After the October 1993 change to Sec. 151.311, can contractors accept exemption certificates for materials and consumable supplies used on realty-improvement jobs for exempt entities?

Subject

Exempt-Entity Contracts — 1993 Sec. 151.311 Amendment Lets Contractors Buy Materials And Consumables Tax-Free With Exemption Certificate — Five Hypotheticals Answered Before And After

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9312880L

Plain-English Summary

This ruling is actually two letters combined, and the "ALERT"-style value here is the timeline the Comptroller lays out between them.

The earlier letter (March 13, 1992) answers a merchant's five hypothetical questions about when a contractor doing realty-improvement work for a tax-exempt entity (a state highway project, a farm, a company, a charitable donation fund, a city) can use an exemption certificate or resale certificate instead of paying sales tax. At that time, the law was governed by HB-11 (effective October 1, 1991), under which contractors generally could not issue exemption certificates on materials, supplies, and equipment used for new-construction or residential repair/remodeling contracts for exempt entities — with three exceptions: contracts with school districts, contracts with nonprofit hospitals licensed under Health and Safety Code Chapter 241 or 577, or contracts qualifying for the "prior contract exemption." Under a separated contract, the contractor is treated as the seller of materials incorporated into realty (can issue a resale certificate to suppliers and let the exempt entity claim the exemption on the materials portion of the price), but still owes tax on consumables and equipment used to perform the job, unless the contract is with a school district/qualifying hospital/prior-contract job. Under a lump-sum contract, the contractor is treated as the end user of all equipment, consumables, and materials, and owes tax on those items at purchase (again, with the same three exceptions) — but does not need a sales tax permit. Consumable supplies can only be bought tax-free if title to them passes to the exempt entity on receipt and the contractor makes no use of them before title passes — the standard set by Day and Zimmerman, Inc. v. Calvert, 519 S.W.2d 106 (Tex. 1975).

Applying that framework, the 1992 letter answers all five hypotheticals: (1) a retail counter may not accept an exemption certificate for fence/barbed-wire materials for a state highway job — a resale certificate is needed on a separated contract, or the contractor owes tax on a lump-sum contract; (2) whether a person buying farm corral panels owes tax depends on whether the job is billed lump-sum (he's the consumer, pays tax) or separated (he's a retailer, can resell tax-free and then accept a farm exemption certificate from the rancher, per Rule 3.291(b)(3)(A) and Rule 3.357(b)); (3) a direct payment permit copy may not be accepted for security-gate installation, but a resale certificate can be used on a repair/remodel or separated new-construction job, with a direct-payment exemption certificate then accepted from the exempt buyer (Rule 3.288(f)); (4) an exemption certificate may be accepted in good faith from individuals buying materials for a charitable backstop project if they are authorized agents of an org with confirmed exempt status (Rule 3.322(f)(4)) or if they are donating the materials outright (Rule 3.287(e)(3)); (5) a contractor without a sales tax permit doing nonresidential repair work for a city may not issue an exemption or resale certificate until he obtains a sales tax permit, after which he can issue a resale certificate on materials and keep the city's purchase voucher as proof.

The later letter (December 16, 1993) is the actual cover letter for this STAR entry and updates the 1992 answers. It explains that effective October 1, 1993, Sec. 151.311 of the Tax Code was amended to let contractors doing realty-improvement work that benefits exempt entities buy — tax-free, with an exemption certificate — both the materials that get incorporated into the realty and the consumable supplies used up in one use on the job. This reverses the answers to Examples 1 and 5 from the 1992 letter: after October 1, 1993, the highway-materials retailer may accept the exemption certificate regardless of whether the contract is lump-sum or separated (Example 1), and COMPANY B may use an exemption certificate for the water-treatment-plant fencing supplies (Example 5). The letter states the answers to Examples 2, 3, and 4 are unchanged by the amendment.

What This Means For You

If you're a contractor doing realty-improvement work for an exempt entity today: This letter's core lesson is that the rules for accepting exemption certificates on contractor purchases changed materially between 1991 (HB-11) and October 1, 1993 (the Sec. 151.311 amendment). Any guidance dated before October 1, 1993 that says a contractor cannot use an exemption certificate for materials or consumables on an exempt-entity job may be outdated for jobs after that date — always check the effective date of any rule or letter you rely on.

If you're a retailer selling to contractors: The letter's distinction between separated contracts (contractor is treated as seller of materials, can issue resale certificates) and lump-sum contracts (contractor is treated as end user, owes tax on materials/equipment/consumables) is central to deciding whether you can accept a resale or exemption certificate at the counter, and it still depends on how the contractor's paperwork is structured.

On consumable supplies specifically: Per the 1992 letter, tax-free purchase of consumables (pre-amendment) required that title pass to the exempt entity on receipt and that the contractor make no use of the items before title passes — tracking the Day and Zimmerman case. The 1993 amendment broadened this by letting consumables used up in one use on an exempt job be purchased tax-free with an exemption certificate directly, without needing to satisfy the stricter Day and Zimmerman title-passage test.

Note on scope: This letter does not provide the "partial list of consumables" referenced in its own subject line/title — no such list appears in the body text reproduced here. It also does not restate the full current text of Sec. 151.311 as amended; it only describes the change in general terms.

Q&A

Q: As of the date of this letter (December 16, 1993), can a contractor accept an exemption certificate for materials and consumables used on a job for an exempt entity?
A: Yes, for jobs after October 1, 1993. The letter explains that Sec. 151.311, Tex. Tax Code, was amended effective October 1, 1993 to allow contractors doing work benefiting exempt entities to purchase tax-free — with an exemption certificate — both items incorporated into realty and consumable supplies used up in one use.

Q: Did the October 1993 amendment change every one of the five hypothetical answers from the earlier 1992 letter?
A: No. The 1993 letter states explicitly that the amendment changed the answers to Examples 1 and 5 (both involving exemption certificates being accepted where they previously couldn't be), while the answers to Examples 2, 3, and 4 remain unchanged.

Q: Before the 1993 amendment, could a contractor ever use an exemption certificate for a new-construction or residential repair/remodel job for an exempt entity?
A: Only in limited cases. Under HB-11 (effective October 1, 1991) as described in the 1992 letter, contractors generally could not issue exemption certificates for such contracts, except when the contract was with a school district, a nonprofit hospital licensed under Health and Safety Code Chapter 241 or 577, or when the contract qualified for the "prior contract exemption."

Q: What was required for a contractor to buy consumable supplies tax-free before the 1993 amendment?
A: The 1992 letter says the contract had to provide that title to the consumables passes to the exempt entity upon the contractor's receipt of the items, with no use of the items by the contractor before title passes — tracking the facts of Day and Zimmerman, Inc. v. Calvert, 519 S.W.2d 106 (Tex. 1975). If met, the contractor could give suppliers a resale certificate for the consumables and accept an exemption certificate from the exempt entity.

Q: How does a lump-sum contract differ from a separated contract for purposes of who owes the tax?
A: Per the 1992 letter, under a separated contract the contractor is treated as the seller of materials incorporated into realty (can use a resale certificate for those materials, and the exempt entity can claim exemption on the materials portion) but still owes tax on consumables and equipment. Under a lump-sum contract, the contractor is treated as the end user of all equipment, consumables, and materials and owes tax on those items at purchase — but does not need a sales tax permit.

Original ruling text

December 16, 1993

Dear **:

Thank you for inquiring about the effect of the change in the sales tax law
last spring. You asked that I review the answers to five hypothetical
situations you raised in your letter of February 25, 1992.

Effective October 1, 1993, Sec. 151.311, Tex Tax Code, was amended to allow
contractors doing work that will benefit exempt entities to purchase tax free
items that will be incorporated into the realty and consumable supplies that
will be used up in one use. This change in the law changes the answers to your
first and fifth hypothetical questions. The answers to questions 2, 3, and 4
remain unchanged.

Example 1: COMPANY A comes to my sales counter to buy materials for a State
highway project. The materials include fence post and barbed wire for
right-of-ways. COMPANY A tells my clerk that this is to be an exempt job and
presents an exemption certificate. What is the next step?

Response: The clerk may accept the exemption certificate and not charge tax on
the purchase without regard to whether the contract is lump sum or separated.

Example 5: COMPANY B is a customer that does work for nearby cities. COMPANY B
does not hold a sales tax permit and may not issue resale certificates. COMPANY
B is purchasing fencing supplies to repair the fence around the CITY A water
treatment plant. COMPANY B always pays tax on his purchases for non-exempt
entities. COMPANY B bills the city for the cost of materials and 2 hours labor.
Do I insist that he pay tax on these materials? Does this amount to paying
taxes with taxes?

Response: After October 1, 1993, an exemption certificate may be accepted from
COMPANY B for the purchase of the fencing supplies that will be used to enclose
the CITY A water treatment plant.

I hope this satisfactorily answers your questions. Should you require
additional information, please contact Wade Anderson, Assistant Director of Tax
Administration, at 111 East 17th Street, LBJ State Office Building, Austin,
Texas 78774, or cal1 toll free at 1-800-531-5441, extension 3-4004.

Sincerely,

JOHN SHARP
Comptroller of Public Accounts

cc: Glen Hunt, Director, Tax Administration
Wade Anderson, Assistant Director, Tax Administration

March 13, 1992

Dear **:

Thank you for your letter of February 25, 1992, regarding the changes HB-11
imposed on contractors improving realty for exempt entities. I apologize for
the inconsistent answers you previously received.

Here are some general guidelines concerning changes imposed by HB-11:

As of October l, 1991, contractors may no longer issue an exemption certificate
on purchases of materials, supplies, and equipment used to perform a new
construction contract or a residential repair/remodeling contract for an exempt
entity with the following exceptions. Contractors may issue exemption
certificates for contracts entered into with school districts, or nonprofit
hospitals licensed under Chapter 241 or 577 of the Health and Safety Code, or
their contract qualifies for the prior contract exemption

The exempt status of organizations listed in 151.309 and 151.310 of the Texas
tax code has not changed. Contractors may follow the provisions in Rule 3.29l,
Contractors, Section (a)(1), (2), and (5) and Section (b)(l) and (3) when
submitting separated bids or contracts for new construction or residential
repair and remodeling. A separated contract makes the contractor the seller of
the materials incorporated into the realty and allows any qualifying exempt
entity to claim the tax exemption on the agreed contract price of materials
incorporated into the realty. The labor necessary to perform the contract is
not taxable. However, the contractor must pay tax on all equipment and
consumables used to perform the contract unless the contract is for a school
district, qualifying hospital, or qualifies for the prior contract exemption.
The contractor would be required to hold a Texas sales tax permit and issue
resale certificates to suppliers for the materials incorporated into the
realty.

Contractors may still follow the lump-sum contract provisions of Rule 3.291,
Sections (a)(2) and (4) and (b)(l) and (2) when submitting lump-sum bids or
contracts for new construction or residential repair/remodeling. However, under
these provisions, the contractor is considered the end user of all equipment,
consumables, and materials incorporated into the realty. Unless the contract is
for a school district, qualifying hospital, or qualifies for the prior contract
exemption, the contractor owes tax on these items at the time of purchase. The
contractor does not need to hold a sales tax permit if using a lump-sum
contract.

It is important to note that consumable supplies may be purchased tax free only
if the contract provides that title to the consumables will pass to the exempt
entity upon receipt of the items by the contractor and no use is made of those
items by the contractor prior to passage of title to the property. The contract
must basically correspond to the facts in Day and Zimmerman, Inc. v. Calvert,
519 S.W. 2d 106 (Tex. 1975). If the contract is written this way, the
contractor may give a resale certificate to his suppliers for the consumables
and accept an exemption certificate from the exempt entity.

A repairman/remodeler may issue a resale certificate for the materials
incorporated into nonresidential realty. The repairman/remodeler may then
accept an exemption certificate from the exempt entity in lieu of tax for the
repair or remodeling service. The repairman is responsible for paying the tax
on consumables and equipment used to perform the service unless the provisions
of Day and Zimmerman are met. I have enclosed a copy of Rule 3.357, Real
Property Repair and Remodeling. Rule 3.357 will be amended to reflect the
changes imposed by HB-11.

You have requested we address the following examples:

Example l: COMPANY A comes to my sales counter to buy materials for a State
highway project. The materials include fence post and barbed wire for
right-of-ways. COMPANY A tells my clerk that this is to be an exempt job and
presents an exemption certificate. What is my next step?

Response: You may not accept the exemption certificate. All sales are presumed
to be taxable unless proven otherwise. The contractor must present you with a
resale certificate if he is using a separated contract. The contractor owes tax
on the cost of the materials if the contract is a lump-sum contract.

Example 2: PERSON A is working on some corrals for the COMPANY C. PERSON A
wants to purchase the corral panels tax free because they are for farm use. He
completes the farm exemption certificate on the back of my invoice and pays me
in green cash. Do I complete the transaction as such or insist PERSON A pay tax
on the panels? There is no contract.

Response: The taxability of this example depends on the method of billing
PERSON A uses. Under a lump-sum contract for new construction of the corrals,
PERSON A is considered the consumer of the materials used in providing his
service. PERSON A should pay tax on the panels at the time of purchase. Please
refer to Section (b)(2)(A) of Rule 3.291. Under a separated contract for new
construction or a repair/remodeling contract, PERSON A is considered a retailer
and may issue a resale certificate in lieu of tax on the panels. PERSON A may
then accept a properly completed exemption certificate from the farmer/rancher
in lieu of the tax if the agriculture exemption applies. Please refer to
Section (b)(3)(A) of Rule 3.291 and Section (b) of Rule 3.357. If PERSON A is
the farmer/rancher directly purchasing the panels, you may accept a properly
completed exemption certificate in lieu of tax. To qualify for the agriculture
exemption, the panels must be used exclusively in connection with raising
livestock.

Example 3: COMPANY D is installing new security gates for COMPANY E. COMPANY D
wants to issue COMPANY E's direct payment permit in lieu of tax. COMPANY D
wants to charge the gates to their account.

Response: You may not accept a copy of COMPANY E's direct payment permit in
lieu of tax. Whether COMPANY D is providing a repair/remodeling or new
construction job will determine the taxability of this example. COMPANY D may
issue a resale certificate in lieu of tax to purchase the gates if the job is a
repair/remodeling or separated contract for new construction. COMPANY D may
then accept a direct payment exemption certificate from COMPANY E. The
contractor is responsible for paying tax on the gates if the contract is a
lump-sum new construction job. Please refer to Section (f) of Rule 3.288,
Direct Payment Procedures and Qualifications.

Example 4: PERSON B and PERSON C wish to purchase fencing material for the
construction of a back-stop for the COMPANY F. They will be reimbursed for the
cost of the materials from COMPANY F's donation fund. The men complete the
exemption certificate on the back of your invoice and pay with their personal
checks.

Response: You may accept, in good faith, a properly completed exemption
certificate from PERSON B and PERSON C provided that PERSON B and PERSON C are
authorized agents of the organization and the COMPANY F has applied for and
received exempt status from this office. You may call the toll-free number
listed below for verification of COMPANY F's exempt status. Please refer to
Section (f)(4) of Rule 3.322, Exempt Organizations. If PERSON B and PERSON C
wish to donate the materials, rather than be reimbursed from COMPANY F's
donation fund, you may accept an exemption certificate. Please refer to Section
(e)(3) of Rule 3.287, Exemption Certificates. Otherwise, PERSON B and PERSON C
would owe tax on this transaction.

Example 5: COMPANY B is a customer that does work for nearby cities. COMPANY B
does not hold a sales tax permit and may not issue resale certificates. COMPANY
B is purchasing fencing supplies to repair the fence around the CITY A water
treatment plant. COMPANY B always pays tax on his purchases for non-exempt
entities. COMPANY B bills the city for the cost of materials and 2 hours labor.
Do I insist that he pay tax on these materials? Does this amount to paying
taxes with taxes?

Response: COMPANY B may not issue an exemption certificate. COMPANY B may not
issue a resale certificate without first obtaining a sales tax permit. COMPANY
B is responsible for obtaining a sales tax permit since he is repairing
nonresidential property. Once COMPANY B has obtained a sales tax permit, he may
issue a resale certificate in lieu of tax on the materials. COMPANY B may then
keep a copy of the City's purchase voucher and his invoice billing the city as
proof no tax was due on the labor and materials used on this job.

This opinion is based on the facts presented. If there are any additional or
different facts, the opinion may change.

If you have any questions or need additional information, you may call toll
free 1-800-252-5555 or the regular Austin number is 512-463-4600. You may also
write to Tax Administration Division.

Sincerely,

Lindey Osborne
Tax Administration Division