When a contractor makes an improvement that increases production capacity at a Texas refinery or chemical plant, does sales tax apply to the material, the labor, or both?

Plain-English summary

The Texas Comptroller's Tax Administration Division answered a taxpayer's question about a September 1995 Legislative Update notice concerning "increased capacity" work at a petrochemical refinery or chemical plant. The taxpayer asked whether tax applies to the material but not the labor when an improvement to a production unit increases its production capacity.

The answer isn't a simple yes. Under the new law that took effect October 1, 1995, labor that would otherwise be taxable repair or remodeling is not taxable when it's an improvement to realty that increases production capacity — that much is true regardless of contract type. But whether the material is taxed depends on whether the contract is lump-sum or separated:

• Separated contracts (material and labor billed as separate charges): the contractor is treated as a seller of the material. The contractor may buy the material for resale and either collect tax on the separate material charge or accept exemption certificates from the customer. Some of that material — qualifying manufacturing machinery, equipment, and repair/replacement parts for the production unit (examples given: reactors, distillation columns, catalytic crackers, fractionators, other primary process equipment, heat exchangers, cooling towers, computer control units, and pollution-control equipment) — can qualify for the manufacturing exemption.
• Lump-sum contracts (one combined charge, not separated): the contractor is legally considered the consumer of the material incorporated into the customer's realty, not a seller. The contractor owes tax on the material, cannot buy it tax-free, and the customer cannot issue (and the contractor cannot accept) direct-pay permits or other exemption certificates to avoid that tax.

The letter also flags what does not qualify for the manufacturing exemption even under a separated contract: material for foundations or slabs (e.g., concrete), and piping and valves for intraplant transportation equipment. It also excludes material for facilities other than the production unit itself — the production unit does not include maintenance equipment, research and development equipment, feedstock/catalyst/finished-product storage equipment, loading and unloading equipment, laboratory equipment, or other equipment not used in the actual processing or manufacturing operation. Repair, remodeling, modification, or restoration of those excluded facilities remains a taxable service.

The letter cites Rule 3.291 (relating to contractors) as governing how separated contracts are treated, and notes a copy of "the rule you asked for" was enclosed.

What this means for you

Contractors doing refinery or chemical plant capacity-expansion work

If you're doing work that increases production capacity at a refinery or chemical plant, the labor is a non-taxable real property improvement under the October 1, 1995 law change — but how you structure your billing determines the material's tax treatment. Separating your material and labor charges lets you sell material to the customer (collecting tax on it, or accepting an exemption certificate for qualifying manufacturing equipment) rather than eating the tax yourself. Under a lump-sum contract, you're stuck paying tax on the material as the deemed consumer, and your customer's exemption certificates won't help.

Plant owners negotiating these contracts

Whether you can use a manufacturing exemption certificate to reduce the cost of a capacity-expansion job depends on your contract structure. If you want to take advantage of the manufacturing exemption on qualifying process equipment (reactors, distillation columns, catalytic crackers, fractionators, heat exchangers, cooling towers, control units, pollution-control equipment), you need a separated contract. A lump-sum contract forecloses that option because the contractor — not you — is treated as the taxable consumer of the material.

Anyone unsure whether specific equipment qualifies

Not everything at a refinery or chemical plant counts as part of the "production unit" for exemption purposes. Foundations, slabs, and intraplant transportation piping/valves are excluded regardless of contract type, as is anything supporting maintenance, R&D, storage, loading/unloading, or laboratory functions rather than the actual manufacturing process.

Common questions

Q: Is labor to expand production capacity at a refinery taxable in Texas?
A: No, under the law effective October 1, 1995, that labor is treated as a non-taxable improvement to realty rather than taxable repair or remodeling.

Q: Does that mean the materials are tax-free too?
A: Not automatically. The material's tax treatment depends on whether the contract is lump-sum or separated, as described above.

Q: What's the difference between a lump-sum and a separated contract here?
A: A lump-sum contract doesn't separately state the material and labor charges; a separated contract states them separately. Under a separated contract the contractor is a seller of the material and can pass through the manufacturing exemption via an exemption certificate. Under a lump-sum contract the contractor is the consumer of the material and owes the tax itself.

Q: What kind of equipment can qualify for the manufacturing exemption in this context?
A: The letter gives as examples reactors, distillation columns, catalytic crackers, fractionators, and other primary process equipment, plus ancillary equipment like heat exchangers, cooling towers, and computer control units, as well as material for pollution-control facilities tied to the manufacturing process.

Q: What material never qualifies for the exemption?
A: Concrete or other material for foundations or slabs, and piping and valves for intraplant transportation equipment, are called out as not qualifying — along with material for facilities outside the production unit (maintenance, R&D, storage, loading/unloading, and laboratory equipment).

Q: Can I rely on this letter for my own project?
A: This is a STAR letter ruling addressed to a specific taxpayer's question; under Comptroller rules, a detrimental-reliance claim based on it generally belongs only to the taxpayer it was issued to, and it may not reflect current policy.

Citations and references

Statutes and rules:

• 34 Tex. Admin. Code Rule 3.291 (Contractors)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9511997L

Original ruling text

ALERT: Senate Bill 2206, 89th Legislative Session, repeals Tax Code Section 151.3182 relating to the exemption for certain property used in research and development activities. Effective 01/01/2026.

ALERT: An exemption for certain depreciable property used in "qualified research", as added to Section 151.3182 by the 83rd (2013) Legislative Session (H.B.800), may be available. See Rule 3.340 for additional details.

November 27, 1995

Dear *:

Thank you for your questions about the notice in the September 1995 Legislative

Update concerning "increased capacity" at a petrochemical refinery or chemical

plant.

You ask whether tax applies to the material but not the labor when making an

improvement to a production unit that increases the production capacity. I wish

I could give you a simple "yes" answer to your simple question.

The new law that went into effect October 1, 1995, as you suspect, does mean

that labor that would otherwise be considered taxable repair or remodeling is

not taxable. The work is a non-taxable improvement to realty. The tax treatment

depends on whether the contract is lump-sum or separated. Lump-sum contracts do

not separate the charge for material from labor. Separated contracts separate

the charge for material from the charge for labor. It does mean that the labor

portion of the work is not taxable. Although the new law does not exempt the

material, some of it can qualify for a different exemption in some cases.

When the contract makes separate charges for material from labor, the

contractor is a seller of the material incorporated into the job. The

contractor may buy the material for resale and either collects tax on the

separate material charge or may accept exemption certificates from the

customer. Rule 3.291 relating to contractors applies.

Some of the material incorporated into the production unit will qualify for the

exemption available to manufacturers. If the contract is separated, the

contractor may accept an exemption certificate for qualifying manufacturing

machinery, equipment, repair or replacement parts for the production unit.

Examples of qualifying equipment include reactors, distillation columns,

catalytic crackers, fractionators or other primary process equipment, and

ancillary equipment such as heat exchangers, cooling towers and computer

control units. Materials for facilities to control pollution resulting from the

manufacturing process also qualify for the manufacturing exemption.

The material for some equipment is excluded or does not qualify for exemption.

For example, concrete or other material for foundations or slabs, piping and

valves for intraplant transportation equipment do not qualify for the

exemption.

Material for facilities other than the production unit also don't qualify for

the manufacturing exemption. The repair, remodeling, modification or

restoration of these facilities is a taxable service. The production unit does

not include maintenance equipment; research and development equipment;

equipment for the storage of feedstock, catalysts, or finished products;

loading and unloading equipment; laboratory equipment or any other equipment

that is not used in the actual processing or manufacturing operation.

The exemption for material does not apply to jobs performed under lump-sum

contracts. A lump-sum contractor is not a seller. By law, a lump-sum contractor

is considered the consumer of the tangible personal property incorporated into

the realty of the customer. If the contract is lump-sum, the contractor owes

tax on the materials and may not claim exemptions available to the customer.

The contractor may not buy materials for the job tax-free. The customer may not

issue and the contractor may not accept direct pay permit exemption or other

type exemption certificates for real property improvements.

Enclosed is a copy of the rule you asked for. If you have additional questions,

you may call me toll free at 1-800-5315441, ext. 3-4675. The direct line is

(512) 463-4675. You also may write to Tax Administration Division, Comptroller

of Public Accounts.

Sincerely,

Tom Soto

Tax Administration Division