Does a private corporation that remodels and operates a detention facility for a city owe Texas sales tax on its purchases and on the remodeling work?

Plain-English summary

A private corporation asked about its Texas tax responsibilities for running a jail. A city had contracted with the federal government to provide a secure detention facility for federal inmates, and the city in turn contracted with a private corporation to provide that service on the city's behalf. The corporation bought a building and was remodeling it to meet federal specifications, after which it would operate the facility. The corporation wanted to hand the remodeling contractor an exemption certificate instead of paying tax on the remodeling.

The Comptroller said it could not. The chain of services is nontaxable: the private corporation operating the facility provides a nontaxable service to the city, and the city provides a nontaxable service to the federal government. But providing a nontaxable service does not make the provider's own purchases tax-free. The corporation owes tax on all taxable goods and services it uses to provide that service — and that includes the remodeling of the facility. So the corporation is the taxable consumer of the remodeling work and cannot issue an exemption certificate to the remodeler.

Note on the attached document. The STAR record for this ruling also contains a separate, unrelated letter dated July 26, 1988, addressed to a different taxpayer ("CORP ABC," described as operating a Fort Worth F-16 plant on a federal enclave). That letter announces an audit-position change: the Comptroller rejected Day v. Zimmerman as controlling precedent and stated it would begin taxing "category one" overhead items (office and plant supplies, materials, equipment, and machinery) used and consumed at the plant but not incorporated into the finished products sold to the government. That attached letter concerns a different taxpayer and issue; the operative ruling for this document is the October 24, 1988 detention-facility letter summarized above.

What this means for you

Private operators of government facilities

Running a facility or providing a service for a governmental unit can itself be nontaxable, but that status stops at your door. You are still the consumer of the goods and taxable services you buy to deliver that service, and you owe sales/use tax on those purchases.

Remodeling and construction inputs

You cannot pass your service-provider status through to a contractor. Because you owe tax on the remodeling as a consumer, you should not issue an exemption certificate to the remodeler — doing so would be improper and leave tax unpaid.

Government-contract chains

A nontaxable service flowing from you to a city, and from the city to the federal government, does not convert your input purchases into exempt buys. Analyze your own purchases separately from the service you provide.

Common questions

Q: Is operating a detention facility for a city a taxable service?
A: No. The private operator provides a nontaxable service to the city, and the city provides a nontaxable service to the federal government.

Q: So are the operator's purchases tax-free?
A: No. The operator owes sales tax on all taxable goods and services it uses to provide that service, including the facility remodeling.

Q: Can the operator give the remodeling contractor an exemption certificate?
A: No. The operator is the taxable consumer of the remodeling, so it cannot issue an exemption certificate for that work.

Q: What is the July 1988 letter attached to this record?
A: It is a separate letter to a different taxpayer about a federal-enclave audit position (rejecting Day v. Zimmerman and taxing certain overhead items). It is not part of the detention-facility ruling.

Q: Can I rely on this 1988 letter for my own government contract?
A: Treat it as guidance only. It is based on the specific facts presented and can change with different facts; on the STAR system it binds the Comptroller only as to the taxpayer it was issued to and may no longer reflect current policy.

Citations and references

Rules and statutes: The operative detention-facility letter states the Comptroller's position without citing a specific rule or Tax Code section by number. The separate attached July 1988 letter refers to the court case Day v. Zimmerman.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/8810L0901A13

Original ruling text

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, 78774

BOB BULLOCK
Comptroller October 24, 1988

Dear ***:

Thank you for your letter concerning the tax responsibilities of a
private corporation providing detention facilities.

I understand that the City of *** has contracted with the
federal government to furnish a secure detention facility for federal inmates.
***** has contracted with a private corporation to provide these
services on behalf of the City.

The private corporation has purchased a facility and is remodeling
the facility to meet the specifications of the federal government. After the
facility is ready, the corporation will operate the detention facility. The
private corporation would like to give the remodeler an exemption certificate
in lieu of tax on the remodeling.

The private corporation in operating the facility is providing a
nontaxable service for the City. The City is in turn providing a nontaxable
service for the federal government. The private corporation owes tax on all
taxable goods and services used to provide that service.

This opinion is based on the facts presented. If there are
additional or different facts, the opinion may change.

If you have any questions or need more information, please call our
toll-free number 1-800-531-5441. The regular number is 512/463-4614. You may
write me at the Taxability Section, Legal Services Division.

Sincerely,
Adina Whittemore
Taxability Section
Legal Services Division

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, 78774

BOB BULLOCK
Comptroller July 26, 1988

Gentlemen:

For record-keeping purposes of our meeting today, this letter
reiterates notice to you of a change in the Comptroller's position regarding
the taxability of certain operations conducted by CORP ABC.

Specifically and taking into consideration audit periods beginning
as far back as October 1, 1963, the pertinent holdings of Day v. Zimmerman are
rejected as controlling precedent for any CORP ABC's method or procedure
thought otherwise or agreed to by this Agency. Moreover, we are now choosing
to disagree with the simultaneous title transfer prin-ciple which, as a legal
conclusion, supported the sale for resale to an exempt purchaser result for
years.

The simple consequence of this announcement is that henceforth tax
will be due on purchases in what has been traditionally called "category one",
viz:

... all overhead items, such as office and plant supplies,
material, equipment and machinery, which were used and consumed within
Claimant's office or plant on a federal enclave, but did not become a part of
the finished products to be sold to the government...

As for now, there will be no other changes in Agency policy
regarding the taxability of category two rentals, capital asset acquisition
which the company presently self-assesses or any other routine audit situation
not affected by the major issue we've been discussing. Additionally, what
we're doing here will have no effect whatsoever on practices and procedures
conducted in the Data Services Division, the Abilene outlet operation or any
other division which may have conducted its tax responsibilities in a different
way than did the Fort Worth F-16 plant.

I would like to add quickly that a recurring reference to some aura
of special treatment created by the existence of a so-called "Federal en-clave"
has been an unfortunate and disabling nuance of the real ques-tions involved
over the years and should not again be regarded as adding anything helpful or
controlling.

We do understand that, although your reception of my presentation
was a positive one and tended toward agreement with it, the advice of your
client on it will be solicited and its consent will be necessary to create any
new and binding conditions governing future tax-reporting responsibilities
beyond what the law and this notice will now require in any event.

Pending receipt from you of word indicating the Corporation's
official position, we have agreed to work against September 1, 1988, as a
target date for completing several matters.

1. You will consult with your client to determine the feasibility
   of an agreed start date for direct-pay accrual of category one overhead
   items, which could be as early as today.

2. Pat Ramirez and I will begin work with Becky Ferguson, James
   Hilliard and Archie Bailey in the Fort Worth Audit Office to create a good set
   of paperwork taken now from her work and design it to provide by example some
   rational guidelines for future audits.

3. We also will develop further the government-owned facilities
   issue and determine how it can be worked to fit into the overall breadth of
   where the complete audit sits at this point.

However, if CORP ABC elects to go its own way without an agreement
for voluntary compliance, please understand that auditors to come will be given
instructions consistent with this notice.

That said, we nonetheless take to heart with appreciation your
professional indication -that CORP ABC will be able to arrange its affairs
with the Government, to the extent required by it internally, to agree
with this Agency's expectations.

Under any circumstances, to today's date, the company will be
entitled to rely on its previous understanding of the Agency's policy and
agree-ment, We believe in conclusion that the excellent quality of our
rela-tionship in working to the common objective of a proper and correct
measure between business and tax will and should support full acceptance by
CORP ABC of these new terms.

Thank you very much for your excellent cooperation.

Yours very truly,
Timothy M. Trickey
Legal Counsel
Audit Division