When the Texas Tax Code provides an exemption from sales and use tax, you’d think everything would be straightforward, right? Unfortunately, it’s sometimes not that simple, especially when it comes to construction contracts. In order to figure out what’s exempt and what’s not in this area, you often have to navigate the tricky interactions between the sales and use taxation of construction contracts and exemptions more generally.
Texas Sales and Use Tax and Construction Contracts, Generally
Let’s recap the basics. Sales of tangible personal property and taxable services in the state of Texas are subject to Texas sales or use tax.[1] Sales and use tax is collected by the seller from the purchaser and is a debt of the purchaser to the seller until paid.[2]
The application of sales and use to tax to contractors varies depending on whether the contractor has entered into a separated or lump sum contract with its customer.[3] “Contractor”, “separated contract”, and “lump sum contract” are all defined terms.
A “contractor” means:
[a]ny person who builds new improvements to residential or nonresidential real property, completes any part of an uncompleted new structure that is an improvement to residential or nonresidential real property, makes improvements to real property as part of periodic and scheduled maintenance of nonresidential real property, or repairs, restores, maintains, or remodels residential real property, and who, in making the improvement, incorporates tangible personal property into the real property that is improved.[4]
A “separated contract” is any “contract in which the agreed contract price is divided into a separately stated agreed contract price for incorporated materials and a separately stated amount for all skill and labor that includes fabrication, installation, and other labor that is performed by the contractor.”[5] A contractor who performs under a separated contract is treated as the retailer of all materials that are physically incorporated into the realty being improved.[6] Generally, a contractor under a separated contract is required to collect sales or use tax from its customer on the agreed contract price of the materials or the price of the materials to the contractor, whichever is greater.[7]
A “lump-sum contract” is “[a] contract in which the agreed contract price is one lump-sum amount and in which the charges for incorporated materials are not separate from any charges for skill and labor, including fabrication, installation, and other labor that the contractor performs.”[8] A contractor who performs under a lump-sum contract has to pay tax to suppliers on all materials, consumable items, equipment, taxable services, and other taxable items that are used by the contractor or incorporated into a customer’s property.[9] The contractor is prohibited from collecting any taxes from its customers on the lump-sum charge.[10]
Further complicating matters is that subcontractors are not required to have the same type of contract as the general contractor.[11] Thus, a general contract may be lump sum while some or all subcontracts may be separately stated.[12] Each subcontractor’s individual contract governs the subcontractor’s tax responsibilities.[13] In the example given (i.e., where a general contractor is operating under a lump sum contract while the subcontractors are operating under separated contracts), the subcontractors with separated contracts must collect sales tax from the general contractor, and the general contractor must not collect any tax from the general contractor’s customer.[14] When the general contract separately states labor and incorporated materials but some of the subcontracts are lump-sum, the general contractor should treat the lump-sum charges as part of its separately stated labor charge and should not collect tax from the prime contractor’s customer on those charges from lump-sum subcontractors.[15]
However, regardless of whether operating under a lump-sum or separated contact, contractors generally have to pay tax on equipment, consumable items, and taxable services used to perform a contract.[16]
Exemptions from Texas Sales and Use Tax
That brings it back to our main topic: exemptions. All gross receipts of a seller are presumed to be subject to sales or use tax unless a properly completed resale or exemption certificate is accepted by the seller.[17] A number of exemptions from sales and use tax may apply, with the most relevant here being the exemption for purchases by certain exempt organizations and the sale-for-resale exemption.[18]
Purchases by Governmental and Nonprofit Entities
Certain purchases of tangible personal property and taxable services by governmental or nonprofit entities are exempt from Texas sales and use tax.[19]
Governmental entities that qualify for exemption from sales and use tax on their purchases include:
- the United States;
- an unincorporated instrumentality of the United States;
- a corporation that is an agency or instrumentality of the United States and is wholly owned by the United States or by another corporation wholly owned by the United States;
- this state;
- a county, city, special district, or other political subdivision of this state; or
- a state, or a governmental unit of a state that borders this state, but only to the extent that the other state or governmental unit exempts or does not impose a tax on similar sales of items to this state or a political subdivision of this state.[20]
Other nonprofit organizations that qualify for exemption include:
- an organization created for religious, educational, or charitable purposes if no part of the net earnings of the organization benefits a private shareholder or individual and the items purchased, leased, or rented are related to the purpose of the organization;
- an organization qualifying for an exemption from federal income taxes under Section 501(c)(3), (4), (8), (10), or (19), Internal Revenue Code, if the item sold, leased, rented, stored, used, or consumed relates to the purpose of the exempted organization and the item is not used for the personal benefit of a private stockholder or individual . . . .[21]
In order to take advantage of this exemption, a contractor should ask the exempt organization to provide a properly completed and executed exemption certificate at or near the time of the transaction.[22]
Contracts for the Improvement of Realty with or for Certain Exempt Organizations.
In addition, the purchase of certain tangible personal property and taxable services for use in the performance of a contract for an improvement to realty for an organization exempted from Texas sales or use tax under section 151.309 or 151.310 of the Texas Tax Code is exempt from Texas sales and use tax.[23] The taxable items for which this exemption applies includes:
- tangible personal property that is incorporated into realty in the performance of the contract;
- tangible personal property, other than machinery or equipment and its accessories and repair and replacement parts, that is necessary and essential for the performance of the contract and completely consumed at the job site; and
- taxable services if the contract expressly requires the specific service to be provided or purchased by the person performing the contract or the service is integral to the performance of the contract.[24]
Contracts that qualify for this exemption include contracts with an exempt entity as well as contracts with a non-exempt entity for the primary use and benefit of an exempt entity.[25] These contracts are called “exempt contracts.”[26] For purposes of qualifying for this exemption, whether the contractor’s contract with the exempt customer is lump sum or separated is irrelevant.[27]
A contract with a for-profit entity is not an exempt contract if the improvement of real property is for the primary use and benefit of the for-profit entity.[28]
There are different tests for determining whether an improvement is for the primary use and benefit of an exempt or a for-profit entity based on whether the exempt organization will own or be the lessee of the improvements.
If an exempt organization will be the lessee of the improvements, the improvements will be for the primary use and benefit of the exempt organization if the term of the lease is sufficiently long in relationship with the life of the improvements themselves.[29]The Comptroller has found this requirement to be met when the term of the exempt organization’s lease exceeds the useful life of the improvements.[30]
If the exempt organization is going to be the owner of the improvements, then all the facts and circ*mstances are evaluated to determine whether the exempt organization will receive the primary use and benefit of the improvements.[31]
In order to take advantage of the exemption under section 151.311 of the Texas Tax Code, a contractor entering into a contract directly with an exempt organization should obtain an exemption certificate from the exempt organization.[32] The exemption certificate should be obtained from the exempt entity at or before the time of the transaction, be properly completed and executed, and the contractor must not know or have reason to know that the sale to the entity is not exempt.[33] If the validity of a claimed exemption or the exempt status of the customer is unclear, then the contractor should not accept the exemption certificate in good faith and should request additional evidence of the exempt status of the contract.[34]
Joint Ventures Between Exempt Organizations and For-Profit Entities.
A joint venture between an exempt organization and for-profit organization that enters into a contract with a for-profit contractor for the construction of a low-income housing project may qualify for an exemption from sales and use on its purchases of incorporated materials to the extent of the exempt organization’s ownership interest in the joint venture.[35] Thus, if the exempt organization owns 50% of the joint venture, the exempt organization would likely be able to claim an exemption with regards to 50% incorporated materials used in the project and would owe tax on the remaining 50% of incorporated materials.[36]
Sale for Resale Exemption
Even apart from the exemption for exempt organizations, certain items purchased for a construction project may qualify under the sale for resale exemption.
A sale of tangible personal property to a purchaser when the purchase intends to resell that property is exempt from Texas sales or use tax.[37] A “sale for resale” means:
a sale of . . . tangible personal property or a taxable service to a purchaser who acquires the property or service for the purpose of reselling it as a taxable item . . . in the United States of America or a possession or territory of the United States of America or in the United Mexican States in the normal course of business in the form or condition in which it is acquired or as an attachment to or integral part of other tangible personal property or taxable service . . . .[38]
In the construction context, a contractor operating under a separated contract with its customer may purchase materials that will be incorporated into the project and taxable services that the contractor resells to its customer tax free under the sale for resale exemption so long as the contractor’s contract with its subcontractor or vendor is also separated.[39] Similarly, a contractor operating under a separated contract may claim the sale for resale exemption on the purchase consumable items if title to the consumable items passes to the customer at or before the time the contractor takes possession of the consumable items and the consumable items are immediately marked, labelled, or otherwise physically identified as the customer’s property.[40]
In order to take advantage of this exemption, the contractor operating under a separated contract must have a Texas sales and use tax permit and needs to issue a fully completed and executed resale certificate to its subcontractors or suppliers.[41]
Parting Thoughts
If you have any questions on exemptions from Texas sales and use tax and constructions contracts, don’t hesitate to give us a call at 214.984.3000 for a free consultation.
[1] See Tex. Tax Code §§ 151.010, 151.051(a), 151.101(a).
[2] Id. §§ 151.052(a), 151.103(a).
[3] See id. § 151.056(a)-(b); 34 Tex. Admin. Code § 3.291(b)(3)-(4).
[4] 34 Tex. Admin. Code § 3.291(a)(3).
[5] Id. at § 3.291(a)(13).
[6] Tex. Tax Code § 151.056(b); 34 Tex. Admin. Code § 3.291(b)(4)(A).
[7] 34 Tex. Admin. Code § 3.291(b)(4)(A).
[8] Id. at § 3.291(a)(8).
[9] Tex. Tax Code § 151.056(a); 34 Tex. Admin. Code § 3.291(b)(3)(A).
[10] 34 Tex. Admin. Code § 3.291(b)(3)(A).
[11] Id. at § 3.291(b)(6).
[12] Id.
[13] Id.
[14] Id.
[15] Id.
[16] See id. at § 3.291(b)(1), (2), (3)(A), (4)(D).
[17] See Tex. Tax Code §§ 151.054(a), 151.104(a).
[18] See id. at §§ 151.302, 151.309, 151.310.
[19] See Tex. Tax Code § 151.309, 151.310(a).
[20] Id. at § 151.309.
[21] Tex. Tax Code § 151.310(a)(1)-(2).
[22] See 34 Tex. Admin. Code § 3.287(d)(2).
[23] Tex. Tax Code § 151.311.
[24] Id. at § 151.311(a)-(c).
[25] See 34 Tex. Admin. Code § 3.291(a)(5), (c)(4).
[26] Id. at § 3.291(a)(5).
[27] See id. at § 3.291(c)(5).
[28] Id. at § 3.291(c)(2)(B).
[29] See, e.g., STAR Accession No. 202007018L (July 31, 2020).
[30] See, e.g., id. (involving for-profit entities’ construction of a charter school campus with a useful life of 22 years that would be leased to an exempt organization for a term of 25 years).
[31] See, e.g., STAR Accession No. 202012011L (December 29, 2020) (involving certain improvements made by a for-profit lessee on land owned by and leased from the Port of Houston Authority of Harris County).
[32] See id. at § 3.291(c)(2).
[33] See id. at § 3.287(d)(2).
[34] Id. at § 3.291(c)(2).
[35] See STAR Accession Nos. 9906539L (June 23, 1999), 9312L1273G03 (Dec. 1, 1993); see also STAR Accession No. 201707003L (July 7, 2017) (involving a public-private partnership contracting for the construction of a hospital).
[36] See STAR Accession No. 9312L1273G03.
[37] See Tex. Tax Code §§ 151.006(a), 151.302(a); 34 Tex. Admin. Code § 3.285(b)(1)
[38] Tex. Tax Code § 151.006(a).
[39] See 34 Tex. Admin. Code § 3.291(b)(4)(A), (D), (c)(5).
[40] Id. at § 3.291(b)(2)(B).
[41] See id. at § 3.285(c)(2)(A).
