When a contractor incorporates its own materials into Colorado real property, is the fee paid to a third-party fabricator excluded from the use tax on those materials?

Plain-English summary

A steel-erection subcontractor buys primary steel out of state, fabricates it into structures, and installs those into Colorado construction projects. As it grows, it increasingly hires third-party fabricators to do the fabrication, while keeping title to and a security interest in the materials. It structured the deals so that (1) it buys the primary steel from out-of-state mills; (2) it buys secondary materials (brackets, plates) from vendors who may or may not also be the fabricators; (3) it signs a Fabrication Services subcontract that doesn't include any transfer of property; and (4) it transfers possession of its materials to the fabricator but keeps title. It argued that under IBM v. Department of Revenue (601 P.2d 622) the fabrication labor is excluded from use tax in both cases — whether the fabricator is a separate party or is also the materials vendor.

The Department agreed on the first and disagreed on the second:

• Baseline: a taxpayer who buys property out of state and incorporates it into Colorado real property is the consumer and owes use tax on its acquisition cost — and that does not include the cost of its own labor to manufacture the finished product (IBM).
• Separate fabricator → labor excluded. If the taxpayer buys materials from one supplier and delivers them to a different party for fabrication services, the fabrication charges are not in the use tax computation.
• Same party sells materials AND fabricates → labor included. When the taxpayer buys both the materials and the fabrication from the same third party, the fabrication labor IS in the use tax base. The true object is acquiring a custom-made article, and Regulation (39)26-102.12 applies use tax to charges for "manufacturing, producing, fabricating, and processing" property made-to-order or tailor-made for the customer. Under § 39-26-102(12) a seller of custom-made products can't separately state the materials from the manufacturing services to dodge tax. IBM doesn't say otherwise, and A.D. Stores (which involved alteration of finished goods) doesn't govern this.

What this means for you

Contractors and fabricators sourcing made-to-order parts

The use tax on materials you incorporate into Colorado realty turns on who does the fabricating. Your own fabrication labor is out (you're taxed on acquisition cost, IBM). A separate fabricator's labor — where you bought the raw materials elsewhere and just hand them over for services — is also out. But the moment you buy the finished, fabricated part from the same vendor that supplied the steel, you're buying a custom-made article, and the fabrication labor is in the taxable cost. Splitting the invoice into "materials" and "fabrication" won't carve the labor out.

Structure follows substance

The taxpayer here tried to keep materials and fabrication legally separate (separate contract, retained title). That works when the fabricator isn't your materials supplier. When it's the same party, the Department looks at the true object — a tailor-made article — and taxes the whole acquisition cost regardless of the paperwork.

Distinguish alteration of finished goods

A.D. Stores (separable alteration of already-finished goods) is a different situation. It doesn't let you treat the original fabrication of a made-to-order part as a separable, untaxed service.

Common questions

Q: Is my own fabrication labor subject to Colorado use tax?
A: No. When you incorporate your materials into Colorado real property, use tax is on your acquisition cost and doesn't include the cost of your own labor to manufacture the finished product (IBM).

Q: I hire a separate company to fabricate materials I bought elsewhere — is their labor taxed?
A: No. If the fabricator is a different party from your materials supplier, those fabrication charges aren't included in the use tax computation.

Q: What if the same vendor sells me the steel and fabricates it?
A: Then the fabrication labor IS in the use tax base. You're buying a custom-made article, and materials and manufacturing services can't be separately stated to avoid tax.

Q: Can I just itemize materials separately from fabrication to keep the labor untaxed?
A: Not for a made-to-order product from a single vendor. Section 39-26-102(12) bars separately stating to dodge tax on a custom-made article.

Q: Can I rely on this letter?
A: No. It's a General Information Letter — general guidance, not binding on the Department.

Citations and references

Statutes, regulations, and cases:
- § 39-26-102(12), C.R.S. — purchase price includes materials and services performed in connection with the sale; bars separately stating to avoid tax on custom-made articles
- Department Regulation (39)26-102.12 — use tax applies to manufacturing/fabricating/processing made-to-order or tailor-made property
- International Business Machines v. Department of Revenue, 601 P.2d 622 (Colo. 1979) — use tax on a consumer's acquisition cost excludes the cost of its own labor
- A.D. Stores Co. v. Department of Revenue, 19 P.3d 680 (Colo. 2001) — alteration of finished goods (distinguished)

Related Colorado contractor/tax-base letters:
- [[gil-08-027-ruling-request-commercial-signage-and-installation]] — contractor time-and-material vs. lump-sum; separability
- [[gil-08-009-taxability-of-telecommunications-tower]] — contractor/consumer framework
- [[plr-08-002-xxxxxxxxxxxxxx]] — IBM v. Charnes and value-shifting in the tax base

Source

• Landing page: https://tax.colorado.gov/sales-use-tax-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/GIL-08-030.pdf

Original ruling text

Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]

GIL-2008-030
December 29, 2008
XXXXXXXXXXXXXXXXX
Attn: XXXXXXXXXXXX
XXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXX
Re: XXXXXXXXXXXXX
Dear XXXXXXXX,
Your company represents XXXXXXXXXXX (“Taxpayer”) which requests a general
information letter regarding the calculation of use tax on certain transactions more fully
described below.
Issue
Is the contract price paid to third-party fabrication service providers to perform fabrication
services on Taxpayer’s materials excluded from Colorado use tax applicable to the
materials that are incorporated into real property by or through Taxpayer in Colorado?
Background
You represent on behalf of your client the following facts. Taxpayer is a [another state]
corporation that subcontracts with general contractors to erect steel into construction
projects that are located in Colorado, as well as other states, under cost-plus or lump
sum subcontracts. Taxpayer purchases the primary steel materials used for such
subcontracting work from steel mills and vendors located outside Colorado. Generally,
taxpayer ships purchase materials directly to its facility located in [other states] where
taxpayer fabricates the material into the desired structures that will be incorporated into
its projects. After Taxpayer fabricates these materials into the desired structure,
Taxpayer ships the final fabricated pieces to project sites to be installed into the projects
by its employees or its agents.
Due to the continued expansion of Taxpayer’s business, the resulting increased volume
of business coupled with Taxpayer’s limited fabrication capacity has required Taxpayer to
more frequently engage third parties to perform the fabrication services, in lieu of

Taxpayer, to form Taxpayer’s material into the structures that will be incorporated by
Taxpayer into its projects. However, Taxpayer’s business need to use third-party
fabricators must be balanced with Taxpayer’s other business interests to retain favorable
pricing of steel materials from the steel mills and vendors, to continue to control the
quality and timing of the procurement of the materials, to track the materials for the
quality specifications required for the various fabricated parts to be incorporated into
Taxpayer’s projects, and to retain title and security interests in the material to enable it to
repossess the materials if necessary. To protect these other business intersect,
transactions with third-party fabricators will be structured as follows:
1. Taxpayer will purchase all primary steel beams/materials from third-party steel
mills located outside Colorado.
2. Taxpayer will purchase all secondary/incidental materials (brackets, plates, etc.)
required for fabrication from a retail vendor that may or may not be located outside
Colorado. The third-party vendors may or may not also be the third-party
fabricators utilized by Taxpayer.
3. Taxpayer will enter into a Fabrication Services Subcontract Agreement with thirdparty fabricators to perform fabrication services. Such Agreement does not
include or relate to any transfer of tangible personal property. These services are
independent and separate from all material purchases.
4. Possession of all materials necessary for the fabrication services (Taxpayer’
primary and secondary materials) will be transferred to third-party fabricators.
However, Taxpayer will retain title to such materials, security interest in such
materials, and can repossess the materials upon a breach of contract by the
fabricator.
Under these contractual relations, Taxpayer owns and retains title to and security interest
in all materials necessary to fabricate its required structures. Any third-party fabricator
provides services only and provides them in a contract that is separate from and
independent of all purchases of tangible personal property.
Taxpayer argues that the holding in International Business Machines v. Department of
Revenue, 374 601 P2d 622 (Colo. 1979),extends both (1) to fabrication services
performed by third-party fabricators to whom Taxpayer provided materials that Taxpayer
acquired from other suppliers, and (2) to fabrication services performed by third-party
fabricators who are also suppliers of the materials. We agree that fabrication services in
the first instance are not included in the use tax calculation, but disagree that the
fabrication services in the second scenario are excluded from the calculation.
Discussion
A taxpayer who purchases outside of Colorado tangible personal property that is then
brought into Colorado and incorporated into real property is considered the consumer of
that property and must pay use tax. Use tax is computed based on the taxpayer’s cost of
acquisition and does not include the cost of its own labor to manufacture the property into
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the finished product. International Business Machines v. Department of Revenue, 374
601 P2d 622 (Colo. 1979). Similarly, if a taxpayer purchases property from one supplier
and then delivers the property to another party who performs fabrication services, the
charges for those services are not included in the use tax computation.
However, when a taxpayer purchases both the materials and fabrication service from the
same third-party, charges for fabrication labor are included in the use tax calculation.
The true object of such a transaction is the acquisition of a custom made article.
Department Regulation (39)26-102.12 specifically addresses the computation of use tax
Sales and use tax applies to charges for manufacturing, producing, fabricating, and
processing tangible personal property which has been made-to-order or tailor-made
for the customer.
Thus, use tax is computed on the purchase price paid to acquire the machined item and
the service costs components are included in the use tax calculation.
Moreover, it is flatly inconsistent with §39-26-102(12), C.R.S.1 to conclude that a seller of
custom made products can, for purposes of sales or use tax computation, separately
state the charge for materials from the charge for manufacturing services. International
Business Machines does not otherwise hold. Nor is this circumstance governed by AD
Stores v Department of Revenue, 19 P.3d 680 (Colo. 2001), which involved alteration
services for finished goods.
Miscellaneous Matters
Please note that the department does not collect sales and use taxes for “home-rule”
cities and counties. You can find a list of these jurisdictions by visiting our web site at:
www.revenue.state.co.us (go to Taxation > Forms > Businesses > Sales and Use >
DRP 1002)
Contact those governments for information about their taxes.
This general information letter represents the advice of experienced members of the
Department’s staff. However, it is not binding on the department. Enclosed is a redacted
version of this ruling. Pursuant to statute and regulation, this redacted version of the
ruling will be made public within 60 days of the date of this letter. Please let me know in
writing within that 60 day period whether you have any suggestions or concerns about
this redacted version of the ruling.

“Sales tax is imposed on the full purchase price of articles sold after manufacture or after having been made to order
and includes the full purchase price for materials used and the service performed in connection therewith, … [S]ales
price is the gross value of all materials, labor, and service, and the profit thereon, included in the price charged to the
user or consumer.”

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Sincerely,
Office of Tax Policy
Colorado Department of Revenue

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