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

SPONSOR Silva

ORIGINAL DATE

LAST UPDATED

2/1/07

HB 396

SHORT TITLE Business-Related Service Gross Receipts

SB

ANALYST Schardin

REVENUE (dollars in thousands)

Estimated Revenue

Recurring

or Non-Rec

Fund

Affected

FY07

FY08

FY09

($3,815.1)

($4,005.9) Recurring General Fund

($7.7)

($8.1) Recurring Small Cities

Assistance Fund

($7.7)

($8.1) Recurring Small Counties

Assistance Fund

(Parenthesis ( ) Indicate Revenue Decreases)

ESTIMATED ADDITIONAL OPERATING BUDGET IMPACT (dollars in thousands)

FY07

FY08

FY09 3 Year

Total Cost

Recurring

or Non-Rec

Fund

Affected

Total

200.0

200.0 Nonrecurring General

Fund

200.0

200.0

400.0 Recurring General

Fund

(Parenthesis ( ) Indicate Expenditure Decreases)

SOURCES OF INFORMATION

LFC Files

Responses Received From

Taxation and Revenue Department (TRD)

SUMMARY

Synopsis of Bill

House Bill 396 creates the business services tax credit. The credit may be claimed against the

state gross receipts tax or compensating tax. A credit that exceeds a taxpayer’s tax liability may

be carried forward for up to three years.

The credit on “qualified expenditures" will be equal to 3.775 percent of gross receipts in

House Bill 396 – Page

2

municipalities and 5 percent in unincorporated areas of New Mexico counties. In other words,

“qualified expenditures" will receive a 100 percent credit against the state share of gross receipts

tax. However, local option taxes of about 1 percent will still be charged on qualified

expenditures.

“Qualified expenditures" are defined as the amount paid by the taxpayer for business services

eligible for a federal income tax deduction pursuant to Section 162 of the Internal Revenue Code,

which pertains to trade or business expenses (see Significant Issues for a description of what

expenditures are deductible under Section 162). However, qualified expenditures do not include

services for linen supply, entertainment or recreation, intrastate telephone and telegraph,

janitorial, landscaping, repair and maintenance, construction, research and development, sewer

and solid waste disposal, or services of which price is the basis for any other New Mexico tax

credit.

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

tax or anyone who owes a tax. The business will also be required to have total receipts of less

than $300 thousand per year to qualify for the credit. 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 receive the credit.

The bill states that the gross receipts of a group of entities under common control will be

aggregated to determine the size of the credit.

The effective date of these provisions is July 1, 2007 (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

business services for companies with total receipts under $300 thousand per year that are eligible

for the new credit created in this bill will total $112 million in FY08. Assuming a statewide

average tax rate of 3.8 percent and 90% utilization of the credit, expenditures qualifying for these

credits will total $3,830.4 thousand per year.

TRD estimates that 98 percent of the credits, about $3,724.0 thousand, will be claimed against

the state portion of gross receipts tax. The remaining 2 percent of the credits, or $76 thousand in

FY08, will be claimed against the compensating tax. Eighty percent of the compensating tax loss

($60.8 thousand) will accrue to the general fund, while the remaining 20 percent loss will accrue

evenly to the small cities and small counties assistance funds ($7.7 thousand each). Fiscal

impacts of the provision are expected to grow by 5 percent each year.

Because the credit applies only to the state share of gross receipts tax liability, the bill does not

impact local government gross receipts tax revenues.

House Bill 396 – Page

3

SIGNIFICANT ISSUES

The bill 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 results 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 imposed 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

competitive disadvantage because their competitors don’t pay multiple taxes on their inputs and

therefore have lower costs of production.

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. By targeting the business services tax credit to businesses with

gross receipts under $300 thousand, the bill targets tax relief to small businesses most in need of

relief from pyramiding.

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

Federal National Mortgage Association. Some items that will not be eligible for the business

services 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

organizations, fines or penalties, damage payments under antitrust laws, foreign advertising,

stock reacquisition expenses, and group health plan payments.

LFC notes that while individual credits from the gross receipts tax may have small fiscal

impacts, their cumulative effect significantly narrows the gross receipts tax base. Narrowing the

gross receipts tax base increases revenue volatility and requires a higher tax rate to generate the

same amount of revenue.

ADMINISTRATIVE IMPLICATIONS

TRD reports that the bill would require major changes to the Combined Revenue System (CRS).

Because an estimated 84 thousand firms will be affected by the bill, credits could not be

processed manually like other existing credits. Automated credit processing will require form

revisions and return processing changes. These administrative changes would be costly and

House Bill 396 – Page

4

cause slower revenue processing. TRD estimates these nonrecurring system changes would cost

about $200 thousand. TRD cautions that these changes could not be completed by the bill’s July

1, 2007 effective date, but could be completed by January 1, 2008.

In addition, about four additional permanent FTE would be required to accomplish 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.

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

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

be more common than in other tax credits.

TECHNICAL ISSUES

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

could not be accomplished by July 1, 2007. TRD recommends changing the effective date of the

bill to January 1, 2008.

On page 3, line 6, consider deleting the word “taxes" to conform to the intent of the bill, which is

for the gross receipts, not the gross receipts taxes, of entities to be aggregated for calculation of

the credit.

TRD notes that the broad reach of the proposal warrants authorizing TRD to promulgate rules

and regulations to implement the new credit.

SS/nt