Could a change order executed during construction retroactively convert a lump-sum real-property contract into a separated contract?

Plain-English summary

The original refinery hydrocracker contract separately identified large equipment/material and service figures but still commingled services with incorporated materials inside the agreed prices. The Comptroller therefore treated it as a lump-sum new-construction contract.

While work was underway, the parties executed a retroactive amendment converting compensation to actual reimbursable costs plus a fixed completion fee. The contractor had to amend earlier progress billings and submit future detailed invoices supported by invoices, vouchers, payroll, and other records.

The Comptroller said the amendment successfully converted the contract retroactively into a separated contract. The cost-plus structure required itemized incorporated-material charges and separate other expenses, satisfying Rule 3.291.

What this means for you

A contract label or top-line division was not enough; the billing terms had to separately identify incorporated materials. This ruling accepted an in-progress retroactive amendment because it changed both the compensation basis and documentary requirements.

Common questions

Was the original contract separated? No. Did the change order convert it? Yes, retroactively. What facts mattered? Dollar-for-dollar cost reimbursement, a fixed fee, detailed itemization, and supporting records.

Citations and references

• 34 Tex. Admin. Code Rule 3.291

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9110L1151G01

Original ruling text

DATE: October 28, 1991

TO: Ledford Kelly, Audit Headquarters

FROM: John Christian, Tax Administration

SUBJECT: * and *

Per your request, we have reviewed the documents submitted by *
regarding a construction contract between * and ****.

Facts: On May 20, 1987, Customer (*) entered into a contract with
Contractor (*) described as an "Agreement for hydrocracker
recreation at * company facility, *, Texas" (Exhibit II).
The contract called for the new installation of a "hydrocracker" at
Customer's refinery . The equipment was to be affixed in such a way as to
become a permanent improvement to real property. Contractor was to be
compensated for the total contract price of:

(a) $6,508,000 plus applicable sales and use taxes for all required
equipment materials, refurbishing and field indirects, plus

(b) $9,356,400 for all required services.

In this condition, the contract was, a lump-sum contract for new
construction because the agreed, contract prices commingled service charges
with charges for materials incorporated into customer's real property.

On November 30, 1988, Customer and Contractor executed the "Fourth Letter
Amendment" (Exhibit III), which converts the basis of compensation to a
"reimbursable with a fixed fee basis" . Contractor was to receive a fixed fee
of $750,000 if the work were completed on time. The fixed fee was reduced in
increments according to any delays in completion. The change order was
retroactive in effect, and Contractor was required to submit amended progress
billings dating back to the commencement of the contract in accordance with
the revised basis of compensation. Future billings were to be submitted
according to a detailed invoice of "actual reimbursable costs", authenticated
by copies of invoices, vouchers, payroll, and other financial records.

The change order became effective while the job was in progress, and some
time before it was completed.

Question 1: Does the change order successfully convert this to a separated
contract for new construction?

Answer: Yes. The Fourth Letter Amendment converts the contract, retroactively,
into a separated contract.

The contract, as amended by the change order, is similar to a cost-plus
contract. Contractor is required under the terms of the change order to supply
Customer with complete information on its costs, which are reimbursed on a
direct dollar-for-dollar basis. The contract thus provides that Contractor
must provide Customer with invoices that itemize charges for materials that are
incorporated into its real property, in addition to itemized charges for
Contractor's other expenses. This meets the definition of a separated contract
in Rule 3.291.