Were consumable overhead materials used by a contractor on a federal real-property contract exempt when title passed to the government?

Plain-English summary

The Comptroller assumed the taxpayer's federal contract was for an improvement to real property. Rule 3.291(c)(4)(B) specifically made overhead materials and supplies used on a federal contract taxable unless they were incorporated into the improved property.

The contract said title to the overhead materials passed to the federal government when the contractor allocated them to the contract, used them, or received reimbursement. The taxpayer cited a California case treating a comparable transfer and later contractor use as exempt.

Texas declined to follow that out-of-state decision. The letter said the Legislature's amendment of Section 151.311, effective October 2, 1984, clearly intended to tax overhead materials and supplies used by contractors on federal contracts, removing the federal-contract exemption while leaving the exemption for other exempt organizations unchanged. The Comptroller acknowledged that an administrative law judge or state court might agree with the California courts, but would not adopt that result at this level.

What this means for you

A contractual title-passage clause did not overcome the Texas rule stated in this letter. Consumable overhead inputs remained taxable unless incorporated into the real property.

Common questions

Were overhead materials used on the federal contract exempt? No, unless incorporated into the property being improved.

Did passing title to the federal government change the answer? No.

Why did Texas reject the California case? The Comptroller viewed the 1984 amendment to Section 151.311 as a clear legislative decision to tax these federal-contract inputs.

Citations and references

• Comptroller Rule 3.291(c)(4)(B) — overhead materials and supplies on federal contracts
• Section 151.311 — federal-contract amendment effective October 2, 1984

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9010L1058A04

Original ruling text

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, TEXAS 78774

BOB BULLOCK
Comptroller October 30, 1990

Dear **:

Thank you for your letter concerning consumable "overhead" materials
and supplies used in performing a contract with the federal government.

From your references to Rule 3.291, Contractors, I assume that the con-
tract is a contract for an improvement to realty.

Subsection (c)(4)(B) of this rule specifically provides that items such
as overhead materials and supplies, when used in a contract with the
federal government, are taxable unless they are incorporated into the
property being improved.

The California case which you have cited, however, dealt with the sale
of these materials to the government. The court ruled that the sale was
exempt and that the subsequent use of the materials by the contractor
was exempt because this use was in behalf of the government.

In the example you have given, the title clause of the contract provides
that title to these overhead materials passes from the contractor to the
government at either:

a. the allocation by the contractor to the contract
b. the time of actual use in performing the contract
c. the reimbursement of the cost of the materials by the government

As in the California case, the materials were used by the contractor.

When the legislature amended Section 151.311 effective October 2, 1984,
the definite intent was to tax overhead materials and supplies used by
contractors on federal contracts. While the exemption for other exempt
organizations remained unchanged, the exemption for federal contracts
was removed.

At this level, we are unwilling to go against the clear intent of Sec-
tion 151.311 on the basis of an out-of-state decision. We realize, how-
ever, that one of our administrative law judges or a state court may
agree with the California courts.

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

Please write or call if you have any questions. You can call toll-free
at 800-531-5441. Our regular number is 512-463-3830 and our FAX num-
ber is 512-475-0900.

Sincerely,
Larry Koenig
Taxability Section
Legal Services Division