Does a private company operating a city-owned prison under a management contract owe sales tax on its own purchases to run the facility, just because its customer is a tax-exempt city government?

Plain-English summary

This document is an internal Tax Policy memo answering a Comptroller field auditor's question during an actual audit, not a letter to a taxpayer directly. The auditor was examining a private company ("Correctional Company") that operates a prison owned by a city under an operational agreement. The company had presented its city contract as proof it was exempt from sales tax on its own purchases, citing the case Day and Zimmerman v. Calvert. The auditor was skeptical -- the contract explicitly made the company responsible for all expenses, contained no language about title to purchases passing to the city, and the company's customer was a city (not the federal government, which was the government party in the cited case). The auditor asked Tax Policy to review the contract and confirm.

Tax Policy agreed with the auditor. After reviewing the contract, the analyst found no basis for applying Day and Zimmerman v. Calvert, and confirmed the contract did not make the private company an agent of the city when it purchased taxable items for the facility. Because the company was buying for itself (not as the city's purchasing agent), its purchases to operate the facility were taxable -- the city's own tax-exempt status as a government entity doesn't automatically flow through to its private contractor.

Notably, the letter points to a different prior STAR document (accession #9605L1412C10) as an example of an "approved procedure for exempting purchases by a private company managing prison facilities for an exempt entity" -- meaning the exemption isn't categorically unavailable to private prison operators, but requires the right contractual structure (apparently one establishing a true agency relationship or comparable arrangement), which this particular contract lacked.

What this means for you

Private companies operating government-owned facilities (prisons, or by extension other public facilities) under management contracts

Don't assume your government customer's tax-exempt status covers your own purchases just because you're operating their facility. Unless your contract specifically establishes you as the government entity's purchasing agent (with the structural features that requires, potentially including how title to purchased items is handled), your purchases to run the facility are taxable to you.

Government entities structuring facility-management contracts

If pass-through tax exemption for your contractor's operating purchases matters to your deal, this letter (and the "approved procedure" it references in a separate STAR document) suggests the contract needs to be deliberately structured to establish a genuine agency relationship for purchasing, not just note that the underlying facility is government-owned.

Auditors and accountants reviewing similar contracts

The case-law distinction drawn here is instructive: Day and Zimmerman v. Calvert turned on title to purchased items transferring to the government before use, in a federal-government context -- a fact pattern narrower than "we operate a facility the government owns."

Common questions

Q: Does a city-owned facility's tax exemption cover a private company operating it under contract?
A: Not automatically -- per this letter, it depends on whether the contract establishes the private company as the city's purchasing agent. A contract that just makes the company responsible for all its own expenses, without an agency or title-transfer structure, does not carry the exemption through.

Q: Is there ever an approved way for a private prison operator to buy tax-free on an exempt government client's behalf?
A: Yes -- this letter references a different prior STAR document (accession #9605L1412C10) describing an approved procedure for exactly that, implying the right contract structure can make it work.

Q: Does this memo bind the Comptroller for other government-facility management contracts?
A: No -- it's an internal memo resolving one audit question about one specific contract's language, not a Private Letter Ruling or General Information Letter, and it cannot be relied on by anyone else.

Citations and references

Case law discussed (found not to apply on these facts):

• Day and Zimmerman v. Calvert (cited by the taxpayer; distinguished because it involved title to purchases transferring to the federal government, not present in this city contract)

Prior STAR guidance referenced (a different, approved exemption procedure):

• STAR document 9605L1412C10 (approved procedure for a private company managing prison facilities to purchase exempt on behalf of an exempt entity)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/200109491L

Original ruling text

September 14, 2001

Michael Denman
[email protected]
** Audit Office

Dear Mr. Denman:

Thank you for your email inquiry concerning the following fact situation and
questions.

I am auditing **, TP# **, ("CORRECTIONAL COMPANY").
They have an operational agreement with the city of ** ("City") to
operate a prison owned by the city. They've provided me with a copy of their
contract with the city as proof that they are exempt from paying any sales tax
on their purchases. I don't feel that this contract provides them with any
such exemption as it explicitly states that all expenses are the responsibility
of CORRECTIONAL COMPANY. The taxpayer has referred to Day and Zimmerman vs.
Calvert, but that case would seem to involve the transfer of title to the
federal government. There is no wording in the contract about title to any
purchases being handed over to the city before being used. Also, the taxpayer's
customer is a city government, not the federal government. I'd like to provide
you with a copy of the contract so that you can determine whether or not they
should be allowed any exemptions

Response: I have reviewed the contract that you provided and can not find
where Day and Zimmerman vs. Calvert would apply to purchases by CORRECTIONAL
COMPANY. In addition, the contract does not provide that CORRECTIONAL COMPANY
is acting as an agent for the City when purchasing taxable items for the
corrections facility. Therefore, purchases by CORRECTIONAL COMPANY to operate
the facility under this contract would be taxable. See also accession #
9605L1412C10 for an approved procedure for exempting purchases by a private
company managing prison facilities for an exempt entity.

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.

Gilbert Zamora

Tax Policy Division