How did proposed Texas contractor Rule 3.291 treat short-lived assets, financing leases later returned as rentals, and intracompany sales under the aggregate method?

Plain-English summary

The Comptroller answered three industry comments on proposed contractor Rule 3.291:

First, if a non-motor-vehicle asset's useful life was less than four years, the contractor could use the asset's actual life. Motor vehicles were excluded because another Tax Code provision governed them.

Second, equipment acquired under a Rule 3.294 financing lease and capitalized had to remain a capital asset under the aggregate method even if later returned to the lessor and reclassified in the books as rental payments. The contractor received no credit for months when tax had accrued. The alternative was to leave the equipment out of the aggregate method from the beginning and keep separate records of its use.

Third, transfers among divisions of the same company were not sales for sales-tax purposes and were excluded when calculating the taxable-sales percentage. Receipts from sales to separate legal entities were included.

What this means for you

The initial accounting and reporting choice for financing-lease equipment had continuing tax consequences. A later return and bookkeeping reclassification did not unwind capital-asset treatment. Related-party calculations also turned on legal-entity boundaries, not merely internal division labels.

Common questions

Could an asset use a reporting life shorter than four years? Yes, if its actual useful life was shorter and it was not a motor vehicle.

Could returned financing-lease equipment be reclassified out of the aggregate method? No, not after it had been capitalized and entered into the method.

Was credit allowed for tax accrued before the equipment was returned? No.

What alternative did the letter give? Do not enter the equipment into the aggregate method initially, and keep separate use records.

Did intracompany division transfers count as sales? No.

Did sales to a separate legal entity count? Yes, when determining the taxable-sales percentage.

Citations and references

• Proposed Comptroller Rule 3.291 — contractor rule under discussion.
• Comptroller Rule 3.294 — financing-lease definition cited in the response.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/8704L0814A08

Original ruling text

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, TX 78774

BOB BULLOCK
Comptroller October 23, 1986

Dear *:

Thank you for your letter of September 22, 1986 offering comments on the
proposed rule 3.291 concerning contractors. Restated below are your
comments with our response.

1. A four year reporting period may be too long for a great number
   of assets. They simply do not have a four year useful life.
   The example I can think of is large generators and pumps which
   are used 24 hours/day in some cases. Company automobiles and
   pickup trucks are rarely kept four years due to high mileage driven.

Response: If an asset's (other than motor vehicles which are taxed under
another provision of the Tax Code) useful life is less than four years,
the asset's actual life may be used.

2. Contractors in our industry will lease/rent many pieces of
   equipment. This differs from conventional leases or out right
   purchases in that you have an option to return the equipment at
   anytime during the lease. At that time, all principal and
   interest payments are reclassified as rental payments. I
   believe you will have a lot of confusion if this happened as to
   the taxability of the payments up to that point. I would take
   the position that if this piece of equipment worked entirely
   on exempt work, then I would be due a credit for the months
   accrued and paid tax on it. It never should have been
   capitalized to begin with and the taxability of the rent would
   depend upon where it was working. You unfortunately don't know
   which Lease/Rentals you will keep and which will be returned
   and expensed as rent at the beginning of the lease.

Response: Equipment acquired under a financing lease, as defined in Rule
3.294, which is capitalized must continue to be treated as a capital
asset under the aggregate method even if the equipment is later returned
to the lessor and the bookkeeping entries are revised to reflect rental
payments. No credit will be allowed for the months tax was accrued.
The
only alternative is not to enter it under the aggregate method to begin
with and to keep separate records of that equipment's use.

3. The subject of intracompany sales used for determining the
   percentage of taxable sales will also cause some confusion. In
   our case, we have six separate divisions each selling to the
   other or directly to third party sales.

Response: For sales tax purposes, intracompany sales are not considered
to be sales. These type sales should not be included in taxable sales
when determining the taxable percentage. However, receipts from sales
to separate legal entities would be used to determine the percentage of
taxable sales.

Thank you for your comments on the proposed rule. Please feel free to
contact me if you have additional questions. You may write me, call toll
free 1-800-252-5555 from anywhere in Texas or phone 512/463-4600.

Sincerely,
Allan Van Allen
Tax Administration Division