Were chilled-water charges and construction of a customer-owned distribution system subject to Florida sales tax?

Subject

Chilled Water Agreement

Plain-English summary

The utility's chilled-water revenue was exempt from Florida sales tax, and the amount paid for the customer-owned distribution piping was a nontaxable real-property-improvement charge. The planned closed system would chill water at a utility-owned plant, circulate it through permanently affixed pipes in the customer's facility to absorb heat, and return the warmer water to be rechilled.

The Department analyzed three possible sources of the circulating water. If the customer bought and supplied the water, the utility sold a cooling service; small amounts of corrosion- or contamination-control chemicals were inconsequential property within an exempt service. If the utility sold the water or retained title while transferring possession through the customer's pipes, the transaction was a sale of water—but water delivered through pipes was itself exempt.

That exemption covered fixed and variable chilled-water charges and passed-through costs of operating, maintaining, and repairing the utility-owned plant. The chemicals did not change the result as long as the delivered product retained its essential character as water rather than becoming mainly a carrier for chemicals.

The customer would acquire the completed, permanently affixed distribution system for a lump sum paid through allocated monthly amounts over 20 years. Because the system was presented as a real-property improvement, those payments were not taxable retail receipts. Separate future maintenance or repair of that system would remain nontaxable only under the listed lump-sum, cost-plus or fixed-fee, or guaranteed-price contract forms.

What this means for you

The tax analysis did not depend solely on calling the product a cooling service. Florida treated the water as tangible personal property and found a transfer of title or possession in each scenario, but the transaction still escaped tax through either the piped-water exemption or the service exemption for inconsequential property.

Contract allocation and property classification mattered separately. Charges tied to the utility-owned plant followed the exempt chilled-water transaction, while charges for the customer-owned piping followed the real-property-construction rules.

Common questions

Q: Was chilled water exempt even when the utility retained title? Yes. The customer possessed and controlled the water while it circulated through customer-owned pipes, creating a sale, but piped water was exempt under the rule applied.

Q: Did added treatment chemicals make the water taxable? Not on the stated facts. The chemicals served secondary purposes and did not change the product's essential character as water.

Q: Were electricity-based usage charges taxable? No. They were part of the exempt chilled-water sales price even though calculated from the electricity used to chill the water.

Q: Was the distribution system itself a taxable equipment sale? No under the assumed facts. It was permanently affixed, treated as a real-property improvement, and sold through a lump-sum arrangement.

Citations and references

• Fla. Stat. §§ 212.02(15), (16), (19), 212.05(1) — sale, sales price, tangible personal property, and retail sales tax
• Fla. Stat. § 212.08(4)(a)1. — exemption for water
• Fla. Stat. § 212.08(7)(v) — services involving inconsequential property with no separate charge
• Fla. Admin. Code r. 12A-1.019 — water delivered through pipes and added minerals or carbonation
• Fla. Admin. Code r. 12A-1.051(2) — contract forms for real-property improvements
• Fla. Stat. § 213.22 — Technical Assistance Advisements

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 98A-044

Original ruling text

SUMMARY

A utility provider will build a water cooling plant and a
system of pipes to carry the water from that plant through
a taxpayer's facility and back to the cooling plant. Title
to the pipe distribution system at the taxpayer's facility
will vest in the taxpayer. As the water flows through the
facility, it will provide air conditioning as heat
transfers from air blown across the pipes to the chilled
water, which will rise in temperature and return to the
utility's plant to be recooled and recirculated. Charges
made by the utility for constructing a chilled water
distribution system that constitutes a real property
improvement at the taxpayer's facility are exempt from
sales tax. Charges for providing chilled water that
circulates through the system and is used to air condition
the facility are exempt, because the sale of water
delivered through pipes such as those comprising the system
is exempt under s. 212.08(4), F.S., and Rule 12A-1.019,
F.A.C.

Jun 17, 1998

Re: Technical Assistance Advisement (98A-044)
Sales and Use Tax -- Chilled Water Agreement
Sections 212.02, 212.05, 212.08, F.S.
Rules 12A-1.019, 12A-1.051, F.A.C.

Dear :

This is in response to your letter to the Florida Department of
Revenue dated April 14, 1998, in which you asked for a technical
assistance advisement concerning the sales tax consequences of
transactions between XXX ("Customer") and the XXX ("Utility").
The facts stated below are based upon your letter and several
conferences you have had with the Department concerning this
request.

FACTS

Utility is a municipally owned utility. Utility desires to
provide Customer with chilled water to be used to provide air
conditioning for a facility owned by Customer. Utility will
construct, operate, and manage a central chilled water system
("CCWS"), which consists of a central chilled water plant
("CCWP") and a chilled water distribution system ("CWDS"). The
plant will consist primarily of equipment designed to cool
water, and the distribution system will consist primarily of
pipes through which the chilled water is circulated. The CCWP
is connected to the CWDS at two points, the supply connection
point and the return connection point.

Once in operation, the entire system is a closed system. Water
is chilled at the CCWP and delivered at the supply connection
point to the CWDS. The water flows through pipes in Customer's
facility where fans blow warm air over the pipes. The warm air
is cooled as its heat is transferred and warms the water in the
pipes. The warm water then returns to the CCWP through the
return connection point and is rechilled to begin the process
again. The water is not consumed or destroyed as it circulates
through the CCWS. Customer controls the temperature in its
facility through thermostats, which in turn control the fans and
thereby how much warm air passes over the pipes and how much
warming of the water in the pipes occurs. There is a cutoff valve
at Customer's facility that Customer can use to stop the flow of
water into the CWDS. This would be necessary, for example, if
there should be a leak in the CWDS.

Utility may add chemicals to the water that is put into the
system. These chemicals would not be an essential element in the
operation of the system but would serve secondary purposes such
as reducing the corrosive effects of the water or preventing its
contamination. No information has been provided concerning what
chemicals might be added. You assert that they would not be
classified as minerals and their addition does not involve
carbonation.

Customer will provide all necessary easements to permit Utility
to enter Customer's property and construct the CCWS. This will

include easements to extend water, electricity, and sewer service
to the CCWP and permanent access and control of the property
necessary for the CCWP so long as Utility is providing chilled
water to Customer as described herein. The CCWP will remain the
property of Utility. The Letter Agreement between the parties
dated April 24, 1997 (the "Letter Agreement"), provides that
Utility will sell the completed CWDS to Customer. It appears
that the sales price will be the actual cost to Utility of the
CWDS. You state as facts that the CWDS will be permanently
affixed to the buildings comprising Customer's facility and will
be a real property improvement. Utility would be permitted to
and anticipates that it may utilize the CCWP to provide chilled
water to other entities as well.

You present three alternatives concerning the source of the water
to be placed in the CWDS. In the first alternative, Customer
would purchase the water from a third party unrelated to Utility.
In the second alternative, Customer would purchase the water from
Utility for a separately stated and invoiced price prior to its
placement in the CCWS. In the third instance, Utility would
provide the water and retain ownership and control. If water
were lost from the system, it would be replaced by the same party
and in the same manner as the original water was acquired. In
all instances, Utility cools the water and circulates it through
the CCWS.

Under Item 6 of the Letter Agreement, Customer will pay Utility
three different types of fees for "Chilled Water Utility
Services", which will be included as three line items on a
monthly statement. The first is a minimum monthly charge. This
charge will be computed to permit Utility to recoup the capital
cost of the CCWS plus a 9.5% annual rate of return. In the final
computations, there will be an allocation of the monthly minimum
charge between the respective costs of the CCWP and the CWDS.
The portion attributable to the CWDS is in effect the purchase
price for Customer's purchase of that completed system, payable
over 20 years. If Customer terminates operations at the facility
during the first 20 years after the CCWS is constructed, Customer
will be required to pay a termination fee. The fee is computed
to equal that portion of the cost of the CWDS that Utility has
not already recouped through the monthly minimum fee. In effect,

if Customer terminates the agreement, the balance of the purchase
price of the CWDS will become due and payable immediately.

There will also be a variable charge based on usage. The Letter
Agreement between the parties dated April 24, 1997, refers to
this as a "consumption" charge. In your conferences with
Department representatives, you explained, and the Letter
Agreement confirms, that this charge is actually based on the
amount of electricity Utility is required to consume in chilling
the water at the CCWP, not on consumption by Customer of water.
The third type of fee is a monthly operation, maintenance, and
repair fee. According to the Letter Agreement, this fee is based
on actual costs for operating, repairing, and maintaining the
CCWP. Your letter also refers to fees for repair and maintenance
of the CWDS, but the Letter Agreement makes no mention of such
fees.

TAXPAYER POSITION

You contend that the entire revenue stream received by Utility
from Customer pursuant to the chilled water transactions
described above is either not taxable or is exempt from tax.
Your primary argument is that Utility is providing cooling
services with no transfer of title or possession of tangible
personal property, regardless of who purchases and owns the water
in the system. Because the water travels through a closed
system, you argue that Customer never is in possession of it.
You have pointed out that the water in this case differs from
electricity, gas, or other forms of power that utilities provide
and that are taxable, because the water is not dissipated or
consumed by Customer and returns to Utility at the return
connection point undiminished and unchanged except for being
warmer. You characterize the activity as only lowering air
temperature and the chilled water as a mere "medium for disposing
of heat energy in the air". The services of cooling air or
chilling water are not among those enumerated as subject to sales
tax in chapter 212, F.S., and therefore, you argue, the
transactions simply are not taxable.

If the Department does not agree that there is no transfer of
possession of tangible personal property, you argue in the

alternative that the transfer of water in this case is exempted
by section 212.08(4), F.S., and Rule 12A-1.019, F.A.C.

REQUESTED ADVISEMENTS

You request the Department's confirmation of the four following
specific conclusions:

1. None of the revenue derived from the provision of chilled
   water (alternatively, from the provision of chilled water
   cooling services) should be subject to the Florida sales tax
   whether the revenue is received in a fixed monthly amount or
   on a variable basis.
2. The portion of the revenue received from the construction
   of the CWDS should be revenue received for the construction
   of an improvement to real property.
3. Any revenue received by Utility which reimburses it for
   the cost of maintaining, operating and repairing the CCWP
   should be considered revenue from the provision of chilled
   water services and not subject to sales tax.
4. Any revenue received by The Utility for the maintenance
   and repair of the CWDS should be treated as a repair or
   improvement to real property and should not be subject to
   sales tax.

RELEVANT AUTHORITIES AND ANALYSIS

Section 212.05(1), F.S., imposes tax on the sales price for
retail sales of tangible personal property. "Sale" is defined in
section 212.02(15), F.S., to include any "transfer of title or
possession, or both, exchange, barter, license, lease, or rental,
conditional or otherwise, in any manner or by any means
whatsoever, of tangible personal property for a consideration".
The term also includes "producing, fabricating, processing,
printing, or imprinting of tangible personal property for a
consideration for consumers who furnish either directly or
indirectly the materials used in the producing, fabricating,
processing, printing, or imprinting". Section 212.02(16), F.S.,
defines "sales price" as "the total amount paid for tangible

personal property, including any services that are a part of the
sale,..." Section 212.02(19), F.S., defines "tangible personal
property" as "personal property which may be seen, weighed,
measured, or touched, or is in any manner perceptible to the
senses,..." Water can be seen, weighed, measured, and touched
and is therefore tangible personal property. If Utility transfers
title or possession of water for a consideration or processes
water furnished by Customer, that transaction is a sale within
the statutory definition of that term. If there is a sale of
water, the sales price will include charges for all related
services.

In this case, the provision of water is solely for the purpose of
cooling it and circulating it through the CWDS to air condition
Customer's plant. If there is a sale of water in this case, all
the charges related to the transaction, including charges for
cooling it so it will serve the intended purpose of removing heat
from Customer's air, will be taxable, regardless of whether the
charges are itemized to try to make the sale and the service
separable transactions. Therefore, if Utility acquires the water
and sells it to Customer, who then puts the water into the CWDS
so Utility can cool it, the sale of the water and the subsequent
cooling services will be viewed as a unified sale transaction and
the charges for both elements of the transaction will be part of
the "sales price" as defined in the statute.

If, on the other hand, Customer were to acquire the water from a
third party and place it in the CWDS and Utility then cooled and
circulated Customer's water, there would be no transfer of the
water from Utility to Customer because Utility would never have
had any interest in the water to transfer. There would, however,
be a transfer of tangible personal property from Utility to
Customer of those chemicals that are added to the water by
Utility. The added chemicals will not be essential to the
functioning of the CCWS and will instead serve secondary purposes
such as reducing corrosion. They will not have any significant
impact on pricing and would not be itemized as a separate item.
Section 212.08(7)(v), F.S., provides an exemption from sales tax
for "professional, insurance, or personal service transactions
that involve sales as inconsequential elements for which no
separate charges are made". In this case, the personal service

exemption would apply in the scenario where Customer purchases
the water for its CWDS from a party other than Utility.

In the third scenario presented in the request, Utility retains
title and risk of loss as to the water that it circulates through
Customer's CWDS. There is no transfer of title to the water to
Customer. You argue that because the water travels through a
closed system there is no transfer of possession either and
therefore no sale. A portion of that closed system is owned by
Customer and located in Customer's plant. Customer controls how
much warming of the water occurs by setting its thermostats and
regulating the fans that circulate air across the pipes
comprising the CWDS. Customer can control whether any water at
all enters the CWDS by operating the cutoff valve.

It is true that Customer employees cannot reach through the pipes
and touch the water, but that is not an essential element of
"possession", a term that is not defined for purposes of chapter
212, F.S. Possession is defined by Black's Law Dictionary (6th
ed. 1990) Possession at 1163 as "[t]he detention and control, or
the manual or ideal custody, of anything which may be the subject
of property, for one's use and enjoyment, either as owner or as
the proprietor of a qualified right in it, and either held
personally or by another who exercises it in one's place and
name". Customer certainly will enjoy the benefits of the water,
i.e., having it remove the heat from the air in Customer's
building. It will be in Customer's custody by virtue of being on
Customer's premises in Customer's CWDS. Because there will be a
transfer of possession, a sale will occur in your third scenario
even though Utility will retain title to the water.

Based on the above analysis, there will be a transfer of title or
possession of tangible personal property from Utility to Customer
in all three scenarios presented in your request. If the
Customer purchases the water from a third party and places it in
the system itself, however, the transfer of tangible personal
property (added chemicals) by Utility will be an inconsequential
element of an exempt personal service transaction.

Another exemption is available in the two scenarios where Utility
sells (i.e., transfers title or possession) water to Customer and

performs related chilling services. Section 212.08(4)(a)1.,
F.S., exempts water, but not mineral water or carbonated water,
from sales tax. Rule 12A-1.019, F.A.C., provides guidance on the
scope of the exemption for water. It provides that the sale of
water delivered through pipes or conduits is exempt. It goes on
to state that drinking water, including water that contains
minerals or carbonation in its natural state, is exempt but that
waters to which minerals or carbonation have been added are
taxable. The Department's position is that under this Rule water
delivered through pipes is always exempt, and the provision of
chilled water as described in this case would therefore be
exempt. The addition of chemicals as described would not change
that result, so long as the product being delivered retains its
essential character as water. (If the water became primarily a
medium for carrying other chemicals that were themselves a
substantial object of the transaction, this exemption would not
apply.)

In addition to the variable charge paid for the provision of
chilled water or the service of chilling Customer's water, an
itemized part of the amount that Customer will pay to Utility
each month is a fixed amount based on the cost to Utility of
constructing the CCWS. This is further allocable to the cost of
the CCWP, to which Utility retains title and which cost is being
passed through as an element of the provision of chilled water,
and the cost of the CWDS, which is being sold to Customer with
the purchase price being paid over 20 years (subject to
acceleration if Customer terminates its agreement to obtain
chilled water from Utility). The Letter Agreement does not state
that the allocation between those components of the monthly fixed
fee will be reflected in the monthly billing, but you have
assured me that the parties will be able to document their
agreement that the fixed fee is to be so allocated and the
application of part of the fee to the purchase price of the CWDS.

It has been presented as a fact that the CWDS is a real property
improvement. Section 212.05(1), F.S., provides that sales of
tangible personal property, not real property, are taxable. Rule
12A-1.051(2), F.A.C., discusses the application of the sales and
use tax laws to contractors who improve or construct real
property. Such a contract will fall into one of four categories

under the rule: lump sum, cost plus or fixed fee, guaranteed
price, and specifically itemized. Contractors performing lump
sum, cost plus, or guaranteed price contracts are the ultimate
consumers of materials and supplies they use. Unless a specific
exemption applies (which would be the case if Utility, a
governmental entity, made direct purchases of tangible personal
property for incorporation into the CWDS), those real property
contractors must pay sales or use tax on materials that are
incorporated into a real property improvement. Contractors
performing specifically itemized contracts are deemed to be
selling tangible personal property at retail, and must collect
tax from the purchaser based on the receipts from those sales,
excluding the charge for installation labor. Based on the Letter
Agreement, it appears that Customer will purchase the completed
CWDS for a lump sum to be paid over 20 years. In that case, the
amounts paid to Utility by Customer for the CWDS are not taxable.

The taxability of purchases by Utility and by contractors engaged
by Utility for construction of the CCWS, including the CCWP and
the CWDS, and of the easements granted by Customer to Utility for
purposes of the transaction contemplated in the Letter Agreement
was discussed in a Letter of Technical Assistance dated February
18, 1998. Your request for a technical assistance advisement did
not request further comment on those issues, and this response
accordingly does not address them.

ADVISEMENTS

Based upon the facts presented, stated assumptions made herein,
and the legal authorities and analysis set forth above, the
following advisements are made in response to your four specific
requests.

1. Consideration received by Utility for the provision of
   chilled water or chilled water services will not be subject
   to the Florida sales tax. It is immaterial whether the
   revenue is received in a fixed monthly amount or on a
   variable basis.

2. Any costs to Utility for providing the chilled water or
   cooling services that are passed through as an element of

the monthly charges for the water or services, including the
costs of maintaining, operating, and repairing the CCWP,
will be part of the sales price for the water or services.
Because the transaction itself will be either an exempt sale
of water or an exempt personal services transaction
(depending on who owns the water and how it was acquired),
the entire sales price will be exempt from tax.

3. Consideration received by Utility from Customer in exchange
   for the construction of the CWDS will be nontaxable payment
   for an improvement to real property.

4. If, in addition to the payments described in the Letter
   Agreement, Customer engages Utility to maintain or repair
   the CWDS, charges related to such maintenance and repairs
   will be nontaxable so long as the contract is a lump sum,
   cost plus or fixed fee, or guaranteed price contract.

This response constitutes a technical assistance advisement under
s. 213.22, F.S., which is binding on the department only under
the facts and circumstances described in the request for this
advice as specified in s. 213.22, F.S. Our response is
predicated on those facts and the specific situation summarized
above. You are advised that subsequent statutory or
administrative Rule changes or judicial interpretations of the
statutes or rules upon which this advice is based may subject
similar future transactions to a different treatment than
expressed in this response.

You are further advised that this response and your request are
public records under Chapter 119, F.S., which are subject to
disclosure to the public under the conditions of s. 213.22, F.S.
Your name, address, and any other details which might lead to
identification of the taxpayer must be deleted by the department
before disclosure. In an effort to protect confidential
information, we request you notify the undersigned in writing
within 15 days of any deletions you wish made to the request or
this response.

Sincerely,

Linda W. Bridges
Tax Law Specialist

Control #: 33790