Are telephone cooperatives exempt from Texas sales tax on construction materials, and must their contractors pay tax on those materials?

Plain-English summary

A construction contractor that builds new fiber and copper cable systems for telephone companies and cooperatives wrote to the Comptroller with several questions about how sales tax applies to contracts with Rural Electrification Administration (REA) telephone cooperatives — customers who had been claiming tax-exempt status on their purchases.

The Comptroller's answer distinguishes two different exemption questions:

1. General exempt-organization status (Tax Code Sec. 151.309 and 151.310). Telephone cooperatives do not automatically qualify as exempt organizations under either of these sections just because they receive federal Rural Electrification Administration funding. Receiving federal funds doesn't make a cooperative a federal agency or instrumentality; unless a cooperative proves that status to the Comptroller, the presumption is that it is not exempt under Sec. 151.309 or Sec. 151.310.

2. Article 1528c telephone cooperatives. Separately, a cooperative formed under Article 1528c of Vernon's Texas Civil Statutes has its own exemption: Article 1528c, Section 29 exempts such a cooperative "from all other excise taxes," which lets it issue a sales/use tax exemption certificate when it purchases taxable items directly. Under 34 Tex. Admin. Code Rule 3.322, a cooperative claiming this status (or a nonprofit telephone cooperative located outside Texas) must send proof of its formation and status to the Comptroller.

Because the cooperatives here are not "exempt entities" under Sec. 151.309 or 151.310, the contractor does not get the Sec. 151.311 exemption that would otherwise apply to a contractor improving realty for an exempt organization — meaning the contractor generally must pay tax on tools, machinery, equipment, and consumables used to perform the work, and (on lump-sum contracts) on the incorporated materials too.

However, that is not the end of the story for separated contracts with cooperatives organized under Article 1528c: because those cooperatives can issue their own exemption certificate under Article 1528c Sec. 29, the contractor may accept that certificate in lieu of collecting tax on the separately-stated charge for incorporated materials, even though the cooperative is not "exempt" for Sec. 151.309/151.310 purposes.

The letter also walks through several specific fact patterns the contractor asked about:

• Three separated contracts with REA cooperatives, bid/awarded/constructed between October 1991 and October 1993: These are "taxable contracts" because the cooperatives aren't exempt under Sec. 151.309/151.310. Under a separated contract, the contractor is the seller of incorporated materials, may buy those materials tax-free using a resale certificate, and must collect tax from the customer on the separated materials charge — unless the cooperative is an Article 1528c cooperative that presents a valid exemption certificate, in which case no tax is collected on that charge.
• A separated contract bid September 23, 1993, with construction starting November 1993: Same analysis — taxable in principle, but the Article 1528c exemption-certificate route is available if applicable.
• Any lump-sum or separated contract with a cooperative dated after October 1, 1993: Yes, taxable, subject to the same separated-contract exemption-certificate mechanism described above.
• Lump-sum new construction contracts generally: The contractor is the end consumer of all taxable items used to perform the contract (including incorporated materials) and must pay tax on all of them, because these cooperatives are not exempt entities.
• Refunds of tax already paid on incorporated materials for what should have been an exempt separated contract: If the contractor accrued and remitted tax on incorporated materials, it may amend its return(s) to claim a credit/refund. If the contractor paid tax to its own supplier on those materials, it may instead issue a resale certificate to the supplier and seek a refund from the supplier. If the contractor already collected the tax from the cooperative and remitted it to the state, the contractor must first refund that tax to the cooperative before filing an amended return to obtain its own refund from the state.

What this means for you

Contractors building for telephone cooperatives

Don't assume a telephone cooperative's federal REA funding, or its general "cooperative" status, makes your contract tax-exempt. Under this letter, the cooperative must be classified as exempt under Sec. 151.309 or 151.310 (or, separately, qualify under Article 1528c and provide a valid certificate) before any tax relief applies. If the cooperative isn't exempt under 151.309/151.310, you as contractor typically owe tax on your own tools, equipment, and consumables regardless of contract type, and on incorporated materials under a lump-sum contract. On a separated contract, you can still avoid collecting tax on the materials charge if the cooperative is organized under Article 1528c and gives you a proper exemption certificate — otherwise you must collect and remit tax on that charge.

Telephone cooperatives (including REA-funded ones)

Simply receiving Rural Electrification Administration funding does not make your cooperative exempt from Texas sales tax. If you were formed under Article 1528c of Vernon's Texas Civil Statutes, you have your own separate statutory basis (Sec. 29) to claim exemption on your own purchases and to issue exemption certificates to contractors — but you (or an out-of-state nonprofit telephone cooperative) must send proof of your formation/status to the Comptroller per Rule 3.322. If you believe you qualify as a federal agency or instrumentality, you must likewise submit proof to the Comptroller; until you do, the presumption is that you are not exempt.

Accountants and tax professionals

This letter is useful for walking through the interaction between the general exempt-organization provisions (Sec. 151.309, 151.310, and the related contractor exemption in Sec. 151.311) and the separate, narrower statutory exemption available to Article 1528c telephone cooperatives. Note that a cooperative can simultaneously be "not exempt" for Sec. 151.309/151.310/151.311 purposes while still being able to issue a valid exemption certificate for its own purchases under Article 1528c — these are two distinct exemption regimes analyzed independently in this letter. Also note the refund mechanics described: the correct refund path depends on whether the contractor accrued its own use tax, paid tax to a supplier, or already collected and remitted tax from the customer.

Common questions

Q: Does federal REA funding make a telephone cooperative exempt from Texas sales tax?
A: No. The letter states that receiving funds from the federal government does not cause a cooperative to be exempt from paying sales tax, absent proof that it qualifies as a federal agency or instrumentality.

Q: Are telephone cooperatives exempt entities under Sec. 151.309 or 151.310?
A: Generally no. The letter concludes the cooperatives at issue did not qualify as exempt entities under either section, so contractors working for them don't get the Sec. 151.311 realty-improvement exemption.

Q: Can an Article 1528c telephone cooperative still avoid paying sales tax on its purchases?
A: Yes. Article 1528c, Section 29 of Vernon's Texas Civil Statutes exempts these cooperatives "from all other excise taxes," letting them issue exemption certificates for their purchases, separate from the Sec. 151.309/151.310 analysis. The cooperative must send proof of its formation under Article 1528c to the Comptroller per Rule 3.322.

Q: Under a separated new construction contract, who pays tax on the incorporated materials?
A: The contractor is the seller of the incorporated materials and may buy them tax-free with a resale certificate, then must collect tax from the customer on the separated materials charge — unless the customer is an Article 1528c cooperative presenting a valid exemption certificate, in which case the contractor accepts the certificate instead of collecting tax.

Q: Under a lump-sum new construction contract, who pays the tax?
A: The contractor is treated as the end consumer of all taxable items used to perform the contract, including incorporated materials, and must pay tax on all of them because the cooperative is not an exempt entity.

Q: If the contractor already paid or collected tax on a contract that turns out to be exempt, how is a refund obtained?
A: It depends on who paid what: if the contractor accrued and remitted its own use tax on incorporated materials, it amends its return for a credit/refund; if it paid tax to its supplier, it can issue a resale certificate and seek the refund from the supplier; if it already collected tax from the cooperative and remitted it, it must first refund the cooperative before amending its own return for a refund from the state.

Citations and references

• Tex. Tax Code Sec. 151.309 — exempt governmental entities; the letter concludes the cooperatives at issue are not exempt under this section absent proof of federal agency/instrumentality status.
• Tex. Tax Code Sec. 151.310 — additional exempt-organization category; the letter concludes it does not grant exempt status to telephone cooperatives per se.
• Tex. Tax Code Sec. 151.311 — exemption for a contractor's purchase of materials used to improve realty for an organization exempt under Sec. 151.309 or 151.310; quoted in part in the letter, and unavailable here because the cooperatives are not exempt under those sections.
• 34 Tex. Admin. Code Rule 3.322 — requires a telephone cooperative formed under the Telephone Cooperative Act (Article 1528c) or a nonprofit telephone cooperative located outside Texas to submit proof of status to the Comptroller.
• Article 1528c, Vernon's Texas Civil Statutes, Sec. 29 — exempts telephone cooperatives formed under this Act "from all other excise taxes," providing an independent basis for these cooperatives to claim exemption on their own purchases.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9404L1302B01

Original ruling text

April 6, 1994

Dear ***:

Your letter addressed to Al Van Allen has been forwarded to me for response.
Thank you so much for your patience while waiting for the written answers to
your questions.

You stated that your company is a construction contractor who contracts out to
various telephone companies and cooperatives. The work performed for these
companies is to bury a new fiber and/or copper cable system and any work
associated with this activity. According to the brief information provided,
the work appears to qualify as new construction.

Taxable entities make up the majority of your customer base. The type of
contract (lump-sum or separated) will determine whether your company or your
customer pays tax on incorporated materials when performing new construction
contracts for taxable entities.

Included in your customer base are Rural Electrification Administration (REA)
Telephone Companies or Cooperatives that receive funding from the United States
Department of Agriculture, Rural Electrification Administration. These
customers claim exemption from paying tax on purchases of taxable items. You
questioned the validity of this claim.

Telephone cooperatives formed under Article 1528c of Vernon's Texas Civil
Statutes are not required to pay sales tax when purchasing taxable items.
Article 1528c Section 29 states, "Each corporation doing business in this State
pursuant to this Act shall ... be exempt from all other excise taxes." This
means that telephone cooperatives formed under Article 1528c may issue
exemption certificates when purchasing items subject to Texas sales or use tax.
Two of the cooperatives claimed exemption based upon their formation under
Article 1528c; Article 1528c Section 29 provides the basis for these telephone
cooperatives to claim exemption on their purchases of taxable items.

Rule 3.322 regarding exempt organizations provides that a telephone cooperative
formed under the Telephone Cooperative Act (Texas Civil Statutes, Article
1528c) and nonprofit telephone cooperatives located outside the state (Texas)
must send information to the Comptroller's Office to prove exempt status. am
attempting to verify the formation of the other two cooperatives.

The fact that these cooperatives receive funds from the federal government does
not cause them to be exempt from paying sales tax. I was unable to locate
information stating these cooperatives are federal agencies or
instrumentalities; presumably they are not. However, if these cooperatives can
establish such a status, then they should submit information to this agency to
be classified as federal governmental agencies or instrumentalities. Until
that is done, the presumption is that these cooperatives are not exempt
entities under Sec. 151.309.

The sales tax statute (Sec. 151.310) does not grant exempt status to telephone
cooperatives per se. Again, if a cooperative can qualify as an exempt entity
under Sec. 151.310, then information that proves this status should be sent to
this agency in order for the cooperative to be classified as an exempt entity.
Until that is done, the presumption is that these cooperatives are not exempt
entities under Section 151.310.

Therefore, these cooperatives do not qualify as exempt entities under the sales
tax statute Sec. 151.309 or Sec. 151.310. This means that contractors (persons
improving realty) for these entities are not entitled to the exemption found in
Sec. 151.311 a portion of this section is restated below.

(a) The purchase of tangible personal property for use in the performance of a
contract for an improvement to realty for an organization exempted under
Section 151.309 or 151.310 of this code is exempt... (Emphasis added.)

You stated that your company has three separated contracts with REA Telephone
Cooperatives. These three contracts were bid, awarded, and constructed after
October 1991 but before October 1993. You asked:

Are these contracts taxable?

Response: Because the cooperatives are not exempt under Sections 151.309 or
151.310, the contracts are "taxable contracts." However, certain exemptions are
applicable to the transactions involved.

Under separated contracts your company is the seller of the incorporated
materials to your customers and may issue resale certificates to your suppliers
when purchasing materials to be incorporated into the customer's realty. Your
company must collect the tax from your customer on the agreed contract price
(separated charge) of the incorporated materials. However, under separated new
construction contracts with telephone cooperatives that are formed under
Article 1528c, you may accept a properly completed exemption certificate in
lieu of collecting tax on the charge for the incorporated materials.

Because telephone cooperatives do not qualify as "exempt entities" under
Sections 151.309 or 151.310, your company must pay tax on tools, machinery,
equipment, consumables, etc., purchased to perform the contracts. This applies
to lump-sum or separated new construction contracts and to nonresidential
repair or remodeling contracts. If your company enters into lump-sum new
construction contracts with these cooperatives, then your company must also pay
tax on the incorporated materials.

You also explained that your company has a separated contract with a REA
Telephone Cooperative that was bid on September 23, 1993, and construction
started in November 1993. You asked:

Is this contract taxable?

Response: This response is based upon the presumption that the contract is a
separated new construction contract and the REA cooperative is also formed
under Texas Article 1528c. Your company is the seller of the incorporated
materials to your customer and may issue resale certificates to your suppliers
when purchasing materials to be incorporated into the customer's realty. Under
separated new construction contracts with telephone cooperatives that are
formed under Article 1528c, you may accept a properly completed exemption
certificate in lieu of tax on the charge for the incorporated materials;
otherwise, your company must collect tax on the agreed contract price for the
incorporated materials.

Is any lump-sum or separated contract for a cooperative dated after October 1,
1993, taxable?

Response: Yes, the contracts are "taxable contracts." However, certain
exemptions are applicable to the transactions involved with separated
contracts. See the previous responses.

Also, under lump-sum new construction contracts, your company is the end
consumer of all taxable items purchased to perform the contract. These
telephone cooperatives do not qualify as exempt entities. This means that your
company must pay tax on all taxable items purchased for use in the performance
of the contract including incorporated materials.

Your last question is:

If our company has paid sales tax direct to the comptroller on separated
contracts that are exempt, what is the process for getting a refund?

Response: If your company accrued tax on incorporated materials that were
incorporated into realty under a separated new construction contract, then your
company may amend the return(s) on which you accrued the tax; this will create
a credit that will be refunded to your company. If your company paid tax to
your supplier on incorporated materials that were purchased to be incorporated
under a separated new construction contract, then your company may issue resale
certificates to your supplier and request the refund of tax from the supplier.

However, if your company collected the tax from the cooperative and remitted it
to the state, then your company must refund the tax to the cooperative. After
the tax has been refunded to the cooperative, your company may file amended
returns with this agency and obtain the refund.

This opinion is based upon the facts presented. Any additional or different
facts may cause this opinion to change.

You may also write to Tax Administration Division, Comptroller of Public Accounts.

Sincerely,

Tax Policy Division

NOTE: Previous Accession Number 9404374L