How does a highway contractor that blasts and crushes rock from a leased quarry compute its taxable cost of rock used in lump-sum construction contracts, versus rock it sells at retail?

Plain-English summary

This letter is a Comptroller auditor's written confirmation of tax treatment for a highway construction contractor that operates rock pits and asphalt plants. The contractor leases the land the pit sits on, pays the landowner a per-ton royalty for rock removed, blasts the rock, and crushes it before use — some of that crushed rock goes into the contractor's own lump-sum construction contracts, and some is sold at retail. The auditor asked a series of linked questions to nail down exactly how to compute the taxable "cost of rock" used on the lump-sum jobs.

The Comptroller answered each point. Equipment used to crush rock that's sold at retail qualifies for the manufacturing exemption — but using that same crushing equipment to process rock destined for the contractor's own lump-sum (or separated) construction contracts is a taxable divergent use, taxed on the fair market rental value of the equipment for the period it's used that way (Rule 3.300(j)). Blasting materials used to produce rock that's never held for sale don't qualify for the manufacturing exemption under § 151.318 either — tax is owed on those. But processing labor performed by the contractor's own employees is NOT part of the taxable cost basis for rock used in a realty-improvement contract — the Comptroller confirmed this is identical to the familiar rule that a cabinetmaker installing cabinets in a home only owes tax on the lumber, nails, and paint used, not on its own labor.

The most consequential point, though, is the last one: no sales or use tax is owed on the rock itself taken under the lease arrangement described, because it's a "profit a prendre" — a legal right to enter someone else's land and remove part of the soil (sand, gravel, rock, etc.). Under this doctrine, the royalty paid per ton removed is not treated as a sale of the material by the landowner; the lessee is instead deemed to obtain the material at no charge, so a lump-sum contractor incurs zero sales tax liability on the rock itself. But this treatment has a strict physical-conduct requirement: the lessee must actually go onto the land and remove the material itself. If the landowner instead mines the material, loads it, and delivers it to the lessee — or if the lessee simply picks up material the landowner already extracted — the arrangement is NOT a profit a prendre; it's a taxable sale of tangible personal property instead.

What this means for you

Quarry operators and mining/rock-pit contractors leasing extraction rights

If your lease genuinely requires you to physically enter the land and extract the material yourself (a true profit a prendre), the royalty you pay per unit removed is not a taxable purchase — you owe no sales tax on the raw material itself. But if your landowner extracts and delivers the material to you, that flips into a taxable sale, so the mechanics of who physically does the extraction matter enormously to your tax exposure.

Contractors using self-extracted materials on both retail sales and their own construction contracts

Track which uses your processing equipment serves. Equipment used to process material you sell at retail is manufacturing-exempt; the SAME equipment used to process material for your own construction jobs is a taxable divergent use, valued at fair rental value for that period — not automatically taxed at full purchase price.

Accountants and tax professionals

This letter is a rare, detailed walk-through of the profit a prendre doctrine as applied to sales tax — worth keeping on hand whenever a client's extraction-lease structure needs to be evaluated for whether royalty payments trigger sales tax exposure.

Common questions

Q: Is equipment used to crush rock for retail sale eligible for the manufacturing exemption?
A: Yes, but using that same equipment to process rock for the contractor's own lump-sum construction contracts is a taxable divergent use, based on the equipment's fair market rental value for that period.

Q: Are blasting materials for rock that's never sold eligible for the manufacturing exemption?
A: No — blasting materials used to produce rock that isn't held for sale don't qualify under § 151.318.

Q: Is a contractor's own employee processing labor part of the taxable cost of rock used in a construction contract?
A: No — self-performed processing labor is not includable in the taxable cost basis, the same as a cabinetmaker's own labor installing cabinets.

Q: Is sales tax owed on rock removed under a lease where the contractor pays a per-ton royalty?
A: No, if the arrangement is a genuine profit a prendre (the lessee physically enters the land and removes the material). If the landowner instead extracts and delivers the material, it becomes a taxable sale of tangible personal property.

Q: Can other quarry operators or contractors rely on this exact letter?
A: No. This is a Texas STAR letter ruling binding on the Comptroller only for the taxpayer it addresses (34 Tex. Admin. Code Rules 3.1, 3.10); confirm your own lease structure and processing facts with a tax professional.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.318 (manufacturing exemption)
• 34 Tex. Admin. Code § 3.300(j) (Manufacturing; divergent use)
• 34 Tex. Admin. Code § 3.287(e) (divergent use of items purchased under an exemption certificate)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/200008654L

Original ruling text

August 30, 2000

From: Gilbert Zamora

To: "Hilliard, Sandy"

Subject: Cost of rock

Dear Ms. Hilliard:

Thank you for your e-mail inquiry requesting written confirmation on the cost

of rock used by your taxpayer in lump-sum contracts and sold at retail. I have

restated your email below:

We talked last week, and you have talked with Connie Metcalf and Carlos Tobias,

about this. I need a little more clarification.

To recap my situation:

I am auditing COMPANY A. They do highway construction and operate rock pits

and asphalt plants. They use the rock that they remove from the pits on (1)

lump-sum contracts and (2) they sell it at retail.

They lease the land that the pit is located on. They pay a royalty to the

landowner for the rock removed. They blast the rock and then send it through a

crusher before use.

1. I am trying to arrive at a cost for the rock to assess tax on rock used on

the lump-sum contracts. I understand that the royalty paid is not a taxable

cost. Since they do sell some of the rock, they get the processing exemption

for blasting materials and the equipment to crush the rock, right? They owe

tax on blasting materials associated with the rock used, right? They also owe

tax on the fair market rental value of the equipment for the time of divergent

use, right?

Response: Equipment used to process rock that is sold at retail is eligible

for the manufacturing exemption. Use of the equipment to process rock that is

used in lump-sum (or separated) contracts to improve realty would be a

divergent use of the equipment and would be taxable based on the fair market

rental value of the equipment for the period of divergent use. See Rule

3.300(j). Blasting materials used to produce rock that is not held for sale

would not be eligible for the manufacturing exemption under Texas Tax Code

151.318.

2. I originally used the cost of direct materials (blasting materials, drill

bits, etc.) and indirect materials (supplies and repairs for the machinery)

plus the equipment rent (they lease the crushing equipment) and I allocated it

on a cost per ton basis to the tons used.

Carlos thought that we should include all costs from the time blasting begins.

This would include some processing labor. He thought that the processing

should be included because the total cost of the rock, when sold, includes the

processing and is taxable.

Didn't we discuss, though, that the processing labor would not be taxable

because it was done by their own employees?

Response: Processing labor by the contractor's employees would not be

includable in the tax base in determining the cost of rock used in contracts to

improve realty.

3. Is this identical to the homebuilder who builds cabinets to put in the home

and only owes tax on the lumber, nails, paint, etc.?

Response: Yes.

4. Would it be fair to set up cost as I described above (using direct and

indirect materials and equipment rent)? It is my understanding that they have

purchased these three items tax free. Wouldn't this set up tax on the taxable

purchases of materials (originally purchased tax-free) and the divergent use of

equipment (which is rented tax-free)? Can you suggest a better way?

Response: No sales or use tax liability will be incurred by your taxpayer for

rock taken from land he leases from the landowner and has the contracted right

to remove material from the land. This type of lease is known as a "profit

a prendre." The royalty payments based on the number of yards of material

removed is not considered a sale of the material by the landowner under such

lease, he would be obtaining the material at no charge. As a lump-sum

contractor he would not be liable for any sales tax on the material.

A profit a prendre is a right of one person to take from the land of another a

part of the soil, such as sand or gravel. Under a lease of land, the lessee

must actually come on to the land and take the material contracted for. If he

does not, as in the case where the lessor mines the gravel himself, loads it

onto trucks and delivers it to the lessee, or if the lessee just picked it up

at the pit, the "lease" would not be treated as a "profit aprendre," but rather

as a taxable sale of tangible personal property.

See Rule 3.287(e) for the tax computation of divergent use of equipment

purchased tax free. A complete set of rules, along with the text of the Tax

Code, and a wealth of other information are available through our website at

through the "Texas Taxes" window.

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, You may e-mail our tax help section at .

You may also 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.