense (Section 7-1-67(A)). Interest "shall" be paid on tax not paid when due, with no exceptions. It is not a penalty — it compensates the state for the lost time value of money it should have had. The Hearing Officer said he shared Burke's concern about the delay, but it changed nothing legally.
• The negligence penalty applies (Section 7-1-69(A)). In a self-reporting system, every taxpayer has a duty to ascertain the tax consequences of what they do (Tiffany Construction). Burke's underpayment came from misunderstanding how the tax applied to government and non-profit sales. Although an accountant prepared his monthly returns, he could not show the accountant had full disclosure of these transactions or that he actually received advice on them, so the professional-reliance exception (Regulation 3 NMAC 1.11.11) did not save him.

The Hearing Officer added two practical points about the delay: it caused no extra penalty (the negligence penalty maxes out at 10% within five months of a missed payment, so it had already capped long before the assessments issued), and even a faster audit would almost certainly not have been assessed any earlier than the penalty cap date — so the delay did not increase what Burke owed.

What this means for you

• Resale/exemption certificates for government and non-profit buyers usually cover goods, not services. Sections 7-9-54 and 7-9-60 deduct sales of tangible personal property to the U.S. and to certain organizations. If you sell services (catering, consulting, labor) to those buyers, holding their certificate generally does not make your receipts deductible.
• A slow audit will not wipe out your interest or penalty. Interest runs from when the tax was due regardless of how long the Department takes. Cooperating fully is wise, but it is not a legal defense to interest or penalty.
• Interest is compensation, not punishment. Because it only offsets the time value of unpaid tax, disagreeing with the rate or the timeline doesn't create an exception — the rate is set by the Legislature.
• To beat the penalty on "I relied on my accountant," you must prove full disclosure and actual advice. Merely having an accountant prepare your returns is not enough. You need to show you disclosed the specific transactions and received advice on how to treat them.
• The negligence penalty caps at 10%. It accrues at 2% per month and maxes out at 10% within five months — so it does not keep growing with a long audit, even though interest does.

Key questions answered

Why weren't the catering sales to governments and non-profits deductible?
The certificates Burke held support deductions for sales of tangible personal property (Sections 7-9-54 and 7-9-60), not services. Catering is a service, so his receipts from those customers remained taxable gross receipts.

Did the Department's year-plus audit delay excuse the interest?
No. Section 7-1-67(A) makes interest mandatory with no exceptions, and interest merely compensates the state for the time value of the unpaid tax. The Hearing Officer shared the taxpayer's frustration but found the delay is not a legal defense.

Why did the penalty stick when the taxpayer was honest and used an accountant?
Negligence for penalty purposes includes failing to ascertain the tax consequences of your business (Tiffany Construction). Burke could not show his accountant had full disclosure of these sales or gave advice on them, so he did not carry his burden under the reliance exception (Regulation 3 NMAC 1.11.11; El Centro Villa).

Did the delay at least increase what he owed?
No. The negligence penalty had already capped at 10% within five months of each missed payment, and the interest would not have differed materially — so the slow audit did not add to the penalty.

Verbatim citations

Interest is mandatory (Section 7-1-67(A)):

If any tax imposed is not paid on or before the day on which it becomes due, interest shall be paid to the state on such amount from the first day following the day on which the tax becomes due, without regard to any extension of time or installment agreement, until it is paid.

Interest compensates the state; delay is no defense:

While the Department offered no explanation as to why its audit took so long and I share the Taxpayer's concern with the amount of time that it took, unfortunately, the Department's delay in issuing the assessments does not provide a defense to the imposition of interest.... Interest is imposed to compensate the state for the lost value of having tax revenues at the time they are required to be paid.

The exemptions cover property, not services (Hearing Officer's footnote):

The deductions found at Sections 7-9-54 and 7-9-60 NMSA 1978 only cover the sales of tangible personal property and not services to such entities.

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Walter Burke Catering
• Decision PDF: D&O 99-05

Original ruling text

THE HEARING OFFICER
OF THE TAXATION AND REVENUE DEPARTMENT
OF THE STATE OF NEW MEXICO

IN THE MATTER OF THE PROTEST OF
WALTER BURKE D/B/A/ WALTER BURKE CATERING NO. 99-05
ID. NO. 02-150869-00 0, PROTEST TO
ASSESSMENT NOS. 2237616, 2249837 AND 2249838

DECISION AND ORDER

This matter came on for formal hearing on January 28, 1999 before Gerald B.

Richardson, Hearing Officer. Walter Burke d/b/a/ Walter Burke Catering, hereinafter,

“Taxpayer”, was represented by its President and Treasurer, Mr. Walter Burke. The Taxation

and Revenue Department, hereinafter, “Department”, was represented by Monica M. Ontiveros,

Special Assistant Attorney General. Based upon the evidence and arguments presented, IT IS

DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. The Department audited the Taxpayer, commencing in February, 1997. The audit

was not completed for over a year, even though the Taxpayer made its books and records

available to the Department’s auditors from the outset of the audit.

2. As a result of the audit, the Department issued three assessments to the Taxpayer.

3. Assessment No. 2237616 was issued on March 31, 1998 for $2,555.81 of gross

receipts tax, $255.59 of penalty and $1,416.74 of interest for the reporting periods of January,

1994 through December, 1994.

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4. Assessment No. 2249837 was issued on April 30, 1998 for $6,297.23 of gross

receipts tax, $629.73 of penalty and $2,003.20 of interest for the reporting periods of January,

1995 through December, 1996.

5. Assessment No. 2249838 was issued on April 30, 1998 for $50.00 of franchise

tax, $5.00 of penalty and $23.75 of interest for the period of January, 1994 through December,

1994.

6. On April 30, 1998, the Taxpayer filed a timely, written protest to the interest and

penalty portion of Assessment No. 2237616.

7. On May 29, 2998, the Taxpayer filed timely, written protests to the interest and

penalty portions of Assessment Nos. 2249837 and 2249838.

8. At the hearing, the Taxpayer withdrew its protest to Assessment No. 2249838.

9. The underreporting of gross receipts tax which was assessed as a result of the

Department’s audit was due to the Taxpayer’s failure to understand how the gross receipts tax

applied to catering services the Taxpayer performed for various governmental and non-profit

organizations from which the Taxpayer had accepted nontaxable transaction certificates.

10. Although the Taxpayer had its monthly CRS-1 returns upon which it reported its

gross receipts taxes to the Department prepared by its certified public accountant, the Taxpayer

did not receive advice from its accountant with regard to whether it could claim a deduction for

catering services provided to governmental and non-profit organizations.

DISCUSSION

The Taxpayer disputes the assessment of penalty and interest on the Department’s gross

receipts tax assessments. The Taxpayer’s dispute was based upon the fact that although he made

his books and records available to the Department at the commencement of its audit, it took the

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Department more than one year to complete the audit and to issue the assessments at issue. After

the assessments were issued, the Taxpayer apparently agreed with the Department’s

determination that it had erroneously claimed a deduction for its receipts from selling catering

services to non-profit organizations and governmental entities which the nontaxable transaction

certificates the Taxpayer had from these entities did not cover.1 The Taxpayer paid the

assessments but protested the assessment of penalty and interest because of the Department’s

delay in issuing the assessments at issue.

Section 7-1-67(A) NMSA 1978 addresses the imposition of interest on tax deficiencies and

provides as follows:

A. If any tax imposed is not paid on or before the day on which it
becomes due, interest shall be paid to the state on such amount from
the first day following the day on which the tax becomes due,
without regard to any extension of time or installment agreement,
until it is paid. (emphasis added).

It is a well settled rule of statutory construction that the use of the word "shall" in a statute indicates

that the provisions are intended to be mandatory rather than discretionary, unless a contrary

legislative intent is clearly demonstrated. State v. Lujan, 90 N.M. 103, 560 P.2d 167 (1977).

Applying this rule to Section 7-1-67, the statute requires that interest be paid to the state on any

unpaid taxes and no exceptions to the imposition of interest are countenanced by the statute. Thus,

it doesn't matter why taxes were not paid in a timely manner. Interest is imposed any time that

taxes are not paid when they are due, and for the period of time that they are unpaid.

While the Department offered no explanation as to why its audit took so long and I share

the Taxpayer’s concern with the amount of time that it took, unfortunately, the Department’s

delay in issuing the assessments does not provide a defense to the imposition of interest. As

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The deductions found at Sections 7-9-54 and 7-9-60 NMSA 1978 only cover the sales of tangible personal

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noted above, the statute contemplates no exceptions to the imposition of interest. Additionally,

the Taxpayer's argument essentially conceives of interest as a penalty imposed to punish a taxpayer

for the late payment of taxes. This argument misapprehends the nature of the assessment of

interest. Interest is imposed to compensate the state for the lost value of having tax revenues at the

time they are required to be paid. Under our self reporting tax system, the responsibility for

determining the correct amount of tax to be reported and paying that tax when due is placed upon

taxpayers. While one may disagree with the rate of interest set by the legislature, as being excessive

in comparison with market rates of interest, that is a matter within the sound discretion of the

legislature, and the Department is without authority to substitute its own judgment for that of the

legislature in setting the rate of interest to be imposed.

The imposition of penalty is governed by the provisions of Section 7-1-69(A)NMSA 1978
which imposes a penalty of two percent per month, up to a maximum of ten percent:
in the case of failure, due to negligence or disregard of rules and regulations, but
without intent to defraud, to pay when due any amount of tax required to be paid or
to file by the date required a return regardless of whether any tax is due,....

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

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

based upon any desire of the Taxpayer to underreport taxes. What remains to be determined is

whether the Taxpayer was negligent in failing to report its taxes properly. Taxpayer "negligence"

for purposes of assessing penalty is defined in Regulation 3 NMAC 1.11.10 (formerly TA 69:3) as:

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

property and not services to such entities.

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In this case the Taxpayer's underpayment of taxes was based upon Mr. Burke’s failure to

understand how the gross receipts tax applied to transactions with governmental and non-profit

entities. As noted above, New Mexico has a self-reporting tax system which requires that taxpayers

voluntarily report and pay their tax liabilities to the state. Because of this, the case law is well

settled that every person is charged with the reasonable duty to ascertain the possible tax

consequences of his actions, and the failure to do so has been held to amount to negligence for

purposes of the imposition of penalty pursuant to Section 7-1-69 NMSA 1978. Tiffany

Construction Co. v. Bureau of Revenue, 90 N.M. 16, 558 P.2d 1155 (Ct. App. 1976), cert. denied,

90 N.M. 255, 561 P.2d 1348 (1977).

The Department does recognize that where a taxpayer provies that the failure to pay tax was

caused by reasonable reliance on the advice of tax counsel or an accountant as to the taxpayer’s

liability after full disclosure of all relevant facts, that this may indicate that a taxpayer was not

negligent and provides a basis to abate the penalty. See, Regulation 3 NMAC 1.11.11. In this case,

although the Taxpayer had its monthly returns prepared by an accountant, the Taxpayer was not

able to establish that its accountant had full disclosure of the facts pertinent to the transactions

which were not taxed, or that the Taxpayer had actually received advice from its accountant as to

how to treat the sale of catering services to governmental and non-profit entities. In the absence of

such advice, the Taxpayer failed to carry its burden of proving that it was not negligent in

underreporting its taxes. El Centro Villa Nursing Center v. Taxation and Revenue Department,

108 N.M. 795, 779 P.2dd 982 (Ct. App. 1989).

Although the imposition of penalty is intended to penalize taxpayers who fail to report and

pay taxes in a timely manner, there are sound policy reasons behind the imposition of penalty. A

self-reporting tax system relies upon taxpayers accurately reporting their tax liabilities to the

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government. There are insufficient government resources to audit every taxpayer periodically to

otherwise assure tax compliance. The imposition of penalty provides taxpayers with an incentive to

understand the tax consequences of their actions and to accurately report their taxes. Otherwise, if

the only consequence of an audit and determination of underpayment of tax was the payment of the

tax which was owed, even completely honest taxpayers, such as the Taxpayer herein, would have

no incentive to ensure that they understand how taxes apply to their business so that mistakes in

reporting do not happen.

With respect to the delay in completing the Department’s audit and issuing the assessments

in this case, it should be noted that the Department’s delay did not result in the accrual of additional

penalty. This is because the negligence penalty, which accrues at 2% of the underreported taxes per

month, maximizes at 10% of the taxes. Thus, within five months of the month that a return was

due on which taxes were not fully paid, the penalty has maximized. In this case, since the audit

covered reporting periods through December of 1996, any penalty on unpaid taxes would have

maximized by May of 1997, for the last reporting period covered by the audit, December of 1996.

Even had the Department completed its audit more expeditiously, by the time the audit was

completed and had gone through the Department’s internal review process prior to issuing the

assessment, it is highly unlikely it would have been assessed prior to May of 1997.

CONCLUSIONS OF LAW

1. The Taxpayer filed timely, written protests to Assessment Nos. 2249837, 2249838

and 2237616 and jurisdiction lies over both the parties and the subject matter of this protest.

2. The Taxpayer withdrew its protest to Assessment No. 2249838.

3. Interest was properly imposed pursuant to Section 7-1-67 NMSA 1978.

4. Penalty was properly imposed pursuant to Section 7-1-69(A) NMSA 1978.

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

DONE, this 1st day of February, 1999.

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