Can a private developer get a refund of sales tax paid on materials used to build an office building that it then leases to the State of Texas under a lease-with-option-to-purchase?

Plain-English summary

A private partnership built an office building on land it owned and leased the finished building to the State of Texas under a lease-with-option-to-purchase. The partnership's contractors paid sales tax on the construction materials, and the partnership sought a refund of that tax under § 151.311, which exempts materials incorporated into realty improvements built for the primary use and benefit of an entity exempt under § 151.309 (governmental entities) or § 151.310.

The Comptroller denied the refund. On privately owned property, § 151.311's exemption only applies if the lease term equals or exceeds the estimated life of the improvement -- otherwise, the improvement isn't really for the primary use and benefit of the exempt (government) tenant, since the for-profit owner will keep using the building after the lease ends. Here, the State was contractually committed only to an initial 10-year term (with optional 10-year renewal increments and a purchase option it didn't have to exercise), while the anticipated life of the steel, concrete, and other improvements exceeded that 10-year period. Because the State wasn't obligated to stay or buy beyond 10 years, the exemption did not apply.

The Comptroller added that even if the exemption had applied, the refund would have been denied anyway on documentation grounds: the required Vendor's Request for Refund and Assignment of Right to Refund forms didn't include the exact tax amounts and reporting periods for each remittance, as required. Some of the assignment forms were also invalid on their face because the listed contractors had only paid tax to their own vendors (as consumers), rather than collecting and remitting sales tax directly to the state on sales to the partnership -- meaning those contractors had no refund right to assign in the first place.

What this means for you

Developers building on leased-to-government arrangements

If you're counting on the § 151.311 exemption for a building you own but lease to a government or exempt entity, make sure the lease term (including any renewal periods the tenant is actually obligated to take, not merely has the option to take) equals or exceeds the improvement's expected useful life. An optional renewal or purchase option that the tenant isn't bound to exercise won't satisfy this test.

Anyone filing a sales tax refund claim built on contractor tax payments

Refund documentation must show exact tax amounts and reporting periods for every remittance. And only the party that actually collected and remitted the tax directly to the state -- not a contractor that merely paid tax to its own vendor -- has a refund right that can be assigned to you.

Accountants and tax professionals

This letter illustrates two independent grounds for denial stacked in one ruling: a substantive exemption failure (lease term too short relative to improvement life) and a procedural documentation failure -- useful for spotting both issues when reviewing a similar refund claim.

Common questions

Q: Does leasing a privately built building to a government entity automatically exempt the construction materials from tax?
A: No -- per this letter, the lease term must equal or exceed the improvement's estimated useful life for the § 151.311 exemption to apply on privately owned property.

Q: Does an optional lease renewal or purchase option count toward that lease-term requirement?
A: Not per this letter -- only the actual committed lease term counted; the State's optional renewals and non-mandatory purchase option did not extend the qualifying term.

Q: What refund-form documentation is required?
A: Per this letter, the exact tax amounts and reporting periods for each remittance must be submitted with the Vendor's Request for Refund and Assignment of Right to Refund form.

Q: Can a contractor assign a refund right for tax it paid to its own supplier?
A: No, per this letter -- only tax the contractor itself collected and remitted directly to the state can be assigned; tax merely paid to its own vendor creates no refund right to assign.

Citations and references

Statutes:

• Tex. Tax Code § 151.311 (exemption for improvements to realty for certain exempt entities)
• Tex. Tax Code § 151.309 (governmental entity exemptions)
• Tex. Tax Code § 151.310 (religious/educational/public service organization exemptions)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9708673L

Original ruling text

August 20, 1997

Dear ***:

Thank you for your letter of August 1, 1997, concerning the taxability of
materials used in the construction of a building to be leased to the State of
Texas. Hayden Denham forwarded your correspondence for my review.

Your partnership paid taxes on construction materials purchased in connection
with the construction of an office building at * in *, Texas.
The project was built in connection with a Lease with Option to Purchase
transaction with the State of Texas. You have submitted a copy of the lease,
summary of sales taxes remitted by project contractors, and completed Vendors
Request for Refund and Assignment of Right to Refund forms.

You are requesting a refund per Section 151.311 of the Texas Tax Code which
allows an exemption for items incorporated into or used for improvement of
realty for entities exempt under Section 151.309 or Section 151.310. In order
for improvements to realty performed on privately owned property to qualify for
this exemption, the improvements must be for the primary use and benefit of the
exempt entity rather than the for-profit entity. For example, if an
improvement will be leased to an exempt entity, the lease term must equal or
exceed the estimated life of the improvement in order for it to be for the
primary use and benefit of the exempt entity.

In your situation, the exempt entity is only committed for the initial 10-year
lease term and may at their option renew for additional increments of ten (10)
years. At any time during the lease, the state may issue an option to purchase
the property. The purchase price at any given moment is based upon an
amortization schedule of 35 years.

The anticipated life of the improvements (steels, concrete, walls, etc.) will
exceed the initial 10 year lease period. Contractually, the State of Texas
does not have to enter into subsequent agreements or purchase the building.
Based on these facts, an exemption cannot be claimed for the building
materials.

Had the purchase qualified for exemption, the refund would have been disallowed
due to insufficient supporting documentation. The Vendor's Request for Refund
and Assignment of Right to Refund form states that "Exact amounts remitted for
State, City, County, Transit and Special Purpose Districts and Reporting
periods for each remittance" must be submitted with the request. This
information did not accompany any of the forms submitted. *** reflected
the local tax breakdown yet did not specify reporting periods. All others
contained no period or local tax breakdowns.

*, * and Texas *** indicated purchases on which they had
paid taxes to their vendors. They should have identified the sales to your
firm on which they collected and remitted sales taxes directly to the state.
They do not have the legal basis to assign the right to refund for taxes that
they paid to their vendors.

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

If you have any further questions, you may call me toll free at 1-800-531-5441,
ext. 5-0613. The direct line is 512/475-0613. You may also write to Tax
Policy Division, Comptroller of Public Accounts.

Sincerely,

Kevin Koller
Tax Policy Division