When a landlord bills a commercial tenant separately for electricity measured through the tenant's own sub-meter, is that billing a taxable sale of electricity, and can a predominant-use manufacturing study exempt it?

Subject

Real Property/Commercial Space Rental — Landlord Bills Tenant For Electricity Measured Through A Separate Meter

Plain-English summary

A landlord's building has one master electric meter from the utility company. The landlord's single tenant has its own separate sub-meter for the space it occupies, and the landlord bills the tenant for that sub-metered usage as a charge separate from rent. An engineer proposed running two predominant-use studies -- one for the landlord's own electricity use and one for the tenant's -- under Rule 3.295, arguing that because the rule talks about "separate meters" (not specifically meters installed by the utility company), the sub-meter arrangement should qualify: if both studies showed predominant exempt (manufacturing) use, an exemption certificate could be given; if only one qualified, an exemption certificate could be given and tax on the taxable portion self-assessed; if neither qualified, no exemption.

The Comptroller rejected that approach. Texas Tax Code 151.317 exempts electricity and natural gas from tax except when used for commercial purposes, and electricity used in manufacturing, fabricating, or processing tangible personal property for sale is exempt. But the landlord's purchase of electricity from the utility is taxable unless the landlord itself uses over 50 percent of that electricity in manufacturing or processing tangible personal property for sale.

Critically, the ruling holds that billing the tenant for its sub-metered electricity is not a sale of electricity at all -- it's simply part of the rental or lease price of the real estate. Under Texas Tax Code 151.006(2), a purchase of tangible personal property (electricity) for resale is not allowed if that property is transferred to another person merely incidental to leasing or renting real estate. The landlord was neither a public utility nor an investor-owned utility authorized to sell electricity, so the fact that it "billed" the tenant using the extra meter reading was immaterial -- it did not turn the landlord into a reseller of electricity. The ruling cites Hearing No. 31,277 for this point.

The Comptroller also invoked Direlco, Inc. v. Bullock, 711 S.W.2d 360 (Tex. App.-Austin 1986), where the Texas Court of Civil Appeals upheld a sales tax assessment on a landlord's purchases of gas and electricity provided to tenants, holding that "commercial use" in the statute is ambiguous and the Comptroller's broad interpretation -- covering the lease of commercial real estate -- controls, because exemption provisions must be strictly construed.

Finally, the letter discusses Hearing No. 32,928, where a manufacturer shared its facility (and its manufacturing equipment) with a related-corporation tenant, and the electricity account was in the manufacturer's name. The manufacturer tried to combine its own manufacturing use with the tenant's use to reach the predominant-use exemption threshold. The Comptroller held that only the account-holder's own manufacturing use counted -- all electricity provided to the tenant for the tenant's use was a taxable commercial use, even though the tenant was also manufacturing. The same logic applies here: the tenant's use cannot be combined with, or substituted for, the landlord's own use when testing the landlord's exemption.

What this means for you

Landlords who sub-meter tenants for utilities

If you bill a tenant separately for electricity that passes through a sub-meter, that billing is treated as part of your rental/lease charge, not as a sale of electricity, regardless of whether the sub-meter was installed by you or by the utility company. You cannot claim a resale exemption on your electricity purchase just because you pass the cost -- and a meter reading -- through to the tenant.

Manufacturers or processors leasing space to another business

Only your own use of electricity counts toward the 50%-predominant-use manufacturing/processing exemption under Tex. Tax Code 151.317. You cannot combine your usage with a tenant's usage (even a related company, even if the tenant is also manufacturing) to clear the 50% threshold, and running separate "studies" for each entity does not change that -- the tenant's manufacturing use is still a taxable commercial use from the landlord's perspective.

Accountants and tax professionals advising commercial landlords

When evaluating whether a landlord can claim the manufacturing/processing exemption on a master utility account, exclude any usage attributable to a tenant, even if that tenant would itself qualify for the exemption if it purchased its own electricity directly. Cite Tex. Tax Code 151.317, Tex. Tax Code 151.006(2), Direlco v. Bullock, and Hearing No. 32,928 when advising on similar sub-metering and predominant-use fact patterns.

Common questions

Q: If a landlord bills a tenant separately for electricity through the tenant's own meter, is that a taxable sale of electricity by the landlord?
A: No. The ruling states the billing "does not constitute a sale of electricity, but merely part of the rental or lease price of the real estate."

Q: Does it matter that the sub-meter was installed by the utility company rather than the landlord?
A: No -- the ruling says the fact that the landlord "bills" the tenant for electricity measured by the additional meter is immaterial to the analysis.

Q: Can the landlord combine its own predominant-use study with the tenant's predominant-use study to qualify for the manufacturing exemption?
A: No. Per the discussion of Hearing No. 32,928, only the account holder's own manufacturing/processing use counts; electricity provided to a tenant for the tenant's use is a taxable commercial use even if combined studies would show a majority exempt use.

Q: What percentage of electricity use must be for manufacturing or processing to qualify for the exemption?
A: Texas Tax Code 151.317 exempts the purchase only if the purchaser uses over 50 percent of the electricity in manufacturing or processing tangible personal property for sale.

Q: Could this outcome change under different facts?
A: Yes -- the letter states the opinion is based on the facts presented, and the opinion may change if there are additional or different facts.

Citations and references

Statutes:

• Texas Tax Code 151.317 (exemption for electricity and natural gas, except commercial use; manufacturing/processing exemption)
• Texas Tax Code 151.006(2) (no resale exemption where tangible personal property is transferred incidental to leasing or renting real estate)

Case law:

• Direlco, Inc. v. Bullock, 711 S.W.2d 360 (Tex. App.-Austin 1986)

Comptroller hearings referenced:

• Hearing No. 31,277 (microfiche 9506H1353A01)
• Hearing No. 32,928 (microfiche 9601H1388B10)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9609L1436A08

Original ruling text

September 9, 1996

Dear ***:

Thank you for your letter of August 30, 1996, asking about the taxation of
electricity bought by your client.

Your client has one utility meter provided by the utility company for its
building. The client has one tenant and there is a separate utility meter
for the space occupied by the tenant. The client then bills the tenant for
the utility usage that goes through the tenant's separate meter. This is a
separate bill from the rental fee.

An engineer has proposed doing two studies, one for the utility used by
each entity.

You think this is an acceptable legal procedure under Rule 3.295 which is
written in terms of separate meters, not meters installed by a utility
company. The follow-up procedure would be as follows:

1. If both studies show a predominant exempt use, then an exemption
   certificate could be given.

2. If only one study qualified, then an exemption certificate could be
   given and then the tax on the taxable utility would be self assessed.

3. If neither study qualified, then obviously there is no exemption.

Response: Texas Tax Code 151.317 exempts all uses of electricity and natural
gas except that used for commercial purposes. Electricity used in processing,
fabricating or manufacturing tangible personal property for sale is exempt.
Your client's purchase of electricity is taxable unless your client uses over
50 percent of the electricity in manufacturing or processing tangible personal
property for sale as tangible personal property. See the discussion of
Hearing No. 32,928 below.

The billing your client makes to the tenant does not constitute a sale of
electricity, but merely part of the rental or lease price of the real estate.
Texas Tax Code 151.006(2) prohibits the purchase of tangible personal property
for the purpose of resale if the tangible personal property is transferred to
another incidental to the leasing or renting of real estate. Your client is
neither a public nor an investor-owned utility authorized to sell electricity.
The fact that your client "bills" the tenant for electricity measured by the
additional meter is immaterial. See Hearing No. 31,277 (microfiche 9506H1353A01).

The Texas Court of Civil Appeals in Direlco, Inc. v. Bullock, 711 S.W. 2d 360
(Tex. App.-Austin 1986), upheld the comptroller's assessment of sales tax on
Direlco's purchase of gas and electricity it provided to tenants. The court
found that the definition of "commercial use" in the statute was ambiguous;
therefore, the comptroller's interpretation of that term encompassing all
areas of commerce, including the lease of commercial real estate, should be
followed. The court went on to state that the statutory section entitled
"Exemptions" was not a statute imposing tax, and thus is required to be
strictly construed.

In Hearing No. 32,928 (microfiche 9601H1388B10),
Petitioner was a manufacturer that shared its manufacturing facility with a
tenant (a related corporation that was also a manufacturer). Petitioner and
the tenant used the same equipment for manufacturing their respective products.
The electricity account was in Petitioner's name. Petitioner sought an
exemption for its electricity purchases by claiming predominant use in
manufacturing (its use and the tenant's use combined). The comptroller held
that only the uses of electricity by Petitioner in manufacturing qualified for
exemption and that all of the electricity provided to the tenant for use was a
taxable commercial use.

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

You may call me at 463-4987 if you have any questions or need more information.
You may also write to Tax Policy Division, Comptroller of Public Accounts,
P. O. Box 13528, Austin, Texas 78711.

Sincerely,

Karey W. Barton, Manager
Tax Policy Division

NOTE: Previous Accession Number 9609679L