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F I S C A L I M P A C T R E P O R T

SPONSOR Snyder

ORIGINAL DATE

LAST UPDATED

1/27/06

HB

SHORT TITLE Business Services Tax Credit Act

SB 334

ANALYST Schardin

REVENUE (dollars in thousands)

Estimated Revenue

Recurring

or Non-Rec

Fund

Affected

FY06

FY07

FY08

(16,000.0)

(33,600.0) Recurring

General Fund

(30.0)

(80.0) Recurring

Small Cities and

Counties

Assistance Funds

(Parenthesis ( ) Indicate Expenditure Decreases)

Relates to HB501.

ESTIMATED ADDITIONAL OPERATING BUDGET IMPACT (dollars in thousands)

FY06 FY07

FY08 3 Year

Total Cost

Recurring

or Non-

Rec

Fund

Affected

Total

200.0

Non-

Recurring General Fund

200.0

Recurring General Fund

(Parenthesis ( ) Indicate Expenditure Decreases)

SOURCES OF INFORMATION

LFC Files

Responses Received From

Taxation and Revenue Department (TRD)

SUMMARY

Synopsis of Bill

Senate Bill 334 creates the business services tax credit to be in effect from FY07 to FY11. After

FY11, the credit will sunset. The credit may be claimed against the state gross receipts tax,

Senate Bill 334 – Page

2

compensating tax, or withholding tax. A credit that exceeds a taxpayer’s tax liability may be car-

ried forward for up to three years.

For most businesses, the credit is equal to 0.5 percent of “qualified expenditures” in FY07, 1.0

percent in FY08, 1.5 percent in FY09, 2.0 percent in FY10, and 2.5 percent in FY11. However,

for for-profit hospitals that receive a 50 percent deduction from gross receipts under Section 7-9-

73.1, the credit is half as large: 0.25 percent of “qualified expenditures” in FY07, 0.5 percent in

FY08, 0.75 percent in FY09, 1.0 percent in FY10, and 1.25 percent in FY11.

“Qualified expenditures” are defined as the amount paid by the taxpayer for services eligible for

a federal income tax deduction pursuant to Section 162 of the Internal Revenue Code, which per-

tains to trade or business expenses (see Significant Issues for a description of what Section 162

does and does not allow to be deducted). However, qualified expenditures do not include ser-

vices for linen supply, entertainment or recreation, intrastate telephone and telegraph, janitorial,

landscaping, repair and maintenance, sewer and solid waste disposal, or services whose price is

eligible for any other New Mexico tax credit.

Taxpayers eligible for the business services tax credit include anyone liable for payment of any

tax, anyone responsible for withholding a payment for collection of any tax, or anyone who owes

a tax. However, governmental entities, nonprofit facilities and other entities that are exempt from

the gross receipts tax such as retirement homes and insurance companies are not eligible to re-

ceive the credit.

The effective date of these provisions is July 1, 2006 (see technical issues).

FISCAL IMPLICATIONS

Based on analysis of “Report 80-Analysis of Gross Receipts Tax by Industrial Classification”

and Implan input-output data of the New Mexico economy, TRD estimates that business to busi-

ness services eligible for the business services tax credit will total $3.2 billion in FY07. Assum-

ing a tax credit of 0.5 percent, the fiscal impact is about $16 million ($3.2 billion X 0.005). The

tax base for this credit is estimated to grow by 5 percent each year, leading to the following gen-

eral fund revenue reductions: -$33.6 million in FY08 ($3.2 billion X $1.05 X 0.01), -$52.9 mil-

lion in FY09, -$74.1 million in FY10, and -$97.2 million in FY11.

FY07

FY08

FY09

FY10

FY11

FY12

Tax Base 3,200,000

3,360,000

3,528,000

3,704,400

3,889,620

4,084,101

Credit

0.50%

1.00%

1.50%

2.00%

2.50%

0.00%

Impact

(16,000)

(33,600)

(52,920)

(74,088)

(97,241)

-

Fiscal Impact of Business Services Tax Credit (Dollars in Thousands)

Because the bill can be claimed against the compensating tax, of which 20 percent is distributed

to the small cities and counties assistance funds, revenues to these funds will be reduced by

about $30 thousand in FY07, $80 thousand in FY08, $120 thousand in FY09, $160 thousand in

FY10, and $200 thousand in FY11.

As drafted, the credit expires after FY11, so in FY12 and beyond there will be no fiscal impact.

Senate Bill 334 – Page

3

SIGNIFICANT ISSUES

Senate Bill 334 attempts to reduce the tax burden on businesses caused by pyramiding, which

results when transactional taxes such as New Mexico’s gross receipts and compensating taxes

are charged on the sale of business services from one business to another. As services are sold

from one business to another in the course of production, the tax is levied multiple times and re-

sults in higher business costs and final product prices.

Pyramiding is a somewhat unique tax dilemma in New Mexico because the gross receipts tax is a

fundamentally different structure than the sales tax used by most other states. While sales taxes

are imposed on the buyer of consumer goods, the gross receipts tax is imposed on the seller of

goods and services, whether that product is a finished good or an input used by another business.

Pyramiding affects some facets of New Mexico’s business community more than others. First,

businesses that compete with other businesses outside of New Mexico may experience a com-

petitive disadvantage because their competitors don’t pay multiple taxes on their inputs. Second,

small businesses that contract with other businesses may experience a competitive disadvantage

relative to larger firms. To exemplify this point, consider a small New Mexico firm that out-

sources its payroll function to another New Mexico firm. While this small business would pay

gross receipts tax on its payroll services, a larger firm with its own payroll division would not

pay gross receipts tax.

The business services tax credit would be available for business expenditures that are deductible

when calculating net income according to Section 162 of the Internal Revenue Code (IRC). This

Section of the IRC states that all ordinary and necessary expenses paid or incurred in the course

of business may be deducted, including a reasonable allowance for salaries and compensation,

travel expenses, rentals or other payments used for business, and capital contributions to the Fed-

eral National Mortgage Association. Some items that will not be eligible for the business ser-

vices tax credit, pursuant to Section 162 of the IRC, are charitable contributions, illegal bribes

and kickbacks, lobbying and political expenditures, application and dues of tax-exempt organiza-

tions, fines or penalties, damage payments under antitrust laws, foreign advertising, stock reac-

quisition expenses, and group health plan payments.

ADMINISTRATIVE IMPLICATIONS

TRD reports that Senate Bill 334 would require major changes to the Combined Revenue System

(CRS) through which approximately $3.5 billion of state and local revenues are processed annu-

ally. Due to the large number of taxpayers affected by the bill, credits could not be processed

manually like other existing credits. Automated credit processing will require form revisions re-

turn processing changes. These administrative changes would be costly and cause slower reve-

nue processing. TRD estimates nonrecurring system changes would cost about $200 thousand.

TRD cautions that these changes could not be completed by Senate Bill 334’s July 1, 2006 effec-

tive date.

In addition, about four additional FTE would be required for the additional workload imposed on

TRD’s revenue processing division. The salaries, benefits, and other recurring costs associated

with these four FTE are estimated to cost $200 thousand.

Senate Bill 334 – Page

4

Automated processing would also mean that the only enforcement tools available to ensure com-

pliance would be audits. Audit frequency is limited, so inaccuracies and non-compliance will be

more common than in other tax credits.

CONFLICT, DUPLICATION, COMPANIONSHIP, RELATIONSHIP

Senate Bill 334 is related to House Bill 501, which would provide a gross receipts tax credit for

the same business services, but only to businesses with total receipts of less than $300 thousand

in the previous year.

TECHNICAL ISSUES

TRD claims that major administrative changes necessary to implement the provisions of this bill

could not be accomplished by July 1, 2006. TRD recommends changing the effective date of the

bill to July 1, 2007.

OTHER SUBSTANTIVE ISSUES

The bill would allow employers to claim the business services tax credit against the withholding

tax they are required to pay on behalf of their employees. Withholding tax is not part of gross

receipts or compensating tax, but rather is a mechanism by which personal income tax is col-

lected from workers. Therefore, the business services tax credit would allow an employer to take

a credit against a tax that is the liability of his or her employees. House Bill 501, which is similar

to Senate Bill 334, does not allow its credit to be taken against withholding payements.

New Mexico’s state and local governments are heavily dependent on the gross receipts tax as a

large and stable revenue source. In FY06, general fund gross receipts tax revenues are expected

to total $1,595 million, or roughly 30 percent of revenue. Tax changes that narrow the gross re-

ceipts tax base should be expected to increase revenue volatility.

ALTERNATIVES

TRD notes that the business services tax credit is designed to provide partial relief from pyra-

miding to the buyer of taxable services. This is a major departure from the traditional design of

New Mexico’s gross receipts tax, which is imposed on the seller. The proposal assumes that sell-

ers pass the entire burden of the gross receipts tax on to the buyer of their services. In reality, the

incidence of the gross receipts tax falls partially on sellers and partially on buyers. Therefore, the

proposal is not clearly targeted at those businesses that are most burdened by pyramiding. A

more effective way to target pyramiding tax relief would be to provide a deduction for the sale of

a service.

SS/yr