How did Texas apply sales and use tax to demolition, site preparation, equipment, freight, and contracts for a new manufacturing project?

Plain-English summary

The Comptroller answered eight groups of questions about a major new construction project at a Texas manufacturing facility. Because the owner had not yet decided whether to use a general contractor or direct subcontractors, or whether contracts would be lump-sum or separated, the letter repeatedly limited its answers to the available facts.

For demolition, a separately contracted charge to entirely raze a structure that would not be reused or reoccupied was not taxable, but debris removal was taxable. Separately stating the debris-removal charge limited tax to that charge.

Labor for dirt work preparing a construction site and labor to pour a new foundation were not taxable. Materials other than cement were taxable. Engineering and procurement services were not taxable unless connected to the sale of a taxable item.

A direct-payment-permit holder owed use tax when equipment was first used in Texas or stored in Texas before use. Supplier freight was part of an item's sales price and followed the item's taxability, while freight paid directly by the purchaser to a common or contract carrier was excluded. Taxable items brought into Texas for use were subject to Texas use tax.

For machinery and equipment, the result depended on what was built and how the contract was structured. If the installed property remained tangible personal property, the total materials, assembly, and installation charge was taxable. If it became a permanent real-property improvement, new-construction labor was not taxable, and lump-sum versus separated contracting affected who owed or collected tax and on what amount.

What this means for you

The letter shows why a construction project's contract structure and the finished property's classification matter. It did not provide a final project-wide conclusion because key contracting facts had not been chosen.

It also gave only general criteria for the then-available 25% manufacturing refund: property had to be tangible personal property when purchased, necessary and essential, used directly in manufacturing, processing, fabricating, or repairing goods for sale, and have a useful life of at least six months. The Comptroller could not determine which specific equipment qualified.

Common questions

Was complete demolition taxable? Not when the existing structure would not be reused or reoccupied, but debris removal was taxable.

Was site-preparation labor taxable? The letter said dirt-work labor and labor to pour a new foundation were not taxable; materials other than cement were taxable.

Were engineering and procurement services taxable? Not unless related to the sale of a taxable item under the described facts.

How were equipment-installation charges treated? If the result remained tangible personal property, the total materials, assembly, and installation charge was taxable. If it became a permanent real-property improvement, new-construction labor was not taxable.

Could the owner give a direct-payment exemption certificate to a contractor's suppliers? The letter said a separated contractor had to hold a sales and use tax permit and the owner could not issue its direct-payment exemption certificate to the contractor's suppliers.

Citations and references

• 34 Tex. Admin. Code Rule 3.291 (contractors)
• 34 Tex. Admin. Code Rule 3.352 (brokers and factors)
• 34 Tex. Admin. Code Rule 3.288 (direct payment procedures)
• 34 Tex. Admin. Code Rule 3.300 (manufacturing)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9101L1070G03

Original ruling text

January 10, 1991

Dear ****:

Thank you for your letter concerning "a major new construction project"
at one of your manufacturing client's (****, Inc.) Texas facili-
ties.

You indicated in our telephone conversation on January 2 that *
has not entered into a contract with a general or prime contractor at
this time. * does not know whether a general contractor will
be responsible for work performed by subcontractors or whether *
will enter directly into contracts with subcontractors. It has not
been decided whether the contracts will be lump-sum or state labor and
material charges separately.

The following responses to your questions a re based on the limited
available information that you provided in your letter and our tele-
phone conversation.

1. Demolition of the existing structures You said that **** will
   enter into an agreement on a stand-alone basis directly with the pro-
   vider of these services. A charge to entirely demolish or raze an ex-
   isting structure that will not be reoccupied or reused is not taxable.
   A charge for removing the debris is taxable. If the charge for taxable
   items (debris removal) is stated separately then tax is due only on
   those charges, not the total amount.

2. Site preparation The labor to prepare a construction site (dirt work)
   and the labor to pour a new foundation are not taxable. The materials
   (other than cement) are subject to sales tax. Contractors performing
   new construction contracts are subject to the provisions of Rule 3.291
   (copy enclosed).

3. Engineering the procurement service The services you described are
   not taxable unless related to the sale of a taxable item. You stated
   in our telephone conversation that **** will purchase the equip-
   ment directly from suppliers rather than from the provider of these ser-
   vices. Rule 3.352-Brokers and Factors is enclosed for your review.

4. Purchase of machinery and equipment. Direct payment permit holders
   owe use tax on equipment purchases when the property is first used in
   Texas or when the property is stored in Texas prior to use. Please re-
   view Rule 3.288 on direct payment procedures.

Freight charges paid to a supplier are a part of the sales price of an
item and are taxable if the item purchased is taxable. Freight paid di-
rectly to a common or contract carrier by the purchaser are not included
in the taxable purchase price of an item. Any taxable items brought
into Texas for use in this state, including items purchased in Europe,
are subject to Texas use tax.

** may not issue direct payment exemption certificates to sup-
pliers in Texas who sell component parts to a European company fabricat-
ing the distillation reactor. The European company will owe sales tax
to its Texas suppliers unless the European company issues exemption cer-
tificates for component parts of the distillation reactor or the Texas
suppliers ship the parts to a location outside Texas. *** will
owe tax on the total amount it pays to the European supplier for the
equipment (parts and labor) regardless of any tax the European supplier
paid to its suppliers.

5. Construction, assembly and erection of new machinery and equipment
   You indicated in our telephone conversation that it has not been decided
   whether **** will enter into contracts with the subs or will hire
   a general contractor to handle the entire project. This will determine
   which entity is responsible for the tax. The following is general infor-
   mation, not a definite taxability ruling.

If the machinery and equipment remain tangible personal property after
construction, the total charge for materials, assembly and installation
will be subject to tax. If the machinery and equipment become permanent
improvements to real property then any new construction labor will not
be taxable. The total charge to **** will be taxable or nontaxa-
ble depending on whether the contracts are lump-sum or separated. Please
refer to Rule 3.291 on contractors and Rule 3.300 on manufacturing.

6. Construction of distillation reactor, oxygen plant, chemical treat-
   ment plant and material clarifying facility Same as answer #5.

7. Separated vs. lump-sum contracts on new construction. A separated
   contractor must have a sales and use tax permit. **** may not issue its
   direct payment exemption certificate to the contractor's suppliers. The amount
   of tax paid under lump-sum and separated contracts may or may not be the same.
   The lump-sum contractor owes tax based on his purchase price. The separated
   contractor must collect tax on the agreed contract price of materials. Please
   see section (a)(1) of Rule 3.291.

8. Manufacturing exemption for 25% refund I cannot tell you specifically
   which pieces of equipment will qualify for the 25% refund of sales tax. In
   general, machinery and equipment qualifies if:

It is tangible personal property when purchased it is necessary,
essential and used directly in manufacturing, processing, fabricating or
repairing tangible personal property to be sold, it has a useful life of six
months or longer.

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

Please feel free to contact me if you have any additional questions. You
may write me, call toll free 1-800-252-5555 (ext. 3-4685) from anywhere in the
United States or phone 512/463-4685.

Sincerely,
Julie Pesl
Tax Correspondence