When a company leases construction equipment (with its own employees as operators) from its parent, and uses that equipment to unload, transport, and rough-set heavy generators for a general contractor, who owes Texas sales/use tax at each step — and should equipment bought for this purpose be purchased under a resale certificate or with tax paid up front?

Plain-English summary

A crane-and-equipment company (the "Company"), a wholly owned subsidiary that leases cranes, loaders, and similar equipment from its parent ("Parent Corporation"), bid as a subcontractor on a Texas construction project. Its job: unload heavy generators from railcars using leased cranes and its own employees, transport them by truck to the job site, and "rough set" them in place (moving and securing them, but not permanently installing them or making them ready for final use). Parent Corporation was also considering buying a new loader to lease to the Company for similar hauling work, and Parent Corporation had previously been audited and told by an auditor that it had two options going forward: pay tax on equipment it buys for its own use (so the Company wouldn't need to charge tax on rentals), or issue a resale certificate on equipment purchases and instead collect tax when it rents the equipment out.

The Comptroller worked through nine numbered questions and reached a consistent core answer: the Company is not renting equipment to the general contractor and is not a contractor improving real property — it is providing a nontaxable transportation/rigging service (receiving, off-loading, transporting, and rough-setting the generators). That's true even though its contract with the general contractor separately states amounts for labor and materials, because the arrangement doesn't meet Rule 3.294(c)(2)(A)(i)'s two-part test for a taxable equipment-with-operator rental: (i) the customer must exercise direct control or supervision over the equipment operator, and (ii) the parties must have intended a lease of equipment with a separately furnished operator. Since the Company (not the general contractor) directs its own crane operators as part of a rigging/hauling job, this isn't a rental — it's a service.

Because the Company provides a nontaxable service, it owes no tax collection obligation to the general contractor, but it does owe tax on its own inputs — specifically, on the equipment it leases from Parent Corporation to perform that service. The ruling then works through the lease chain: Parent Corporation should issue a resale certificate when it buys equipment it intends to lease out, and instead collect tax from the Company on the lease payments (Rule 3.294(f)(1), operating lease). If Parent Corporation already paid tax up front on equipment and later leases it to the Company, it must still collect tax on those lease payments going forward (no exemption just because it paid tax at purchase) — and it generally can't get a credit back for the tax it paid at purchase once it has made a "use" of the equipment (such as leasing it out) rather than holding it purely for resale. The auditor's advice was correct only for the period before the Company existed, when Parent Corporation was buying equipment purely for its own nontaxable-service use; once the Company exists as a distinct lessee, Parent Corporation must collect tax on its rentals to the Company regardless of how it handled tax on the original purchase.

The one place a true rental can become taxable to the ultimate customer is if the Company's arrangement with a customer independently meets the Rule 3.294(c)(2)(A)(i) test (customer-controlled operator + lease-with-operator intent) — in that scenario the Company would charge its customer tax on the rental, and Parent Corporation's earlier resale-certificate purchase would be validated by that downstream taxable rental.

What this means for you

Equipment-rental and rigging/hauling companies

Whether you're "renting equipment" or "providing a transportation/rigging service" turns on control and intent, not on how your invoice is worded. If your own employees operate the equipment and the customer doesn't direct that operator, you're likely providing a nontaxable service — which means you owe tax on your own equipment inputs (leases or purchases) rather than collecting tax from the customer.

Parent/subsidiary equipment-leasing structures

A resale certificate is appropriate when you buy equipment specifically to lease it out and will collect tax on those lease payments — not when you (or an affiliate) will actually use the equipment to perform your own nontaxable service. Get this backwards and you risk both an uncollected tax liability downstream and a denied credit for tax "paid in error" once you've made an intervening use of the equipment.

Accountants and tax professionals advising multi-entity equipment operations

This letter is a useful worked example of Rule 3.294(c)(2)(A)(i)'s two-part operator-control/intent test, Rule 3.294(f)(1)'s operating-lease tax treatment, and the general rule that a credit for tax paid in error on a purchase is unavailable once the buyer has used the property (e.g., leased it out) rather than holding it exclusively for resale.

Common questions

Q: If our contract separately states labor and equipment charges, does that automatically make it a taxable equipment rental?
A: No. This letter treats a "separated" contract as still a nontaxable service where the company's own employees operate the equipment and the customer doesn't control the operator — the separately-stated format didn't change the underlying service characterization.

Q: Should a leasing parent company issue a resale certificate when buying equipment it will lease to an affiliate?
A: Yes, if it intends to collect tax on the lease payments to that affiliate (an operating lease under Rule 3.294(f)(1)). It should not issue one if the affiliate will use the equipment to perform its own nontaxable service.

Q: Can we get a refund/credit for tax paid at purchase if we later decide to lease the equipment out instead?
A: Generally no, once you've made a use of the equipment (such as leasing or otherwise using it) rather than holding it strictly for resale from the moment of purchase.

Q: Does paying tax on equipment at purchase ever exempt a later rental of that same equipment from tax?
A: No. Even if tax was paid on the full purchase price, the lessor is still required to collect and report tax on its lease/rental payments unless the transaction otherwise falls outside the taxable-rental definition.

Citations and references

Statutes and rules:

• 34 Tex. Admin. Code Rule 3.294(c)(2)(A)(i) (criteria for a taxable equipment-with-operator rental)
• 34 Tex. Admin. Code Rule 3.294(f)(1) (operating lease — tax on lease payments)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/200006409L

Original ruling text

June 14, 2000

Dear **:

Thank you for your letter request on behalf of your client. You asked for a
written response to the questions that follow the following set of facts.

FACTS

We represent a company (the "Company") whose business includes renting
equipment to contractors and supplying operators to run the equipment. The
Company is a wholly-owned subsidiary of another corporation (the "Parent
Corporation"). Parent Corporation owns equipment such as cranes and loaders.
Parent Corporation leases this equipment to the Company.

The Company intends to submit a bid for a construction project that will take
place in Texas (the "Project"). The Company is submitting this bid to the
general contractor as a potential subcontractor. The general contractor has
been hired to build a steam and electricity production facility from the ground
up in Texas. In order to complete the Project, the general contractor will
purchase equipment such as generators (the "Generators") for installation at
the proposed facility.

As shown by the redacted documents that I enclose and incorporate into this
request, if the Company is awarded the subcontract for the Project, the Company
will be hired by the general contractor to unload the Generators off of the
rail road. The Company will accomplish this by using equipment such as cranes
that the Company leases from the Parent Corporation. The Company's employees
will operate the cranes and other equipment that are used to unload the
Generators. After unloading the Generators, the Company will transport the
Generators to the job site using the Company's trucks, trailers, and employees.

When the Generators reach the job site, the Company will unload the Generators
from the trucks and trailers. Thereafter, the Company will rough set the
Generators at the job site. A rough set of the Generators means moving the
Generators to a specific location at the job site and securing the Generators.
A rough set does not include installing or permanently affixing the Generators
to the real property. A rough set also does not include making the Generators
ready for their intended use by the final customer. In order to move and rough
set the Generators, the Company will use the cranes it leases and its
employees.

Parent Corporation is considering buying a new piece of equipment (the "New
Loader") and leasing it to the Company for use in the Company's business. The
Company will use the New Loader to lift heavy loads from railroad cars and
suspend the loads in the air. Thereafter, the New Loader will lower the loads
onto trucks and trailers for transportation. The Company will use the New
Loader at locations Texas. The Company may also use the New Loader at
locations in other States. For the jobs in Texas, the Company may use the New
Loader pursuant to either lump sum contracts or separated contracts. For the
most part, the Company will use the New Loader as a subcontractor in new
construction jobs. However, periodically, the Company may use the New Loader
as a subcontractor in repair, remodeling, or restoration jobs.

Parent Corporation was audited for Texas sales and use tax compliance in the
past. This audit occurred before the Company became a subsidiary of the Parent
Corporation. During the period covered by the prior audit, the Parent
Corporation performed the same types of transactions that are now performed by
both the Parent Corporation and the Company (i.e., during the prior audit,
Parent Corporation bought equipment and rented that equipment, together with an
operator, to unrelated customers). As a result of the audit, Parent Corporation
was assessed additional sales tax on some of the equipment that it purchased
for use in its business. The equipment consisted of cranes and other types of
equipment used to move items around at construction sites. The auditor told
the Parent Corporation that it could eliminate its future Texas sales and use
tax problems through two courses of action. First, the auditor told the Parent
Corporation that if it paid Texas sales tax on the purchase price of equipment
it bought for use in its business, then the Company would not have to charge
Texas sales tax when it rented the equipment to its customers, the general
contractors. Second, the auditor told the Parent Corporation that it could
issue a sale for resale certificate when it bought equipment if it charged and
collected tax from its customers when it rented the equipment to them.

QUESTIONS

On the basis of the facts stated above, the Company seeks answers to the
following questions:

1. Is the contract between the Company and the general contractor for the
   Project a lump sum or separately stated contract?

Response: The "Heavy Haul" contract between the Company and the general
Contractor appears to be separated in that it calls for separately stated
amounts for materials and labor. However, the Company is not considered a
contractor improving real property, as it is not incorporating tangible
personal property into the realty. The Company is contracting to provide the
service of receiving, off-loading, transporting and rough setting the four
turbines for the contractor.

Neither is the contractor renting equipment from the Company. The agreement
between the contractor and the Company does not meet the criteria establishing
a rental with an operator found in TAC 3.294(c)(2)(A)(i). This criteria
requires that:

(i) the customer exercised direct control or supervision over the operator of
the tangible personal property; and

(ii) the intent of the agreement was to lease a piece of tangible personal
property and separately furnish an operator.

The Company is performing a nontaxable transportation service. As a provider of
nontaxable services the company is responsible for tax on all of its purchases
of taxable items used to perform its nontaxable service. This applies to
materials separately that are stated to the customer that are used to perform
the nontaxable service.

2. Based on your answer to question one above, on what amounts, if any, should
   the Company charge and collect tax from the general contractor (equipment used
   in the job, labor for the operators, materials incorporated into the real
   property)?

Response: No tax is due on the Company's charge to the contractor. I was not
able to ascertain from the facts presented or from the contract provided where
the Company was incorporating materials into realty.

3. Based on your answers to questions one and two above, should the Parent
   Corporation charge tax to the Company on the lease payments for the equipment?

Response: Under an operating lease, the Parent Corporation should charge the
Company tax on lease payments for the equipment. See subsection (f)(1) of TAC
3.294.

4. Should the Parent Corporation pay Texas sales and use tax on the New Loader
   to the vendor when the Parent Corporation buys the New Loader? If the Parent
   Corporation pays Texas sales and use tax on the full purchase price of the New
   Loader when it buys it, are both the Parent Corporation and the Company
   thereafter relieved from charging and collecting tax from their customers when
   the New Loader is used at jobs in Texas?

Response: If the Parent Corporation intends to lease the new loader to the
Company, it should issue a resale certificate to the vendor. The Parent
Company should then collect tax from the Company on leases to the Company. If
the Parent Corporation pays Texas sales and use tax on the full purchase price
of the New Loader when it buys it, the Parent Corporation is still required to
collect and report tax on leases or rentals of the loader to its Texas
customers. If Parent Corporation does not make an intervening use of the new
loader while holding it for lease or rental it may take a credit for tax that
it paid in error to the vendor on the purchase of the loader.

5. Is the auditor's advice to the Parent Corporation correct? If the Parent
   Corporation buys or has bought a piece of equipment for use in its business and
   the Parent Corporation pays or has paid Texas sales and/or use tax on the full
   purchase price at the time of the purchase, are the Parent Corporation's future
   charges to the Company for the rental of the equipment free from the sales tax?
   If Parent Corporation paid tax when it purchased the equipment that it leased
   to the Company, are the Company's future charges to its customers for the
   rental of the equipment subject to the Texas sales and use tax?

Response: The Auditor's advice is correct for periods prior to the creation of
the Company, when Parent Corporation was purchasing equipment for its own use
in performing nontaxable services. After the creation of the Company, Parent
Corporation is required to collect tax on subsequent rentals for consideration
to the Company of equipment that Parent Corporation paid tax on. A credit for
tax paid in error is not available to Parent Corporation as it made a use of
the equipment prior to leasing it to the Company.

The auditor's advice regarding resale certificate issued to vendors for
equipment that will be held for lease or rental is correct.

6. What tax payment/collection method should the Parent Corporation adopt in
   the future when it purchases equipment that it intends to lease to the Company?
   Should Parent Corporation pay Texas sales tax when it purchases the equipment
   and thereafter, not collect tax from the Company on the lease payments for the
   equipment? Or, should Parent Corporation issue a resale certificate to the
   vendor of the equipment and charge the Company Texas sales tax on the lease
   payments for the equipment?

Response: Parent Corporation should issue a resale certificate on future
purchases of equipment that it intends to lease to the Company. Parent
Corporation will then collect and report tax on leases of the equipment to the
Company.

7. What tax payment/collection method should the Company adopt in the future
   with respect to equipment that it leases for use in its business? Should the
   Company pay the Texas sales tax on the equipment when it leases the equipment
   from the Parent Corporation and not charge its customers tax when it rents the
   equipment to its customers? Or, should the Company issue a sale for resale
   certificate when it leases the equipment from the Parent Corporation in the
   future and thereafter, collect tax from its customers when it rents the
   equipment?

Response: The Company should pay tax on its leases of equipment used to
perform its nontaxable transportation services. The Company may only issue a
resale certificate to its vendors on its leases or rentals of the equipment
meeting the criteria found in TAC 3.294(c)(2)(A)(i).

8. If the Parent Corporation initially pays the Texas sales and use tax on
   equipment it buys and thereafter, the Parent Corporation leases the equipment
   to the Company who uses the equipment to perform a new construction job
   pursuant to a contract that separately states the charge for the equipment from
   the charge for the operator, should the Company charge tax to its customer? In
   that situation, is the Parent Corporation entitled to a credit for the taxes
   (or a portion thereof) that it paid when it bought the equipment?

Response: The Company should charge tax to its customer if the lease or rental
meets the criteria found in TAC 3.294(c)(2)(A)(i). Parent Corporation is not
entitled to a credit offsetting the tax it paid on the equipment if it made a
use of the equipment other than holding it for resale.

9. If the Parent Corporation does not pay Texas sales tax when it buys a piece
   of equipment (it issues a resale certificate) and thereafter, the Parent
   Corporation leases the equipment to the Company who uses the equipment to
   perform new construction pursuant to a lump sum contract, are either the
   Company or the Parent Corporation liable for Texas sales and/or use tax when
   the equipment is used in that manner?

Response: The Company owes tax on its lease of the equipment used to perform a
nontaxable service (i.e., transportation) or used to incorporate tangible
personal property into realty. Tax is not due on its lease of equipment where
the Company releases the equipment under an agreement meeting criteria found in
TAC 3.294(c)(2)(A)(i).

This opinion is based on the facts presented. Other facts though similar may
provide a different result.

I hope this information answers your questions. If you need additional
information, please call me toll-free at 1-800-531-5441, extension 3-4502. The
direct line is 512/463-4502. You may also write to Tax Policy Division,
Comptroller of Public Accounts. You may also e-mail our tax help section at: