Is a private contractor exempt from sales tax on materials used to build city-owned airport facilities that the contractor then leases back from the city for 15 years?

Subject

Airport Facilities — Built By Private Contractor On City — Owned Land — City Leases Facilities To Private Entity

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9308L1254B05

Plain-English Summary

A general contractor develops small airports for municipalities. The city owns the land, and the contractor builds terminals, hangars, and similar facilities on it. As soon as construction is complete, ownership of the facilities passes immediately to the municipality. But the contractor then keeps a 15-year leasehold interest in the facilities — during that period he must make the facilities available to the public, and he may use, rent, or assign the leasehold interest. The contractor also pays the city a monthly land lease for use of the land underlying the leasehold. All of this is set out in contracts between the cities and the developer.

The contractor asked whether he should be exempt from sales tax when purchasing construction materials for these airport facilities, reasoning that since the city immediately owns what's built, and the contractor pays the city rent for the land, he is effectively constructing the project for the city — a tax-exempt entity.

The Comptroller's office disagreed. It cited a prior case, Hearing No. 19,892 and 19,965 (January 7, 1988), involving a similar fact pattern: a contractor built a motel and hangar facilities at a city-owned airport, title passed to the city, and the contractor then leased the improvements back from the city to run a motel and airplane hangar business. In that hearing, the Administrative Law Judge relied on Attorney General Opinion MW-94, which holds that to benefit from the exemption, the contract between the taxpayer and the city must be "for the primary use and benefit" of the city. The petitioner's claim in that hearing was denied.

Applying the same reasoning here, the Comptroller found that the contracts between the contractor and the municipalities — even though title to the improvements passes to the municipalities — are not "for the primary use and benefit" of the municipalities. Instead, the contractor is the primary beneficiary of the improvements, at least during the 15-year lease, through occupying, leasing, or assigning the leasehold interest. As a result, the materials used for the improvements at these airports are not exempt from sales tax.

The letter closes by noting the opinion is based on the facts presented, and other facts, though similar, may produce a different result.

What This Means For You

Immediate transfer of title to a government entity is not enough on its own. Even though the city owns the airport facilities the moment construction finishes, that alone did not make the contractor's material purchases exempt. The Comptroller looked past legal title to who actually benefits from the arrangement in practice.

A leaseback arrangement can defeat the exemption. Because the contractor retained a 15-year leasehold interest and could use, rent, or assign the facilities, the Comptroller treated the contractor — not the city — as the "primary" beneficiary of the improvements. Contractors and developers structuring build-then-lease-back deals with municipalities should recognize that the leaseback itself can be the deciding factor against exemption.

The "primary use and benefit" test controls. Per Attorney General Opinion MW-94, as applied in the prior hearing this letter relies on, the relevant question isn't who holds title but whether the contract is "for the primary use and benefit" of the exempt government entity. If the contractor, rather than the city, gets the primary benefit (through occupancy, rental income, or assignment rights), the exemption doesn't apply.

This is fact-specific. The letter explicitly states the opinion is based on the facts presented, and other facts — even similar ones — may lead to a different outcome. Contractors in comparable airport-development or build-lease-back arrangements with municipalities should not assume this letter's conclusion automatically extends to their own contract terms.

Q&A

Q: Does a private contractor owe sales tax on materials used to build airport facilities that a city will own immediately upon completion?
A: Yes, according to this letter, if the contractor retains a leasehold interest in the facilities and is the primary beneficiary of them (through use, rental, or assignment), the materials are not exempt — they are taxable.

Q: Why doesn't immediate transfer of ownership to the city make the materials exempt?
A: Because the relevant test, per Attorney General Opinion MW-94, is whether the contract is "for the primary use and benefit" of the city, not simply who holds title. Here, the contractor — not the city — was found to be the primary beneficiary during the 15-year lease.

Q: What prior case did the Comptroller rely on?
A: Hearing No. 19,892 and 19,965 (January 7, 1988), which involved a contractor who built a motel and hangar facilities at a city-owned airport, took title in the city's name, then leased the improvements back to operate a motel and hangar business. The petitioner's exemption claim in that hearing was denied.

Q: What was the contractor's leasehold arrangement in this letter?
A: For a period of 15 years, the contractor retains a leasehold interest in the facilities, must make the facilities available to the public, and may use, rent, or assign the leasehold interest. The contractor also pays the city a monthly land lease for use of the underlying land.

Q: Does this ruling apply to every contractor building government-owned facilities?
A: No. The letter states the opinion is based on the facts presented, and other facts, though similar, may provide a different result.

Original ruling text

August 17, 1993

Dear **:

This is in response to your letter requesting a policy statement
regarding a client that develops small airports for municipalities.
The municipalities own the land upon which your client, the general
contractor, builds terminals, hangars, and similar facilities. Upon
completion of the construction, the ownership rights of the facilities
pass immediately to the municipalities. For a period of 15 years, the
contractor retains a leasehold interest in the facilities; he is
required to make these facilities available to the public and may
either use, rent, or assign the 15-year leasehold interest. However,
ownership of the physical property, and land, remains in the hands of
the municipality. Your client pays a monthly land lease to the city
for use of the land underlying the leasehold interest in the
facilities. All transactions are substantiated by contracts between
the cities and the developer.

You are seeking an opinion as to whether your client should be exempt
from sales tax when purchasing construction materials for the airport
facilities. Since the contractor is building a project which the city
will immediately own, and the contractor pays the city monthly rent
for the land underlying the facilities, the contractor is effectively
constructing for the city, a sales tax exempt entity.

RESPONSE: Hearing No. 19,892 and 19,965 (January 7, 1988), dealt with
a similar issue. In that case, the petitioner, a contractor, built
several improvements (a motel and hanger facilities) at a city-owned
airport. Petitioner's contract with the city provided that title to
the improvements passed to the city. Petitioner leased these
improvements from the city and operated a motel and airplane hanger
business. The Administrative Law Judge cited Attorney General Opinion
MW-94, as being directly on point. MW-94 holds that in order for a
taxpayer to benefit from the exemption the Petitioner is claiming, the
contract between the taxpayer and the city must be "for the primary
use and benefit" of the city. The Petitioner's contention in the
hearing was denied.

Similarly, in the situation at hand, the contracts between your client
and the municipalities which take title to the improvements made by
your client, are not for the "primary use and benefit" of those
municipalities. Rather, your client will be the primary beneficiary (
at least for the 15-year lease) of these improvements, by occupying,
leasing or assignment of its leasehold interest. As such, the
materials used for the improvements at these airports would not be
exempt.

This opinion is based on the facts presented. Other facts though
similar may provide a different result.

If you have other questions or need more information, you may call me
at 1-800-5315441, extension 3-4502. The regular number is
512/463-4502. You may also write to Tax Administration Division at the
above address.

Sincerely,

Gilbert Zamora
Administration Division

NOTE: Previous Accession Number 93070066L.3 and/or 9307066L