Can a certified Texas large-data-center operator extend its sales tax exemption to new "expansion buildings" by using a sale/leaseback structure to become their formal owner, when the transaction is disregarded for accounting and federal income tax purposes?

Plain-English summary

A company operates a Comptroller-certified "qualifying large data center project" and gets a sales/use tax exemption under Tex. Tax Code § 151.3595 for property used there. It wanted to add one or two new "Expansion Buildings" on adjacent land owned by a related seller — but the taxpayer's own operations, investment, or ownership of those buildings wasn't on its own enough to qualify them for the exemption, since the exemption requires the taxpayer to be the owner. So the taxpayer proposed a Sale/Leaseback: buy the underlying land from the seller with a promissory note, ground-lease the land right back to the seller so the seller could construct the buildings, then take "ownership" of the finished buildings while the seller kept operating them under a lease — with fee ownership automatically reverting back to the seller once the lease term (matched to the exemption's remaining life) ended.

The Comptroller ruled no dice: the exemption would not extend to the Expansion Buildings. The Sale/Leaseback was formally structured to make the taxpayer the record owner, but substantively it wasn't a real transaction — the seller stayed the owner for federal income tax purposes, the whole arrangement was disregarded for accounting and income tax purposes, the ground-lease and note payments were designed to net to zero, ownership automatically reverted to the seller at lease-end, and the taxpayer would hold early termination rights. Citing Cantu Enterprises v. Hegar (2017) and the federal Coltec Industries case it relies on, the Comptroller drew the classic line: structuring a real transaction to get a tax benefit is legitimate, but creating a transaction with no business purpose solely to manufacture a tax benefit is not. Because the exemption's ownership requirement is meant to ensure genuine common ownership across a data center project, and this arrangement existed only on paper for tax purposes, the Comptroller looked through the form to the substance and declined to recognize the taxpayer as the qualifying owner of the Expansion Buildings.

What this means for you

Data center operators expanding a certified project

If you want a new building added to an existing § 151.3595 exemption, you generally need to be its real owner — meaning ownership that holds up for accounting and federal income tax purposes too, not just a deed recorded for state property tax records. A structure that's disregarded everywhere except the county real property records is a strong signal to the Comptroller that there's no genuine economic substance.

Businesses considering sale/leaseback or similar related-party restructurings for tax purposes

This ruling is a clear illustration of Texas's economic-substance doctrine in practice: automatic reversion of ownership, payments engineered to net to zero, and disregarding the transaction for federal tax/accounting purposes are all red flags the Comptroller will weigh together. Legitimate business reasons for structuring a transaction a particular way are fine; a transaction invented purely to unlock a tax exemption is not, and exemptions are strictly construed against the taxpayer, who bears the burden of proving genuine economic substance.

Accountants and tax professionals

The key authorities are Cantu Enterprises v. Hegar, No. 03-15-00516-CV (Tex. App. 2017) (citing federal Coltec Industries, Inc. v. United States, 454 F.3d 1340 (Fed. Cir. 2006)) and Bullock v. National Bancshares Corp., 584 S.W.2d 268 (Tex. 1979) for the "letter and spirit of the law" standard, plus Comptroller's Decisions 104,123 (2012) (totality-of-circumstances review) and 107,105 (2013) (taxpayer's burden to show economic substance). Note the Comptroller declined to reach the taxpayer's follow-up questions about involuntary events, subsequent additions/removals, and early termination — once the threshold ownership question failed, those became moot.

Common questions

Q: Does formal legal title (a recorded deed) automatically make you the "owner" for the data center exemption?
A: No. The Comptroller looks at substance over form — if the transaction is disregarded for accounting and federal income tax purposes and structured to automatically reverse itself, formal title alone won't establish qualifying ownership.

Q: Is a sale/leaseback between related entities always disregarded for Texas sales tax purposes?
A: No — structuring a genuine transaction with real economic substance to also achieve tax benefits is legitimate. The problem here was the absence of any business purpose independent of the tax benefit, evidenced by factors like disregarded accounting treatment, offsetting payments, and automatic reversion.

Q: What happened to the taxpayer's existing data center exemption?
A: It was unaffected — entering into the proposed Sale/Leaseback would not jeopardize the existing certified project's exemption. Only the extension to the new Expansion Buildings was denied.

Q: Can another data center operator rely on this ruling for a similar expansion?
A: No. It binds the Comptroller only for the taxpayer and facts presented; a sale/leaseback with genuine economic substance (real risk transfer, no automatic reversion, recognized for accounting/income tax purposes) could be analyzed differently.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.3595 (large data center project exemption); § 151.3595(a)(2) (definition of large data center project); (a)(6), (a)(8) (qualifying operator/occupant); (d)(2) (independent or joint certification)

Cited case law and decisions:

• Cantu Enterprises v. Hegar, No. 03-15-00516-CV (Tex. App. 2017), citing Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1357 (Fed. Cir. 2006) — real transaction vs. sham transaction distinction
• Bullock v. National Bancshares Corp., 584 S.W.2d 268, 272 (Tex. 1979) — letter and spirit of the law standard
• Comptroller's Decision No. 104,123 (2012) — totality-of-circumstances review of related-party transactions
• Comptroller's Decision No. 107,105 (2013) — taxpayer's burden to show economic substance

Source

• Landing page (STAR search): https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201908001L

Original ruling text

August 13, 2019

RE: Private Letter Ruling No. 20181217152342

Dear **:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters. [ENDNOTE 1] We are responding to your request dated **, and additional information received via e-mail on ** and **. Detrimental reliance relief is provided in accordance with Rule 3.10, Taxpayer Bill of Rights.

You requested guidance on the addition of newly constructed buildings to an existing Comptroller certified qualifying large data center project, in order to extend the data center project’s sales and use tax exemption to the newly constructed buildings. You also requested guidance on the effects of involuntary events; subsequent additions, removals, or disqualifications of buildings or areas; and early termination lease rights.

Facts Presented

** (Taxpayer) owns and operates a Comptroller certified qualifying large data center project (Data Center), as defined in Section 151.3595(a)(2) (Property Used in Certain Large Data Center Projects; Temporary Exemption) in CITY, Texas. Taxpayer qualified for the sales and use tax exemption (Exemption) under Section 151.3595. Taxpayer is the qualifying owner, qualifying operator, and qualifying occupant of the Data Center.

** (Seller) owns land and improvements which are contiguous to the Data Center. Taxpayer is proposing to extend its Exemption to one, and possibly two, yet to be constructed buildings (Expansion Buildings). Taxpayer’s operations of, investment in, or ownership of the Expansion Buildings is not sufficient on its own to qualify for a data center exemption.

The Expansion Buildings will be specifically constructed to primarily house servers, related equipment, and support staff for the processing, storage, and distribution of data. The Expansion Buildings will have an uninterruptible power source, backup generators, fire suppression and prevention systems, as well as physical and digital security. Neither Seller nor Taxpayer are telecommunications providers, and the Expansion Buildings will not be used to primarily provide telecommunications services.

In an attempt to include the Expansion Buildings as part of the Data Center, Taxpayer and Seller have discussed constructing the Expansion Buildings using what is described as a Sale/Leaseback. Taxpayer states that under the Sale/Leaseback:

(1) Seller will sell a portion of the undeveloped Seller property (Sale/Leaseback Property) to Taxpayer and Taxpayer will become the fee owner of the Sale/Leaseback Property,

(2) Taxpayer will ground lease the Sale/Leaseback Property and any improvements pursuant to a ground lease (Ground Lease) to the Seller,

(3) Seller will construct the Expansion Buildings on the Sale/Leaseback Property,

(4) Taxpayer will acquire ownership of the Expansion Buildings built by Seller, which then become part of the Ground Lease to Seller, and

(5) Seller will lease the Expansion Buildings to Taxpayer pursuant to a lease (Expansion Lease).

The Sale/Leaseback Property will be subdivided into three or four parcels. Each Expansion Building (Building 3 and Building 4) will be constructed on a separate parcel that can be conveyed to Taxpayer independently of the other parcels. The parcel underlying Building 4 is referred to as the Building 4 Parcel, and the parcel underlying Building 3 is referred to as the Building 3 Parcel. Each parcel is contiguous to the Data Center.

Seller will convey the Sale/Leaseback Property to Taxpayer pursuant to a special warranty deed. Upon conveyance of the Sale/Leaseback Property, the special warranty deed will be recorded in the real property records of COUNTY, Texas, identifying Taxpayer as the owner of the property for real property tax purposes. Afterwards, either a new property tax account will be established for the Sale/Leaseback Property, identifying Taxpayer as the record owner and taxpayer, or the existing property tax account will be updated to show Taxpayer as the record owner and taxpayer.

Taxpayer will lease Seller constructed Building 4 on the Sale/Leaseback Property. Taxpayer will also have the option to lease Building 3 if it is constructed. The lease of Building 4, and if applicable that of Building 3, will be subject to the Sale/Leaseback. Taxpayer alleges it will own Building 4, and if applicable Building 3. Taxpayer will pay for the Building 4 Parcel by issuing a promissory note (Note) to Seller.

The Note will have a principal sum equal to the sales price of the Building 4 Parcel prior to construction of Building 4. The interest of the Note will be set at the 20 year U.S. Treasury Rate in effect at the time of issuance. The Note will be secured by a deed of trust on the Sale/Leaseback Property. Simultaneously, Taxpayer will ground lease the Building 4 Parcel back to Seller under the Ground Lease. The monthly rent under the Ground Lease will equal the monthly interest due under the Note, so that the payments offset each other.

The initial term of the Ground Lease will be equal to or longer than the remaining life of the Exemption, approximately * years. The initial term of the Expansion Lease may be less than the remaining life of the Exemption. Taxpayer expects to have limited termination rights in the Ground Lease and Expansion Lease to mitigate against certain business and operational risks. At the end of the term of the Ground Lease, fee ownership of the Sale/Leaseback Property, including the Expansion Buildings, revert to Seller.

After netting out all amounts due under the various components of the Sale/Leaseback, the total aggregate net payments by Taxpayer to Seller will equal the fair market rental value of the Expansion Buildings as if Taxpayer and Seller had entered into a standard lease instead of a Sale/Leaseback.

Taxpayer and Seller expect that the Sale/Leaseback can be structured so that it will be disregarded for accounting and income tax purposes. Following the Sale/Leaseback, Seller will be reported as the owner of the Sale/Leaseback Property for federal income tax purposes and rents. Additional amounts payable under the Ground Lease and the Note will also be disregarded.

Question, Ruling, and Analysis

Our restatement of your questions is shown below, followed by our response and analysis.

Question: After entering into the Sale/Leaseback, will Taxpayer maintain its current qualifying status under the existing Exemption, and will the Exemption extend to include the Expansion Buildings?

Ruling: Entering into the Sale/Leaseback will not affect the existing Exemption. The Exemption will not extend to the Expansion Buildings.

Analysis: The Data Center met the requirements for certification as a qualifying large data center project under Section 151.3595, effective **.

Section 151.3595(a)(2) defines “large data center project.” Section 151.3595(a)(2)(B) states that a large data center project must be “composed of one or more buildings comprising at least 250,000 square feet of space located or to be located on a single parcel of land or on contiguous parcels of land that are commonly owned or owned by affiliation with the qualifying operator.”

Section 151.3595(d)(2) allows for a qualifying owner, qualifying operator, or qualifying occupant, to independently or jointly meet the requirements for certification. Additionally, a qualifying owner may be the qualifying operator and the qualifying occupant. Sections 151.3595(a)(6) and (a)(8).

Under the Exemption, Taxpayer is the qualifying owner, qualifying operator, and qualifying occupant of the Data Center. Therefore, Taxpayer must be the owner of any land and buildings that are expansions of the Data Center for the Exemption to extend.

Taxpayer contends that the Sale/Leaseback establishes it as the owner of the Expansion Buildings. The property will be conveyed to Taxpayer pursuant to a special warranty deed and Taxpayer will be recorded in the real property records of COUNTY, Texas, as the owner of the property for real property tax purposes.

However, the Sale/Leaseback as described does not serve a business or economic purpose. The transactions have been structured solely to generate specific tax benefits. When a series of transactions are undertaken for no apparent reason other than to allow both parties to benefit from one party’s tax avoidance, the Comptroller is not required to sanction the construct and approve an exemption. See Cantu Enterprises v. Hegar, NO. 03-15-00516-CV (2017), citing to Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1357 (Fed. Cir. 2006). (“[T]here is a material difference between structuring a real transaction in a particular way to provide a tax benefit (which is legitimate), and creating a transaction, without a business purpose, in order to create a tax benefit (which is illegitimate).”

Several elements of the Sale/Leaseback indicate that the transactions have no business purpose or economic substance.

Seller will be reported as the owner of the Sale/Leaseback Property for federal income tax purposes;

the sale/leaseback transaction is disregarded for accounting and income tax purposes;

rents and other amounts payable under the Ground Lease would be disregarded for accounting and income tax purposes;

fee ownership of the Sale/Leaseback property reverts to Seller at the end of the term of the Ground Lease;

Taxpayer will have termination rights in the Ground Lease.

Exemptions from tax are strictly construed against the taxpayer and the taxpayer bears the burden to show it is entitled to an exemption. Cantu at 2. Specifically, a taxpayer must demonstrate that an agreement has economic substance. Comptroller’s Decision 107,105(2013). Taxpayer has not shown that the sale/leaseback serves any economic purpose. Nor has Taxpayer shown that its “demand is within the letter as well as the spirit of the law.” Bullock v. National Bancshares Corp., 584 S.W.2d 268, 272 (Tex. 1979).

The spirit of the common ownership requirement in 151.3595 is violated by Taxpayer’s scheme. Although the statute allows the qualifying owner to also be the qualifying operator and qualifying occupant, the statute contemplates ownership as the key element to the exemption. Taxpayer’s ownership of the Data Center and the Expansion Buildings are not equivalent. The Comptroller may look beyond individual transactions and view the totality of the circumstances to determine taxability or the applicability of an exemption. Comptroller’s Decision 104,123 (2012). Viewing the series of events proposed by Taxpayer, it is clear that the complex structure of the Sale/Leaseback used to establish ownership of the Expansion Buildings was created solely for Taxpayer to benefit from the Exemption.

Based on these facts related to the Sale/Leaseback, Taxpayer is not recognized as the qualifying owner of the Expansion Buildings. The current Exemption for the Data Center will not apply to the Expansion Buildings.

Taxpayer’s request included several additional questions regarding involuntary events; subsequent additions, removals, or disqualifications of buildings or areas from the Exemption; and early termination lease rights. Based on the facts provided, the existing Exemption cannot be extended to the Expansion Buildings. Therefore, these questions will not be addressed in this response.

Comptroller’s Decisions and STAR documents cited can be found on the Comptroller’s State Tax Automated Research (STAR) system. The Texas Tax Code and Texas Administrative Code are accessible at comptroller.texas.gov/taxes.

If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/web-forms/tax-help/ and reference Private Letter Ruling No. 20181217152342.

Sincerely,

Tax Policy Division – Indirect Taxes

Texas Comptroller of Public Accounts

ENDNOTE:

[1] Unless otherwise indicated, all references to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code.