If a charter school's build-to-suit lease runs through a chain of separate holding entities (one created just to shield against environmental liability), does the § 151.311 construction-contract exemption still apply?

Plain-English summary

A Texas nonprofit charter-school operator, holder of three charters (K-4, 5-8, and 9-12 schools), was relocating an existing campus to a new facility. To finance construction, it entered a 30-year build-to-suit lease. But the ownership chain behind the landlord was unusually layered: the school first had a separate non-qualified nonprofit entity buy the site — a former stockyard — specifically to keep any environmental liability from that prior use away from the school itself. That holding entity then ground-leased the property for 100 years to a single-purpose "Landlord" entity, which is the one that actually signed the build-to-suit lease with the school.

The Comptroller applied its usual two-prong test under § 151.311 and found it satisfied regardless of the extra entities in between:

1. Is the lessee (the school) a qualified exempt entity? Yes, under § 151.310.
2. Is the lease term long enough relative to the improvement's useful life? The 30-year lease term exceeds the campus's 22-year expected useful life (the school's own figure, from the state's capital-asset depreciation schedule), so yes.

Because both prongs are met, the build-to-suit lease is an exempt § 151.311 contract, letting the landlord buy construction materials and qualifying services tax-free. The layered ownership structure — driven by environmental-liability planning rather than tax planning — didn't change the outcome, because the statute looks at the ultimate exempt lessee and the lease term it holds, not at how many entities sit above the landlord.

What this means for you

Charter schools and developers using multi-entity ownership structures

If your site has a prior contaminated-use history (a former industrial or stockyard site, for example) and you're routing ownership through a special-purpose holding entity for liability reasons, this ruling shows that structure alone doesn't disqualify the site from the § 151.311 construction exemption — what matters is the final lease term the exempt tenant holds against the building's useful life.

Landlords and developers financing a school build-to-suit

Confirm the ultimate tenant's exempt status and the lease term/useful-life relationship even where multiple holding entities are involved — the Comptroller traced through the ownership chain to the substance of who actually leases and uses the building.

Related rulings

This ruling is part of a same-day (September 1, 2015) batch of build-to-suit charter-school lease rulings applying the identical two-prong test to different campuses and landlord structures. It is distinguished from its companions by the unusual layered ownership — a separate holding entity plus a 100-year ground lease inserted for environmental-liability reasons, rather than a single landlord contracting directly with the school.

Common questions

Q: Does routing ownership through a separate holding company defeat the § 151.311 exemption?
A: Not per this ruling — the Comptroller looked past the intermediate holding and ground-lease entities to the ultimate exempt lessee and its lease term.

Q: Why would a charter school insert an extra holding entity at all?
A: In this ruling, the school explained it was to keep environmental liability from the site's prior use (a stockyard) separate from the school itself — a liability-management reason, not a tax-avoidance one.

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 30-year lease against a 22-year useful life was sufficient, while 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/201509412L

Original ruling text

September 1, 2015

RE: Private Letter Ruling # 151530958

Dear *****:

We issue this private letter ruling in accordance with Rule 3.1 in response to
your request dated May 22, 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 Tax Code Section 151.310. The
Comptroller’s office 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
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. * is the charter holder for
* (grades K-4), * (grades 5-8), and * (grades
9-12), all Texas open-enrollment charter schools. * is preparing to
relocate an existing campus to a new facility *, CITY, Texas (the
“Campus”). To finance the construction of the new facility, *
entered into a build-to-suit lease (“Lease”) [ENDNOTE 1] for the construction
of the * Campus to be built to **’s specifications. The
lease has a primary term of 30 years.

** created a separate entity, *, a non-qualified Texas
non-profit corporation [ENDNOTE 2], to purchase the property. *,
then leased the property under a 100-year lease to a single-purpose entity
called * (“Landlord ”), which had been created to hold the property
for the purpose of entering into the Lease with **** as the named
tenant.

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 Landlord to make all of
the 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 and its leasehold is pursuant to Texas Education Code Section 12.128,
which 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 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 30 year (360
month) term of the Lease. Therefore, the 30 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 151.11.

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 Payment 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 #15130958.

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. ***** was created to hold the property in order to defer liability
   from any environmental hazards as a result of the property’s previous usage as
   a stockyard.

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.