Can a contractor that improves a government facility under an informal but binding agreement buy the incorporated materials free of Connecticut sales tax?

Note: DRS has obsoleted this Ruling in part by Announcement AN 2000(8). It still illustrates how DRS analyzed whether an informal arrangement counts as a "construction contract" with an exempt entity, but check AN 2000(8) and current DRS guidance before relying on it.

Plain-English summary

A limited partnership was hired by a Connecticut political subdivision (the "Agency") to operate, manage, and maintain the Agency's facility, which the Agency owned. After a prior operator failed, the Agency brought in the partnership and agreed to pay for certain improvements the partnership deemed necessary — funding them through bond proceeds, with the partnership executing a Tax Compliance Certificate and the Agency's engineers reviewing requisitions before payment. The service contract also let the Agency require the partnership to undertake capital projects at the Agency's cost. The question: were those improvements made under a "construction contract" with an exempt entity, so the partnership could buy the incorporated materials and supplies tax-free?

Under Conn. Agencies Regs. § 12-426-18, a contractor working under a construction contract with an entity exempt via § 12-412(1), (2), or (5) may buy, free of sales and use tax, materials and supplies physically incorporated into that entity's real property. The Agency clearly qualified as an exempt entity under § 12-412(1) (a political subdivision). So the whole question came down to: was there a construction contract between the Agency and the partnership?

DRS said yes — despite the messy, informal history. The arrangement grew out of a letter of intent, an escrow agreement, and a letter of understanding, plus the service contract, and "did not result in a traditional construction contract as that term is customarily used." But the elements of a binding contract were all present: offer and acceptance for consideration, with sufficient certainty about the improvements to be made and who would make them (the partnership) (13 Am. Jur. 2d Building and Construction Contracts § 1). "While the agreement … may lack many of the formalities often associated with contracts, it nonetheless is a binding contract." That satisfied the regulation. So the partnership, as a contractor under that construction contract, could buy the materials and supplies incorporated into the Agency's facility exempt from sales and use tax.

As flagged above, DRS later obsoleted this Ruling in part by AN 2000(8).

What this means for you

Contractors working on government projects

Materials and supplies you physically incorporate into a tax-exempt government entity's real property can be bought tax-free when you're working under a construction contract with that entity (§ 12-426-18). This 1993 ruling shows the contract need not be a formal, traditional construction contract — but given AN 2000(8), confirm the current requirements before relying on informal arrangements.

Substance over form — but document it

DRS looked past the lack of a formal construction contract to the substance: a binding agreement (offer, acceptance, consideration, certainty) for specified improvements at the exempt entity's expense. Keep your letters of intent, understandings, and service-contract capital-project provisions organized so the binding agreement is demonstrable.

Government facility operators and P3s

Public-private arrangements where the private operator makes owner-funded improvements can support the governmental construction-contract exemption on incorporated materials. Because AN 2000(8) has since narrowed this area, verify present treatment before assuming the exemption applies.

Common questions

Q: Can a contractor buy materials tax-free when improving a government building?
A: Yes, when working under a construction contract with a tax-exempt government entity (§ 12-412(1)); materials and supplies physically incorporated into the entity's real property are exempt under Conn. Agencies Regs. § 12-426-18. Note that AN 2000(8) has since obsoleted part of this ruling.

Q: Does the contract have to be a formal construction contract?
A: In this 1993 ruling, no. DRS found that an informal arrangement (letters of intent/understanding plus a service contract) was still a binding contract with the necessary offer, acceptance, consideration, and certainty, satisfying the regulation's construction-contract requirement.

Q: Who has to pay for the improvements for the exemption to apply?
A: Here the exempt Agency bore the cost (through bond proceeds), and the improvements were physically incorporated into the Agency's own facility — the setup the exemption is built around.

Q: Can I still rely on this ruling?
A: Not without checking AN 2000(8), which obsoleted it in part, and confirming the current DRS rules for governmental construction-contract purchases.

Citations and references

Statutes, regulations, and authorities:

• Conn. Agencies Regs. § 12-426-18 (contractor purchases incorporated into an exempt entity's realty); § 12-426-18(a) (construction contract / contractor definitions)
• Conn. Gen. Stat. § 12-412(1) (State and political subdivisions exempt); § 12-412(2), (5) (other exempt entities)
• 13 Am. Jur. 2d Building and Construction Contracts § 1 (contract formation)

Related guidance (described in prose, not linked):

• Announcement AN 2000(8) (obsoletes this Ruling in part)

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 93-22

Original ruling text

Ruling 93-22, Sales and Use Taxes / Construction Contract / Exemption, Governmental

This Ruling is obsoleted in part by AN 2000(8)

FACTS:

A limited partnership (hereinafter "the Partnership") is under contract with a political subdivision of the State of Connecticut (hereinafter "the Agency") to operate, manage and maintain the Agency's facility (hereinafter "the Facility"). The general partner (hereinafter "the Partner") of the Partnership is the wholly-owned subsidiary of another company (hereinafter "the Company").

The Agency has title to the Facility and fee ownership of the real property on which the Facility is located. Prior to the aforementioned contract being entered into, the Agency had contracted with another party (hereinafter "the Predecessor") to design, construct, test and conduct interim operations of the Facility and later to operate, manage and maintain the Facility. After the Predecessor was unable to fulfill its contractual obligations, the Agency negotiated with the Company to purchase the Predecessor's partnership interest and to enter into its own service contract with the Agency. To induce the Company to purchase the partnership interests, the Agency agreed to bear the cost of certain improvements to the Facility that would be made by the Partnership and that the Partner and the Company deemed necessary to the proper operation of the Facility. The Agency issued bonds whose stated purpose was to pay for the aforementioned improvements. As part of the bond issuance, the Partner executed a Tax Compliance Certificate providing that the Partnership would employ the bond proceeds to make the specified improvements. Requisitions for payment of completed work were to be reviewed by the Agency's engineers to insure that the work had been completed prior to payment being made from the bond proceeds.

Coincident with the above, the Agency and the Partnership entered into a service contract under which the Partnership agreed to operate, manage and maintain the Facility. That contract provided, inter alia , that the Partnership might undertake or be required to undertake certain capital projects at the cost and expense of the Agency. These costs the contract distinguished from certain other costs incurred by the Partnership for which there was no right to reimbursement from the Agency pursuant to the Partnership's obligation to operate and maintain the Facility.

ISSUE:

Whether improvements made by the Partnership to the Agency's Facility were made pursuant to a construction contract within the meaning of Conn. Agencies Regs. § 12-426-18(a), thus allowing the Partnership, because the contract was with a political subdivision of the State of Connecticut, to make purchases of materials and supplies to be physically incorporated into, and become a permanent part of, the Facility that are exempt from sales and use taxes.

DISCUSSION:

A contractor who enters into a construction contract with an entity exempt from sales and use taxes by virtue of Conn. Gen. Stat. § 12-412(1), (2) or (5) may make purchases of materials and supplies to be physically incorporated into such entity's real property that are exempt from sales and use taxes. Conn. Agencies Regs. § 12-426-18. In order for those purchases to be so exempt, there must be a construction contract, as defined in Conn. Agencies Regs. § 12-426-18(a), between a contractor, as defined therein, and an exempt entity.

The Agency is an entity exempt from sales and use taxes pursuant to Conn Gen. Stat. § 12-412(1). The critical question, thus, is whether there is a construction contract between the Agency and the Partnership for the improvement of the Agency's Facility. If such a contract exists, then the partnership as a contractor may make purchases of materials and supplies to be physically incorporated into the Agency's Facility as part of that contract that are exempt from sales and use taxes.

It is apparent that the road to operational capacity for the Agency's Facility was a long and tortuous one. After failing to achieve operational status with the Predecessor, the Agency contracted with the Company to bring the Facility to operational ability. Through a chain of events that included a letter of intent, an escrow agreement and a letter of understanding, the Agency, the Company and the Partnership arrived at a point where the Agency agreed to pay for improvements that the Company and the Partnership deemed necessary for the proper operation of the Facility. These improvements were delineated and the party responsible for making the improvements, the Partnership, was designated.

The negotiations between the parties did not result in a traditional construction contract as that term is customarily used. However, it is clear that there was an agreement between the parties based on an offer and acceptance for consideration with sufficient certainty as to the improvements to be made. 13 Am. Jur. 2d Building and Construction Contracts §1. While the agreement between the parties may lack many of the formalities often associated with contracts, it nonetheless is a binding contract between the parties for the improvement of the Agency's Facility. As such it meets the construction contract requirement of Conn. Agencies Regs. § 12-426-18(a).

The capital projects that the parties agreed that the Partnership might undertake or be required to undertake at the cost and expense of the Agency also comply with the construction contract requirement of the regulation. Thus, purchases of materials and supplies to be physically incorporated into the Agency's Facility and the cost for which is borne by the Agency are exempt from sales and use taxes pursuant to Conn. Agencies Regs. § 12-426-18.

RULING:

As a contractor acting pursuant to a construction contract between the Partnership and the Agency, under which contract the Partnership is obligated to make, and the Agency is obligated to pay for, certain improvements, the Partnership may make purchases of materials and supplies to be physically incorporated into the Agency's Facility pursuant to the contract that are exempt from sales and use taxes.

LEGAL DIVISION

Issued: November 9, 1993