On April 4, 2019, New Mexico Governor Michelle Lujan Grisham signed into law tax reform bill Ch. 270 (HB 6) (hereafter, the Bill). Key provisions of the Bill adopt mandatory combined reporting, move to market-based sourcing for sales of services, address certain provisions of the federal Tax Cuts and Jobs Act (P.L. 115-97) (TCJA), adopt economic nexus provisions for remote retailers and marketplace providers, and amend rules for reporting gross receipts and compensating tax, among other changes. These provisions have various effective dates, and are discussed in detail below.

Corporate income tax

Mandatory combined reporting

Effective for tax years beginning on and after January 1, 2020, New Mexico adopts mandatory combined reporting for corporations that are part of a unitary group. New Mexico rules default to worldwide combination with an election to file on either a water's-edge ¹ or consolidated-group basis. This election must be made on the first original return required to be filed for tax years beginning on or after January 1, 2020, and, once made, is binding for seven consecutive years. Those electing to file a consolidated return also must file on the same basis for federal income tax purposes.

Corporations required to file a combined return may designate a member of the group to act as the principal corporation (such corporation will file returns, make elections, claim tax credits and refunds, and perform other acts on behalf of the group).

A "unitary group" is defined to mean a group of two or more corporations (including a captive real estate investment trust (REIT)) that are (1) related through common ownership; ² and (2) economically interdependent with one another as demonstrative by centralized management, functional integration and economies of scale. A unitary group does not include S corporations, REITs that are not captive, or insurance companies.

In determining net income of the group, intercompany income and expenses are eliminated in a manner consistent with the federal and state consolidated filing requirements.

Regarding net operating losses (NOLs), the Bill provides rules for carrying over NOLs pre- and post- combination. Grandfathered NOL carryovers are NOLs reported to New Mexico for tax years beginning January 1, 2013 and before January 1, 2020, to the extent the NOLs can be attributed to one or more corporations properly included in the taxpayer's return for the first tax year beginning on or after January 1, 2020. Grandfathered NOLs are reduced by (1) adding back deductions for royalties or interest paid to one or more related corporations, but only to the extent the adjustment would not create a net loss for the related corporation; and (2) the amount of the NOL deduction taken before January 1, 2020, that would be charged against those losses, consistent with the federal and state law that applied in the year of the deduction. Grandfathered NOLs are apportioned to New Mexico using apportionment factors that applied to the corporation in the year of the deduction.

NOL carryover is the apportioned net loss properly reported by the taxpayer on an original or amended tax return for tax years beginning on or after January 1, 2020, plus (1) the portion of the apportioned net loss reported to New Mexico for a tax year beginning on or after January 1, 2020, on a separate-year return, to the extent the taxpayer would have been allowed to include a portion of the net loss in its federal consolidated NOL carryover if the taxpayer filed a consolidated return; and (2) the taxpayer's grandfathered NOL carryover; minus (a) the amount of NOL carryover attributable to an entity that has left the filing group, and (b) the amount of NOL deduction taken by the taxpayer

The Bill follows the TCJA's 80% limitation on the use of NOLs to offset taxable income.

In addition, the Bill allows publicly traded companies to take a deduction to offset material financial effects of changes in the deferred tax amount resulting from the state's adoption of mandatory combined reporting. The deduction is allowed for 10 consecutive tax years beginning on or after January 1, 2026. A filing group wanting to claim this deduction will need to file a preliminary notice with the Secretary of Taxation and Revenue before January 1, 2023.

Apportionment and sourcing

New Mexico adopts an equally weighted three-factor apportionment formula, but manufacturers and headquarter companies that meet certain criteria are allowed to make an election to use a single sales factor apportionment formula. The Bill revises the criteria used to determine whether a manufacturer or headquarter company is eligible to make such an election to reflect the enactment of mandatory combined reporting. Elections made for a tax year beginning on or after January 1, 2020, are effective until the taxpayer notifies the New Mexico Taxation and Revenue Department (department) of the termination of the election, except that the taxpayer cannot terminate the election until it has used the elected method for at least three consecutive tax years (including a total of at least 36 calendar months).

The Bill also changes the manner in which the state sources sales from services and non-tangible property from the cost-of-performance method to a market-based sourcing method. Under the new provisions, sales are sourced to New Mexico as follows:

• Sale, rental, lease or license of real property/tangible personal property, if and to the extent the property is located in New Mexico
• Sale of services, if and to the extent the service is delivered to a location in New Mexico
• Sale, rental, lease or license of intangible property, if and to the extent the intangible property is used in New Mexico

If the state(s) of assignment cannot be determined under these rules, the state(s) of assignment will be reasonably approximated.

The Bill also adopts a throwout rule. Under this rule, if the taxpayer is not taxable in a state to which the sale is assigned or if the state of assignment cannot be determined or reasonably approximated, the sale is excluded from the numerator and denominator of the sales factor.

The Department has the authority to promulgate rules to implement the new sourcing rules.

These changes are effective for tax years beginning on and after January 1, 2020.

Tax base and the TCJA

Regarding the TCJA, the definition of "base income" means federal taxable income or a corporation's federal NOL for the tax year calculated under the IRC, after special deductions in IRC Section 241 through 249 (which, as defined, include the federal foreign dividend received deduction added by the TCJA under IRC Section 245A) but without any NOL deductions, as if the corporation filed a federal tax return as a separate domestic entity, with certain modifications. Some of the modifications specified by the Bill include a requirement to add back to base income the amount of any deduction (other than for premiums) for amounts paid to a commonly controlled entity that is exempt from corporate income tax as an insurance company. Amounts required to be subtracted from base income include: (1) amounts the state is prohibited from taxing under the US Constitution, net of any related expenses; (2) an amount equal to 100% of subpart F income, as defined in IRC Section 952; and (3) an amount equal to 100% of a corporation's income under IRC Section 951A after the deduction under IRC Section 250 (i.e., net GILTI amount). This provision applies to tax years beginning on or after January 1, 2020.

Gross receipts and compensating tax

Economic nexus

Following other states, New Mexico adopts economic nexus provisions for remote retailers and marketplace providers. For persons lacking a physical presence in New Mexico, including a marketplace provider, "engaging in business" means having, in the prior calendar year, total gross receipts from sales, leases and licenses of tangible personal property, sales of licenses and sales of services or licenses for use of real property sourced to New Mexico under NMSA Section 7-1-14, of at least $100,000. "Gross receipts" includes receipts collected by marketplace providers from such sales that it facilitates on behalf of marketplace sellers, regardless of whether the marketplace sellers are engaged in business in the state.

In addition, the Bill provides that a marketplace provider is not liable for incorrectly collected gross receipts tax if it reasonably relied on erroneous information provided by the seller.

The Bill further provides that the Department will audit the marketplace provider with respect to gross receipts from transactions it facilitates and for which the marketplace seller may claim a deduction. The marketplace seller, however, may be audited when necessary to determine the correct amount of tax due. In addition, marketplace sellers may deduct receipts for sales, leases and licenses of tangible personal property, sales of licenses and sales of services or licenses for use of real property that are facilitated by marketplace providers if the seller obtains documentation from the provider indicating that the provider is registered with the department and has or will remit the gross receipts from the facilitated transactions. The deduction will not apply if the marketplace provider is determined to not owe tax due to its reliance of information provided by the seller.

In addition, the Department is barred from taking action to enforce collection of gross receipts tax for a tax period before July 1, 2019, on persons engaging in business if those persons lacked a physical presence in the state and did not report taxable gross receipts before that date.

These changes take effect July 1, 2019.

Expansion of the gross receipts and compensating tax

The Bill expands the definition of "property" under the gross receipts and compensating tax to include franchises and, as an example of a license, digital goods (i.e., electronically delivered software, music, photography, video, reading materials, applications and ringtones).

In addition, for the privilege of using a license or franchise in New Mexico, a 5.125% excise tax applies to the value of the license or franchise in its use in New Mexico. The Department, by rule, ruling or instruction, will fairly apportion the value of a license or franchise to its value in use in New Mexico. This tax applies if the license or franchise is acquired through a transaction with a person that is located outside the state and would have been subject to the gross receipts tax had the license or franchise been acquired from a person that has nexus with New Mexico.

These changes take effect July 1, 2019.

Sourcing gross receipts and compensating tax

The Bill changes the rules for reporting gross receipts and compensating tax. Under the revised rules, gross receipts and deductions are sourced as follows:

• Gross receipts and deductions from the sale or lease of tangible personal property or licenses are reported to the location of delivery of the property to the customer
• Gross receipts and deductions from the licensing of tangible personal property are reported to the location of delivery of the property to the customer; if, however, receipts are from licensing a vehicle, the reporting location is the location where the customer makes first use of the vehicle
• Professional services are reported to the seller's place of business
• Services related to a construction business are reported to the "place of business," which is the location where the construction project is performed (all gross receipts and deductions from the project are reported from that place of business)
• Services related to selling real estate are reported to the "place of business," which is the location of the real property (all gross receipts and deductions from the sale are reported from that place of business)
• Services not previously describe are reported to the location where the service is performed
• Gross receipts and deductions from the sale, lease or granting of a license to use real property are reported to the location of the real property
• Gross receipts and deductions from a customer for services provided by a transportation network company are reported to the location where the customer enters the vehicle

The Secretary of Taxation and Revenue is authorized to adopt rules addressing reporting gross receipts and deductions from transactions not otherwise specified by the statute, including reporting gross receipts and deductions to locations when the taxpayer has more than one place of business and "for reporting tax imposed by taxing jurisdictions at the jurisdiction's location, including: (a) outside a municipality; (2) within an Indian reservation or pueblo grant; (3) within a tax increment development district; and (d) within any other taxing jurisdiction." In addition, the Secretary is required to develop and provide a location-rate database that includes applicable local tax rates.

Compensating tax is reported consistent with these provisions.

The provisions take effect July 1, 2021.

Other changes

Other tax changes contained in the Bill will:

• Increase the number of individual income tax brackets, adding a new top individual income tax rate of 5.9%, effective for tax years beginning on or after January 1, 2021
• Set the net capital gain deduction at the greater of (1) the taxpayer's net capital gain income for the year in which the deduction is being claimed, but not to exceed $1,000 or (2) 40% (from 50%) of the taxpayer's net capital gain income for the tax year for which the deduction is being claimed, applicable to tax years beginning on or after January 1, 2019
• Allow those filing as head of household or married filing a joint return a deduction from net income for certain dependents, applicable to tax years beginning on or after January 1, 2019
• Authorize the Secretary of Taxation and Revenue to establish standards for certified service providers for purposes of the gross receipts and compensating tax
• Amend provisions related to cigarettes and tobacco, including tax rates and definitions
• Increase the excise tax on motor vehicles to 4% (from 3.5%)
• Sunset on July 1, 2021, the exemption from supplemental municipal gross receipts tax for transporting persons or property for hire by railroad, motor vehicles, air transportation or any other means from a point within the municipality to another point outside the municipality
• Impose, starting July 1, 2021, a municipal compensating tax and a county compensating tax on certain transactions related to using, in a municipality/county, tangible personal property, a license or franchise, or services
• Exempt receipts of a nonprofit hospital licensed by the Department of Health from any local option gross receipts tax (but not the state gross receipts tax) — effective July 1, 2019, a hospital may deduct 60% (from 50%) of its receipts from gross receipts, and 60% of a hospital's receipts may be deducted from governmental gross receipts
• Exempt from gross receipts tax certain receipts from selling research and development services, effective July 1, 2021.

Implications

Taxpayers will need to review these changes and determine whether they are now required to file a combined report in New Mexico and, if so, whether it would beneficial to file on a worldwide, water's-edge or consolidated basis. Publicly traded companies also will need to determine whether to elect to claim the deduction to offset material financial effects of changes in the deferred tax amount. Further, it is likely that the Department will adopt rules to implement these new provisions. If so, affected taxpayers may want to consider participating in the rule-making process. Taxpayers also will need to consider whether they will need to adjust how they source sales of services and other non-tangible property under the new market-based sourcing method.

Out-of-state taxpayers should review the new nexus provisions and consider whether they now have nexus with New Mexico and update their systems accordingly.

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ENDNOTES

¹ A "water's-edge group" includes all the corporations that are part of the "unitary group" except the following: (1) corporations exempt from the corporate income tax under NMSA Section 7-2A-4 (e.g., insurance companies); and (2) corporations wherever organized that have less than 20% of their property, payroll and sales sourced to location with the US (following the sourcing rules in the Uniform Division of Income for Tax Purposes Act, or UDITPA).

² "Common ownership" is defined as direct or indirect control or ownership of more than 50% of the outstanding voting stock of (1) a parent-subsidiary controlled group as defined in IRC Section 1563 (except 50% is substituted for 80%); (2) a brother-sister controlled group as defined in IRC Section 1563; or (3) three or more corporations each of which is a member of a group described in (1) or (2) and one of which is a common parent as described in (1) and included in a group described in (2).