In the Matter of the Protest of Process Equipment & Service Company, Inc.

Process Equipment & Service Company (PESCO), a small Farmington, New Mexico manufacturer of custom oil and gas production equipment, applied for technology jobs and research and development tax credits of $88,014 for 2014 and $79,827 for 2016. The Department denied both applications, finding that PESCO's accounting firm's methodology — reviewing contemporaneous 'drafting logs' and interviewing engineers to estimate the percentage of drafting time devoted to qualifying research projects — did not satisfy the statutory requirement that a taxpayer's cost accounting methodology for allocating expenditures be the same methodology used in its other business activities.

The State Credit Is Not a Carbon Copy of the Federal Credit

PESCO argued that because New Mexico's credit incorporates concepts from the federal research credit under IRC section 41, the federal standard of proof — which permits reasonable estimates based on testimony — should govern. The Chief Hearing Officer disagreed, finding that the New Mexico Legislature's addition of a requirement that the cost accounting methodology used for the credit be 'the same cost accounting methodology used by the taxpayer in its other business activities' — a requirement with no federal analogue — showed a deliberate intent to impose a distinct, New Mexico-specific substantiation standard.

No Formal Time-Keeping System Required

Nonetheless, the Hearing Officer rejected the Department's position that only a formal, contemporaneous project time-tracking system could satisfy the statute. Crediting testimony from PESCO's Vice President of Engineering that he informally used the same drafting-log-based approach to decide whether to continue or kill a research project, the Hearing Officer found this satisfied the 'other business activities' requirement, reasoning that requiring small businesses to adopt costly, formal time-management systems merely to prove the credit would defeat the Act's stated purpose of creating a favorable tax climate for smaller technology-based businesses.

The Hearing Officer granted PESCO's protest in full for both tax years, subject only to PESCO's own concession that it could not apply the federal 80% wage-allocation rule.

Significance: This decision — later affirmed on appeal in Process Equipment & Service Company, Inc. v. New Mexico Taxation & Revenue Department, 2023-NMCA-060 — was the first to substantively interpret the Technology Jobs Tax Credit Act's 'cost accounting methodology' requirement, establishing that small businesses may satisfy it through informal, consistently applied practices rather than a dedicated formal accounting system.