THINKING MACH. CORP. v. NEW MEXICO TAX. & REV. DEPT.

• Decision Date: 22 July 1997
• Docket Number: Civ. A. No. 96-12513-WGY.
• Parties: THINKING MACHINES CORPORATION, Debtor-Appellant, v. NEW MEXICO TAXATION AND REVENUE DEPARTMENT, Claimant-Appellee.
• Court: U.S. District Court — District of Massachusetts

211 B.R. 426 (1997)

THINKING MACHINES CORPORATION, Debtor-Appellant, v. NEW MEXICO TAXATION AND REVENUE DEPARTMENT, Claimant-Appellee.

Civ. A. No. 96-12513-WGY.

United States District Court, D. Massachusetts.

July 22, 1997.

Brian P. Lenihan, Charles R. Dogherty, Hill & Barlow, Boston, MA, for Thinking Machines Corporation.

Gregory S. Gilman, Attorney General's Office, Boston, MA, Donald F. Harris, Special Assistant Attorney General, Sante Fe, NM, for New Mexico Taxation and Revenue Department.

MEMORANDUM AND ORDER

YOUNG, District Judge.

This bankruptcy appeal presents a question of law which has yet to be addressed by the First Circuit and has split the other federal circuit courts of appeals: which party bears the ultimate burden of proof when a tax claim is asserted in the context of a bankruptcy proceeding?

I. BACKGROUND

Thinking Machines Corporation ("Thinking Machines") appeals the decision of the Bankruptcy Court awarding the New Mexico Taxation and Revenue Department (the "Department") a pre-petition tax claim on a tax base of $2,158,042.27. See In Re Thinking Machines Corp., 203 B.R. 1 (Bankr.D.Mass.1996) (Hillman, J.).¹ Thinking Machines argues that the Bankruptcy Court erred 1) by placing the burden of proof on the taxpayer to disprove the validity of the Department's tax claim; 2) in concluding that Thinking Machines' computer maintenance agreements with New Mexico residents were subject to New Mexico's "gross receipts" tax; and 3) in calculating what percentage of services under those contracts was performed out-of-state, and thus exempt from the gross receipts tax.

Thinking Machines is a Massachusetts corporation engaged in the manufacture, sale, and servicing of computers. Between 1988 and 1991, it sold computer products and services to a number of government laboratories located in New Mexico pursuant to contracts referred to as "Maintenance Agreements." These agreements called for Thinking Machines to provide full-service maintenance and support for its computers, including 1) hardware support (i.e., provision and installation of replacement parts, as well as repair of existing parts), 2) software licensing and support (i.e., debugging, provision of upgrades), and 3) an on-site applications engineer to troubleshoot and help customers get their own applications running in the Thinking Machines environment.

In May of 1992, the Department conducted an audit of Thinking Machines for the period of January 1, 1988 through March 31, 1992, and issued an assessment for outstanding "gross receipts" taxes, see N.M.Stat.Ann. § 7-9-4(A), interest, and penalties on a tax base of $3,259,291.00. On August 17, 1994, Thinking Machines filed a Chapter 11 bankruptcy petition, and on September 21, 1994, the Department filed a proof of claim pursuant to 11 U.S.C. § 504 for the amount of the assessment.

Thinking Machines filed a timely objection to the Department's claim on November 27, 1995, arguing that the Maintenance Agreements predominantly involved sales of tangible personal property to organizations possessing certain nontaxable transaction certificates, and were therefore exempt from New Mexico's gross receipts tax. See N.M.Stat.Ann. § 7-9-60. The Department, in contrast, contends that the sale of services was predominant throughout the Maintenance Agreements, thus rendering these Agreements fully taxable. Under New Mexico law, the "predominant ingredient" test is used to determine whether an activity constitutes the provision of a service or a sale of tangible property for purposes of the gross receipts tax. See EG & G, Inc. v. Director, Revenue Division Taxation and Revenue Dep't, 94 N.M. 143, 607 P.2d 1161, 1163-64 (App.), cert. denied, 94 N.M. 628, 614 P.2d 545 (1979).

After an evidentiary hearing, the Bankruptcy Court overruled Thinking Machines' objection to the Department's tax claim. The Bankruptcy Court held that Thinking Machines 1) had the ultimate burden of proving that the Department's tax assessment was incorrect, 2) failed to satisfy its burden of proving that the revenues generated from its Maintenance Agreements were derived predominantly from sales of tangible property, and 3) failed to introduce adequate evidence of the proper allocation of out-of-state service costs. Relying upon one of the allocation models submitted by the Department, the Bankruptcy Court awarded the Department a pre-petition tax claim on a tax base of $2,158,042.27.

II. ANALYSIS

A. Burden of Proof

The Bankruptcy Court's ruling that, even in bankruptcy, the ultimate burden of proof rests with the taxpayer to disprove the validity of a tax claim, is a legal conclusion that this Court must review de novo. See Fed. R.Bankr.P. 8013; In Re Winthrop, 50 F.3d 72, 73 (1st Cir.1995).

Outside of the bankruptcy forum, "it is settled law that taxpayers bear the burden of proving that a tax deficiency assessment is erroneous." Delaney v. Commissioner, 99 F.3d 20, 23 (1st Cir.1996) (citing United States v. Rexach, 482 F.2d 10, 16 1st Cir., cert. denied, 414 U.S. 1039, 94 S.Ct. 540, 38 L.Ed.2d 330 1973). "This rule is supported by `the presumption of administrative regularity; the likelihood that the taxpayer will have access to the relevant information; and the desirability of bolstering the record-keeping requirements of the Code."' Thinking Machines, 203 B.R. at 3 (quoting Rexach, 482 F.2d at 16).

Subject to certain exceptions, the United States Bankruptcy Code confers jurisdiction upon the bankruptcy courts to "determine the amount or legality of any tax" assessed against the debtor. 11 U.S.C. § 505. The Bankruptcy Code and the Federal Bankruptcy Rules of Procedure are silent, however, with respect to the proper allocation of the ultimate burden of proof when a tax claim is asserted in bankruptcy, see In re MacFarlane, 83 F.3d 1041, 1045 (9th Cir.1996), cert. denied, ___ U.S. ___, 117 S.Ct. 1243, 137 L.Ed.2d 326 (1997); In re Landbank Equity Corp., 973 F.2d 265, 269 (4th Cir.1992), and indeed with respect to the ultimate burden of proof for any claim asserted against the debtor. See 11 U.S.C. § 502; Fed.R.Bankr.P. 3001(f).² Although courts generally assume that this ultimate burden rests with the claimant, see In re Hemingway Transp., Inc., 993 F.2d 915, 925 (1st Cir.), cert. denied, 510 U.S. 914, 114 S.Ct. 303, 126 L.Ed.2d 251 (1993), the federal circuit courts of appeals are split on the question of whether the ultimate burden falls upon the taxpayer or the taxing authority when a tax claim is asserted in the context of a bankruptcy proceeding. The Third, Fourth, and Seventh Circuits have held that the taxpayer-debtor bears the ultimate burden of proof, just as it does outside of bankruptcy, see Resyn Corp. v. United States, 851 F.2d 660, 663 (3d Cir.1988); In re Landbank Equity Corp., 973 F.2d 265, 268-271 (4th Cir.1992); United States Internal Revenue Serv. v. Charlton, 2 F.3d 237, 239-40 (7th Cir.1993), while the Fifth, Eighth, Ninth, and Tenth Circuits place the ultimate burden on the taxing authority, see In re Placid Oil Co., 988 F.2d 554, 557 (5th Cir.1993) (citing In re Fidelity Holding Co., 837 F.2d 696, 698 5th Cir.1988); In re Brown, 82 F.3d 801, 805 (8th Cir.1996); In re MacFarlane, 83 F.3d 1041, 1045 (9th Cir.1996), cert. denied, ___ U.S. ___, 117 S.Ct. 1243, 137 L.Ed.2d 326 (1997); In re Fullmer, 962 F.2d 1463, 1466 (10th Cir.1992).³ The First Circuit has yet to address this issue.⁴

As this case involves the determination of a state tax claim, this Court must look to state law "unless some federal interest requires a different result." Butner v. United States, 440 U.S. 48, 55, 99 S.Ct. 914, 918, 59 L.Ed.2d 136 (1979); see 28 U.S.C. § 1652; Vanston Bondholders Protective Comm. v. Green, 329 U.S. 156, 161, 67 S.Ct. 237, 239, 91 L.Ed. 162 (1946) ("What claims of creditors are valid and subsisting obligations against the debtor at the time a petition in bankruptcy is filed, is a question which, in the absence of overruling federal law, is to be determined by reference to state law.") Under New Mexico law, a tax assessment made by the Department is presumptively correct, see N.M.Stat.Ann. § 7-1-17(C); Stohr v. New Mexico Bureau of Revenue, 90 N.M. 43, 559 P.2d 420, 423 (App. 1976), cert. denied, 90 N.M. 254, 561 P.2d 1347 (1977) (presumption that an assessment of gross receipts taxes is correct), and the ultimate burden of proof that the assessment is erroneous rests with the taxpayer. See Torridge Corp. v. Commissioner of Revenue, 84 N.M. 610, 506 P.2d 354, 356 (App.1972), cert. denied, 84 N.M. 592, 506 P.2d 336 (1973). The United States Supreme Court has long recognized that burdens of proof constitute part of the substantive law of a state. See Dick v. New York Life Ins. Co., 359 U.S. 437, 446, 79 S.Ct. 921, 927, 3 L.Ed.2d 935 (1959).

Courts of appeals on both sides of this issue have acknowledged that the Bankruptcy Code provides no express rules of decision for the determination of tax claims. See MacFarlane, 83 F.3d at 1045; Landbank, 973 F.2d at 270-71.⁵ In MacFarlane, however, the Tenth Circuit held that implicit in the Bankruptcy Code is the principle that "taxing authorities are to be treated the same as other claimants," and that, accordingly, bankruptcy courts must disregard the substantive tax law rule that the burden of proof rests with the taxpayer. MacFarlane, 83 F.3d at 1045; see also Fidelity, 837 F.2d at 698 ("The Bankruptcy Code . . . does not differentiate between government and private claimants when proofs of claim are filed"). The MacFarlane court further explained that "the policy goals of the bankruptcy system are put at risk when one class of creditors is given the benefit of a favorable presumption which has its origins outside of bankruptcy law." MacFarlane, 83 F.3d at 1045 (quoting In re Wilhelm, 173 B.R. 398, 402 Bankr.E.D.Wis.1994).

This Court finds MacFarlane and Fidelity unpersuasive. By its express terms, the Bankruptcy Code does not treat taxing authorities...