Is a construction contractor exempt from sales tax when building a rental-car service center on city-owned airport land, where the building will eventually revert to the city, on the theory that the traveling public ultimately benefits from having rental car facilities at the airport?

Plain-English summary

A contractor (HCI) building a rental-car service center at a new airport, for a rental car company (ARCS) leasing airport land from the city for 20 years, asked whether the construction was exempt from sales tax under Tax Code Section 151.311. ARCS's argument had three prongs: the land is city-owned, the completed building will become city property at the end of the lease, and rental car facilities at the airport ultimately benefit the traveling public.

The Comptroller reviewed both the lump-sum construction contract (HCI-ARCS) and the underlying lease (ARCS-City) and rejected the exemption, leaning heavily on Hearing No. 33,049 as controlling precedent. That hearing involved nearly identical facts -- a private company (DFS) operating duty-free shops and a gift concession at a city airport under a concession agreement where the city held a reversionary interest in improvements, required minimum construction spending, approved construction plans, and took a percentage of gross sales. The administrative law judge in that hearing denied the governmental exemption, citing a consistent line of Comptroller decisions (No. 28,602 (1992), No. 20,179 (1987), Tex. Atty. Gen. Op. No. MW-94 (1979)) holding that when the primary purpose of a contract is to benefit the private lessee conducting business at the location -- even on exempt-entity-owned real property -- the governmental exemption doesn't apply. The hearing also cited Comptroller Decision No. 17,245 (1988): purchases made for private airlines by an airport authority are not tax-exempt because the dominant purpose serves the tenants, not the exempt government entity -- and a government entity can even lose its own exemption if it acts in a proprietary rather than governmental capacity.

Applying this directly: ARCS, not the city or the traveling public, is the primary beneficiary of the 20-year construction, so the Sec. 151.311 exemption doesn't apply, regardless of eventual reversion to the city or incidental public benefit. Practically, under the lump-sum contract structure, HCI (the contractor) -- not ARCS -- is treated as the consumer of the materials incorporated into the realty: HCI must pay tax to its own suppliers on all materials, supplies, and equipment used to build the service center, while no tax is due on HCI's labor.

What this means for you

Contractors building on government-owned land for private tenant businesses

Don't assume that city/government land ownership, an eventual reversion clause, or incidental public benefit is enough to secure a governmental construction exemption -- the controlling question is whether the primary beneficiary of the construction is the government (exempt) or the private tenant conducting business there (not exempt). Expect to pay tax to your suppliers on materials as the lump-sum contractor/consumer, with only your labor staying untaxed.

Airport authorities and municipalities leasing facilities to private tenants

Structuring a lease with a reversionary interest, minimum spending requirements, or revenue-sharing doesn't by itself convert tenant-benefiting construction into exempt governmental construction -- this fact pattern (and the Hearing No. 33,049 precedent it relies on) shows the Comptroller looking past ownership/reversion formalities to who actually benefits during the lease term.

Accountants and tax professionals

A rich precedent chain worth keeping on hand for any government-facility-plus-private-tenant construction question: Hearing No. 33,049, Comptroller Decisions No. 28,602/20,179/17,245, and Attorney General Opinion No. MW-94 all point the same direction -- primary-benefit analysis controls over land ownership or reversion clauses, and government entities can even lose their own exemption when acting in a proprietary capacity.

Common questions

Q: Does building on city-owned land automatically qualify a contractor for the governmental construction exemption?
A: No, what matters is who primarily benefits from the construction during the lease term, not who owns the underlying land.

Q: Does an eventual reversion of the building to the city change the answer?
A: No, that alone doesn't establish the government as the primary beneficiary if a private tenant is the one actually using and profiting from the facility.

Q: Who pays tax on materials under this lump-sum contract?
A: The contractor (HCI), who is treated as the consumer of materials incorporated into the realty; no tax is due on the contractor's labor.

Q: Can I rely on this letter for my own airport or government-facility construction contract?
A: No. It is based on the specific facts presented and can only be relied on by the taxpayer to whom it was issued.

Citations and references

Statutes and rules:

• Texas Tax Code Section 151.311 (exempt organization construction contracts)
• Texas Tax Code Section 151.309(5) (governmental entities exemption)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9904310L

Original ruling text

April 7, 1999

Dear Mr. **:

This is to follow up in writing my verbal response to your request with regard
to your client's, **, ("HCI") contract to build a service center at
the new AIRPORT for ** ("ARCS").

ARCS is leasing the property on which the service center is to be built from
the City of ** ("CITY") for a period of twenty (20) years. HCI is
asking if it is exempt from paying sales tax in connection with the service
center pursuant to Texas Tax Code Section 151.311 given that (i) the service
center is being built on land owned by the CITY, (ii) the service center will
become the property of the CITY, (ii) the service center will become the
property of the CITY at the end of the term of the Lease Agreement, and (iii)
the presence of rental car facilities at the new airport is for the ultimate
benefit of the traveling public.

Response: I reviewed the lump-sum contract between HCI and ARCS and the lease
agreement between ARCS and CITY as you requested. While the public will benefit
from having car rental facilities at the airport, I would have to conclude that
the major benefit would be to ARCS for the twenty year lease period.

As we discussed over the phone, we feel that Hearing No. 33,049 is controlling
in this situation. In that hearing Petitioners performed work for ("DFS"). DFS
had Concession Agreements with CITY to operate certain duty-free shops and an
"Airport News and Gift Concession" at the CITY's AIRPORT. Under the terms of
those agreements, the CITY had a reversionary interest in all non-removable
improvements made. In addition, the agreements specified a minimum amount to be
expended by DFS in making those improvements and required that the construction
plans be submitted to and approved by the CITY. The CITY also was entitled to a
percentage of the gross sales of the concessions as determined pursuant to the
terms of the Concession Agreements. The administrative law judge concluded:

"Given the stringent requirements needed to be met in order to show an exemption
from tax, it is not surprising that the Comptroller has been reluctant to find,
in previous Comptroller's Decisions, an exemption in situations very similar to
the instant case:

'Furthermore, although the real property remodeled is owned by an exempt
entity, it is apparent from the facts that the primary purpose of the contract
was to benefit the lessee...who conducts its business from this location.'
Comptroller Decision No. 28,602 (1992); See also: Comptroller Decision No.
20,179 (1987); Op. Tex. Atty. Gen. No. MW-94 (1979). This is especially the
case here where there is no evidence that the CITY and DFS are jointly and
severally liable, a factor indicating a partnership. Brown v. Coats, 420 S. W.
2d 822 (Tex. Civ. App.--Corpus Christi 1967, writ ref'd n.r.e.). Nor is there
any other evidence of partnership between DFS and the CITY.

Moreover, the Comptroller has ruled that purchases made for private airlines by
an airport authority are not tax exempt because the dominant purpose of the
purchases served the needs of the tenants, not the exempt governmental entity.
Comptroller Decision No. 17,245 (1988). In fact, governmental purchases may
result in the governmental entity losing its exemption from taxation if the
purchases are not made for a public purpose or if the governmental entity is
acting in a proprietary as distinguished from a governmental capacity. Id.

Hence, based on the above cited authority, I am compelled to find that the
transactions at issue here between DFS and Petitioners were not entitled to a
governmental exemption from taxation under Section 151.309(5), and that
Petitioners' Contention No. 1 should be denied."

Similarly, in the situation that you present ARCS will be the primary
beneficiary of the construction of the car rental facilities.

In addition, under the lump-sum contract for the new improvements between HCI
and ARCS, HCI, and not ARCS, is considered the consumer of the materials
incorporated into the realty being improved. HCI should pay tax to suppliers on
all materials, supplies and equipment used to construct the service center for
ARCS. No tax is due on HCI's labor to construct the service center.

This opinion is based on the facts presented. Other facts though similar may
provide a different result.

I hope this information answers your questions. If you need additional
information, please call me toll-free at 1-800-531-5441, extension 3-4502. The
direct line is 512/463-4502. You may also write to Tax Policy Division,
Comptroller of Public Accounts. You may also e-mail our tax help section at:
[email protected].

Sincerely,

Gilbert Zamora
Tax Policy Division