New Mexico Gross Receipts Tax Ruling Addresses Transactions with the Federal Government

By: Michael Colavito, SALT Director

At a glance:

• The main takeaway: A New Mexico ruling sheds light on the state’s application of its Gross Receipts Tax to transactions involving the provision of services by a prime and subcontractor to the federal government.
• Assess the impact: It’s important for government contractors to understand their state tax compliance obligations when venturing into new states.
• Take the next step: Aprio’s State and Local Tax (SALT) team can advise government contractors on unique state tax regimes and how they may impact their business.

Schedule a free consultation today to learn more!

The full story

Government contractors, especially those that mainly provide services, can often be lulled into a false sense of security when it comes to state sales and use taxes. This is because in most states, sales to the federal government (and typically to the state government as well) are exempt from sales tax. Further, there is a reasonable chance that the services a government contractor provides are not subject to sales tax regardless of whether those services are sold to a tax-exempt customer. However, not all transactions with the federal government are exempt, and it is important to understand how these transactions will be treated by the states.

A recently-issued ruling in New Mexico provides some insight into the treatment of service receipts generated by government contractors under the state’s Gross Receipts Tax (GRT), and it also serves as a reminder to government contractors about some of the unique aspects of the GRT. Although the GRT does have some similar features of a typical sales tax, there are three unique aspects of the tax that can catch government contractors off-guard. 

1. First, unlike most states that impose sales tax on a limited number of services, the GRT is generally imposed on services unless there is a specific exemption for the services at issue.
2. Second, the tax is imposed on the seller’s gross receipts and not on the transaction itself (although sellers are allowed to pass along the tax to the customer)[1]
3. Third, receipts from the sale of services to the federal government are not exempt from the tax. 

A closer look at the case

In the ruling, the New Mexico Taxation and Revenue Department (the Department) addressed how the sale for resale exemption and out-of-state deduction applied to the gross receipts of a prime contractor and subcontractor. A federal agency in Maryland engaged a prime contractor to perform services related to the operation of a database system. The prime contractor engaged a subcontractor to provide support during the performance of its contract. All services related to the contract were performed from within New Mexico, and the delivery of the services was to the federal agency in Maryland.

The taxpayer requested that the Department address the following two issues:

• Whether the subcontractor may claim the deduction for its receipts being from services sold for resale, as the prime contractor resold the subcontractor’s services to the federal agency.  
• Whether the prime contractor’s receipts were also not taxable pursuant to the deduction for receipts from performing services in New Mexico when the product of the service is neither delivered to nor initially used by the buyer in New Mexico. 

Both the prime and subcontractor obtained the result for which they were hoping – i.e., that their receipts related to the services performed for the federal agency in Maryland were not subject to the GRT. However, the Department reached its conclusion on different grounds from which the taxpayer appeared to expect. 

The Department reasoned that the subcontractor’s gross receipts were not deductible as a sale for resale because the GRT rule only permitted this deduction when the resale resulted in receipts that were subject to the tax.[2] This was not case in this instance because the prime contractor’s receipts were deductible due to its services being delivered outside of New Mexico.[3] However, the Department concluded that the subcontractor’s receipts were similarly exempt because its services were also delivered outside of New Mexico and not initially used within the state by the prime contractor. 

Making sense of the ruling

The Department ultimately viewed the subcontractor’s sale to the prime contractor somewhat analogous to a drop shipment transaction in the context of a sale of tangible personal property in that the subcontractor’s services were delivered directly to the federal agency in Maryland. This can be important in applying New Mexico’s rules in the context of a fact pattern involving service providers located outside of the state that are providing services to an in-state customer. For example, assume a prime contractor and subcontractor located in Maryland are providing services to a federal agency located in New Mexico. 

Based on the logic in the ruling, the subcontractor would have New Mexico source gross receipts because the subcontractor’s services would be treated as not being used by the prime contractor at its business location in Maryland, but instead directly delivered to the federal agency in New Mexico. Assuming that this subcontractor had nexus with New Mexico, it would need to obtain the appropriate non-taxable certificate (i.e. a resale certificate) from the prime contractor to avoid being subject to the GRT on its receipts received from the prime contractor. Unlike the conclusion reached in the ruling, in this example, the resale exemption would apply because the prime contractor’s resale of those services to the federal agency would be subject to the GRT due to the services being delivered to a location within the state.          

The bottom line

This ruling provides some insight into how the Department applies its sourcing rules in New Mexico. Noncompliance with these unique state tax regimes can often become an issue during due diligence when the owners of a government contracting business are seeking to sell the company. Thus, it’s important for government contractors venturing into new states to be proactive in obtaining advice from their tax advisors regarding their state tax compliance obligations.

Aprio’s SALT team has experience with advising government contractors on unique state tax regimes and how they impact their businesses. Our team will ensure that you are in compliance with your state tax obligations and do not incur unexpected liabilities and penalties. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

---

[1] In most states, sales tax imposed on the “retail sale” itself and is measured by the gross receipts from the transaction.  Sellers are treated as “collection agents” who collect the sales tax from the consumer and remit it to the state.  Typically, both the buyer and seller can be held liable for any tax delinquencies.

[2] NMSA § 7-9-48.

[3] NMSA § 7-9-57.