When a private company operates a municipality's wastewater treatment facility under a service contract, does the company have to pay sales tax on its own operating supplies, given that the municipality itself is tax-exempt?

Plain-English summary

The Village of East Aurora, under a state Department of Environmental Conservation consent order, built a new wastewater treatment facility financed through Environmental Facilities Corporation bonds, and in 1985 contracted with Environmental Elements New York Inc. ("Enelco") to operate it. Enelco held title to the facility (the Village had a standing option to buy it, which it exercised in 1995), and the Village reimbursed Enelco quarterly for all its costs -- including taxes -- plus a management fee. Enelco carried its own liability insurance, and the service agreement had no language making Enelco the Village's agent; a clause even shielded the Village from liability for Enelco's operation and maintenance decisions. The Village asked whether Enelco's purchases of materials to run the facility are subject to sales and use tax.

The Village itself, as a political subdivision of New York, is a tax-exempt organization. But that exemption belongs to the Village -- it doesn't automatically flow through to an independent contractor operating on the Village's behalf. Under the Department's regulations, a contractor's purchases of supplies used to perform its own operations (rather than becoming a physical part of the exempt organization's real property) stay taxable unless the contractor is genuinely acting as the exempt organization's agent when it buys them. And agency isn't just a label -- it requires an actual manifested consent by the contractor to act on the principal's behalf, subject to the principal's control, plus the principal's own authorization of that fiduciary relationship. Here, the contract had no agency language at all, and the liability-shielding clause pointed the opposite way (principals are normally on the hook for their agents' actions; the Village expressly wasn't). So the Department concluded Enelco was operating as an independent contractor, not the Village's agent -- meaning Enelco's supply purchases (to the extent they don't become part of the facility itself) are taxable, regardless of the contract's reimbursement arrangement for Enelco's tax costs.

There's one important timing wrinkle: while Enelco held title to the facility (1985–1995), the facility wasn't yet the Village's own real property, so the separate exemption for contractor materials that get incorporated into an exempt organization's real property didn't apply at all during that period. Only after the Village exercised its purchase option in 1995 and actually owned the facility could Enelco's purchases of materials that get built into the facility qualify for that incorporation-based exemption going forward.

What this means for you

Municipalities contracting out operation of public facilities

Don't assume your own tax-exempt status protects your operating contractor's purchases. Unless the contract genuinely establishes an agency relationship (with real consent, control, and authorization -- not just a label), the contractor will generally owe tax on its own operating supplies, and reimbursing that tax cost through your service fee doesn't change who legally owes it.

Contractors operating exempt-organization facilities under service agreements

Check your contract for agency language and liability allocation before assuming your supply purchases are tax-exempt just because your customer is exempt. A clause disclaiming your principal's liability for your operational decisions -- common in service agreements to limit municipal liability -- can actually work against an agency argument if you're later trying to claim exempt-purchaser status.

Accountants and tax professionals

This ruling offers a clean two-factor checklist for any exempt-organization service contract: (1) is there a genuine agency relationship (manifested consent + control + authorization, not contract labels) that would let the contractor buy as the exempt organization's own purchasing agent, and (2) separately, do specific materials actually become incorporated into the exempt organization's real property (which has its own exemption under § 1115(a)(16), but only once the organization actually owns that real property).

Common questions

Q: Does a municipality's tax-exempt status cover its contractor's purchases automatically?
A: No -- the exemption belongs to the exempt organization itself; a contractor's own purchases stay taxable unless it's genuinely acting as the exempt organization's agent, or the materials are actually incorporated into the exempt organization's real property.

Q: What makes a contractor a true "agent" of an exempt organization for this purpose?
A: A real manifestation that the contractor consents to act on the exempt organization's behalf, subject to its control, plus the exempt organization's own authorization of that relationship -- not just contract language reimbursing costs or taxes.

Q: Why did the outcome change after 1995?
A: Before 1995, Enelco (not the Village) owned the facility, so it wasn't yet the Village's exempt real property and the incorporation-based materials exemption couldn't apply at all. After the Village exercised its purchase option and took ownership in 1995, materials Enelco purchased that actually became part of the facility could then qualify under that exemption.

Citations and references

Statutes, regulations, and case law:

• Tax Law § 1115(a)(16) (exemption for contractor materials incorporated into exempt organization's real property)
• Tax Law § 1116(a)(1) (exemption for New York State political subdivisions)
• 20 NYCRR § 541.3(d)(2)(iv) (contractor purchases subject to tax absent agency contract or incorporation into realty)
• Matter of Hooper Holmes v Wetzler, 152 AD2d 871 (agency relationship requires manifested consent and control)
• Matter of Swet, TSB-S-91(10)S

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1999.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a99_24s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-99(24)S
Sales Tax
April 8, 1999

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S981023A

On October 23, 1998, the Department of Taxation and Finance received a Petition for
Advisory Opinion from the Village of East Aurora, 571 Main St., East Aurora, New York 14052.
Petitioner, the Village of East Aurora, provided additional information pertaining to the petition on
January 5, 1999.
The issue raised by Petitioner is whether the purchase of materials by Environmental
Elements New York Inc. ("Enelco") used for the operation of a wastewater treatment facility
constructed and operated solely for Petitioner is subject to sales and use tax.
Petitioner submits the following facts as the basis for this Advisory Opinion.
Petitioner, pursuant to an Order on Consent issued by the Department of Conservation, was
required to build a new wastewater treatment facility (the "facility"). This was done by Petitioner
with financing through the Environmental Facilities Corporation (a New York Public Authority)
issuing its special obligation bonds. Petitioner contracted with Enelco in 1985 to operate the facility.
All costs, including taxes, incurred by Enelco in the operation of the facility were reimbursed by
Petitioner. Title to the facility was in Enelco. Petitioner had an option at all times to purchase the
facility, which option was exercised by Petitioner in 1995.
Petitioner submitted a copy of its service agreement with Enelco. The agreement does not
contain any language expressly making Enelco the agent of Petitioner. Under the agreement,
Petitioner pays Enelco a service fee on a quarterly basis, which covers Enelco’s costs and also
includes a management fee. Enelco is responsible for obtaining insurance, including liability
insurance, in its own name. Paragraph 7.10 of the agreement provides, in part, as follows:
No Waiver. The exercise or performance by the village of any of its approval
rights or obligations respectively under paragraph 5.18 [pertaining to modifications
by Enelco to the operation and maintenance manual for the facility] or Section 11
[pertaining to changes to operating or maintenance procedures, or repairs to the
facility] may not subject the Village to any responsibility or liability for the design
or construction of New Facilities, operation or maintenance of the New Facilities .
. . . (emphasis added)

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TSB-A-99(24)S
Sales Tax
April 8, 1999
Applicable Law & Regulations
Section 1115(a) of the Tax Law provides, in part:
Receipts from the following shall be exempt from the tax on retail sales
imposed under subdivision (a) of section eleven hundred five and the compensating
use tax imposed under section eleven hundred ten:
*

*

*

(16) Tangible personal property sold to a contractor, subcontractor or
repairman for use in maintaining, servicing or repairing real property, property or
land of an organization described in subdivision (a) of section eleven hundred
sixteen, as the terms real property, property or land are defined in the real property
tax law; provided, however, no exemption shall exist under this paragraph unless
such tangible personal property is to become an integral component part of such
structure, building or real property.
Section 1116 of the Tax Law provides, in part:
Exempt organizations. (a) Except as otherwise provided in this section, any
sale or amusement charge by or to any of the following or any use or occupancy by
any of the following shall not be subject to the sales and compensating use taxes
imposed under this article:
(1) The state of New York, or any of its agencies, instrumentalities, public
corporations (including a public corporation created pursuant to agreement or
compact with another state or Canada) or political subdivisions where it is the
purchaser, user or consumer, or where it is a vendor of services or property of a kind
not ordinarily sold by private persons;
Section 541.3(d)(2)(iv) of the Sales and Use Tax Regulations provides, in part:
Except for agency contracts, contractors’ purchases of construction supplies
which do not become part of an exempt organization’s real property and are used or
consumed by the contractor, as well as purchases of taxable services, such as
electricity used by the contractor, are subject to the tax.
*

*

*

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TSB-A-99(24)S
Sales Tax
April 8, 1999

The following types of property and services are representative, but not
intended to be all inclusive, of contractors’ purchases which are subject to tax,
irrespective of whether the contractor has a time and material, lump sum, or other
type of contract (except agency contract), with an exempt organization:
(a) construction machinery and equipment, including rentals and repair parts;
(b) contractors’ office supplies;
(c) contractors’ supplies, tools, and miscellaneous equipment, whether
purchased or rented, including materials to make forms and scaffolding;
(d) any other items purchased or rented by a contractor for his use in
performing the contract and not incorporated into the realty.
Example 7: Lumber and other materials which are used to build forms are not
exempt since they do not become part of the structure.
Example 8: Equipment rentals under the dominion and control of the
contractor, such as rentals of cranes, bulldozers, backhoes, etc. for use in building a
structure for an exempt organization are subject to tax.
Opinion
Petitioner is a political subdivision of New York State which is exempt from sales and use
tax under Section 1116(a)(1) of the Tax Law.
Purchases of materials by a contractor for use in performing services for an exempt
organization are not exempt merely because the contractor has an agreement with the exempt
organization. As provided in Section 541.3(d)(2)(iv) of the Sales and Use Tax Regulations, "Except
for agency contracts, purchases of construction supplies which do not become part of an exempt
organization’s real property and are used or consumed by the contractor, as well as purchases of
taxable services, such as electricity used by the contractor, are subject to tax." Enelco’s purchases,
therefore, of tangible personal property for use in operating the wastewater treatment facility which
does not become part of the facility are subject to sales and compensating use tax, unless Enelco
makes such purchases as Petitioner’s agent.
In order for an agency relationship to exist, there must be a "manifestation" that Enelco
consents to act on behalf of Petitioner, subject to its control, and that Petitioner authorizes the
fiduciary relationship. See Matter of Hooper Holmes v Wetzler, 152 AD2d 871, lv den, 75 NY2d
706; Matter of Swet, Dec Tx App Trib, February 22, 1991, TSB-S-91(10)S. Whether an agency

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TSB-A-99(24)S
Sales Tax
April 8, 1999

relationship exists is a question of fact that must be resolved based upon the circumstances in each
case.
The service agreement submitted by Petitioner does not contain any language which
expressly confers agency status on Enelco. Paragraph 7.10 of the agreement indicates that Petitioner
is not subject to liability for the operation or maintenance of the facility by Enelco. This is
inconsistent with a principal-agent relationship, since the principal generally will be liable for actions
performed by its agent within the scope of its agency. It appears from this contract that Petitioner
intended Enelco to operate the treatment facility as an independent contractor. Assuming Enelco
does not make purchases as Petitioner’s agent, any supplies used by Enelco in operating the facility
for Petitioner, which do not become part of the facility, are subject to sales and use tax when
purchased by Enelco. It is immaterial that Petitioner’s contract contains language that allows Enelco
to recoup its sales tax expense from Petitioner.
Under the provisions of Section 1115(a)(16) of the Tax Law, a contractor is allowed to make
tax exempt purchases of tangible personal property for use in maintaining, servicing or repairing real
property of an exempt organization as described in Section 1116(a) of the Tax Law if the tangible
personal property is actually incorporated into the real property. Therefore, those purchases of
tangible personal property by Enelco after the village purchased the facility in 1995 would be exempt
where the property became part of the facility. Purchases by Enelco while it owned the facility were
not exempt under Section 1115(a)(16), since the facility at that time was not real property of an
exempt organization.

DATED: April 8, 1999

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.