How did Texas tax HVAC maintenance and repair contracts for tangible equipment, commercial real-property systems, and residential real-property systems?

Plain-English summary

The first distinction was whether the HVAC equipment remained tangible personal property or became part of real property. Repair, remodeling, restoration, or maintenance of tangible HVAC equipment was taxable under Rule 3.292, including service-contract charges and separately billed parts and labor.

For HVAC systems that were improvements to commercial real property, scheduled periodic work on equipment that had not malfunctioned qualified as nontaxable maintenance under Rule 3.357. Separately billed repair charges, including labor and parts, were taxable. Parts separately sold to the customer were taxable and could be bought for resale; the provider instead owed tax on materials included in nontaxable maintenance.

A commercial contract covering both maintenance and repairs could state the charges separately and collect tax only on repairs. If it used one lump sum, the entire price was taxable unless the repair portion was 5% or less and supported by records. At 5% or less, the contract was treated as nontaxable maintenance and the provider paid tax on included parts and materials. Above 5%, the whole contract was treated as taxable repair, and incorporated parts could be bought for resale.

The provider could develop a documented repair-versus-maintenance allocation from the prior year's aggregate contracts or for an individual contract, using time sheets or other records and reevaluating an aggregate percentage annually.

For residential real-property systems, Rule 3.291 treated the provider as a contractor. Labor to repair, maintain, remodel, or restore the residential improvement was nontaxable. Under a separated contract, the provider collected tax on separately stated incorporated parts and could buy them for resale. Under a lump-sum contract, the provider paid tax on the parts and charged no tax on the customer-facing lump sum.

What this means for you

HVAC service-contract tax treatment depended on property classification, residential versus commercial use, scheduled maintenance versus repair, and whether prices were separated. Contract drafting and contemporaneous allocation records directly affected the result.

Common questions

Was service on freestanding tangible HVAC equipment taxable? Yes. Was scheduled commercial preventive maintenance taxable? No under the stated conditions. What if repairs exceeded 5% of an unallocated commercial contract? The entire contract was taxable. Was residential repair labor taxable? No. Who paid tax on residential parts? The customer under a separated contract; the contractor under a lump sum.

Citations and references

• Rule 3.292 (tangible-personal-property repair and maintenance)
• Rule 3.357(a)(3) and (c)(2) (scheduled maintenance and commercial real-property work)
• Rule 3.291 (residential real-property contractors)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9110L1138C01

Original ruling text

October 9, 1991

Dear ***:

Thank you for your recent letter. From the facts you provided in the letter and
in our telephone conversation, I understand that your plans to sell service
contracts for heating and air conditioning systems.

Generally speaking, all charges for the repair, remodeling, restoration, or
maintenance of heating and air conditioning equipment that remains tangible
personal property (as opposed to real property) are subject to tax. See
enclosed Rule 3.292. You are required to collect tax on the sale of a contract
for services to tangible personal property, and also on all parts and labor
billed separately.

For purposes of the responses below, I presume that the described contracts
cover services to central heating and air conditioning systems, to "chillers"
that are permanently affixed to a building's plumbing system, or to other types
of heating and air conditioning systems that are affixed in such a way as to
become improvements to real property.

You asked whether you are required to collect tax under the following types of
service contracts for heating and air conditioning equipment that is "real
property":

1. On a commercial building: Service contract for service maintenance only;
   definite dates scheduled on contract (no parts or labor for repairs
   included; this is billed separately).

Answer: This appears to be a nontaxable maintenance contract under Rule 3.357
(a) (3) and (c) (2). Please note that the service must be "scheduled" and
"periodic", and must be performed to maintain property that has not
malfunctioned or broken down, in order to constitute nontaxable maintenance.

No tax would be due on the charge for the maintenance contract. You would be
required to collect tax on all parts billed separately, which you could
purchase tax free with a resale certificate. You would be required to pay tax
on parts and materials included in a charge for maintenance services. You would
be required to collect tax on all additional charges for repair, including
labor and parts.

2. On a commercial building: Service contract for service maintenance and
   parts and labor for repairs; definite dates scheduled on contract for
   routine maintenance; contract also includes emergency repairs (labor and
   parts included in contract); no additional billing done even for
   emergency calls.

Answer: This is a contract for both maintenance of real property (a nontaxable
service) and repair of nonresidential real property (a taxable service). Both
parts and labor are included in the contract price.

If the contract contains separate charges for maintenance and repairs, you
would be required to collect tax on the charge for repairs. Parts used in
repairs could be purchased tax free with a resale certificate; you would be
responsible for paying tax on materials used in maintenance.

If the charges for repair and maintenance are not separately identified in the
contract, the entire contract price is taxable to the customer unless the
charge attributable to repairs constitutes 5% or less of the total contract
price. You must be able to document this fact through your business records, to
overcome the presumption that the entire contract is taxable.

If repair is 5% or less:

If you can demonstrate through records that the charges for repair constitute
5% or less of the total lump-sum contract price, then this is a nontaxable
maintenance contract. In this case, you are responsible for paying tax on parts
and materials included in the lump-sum contract price.

Additional parts, billed separately, are taxable to the customer. You may
purchase such parts tax free with a resale certificate. The total charge for
additional repairs, billed separately, is taxable to the customer. Parts
transferred to the customer in these additional repairs may be purchased
tax-free with a resale certificate.

If repair is more than 5%:

If repairs constitute more than 5% of the lump-sum contract price, then the
entire contract is a repair contract. In this case, the customer must pay tax
on the total contract price, and you would be entitled to purchase tax-free
with a resale certificate parts that will be incorporated into the customer's
property under the contract.

The total charge for additional repairs, billed separately, is also taxable to
the customer. Parts incorporated into the customer's property as part of these
additional repairs may be purchased tax-free with a resale certificate.

3. On a commercial building: Service contract for service maintenance and
   labor only for repairs (parts not included); definite dates scheduled on
   contract for routine maintenance (contract includes emergency repairs,
   labor only, parts not included, billed separately); additional billing
   done for parts only.

Answer: Same as answer 2.

General observations:

Instead of having to collect tax on the entire lump-sum contract for
maintenance and repair (where repair is more than 5%), you may develop for such
contracts a percentage attributable to repairs and a percentage attributable to
maintenance. You could apply that percentage to your contracts in order to
calculate separate charges for repair and maintenance. You would then collect
tax from your customers on the separately stated charge for repairs, but not
the separately stated charge for maintenance.

The percentage should be derived from the total receipts for repairs performed
under such contracts divided by the total receipts for repairs and maintenance
combined. Daily time sheets or other documentation that details time spent on
repairs vs. time spent on maintenance may be used to develop the allocation.
The percentage should be taken from an aggregate of all contracts from the
preceding year, and should be reevaluated annually to adjust for any changes.

You may also calculate a percentage for each contract individually, rather than
for the aggregate. On original repair/maintenance contracts, you may use a
reasonable estimate (supported by business records) to calculate the
percentage.

You would be required to pay tax on materials that are used to perform
maintenance under the contract. You would be required to collect tax from the
customer for parts billed separately, but you could issue a resale certificate
to buy such parts tax-free.

You would be required to collect tax on the entire separately stated charge for
repairs. Parts incorporated into the customer's property as part of a repair
may be purchased tax-free with a resale certificate. Of course, separately
billed repairs are also taxable to the customer.

4. On a residential building: Service contract for service maintenance only;
   definite dates scheduled on contract (no parts or labor for repairs
   included; this is billed separately).

Answer: When you repair, maintain, remodel, or restore residential real
property, you are treated as a contractor. Your services are covered in Rule
3.291 (enclosed).

There is no tax due on the labor to repair, remodel, maintain, or restore a
residential improvement to real property. Under a separated contract (parts
billed separately), you are required to collect tax on the separately stated
charge for parts that you incorporate into the customer's property. You may
issue a resale certificate to buy such parts tax free. Under a lump-sum
contract (contract price does not separately state charges for parts from
charges for labor and services), you are required to pay tax on the parts. You
would charge no tax to the customer on the lump-sum contract price.

See also the discussion on page one of this letter regarding repair,
remodeling, maintenance, or restoration of tangible personal property. These
services are taxable when performed at both residential and nonresidential
properties.

5. On a residential building: Service contract for service maintenance and
   parts and labor for repairs; definite dates scheduled on contract for
   routine maintenance; contract also includes emergency repairs (labor and
   parts included in contract); no additional billing done even for
   emergency calls.

Answer: Same as answer 4.

6. On a residential building: Service contract for service maintenance and
   labor only for repairs (parts not included): definite dates scheduled on
   contract for routine maintenance (contract includes emergency repairs,
   labor only, parts not included, billed separately); additional billing
   done for parts only.

Answer: Same as answer 4.

This opinion is based on the facts presented. Different facts, though similar,
might lead to different answers. If you have further questions, feel free to
write or call me at 1-800-252-5555, ext. 3-3889.

Sincerely,

John Christian
Attorney
Tax Administration Division