When a developer has a contractor improve realty that will later be sold to a water district, can the contractor buy materials tax-free under Tax Code Section 151.311?

Subject

Exempt Contract To Improve Realty For Later Resale To A Water District — Does The Section 151.311 Exemption Apply?

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9310L1271B10

Plain-English Summary

This 1993 letter answers a question about contractors who improve real property for developers who then intend to resell the improvements to a governmental entity — specifically a water control and improvement district (WCID). The letter explains that, effective October 1, 1993, Tax Code Section 151.311 changes and closely resembles the version of that section that existed before October 1, 1991.

Under the pre-October-1991 (and, per this letter, soon-to-be-restored) version of Section 151.311, a contractor could accept an exemption certificate from a developer who was improving real property that had been dedicated to and tentatively accepted by a governmental entity. Dedicated improvements generally included things like streets, roads, sewer lines, and water lines built to governmental specifications, with the governmental entity becoming the owner and maintainer once the development phase was completed. Under that exemption, the contractor could purchase, tax-free by issuing an exemption certificate: materials incorporated into the property being improved, consumable items (not reusable after being used once for their intended purpose), and taxable items that are integral to or required under the contract. Equipment purchases and rentals, however, remained taxable even for work done for exempt entities.

The letter notes that the specific language of Section 151.311 was considered to take precedence over the more general language of Section 151.056, so it did not matter whether the contractor-developer contract was separated or lump sum — because the improvements were for the primary use and benefit of the exempt entity. But if the improvements were not accepted by the governmental entity, Section 151.056 applied instead, and tax was due on incorporated materials based on the type of contract (lump sum or separated) between the developer and contractor.

Applying this to the taxpayer's specific facts: the developer is having realty improved in order to sell the realty to the WCID, rather than donate it. The letter draws a sharp line: if the WCID contracts with the developer to have the improvements built and subsequently accepts the work, the Section 151.311 exemption will apply after October 1. But if the developer simply hopes to sell the improvements to the WCID without any contract between the developer and the WCID, then Section 151.056 applies, and tax responsibility on the materials depends on whether the developer-contractor contract is lump sum or separated.

What This Means For You

If you are a contractor working for a developer on a project ultimately destined for a governmental entity: Whether you can buy materials tax-free with an exemption certificate under Section 151.311 hinges on a fact outside your immediate contract — namely, whether the governmental entity itself has a contract with the developer for the improvements and has agreed to accept the finished work. Ask the developer for documentation of that relationship before relying on an exemption certificate.

If there is no contract between the developer and the governmental entity: Per this letter, the Section 151.311 exemption does not apply, and the general contractor-as-seller-or-consumer rules of Section 151.056 govern instead — meaning tax treatment of materials depends on whether your contract with the developer is a lump-sum contract or a separated contract.

If you are a developer planning to sell improved realty to a water district or similar entity: Simply hoping to sell finished improvements to a governmental buyer, without that buyer under contract for the work, will not secure the Section 151.311 exemption for your contractor's material purchases, per this letter.

Equipment is treated differently: The letter is explicit that even where the Section 151.311 exemption otherwise applies, equipment purchases and rentals used for work performed for exempt entities remain taxable.

Q&A

Q: Does Tax Code Section 151.311 change effective October 1, 1993?
A: Yes. The letter states that effective October 1, 1993, Tax Code Section 151.311 will change and closely resemble that section as it existed before October 1, 1991.

Q: Under the (restored) pre-October-1991 version of Section 151.311, what could a contractor buy tax-free?
A: Per the letter, the contractor could purchase materials incorporated into the property being improved, consumable items (not reusable after being used once for their intended purpose), and taxable items that are integral to the performance of the contract or required to be provided under the contract's terms, tax free by issuing an exemption certificate. Equipment purchases and rentals for work performed for exempt entities are taxable.

Q: Does it matter whether the contractor's contract with the developer is lump sum or separated?
A: When the Section 151.311 exemption applies (because the improvements are dedicated to and accepted by a governmental entity, or in this case contracted for and accepted by the WCID), the letter states it did not matter whether the contract was separated or lump sum, since the specific wording of 151.311 took precedence over the more general language of 151.056.

Q: What happens if the governmental entity does not accept the improvements?
A: According to the letter, if the improvements were not accepted by the governmental entity, the provisions of Section 151.056 applied, and tax was due on the materials incorporated into the job based on the type of contract between the developer and contractor.

Q: In the taxpayer's situation — a developer improving realty to sell to a WCID — when does the Section 151.311 exemption apply?
A: Per the letter, if the WCID contracts with the developer to have the improvements built and subsequently accepts the work, the exemption in 151.311 will apply after October 1. However, if the developer simply hopes to sell the improvements to the WCID but has no contract with them, the provisions of 151.056 apply, and tax responsibility on the materials is based on the type of contract, either lump sum or separated.

Original ruling text

September 14, 1993

Dear ****:

I am writing in response to your question about contractors improving
realty for developers who will in turn resell the improvements to a
governmental entity. Effective October 1, 1993, Tax Code Section
151.311 will change and closely resemble that section as it existed
before October 1, 1991.

Under Tax Code Section 151.311 as it existed before October 1, 1991, a
contractor could accept an exemption certificate from a developer who
was improving real property that had been dedicated to and tentatively
accepted by a governmental entity. Dedicated improvements generally
included streets, roads, sewer lines, water lines, etc., that were
built to governmental entity specifications and when the development
phase was completed the governmental entity became the owner of the
improvements and responsible for their maintenance.

The contractor could purchase materials incorporated into the property
being improved, consumable items (not reusable after being used once
for its intended purpose), and taxable items that are integral to the
performance of the contract or that are required to be provided under
the terms of the contract, tax free by issuing an exemption
certificate in lieu of tax. Equipment purchases and rentals for work
performed for exempt entities are taxable.

We considered that the specific wording in 151.311 took precedence
over the more general language in 151.056 so that it did not matter if
the contractor's contract with the developer was separated or lump
sum. This was based on the concept that the improvements were for the
primary use and benefit of the exempt entity. However, if the
improvements were not accepted by the governmental entity, the
provisions of 151.056 applied and tax was due on the materials
incorporated into the job based on the type of contract between the
developer and contractor.

In your situation, the developer is having realty improved in order to
sell the realty to a water control and improvement district (WCID),
rather than to donate the property to the district. If the WCID
contracts with the developer to have the improvements built and
subsequently accepts the work, the exemption in 151.311 will apply
after October- 1. However, if the developer simply hopes to sell the -
improvements to the WCID, but has no contract with them, the
provisions of 151.056 apply and the tax responsibilities on the
materials will be based on the type of contract, either lump sum or
separated .

This opinion is rendered based on the facts you submitted. Other
facts, though similar, may yield different results.

If you have questions or need more information, please call or write.
You may reach me by calling toll free, (800) 531-5441 (ext. 34680). My
direct line number is (512) 463 -4680. The number for FAX
transmissions is (512) 475-0900. You may write to me in care of Tax
Administration Division.

Sincerely,

Al Van Allen
Tax Administration Division

NOTE: Previous Accession Number 9311081L.3 and/or 9311108L