A charter school's build-to-suit lease was amended to stretch its term from 20 to 25 years shortly before the ruling request -- does that longer, amended term satisfy the § 151.311 two-prong exemption test?

Plain-English summary

A Texas nonprofit charter-school operator, running several campuses, built a new facility financed through a build-to-suit lease. The notable twist: the lease was originally written with a 20-year term, but the parties amended it on June 12, 2015 — shortly before the ruling request — to stretch the term to 25 years.

Applying its standard two-prong test under § 151.311:

1. Is the lessee a qualified exempt entity? Yes — the school is exempt under § 151.310.
2. Is the lease term long enough relative to the improvement's useful life? Using the school's own asserted 22-year useful-life figure (from the state's capital-asset depreciation schedule), the amended 25-year term clears the bar. The original 20-year term would not have — 20 years is shorter than the 22-year useful life the school itself was relying on.

Because the amended 25-year term is what's actually in effect, both prongs are satisfied and the lease qualifies as an exempt § 151.311 contract. The ruling doesn't say whether the amendment was made specifically to secure this exemption, but the timing — an amendment shortly before the ruling request, moving the term from just below to comfortably above the useful-life threshold — is a useful illustration of how close some deals sit to the two-prong test's line.

What this means for you

Charter schools structuring or renegotiating a build-to-suit lease

If your projected useful-life figure is close to your lease term, this ruling shows the fix can be as simple as amending the lease term upward before requesting a ruling — the Comptroller looked only at the lease term as amended and in effect, not at the original term or why it changed.

Landlords and developers

Confirm the CURRENT, final lease term (not an earlier draft or superseded term) before assuming a construction contract qualifies — a term that looked short on paper earlier in the deal's life may no longer be the operative one.

Related rulings

This is part of a large cluster of same-year (2015) build-to-suit charter-school lease rulings applying the identical two-prong test from Comptroller's Decision No. 28,391. It's distinguished from its companions by the lease-amendment fact pattern — most other rulings in this cluster show the parties setting the qualifying term (25 or 30 years) from the start, rather than amending an already-signed lease upward.

Common questions

Q: Does an original lease term that's too short permanently disqualify a project from the § 151.311 exemption?
A: Not necessarily — per this ruling, the Comptroller evaluated the lease term as amended and in effect at the time of the ruling, not the project's original term.

Q: What lease term is long enough to satisfy the "primary use and benefit" test?
A: There's no fixed bright line — per this ruling, a 25-year lease against a 22-year useful life was sufficient (while the earlier 20-year version of the same deal would not have been), and a 5-year lease against a longer useful life failed in a prior cited decision.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.311 (Taxable Items Incorporated Into or Used for Improvement of Realty of an Exempt Entity)
• Tex. Tax Code § 151.310 (Religious, Educational, and Public Service Organizations)
• 34 Tex. Admin. Code Rule 3.291(a)(5) (Contractors — exempt-contract definition)
• 34 Tex. Admin. Code Rule 3.1; Rule 3.10 (Taxpayer Bill of Rights — detrimental reliance)
• 34 Tex. Admin. Code Rule 3.325 (Refunds and Payments Under Protest)

Cited prior guidance:

• Comptroller's Decision No. 28,391 (1993) — source of the two-prong "primary use and benefit" test
• Comptroller's Decision No. 31,505 (1994) — contrasting failure: 5-year lease term too short relative to improvements' useful life

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201508392L

Original ruling text

August 17, 2015

RE: Private Letter Ruling # 150840436

Dear *****:

We issue this private letter ruling in accordance with Rule 3.1 in response to
your request dated March 19, 2015. Detrimental reliance is provided in accordance
with Rule 3.10, the Taxpayer Bill of Rights.

You requested guidance on the ’ interpretation
of the exemption in Texas Tax Code Section 151.311 for tangible personal property
and taxable services purchased for use in the performance of a contract to improve
real property for an organization exempt under Texas Tax Code Section 151.310.
The Comptroller’s has addressed similar facts presented by this inquiry; most recently
in other private letter rulings, particularly STAR DOCUMENT NOS. 201411982L,
201411981L, 201411980L, and 201409958L, all issued in 2014. However, we issue
this private ruling because guidance on this issue is not expressly provided in statute
or agency rule.

Relevant Facts Presented

**, formerly known as *, is a Texas non-profit corporation
which was granted tax-exempt status by the Internal Revenue Service pursuant to
Section 501(c)(3) of the Internal Revenue Code. In addition, **** met
the qualifications for exemption from Texas Sales or Use Tax outlined in Rule
3.322 (Exempt Organizations).

** received a charter from the Texas Education Agency to operate an
open-enrollment charter school. * presently operates several campuses
in CITY, Texas, and recently has had a new facility constructed at *.
To finance the construction of the * Campus, * entered into
a build-to-suit lease (“Lease”) [ENDNOTE 1] with * (“Landlord”),
where Landlord agreed to construct the * Campus per *’s
specifications and to lease the * Campus to ** for an
initial term of twenty-five (25) years. [ENDNOTE 2]

Under the Lease, Landlord is required to implement a construction program to
build the ** Campus to *’s specifications, with the cost
incorporated into the Lease and paid for by * either in monthly
payments, or by exercising its option to purchase. The Lease requires the
Landlord to make all improvements described within the exhibits to the Lease.
The * Campus is being improved for, leased by, and used exclusively
by **** as an open-enrollment charter school. Texas Education Code
Section 12.105 states that an open-enrollment charter school is part of the
Texas public school system.

** receives its funding from the State of Texas (“State”) through a
funding system known as the Foundation School Program as authorized by Texas
Education Code Section 12.106. * used state funds to lease the
**** Campus. Texas Education Code Section 12.128 states that property,
whether purchased or leased, is considered public property for all purposes
allowed by state law and is deemed to be state property held in trust by the
charter holder for the benefit of the students and may be used only for a
purpose for which a school district may use school district property.

The charter holder—in this case, ** —holds the state-owned property in
trust for the benefit of the attending students. If ** closes or
ceases to exist, the Texas Commissioner of Education, on behalf of the State,
takes immediate possession and assumes control over the property, including
leasehold rights under Texas Education Code Section 12.128(c)(1).

Requested Ruling and Analysis

Our restatement of the ruling you requested is shown below, followed by our
response and analysis.

Is the build-to-suit lease at issue an exempt contract as contemplated by Texas
Tax Code Section 151.311, thereby allowing the tax-free purchase of taxable
items by the taxable entity for incorporation into property leased by the
tax-exempt entity?

Response: This question is not addressed by statute or rule and the response
provided will be memorialized in a future amendment to Rule 3.291 (Contractors).
The build-to-suit lease at issue is an exempt contract as contemplated by Texas Tax
Code Section 151.311 because it is a contract to improve real property for the primary
use and benefit of an exempt entity. Tangible personal property or taxable services meeting
the requirements expressed in Texas Tax Code Section 151.311 are exempt from Texas Sales
or Use Tax.

Texas Tax Code Section 151.311 provides, in part, that the purchase of tangible
personal property for use in the performance of a contract for an improvement
to realty for an organization exempted under Texas Tax Code Sections 151.309 or
151.310 is exempt if the tangible personal property is incorporated into realty
in the performance of the contract. Texas Tax Code Section 151.311 further
provides that the purchase of a taxable service for use in the performance of a
contract for an improvement to realty performed for such an organization is
exempt if the service is performed at the job site and if the contract
expressly requires the specific service to be provided or purchased by the
person performing the contract or the service is integral to the performance of
the contract.

Rule 3.291(a)(5) defines an exempt contract to include a contract for the
improvement of real property with an entity that is exempt under Texas Tax Code
Section 151.309 or 151.310. The Rule further provides that an example of an
exempt contract is a contract with a non-exempt entity to improve real property
for the primary use and benefit of an organization exempted under Section
151.309 or 151.310.

Texas Tax Code Section 151.311 does not require that the real property be owned
by the exempt organization. For situations involving an exempt lessee and a
non-exempt lessor, the Comptroller’s office developed a two-prong test to
determine whether improvements to real property are for the primary use and
benefit of the exempt entity. The test was first set forth in COMPTROLLER’S
DECISION NO. 28,391 (July 7, 1993), STAR DOCUMENT NO. 9307H1248D05.

First, the lessee must qualify for exempt status under Texas Tax Code Section
151.309 or 151.310. Based on the facts presented, ***** is a qualified
tax-exempt entity under Section 151.310; therefore, it meets the first prong of
the test.

Second, the term of the lease must be sufficiently long in relationship to the
life of the improvements themselves. This test has been consistently applied by
the Comptroller. See for example, COMPTROLLER’S DECISION NO. 31,505 (April 20,
1994), STAR DOCUMENT NO. 9404H1297E01, which found extensive renovations and
improvements failed to meet the second prong of the test because the life of
the improvements exceeded the term of the lease which was only five (5) years.

Determining the life of the real property improvements for the second prong of
the test is a fact issue, and the Comptroller’s office has not developed a
standard for when the test is met. ***** references Appendix A, titled
“Class Codes”, of the State Property Accounting Process User’s Guide for
depreciation of state capital assets that sets 264 months (22 years) as the
useful life for buildings and building improvements. [ENDNOTE 3]

The ** Campus’s expected useful life of 22 years is less than the 25
year (300 month) term of the Lease. Therefore, the 25 year term of the Lease is
sufficiently long to ensure that ** will have the primary use and
benefit of the improvements under the Lease. The second part of the test is
met, and the Lease is exempt under Texas Tax Code Section 151.311.

This ruling does not address the validity of any refund claim that might be
submitted by **. * may request a refund of Texas Sales and
Use Tax paid on taxable items purchased for construction of the *
Campus. ** must obtain a properly completed assignment of right to
refund for items on which it did not directly pay the Texas Sales and Use Tax
that are part of any refund request. Any refund request is subject to the
requirements of Rule 3.325 (Refunds and Payments Under Protest).

If you have questions about this private letter ruling, please email us at the
following link, https://www.window.state.tx.us/taxhelp/ and please be sure to
reference Private Letter Ruling #150840436.

Sincerely,

Tax Policy Division

ENDNOTES:

1. The Association of Corporate Counsel defines a build-to-suit (or
   design-build) lease to be “essentially a landlord/developer’s agreement to
   construct a purpose built building, usually for a single tenant. The landlord
   will typically own or ground lease the lands (and once constructed, the
   building) and has the option of re-letting the building to a new tenant upon
   the expiry of the term of the build-to-suit lease to the original tenant.
   Build-to-suit leases typically are for a longer term than a normal lease in
   order to permit the landlord to recoup its investment over the duration of the
   lease term.”

2. The Lease was amended June 12, 2015 to increase the term of the Lease from
   20 years to 25 years.

3. In its request for a Private Letter Ruling, ** does not request a
   determination for the “building shell”. The guidance provided in this response
   does not approve or disapprove of **’s depreciation methodology or its
   choice of applicable class codes or descriptions.