Does the sales tax base for construction materials differ depending on whether the real property contractor manufactures its own materials, buys fabricated materials from a manufacturer, or has a separate installer convert purchased materials into real property?

Plain-English summary

A requester asked the Commission to compare the sales tax treatment across three common construction fabrication arrangements: (1) a real property contractor manufactures/fabricates its own construction materials AND installs and converts them to real property under a single contract; (2) a manufacturer fabricates the materials and sells the finished items to the real property contractor, who installs and converts them; and (3) a general contractor buys fabricated materials directly from a manufacturer, then enters a SEPARATE contract with another contractor to install and convert the materials to real property. The requester was specifically concerned about whether self-fabricating contractors (scenario 1) gain a bidding advantage over contractors who must buy from an outside manufacturer (scenarios 2 and 3).

A real property contractor is always liable for tax as the final consumer of tangible personal property it converts to real property -- but the TAX BASE differs by scenario. In scenario 1, because the same contractor both fabricates and installs, the contractor's own purchase price for the RAW materials used to fabricate the item is the tax base -- fabrication labor performed by the contractor itself is not separately taxed. In scenario 2, the manufacturer can buy its own raw materials tax-free under Utah's manufacturing exemption (§ 59-12-104(27)), but the SALE from the manufacturer to the real property contractor is fully taxable, with the contractor's purchase price (which necessarily embeds the manufacturer's fabrication labor and profit markup) as the tax base. Scenario 3 works the same way as scenario 2 for the manufacturer-to-contractor sale (taxable, tax base = contractor's purchase price, manufacturer's own raw materials bought tax-free) -- but ADDS that because labor to install tangible personal property in connection with real property is not taxable, the separate amount the general contractor pays the third-party installer is untaxed.

The Commission acknowledged, but didn't fully resolve, the competitive-advantage concern. The Commission agreed that a contractor who self-fabricates (scenario 1) may have a sales tax advantage over contractors who must buy pre-fabricated materials (scenarios 2/3), because self-fabrication avoids taxing the fabrication-labor markup baked into a purchased item's price. However, the Commission noted that a contractor operating its own manufacturing arm also carries additional overhead and its own manufacturing-related tax costs, which get factored into its bids -- making the OVERALL competitive advantage difficult to quantify. The Commission also surveyed other states' approaches: Arizona, Hawaii, New Mexico, and Washington tax the entire real property contract price (with certain deductions), while Nevada's law resembles Utah's (taxing only material cost in the self-fabrication scenario) but goes further by ALSO taxing outside fabrication labor even when the contractor supplies the raw materials to an outside fabricator -- a broader approach than Utah's, which was mentioned for comparison but not adopted here.

What this means for you

Real property contractors deciding whether to self-fabricate construction materials

Fabricating your own materials in-house and installing them yourself can reduce your sales/use tax base to just the raw material cost, avoiding tax on fabrication labor markup that you'd otherwise pay when buying pre-fabricated items from an outside manufacturer -- but weigh that against the added overhead and tax costs of operating your own manufacturing operation.

Manufacturers selling fabricated construction materials to contractors

You can buy your own raw materials tax-free under Utah's manufacturing exemption (§ 59-12-104(27)), but your sale of the finished, fabricated item to a real property contractor is fully taxable on the contractor's purchase price -- your fabrication labor and markup become part of the taxable base at that sale.

General contractors using separate installation subcontractors

Purchasing fabricated materials directly from a manufacturer and hiring a separate contractor just to install/convert them to real property keeps the installer's labor charge untaxed, while the earlier manufacturer-to-you sale remains taxable on your purchase price -- structurally the same tax outcome as buying pre-installed materials from one combined vendor, just split across two contracts.

Common questions

Q: Does a contractor who fabricates its own construction materials pay less sales tax than one who buys fabricated materials?
A: The contractor's own tax base is smaller in that scenario -- it's taxed only on the raw material purchase price, not on fabrication labor markup, unlike buying a pre-fabricated item where the seller's fabrication labor gets built into the taxable purchase price.

Q: Can a manufacturer buy raw materials tax-free before fabricating them into a finished construction item?
A: Yes, under Utah's manufacturing exemption (§ 59-12-104(27)), but the manufacturer's SALE of the finished item to a real property contractor is still fully taxable.

Q: Is a separate installer's labor to attach purchased materials to real property taxable?
A: No. Labor to install tangible personal property in connection with real property is not taxable, regardless of who purchased the materials.

Q: Does Utah tax fabrication labor the same way Nevada does?
A: No. Utah taxes only the raw material cost when a contractor self-fabricates and installs; Nevada goes further and also taxes outside fabrication labor even when the contractor supplies the raw materials to an outside fabricator.

Q: Does this ruling apply to my construction business's fabrication arrangement?
A: No. It binds the Commission only for the requesting taxpayer and the facts described, and can't be relied on by another taxpayer, though it illustrates how the Commission analyzes the tax base across different fabrication/installation contract structures.

Citations and references

Statutes:

• § 59-12-104(27) (manufacturer's exemption for raw materials used in fabrication)

Source

• Landing page: https://tax.utah.gov/commission/rulings/
• Original PDF: https://files.tax.utah.gov/tax/commission/ruling/97-067.pdf

Original ruling text

97-067

Response October 29, 1997

Request

October 29, 1997

Advisory Opinion- Sales tax base on items purchased for the purpose of fabricating property

that will be installed and converted to real property.

Dear NAME,

Rod Marrelli has informed us that he had a conversation with you concerning the sales tax treatment of fabrication labor for items that are converted to real property. I am issuing this advisory opinion in response to your questions.

As I understand your discussion with Mr. Marrelli, you outlined three scenarios as follows:

(1) Under terms of a contract, a contractor manufactures or fabricates some of the construction materials used in the project and also installs and converts the materials to real property.

(2) A manufacturer fabricates or manufactures construction materials and sells them to the real property contractor, who installs and converts the materials to real property.

(3) A general contractor purchases fabricated construction materials directly from the manufacturer or fabricator. The general contractor enters a separate contract with another contractor to install and convert the materials to real property.

As you know, the real property contractor is liable for sales or use tax on his purchase of any item that he converts to real property because he is the final consumer of that item in its state as tangible personal property. Therefore, under scenario 1 above, the contractor pays sales or use tax on all construction materials that he purchases and converts to real property. That includes the all items that he purchases to fabricate construction materials that he will convert to real property. The tax base is his purchase price.

In the second scenario, the manufacturer fabricates an item and sells that item to the real property contractor. The manufacturer is entitled to purchase the raw materials used to fabricate the item tax free under Utah Code section 59-12-104(27). The transaction between the manufacturer and the real property contractor is taxable. The tax base is the contractor�s purchase price.

In the third scenario, the manufacturer fabricates an item and sells that item to the real property general contractor. Under a separate contract, the general contractor hires a third party to install and convert the item to real property. As in the previous scenario, the manufacturer is entitled to purchase the raw materials used to fabricate the item tax free under Utah Code section 59-12-104(27). The transaction between the manufacturer and the real property contractor is taxable. The tax base is the contractor�s purchase price. Because charges for labor to install tangible personal property in connection with real property are not taxable, the amount paid by the general contractor to the installer is not taxable.

With that background, we move to your main concern. The real property contractor who manufactures or fabricates its own construction materials (scenario 1) may have a sales tax advantage when it bids against contractors who must purchase fabricated construction materials from another party (scenarios 2 and 3) by avoiding the cost of fabrication labor and other markups. However, the real property contractor who also operates as a manufacturer or fabricator presumably has additional overhead and taxes associated with its manufacturing operation, and that overhead will be factored into his bids. For that reason it is difficult to determine the extent of this contractor�s overall advantage in the bid process.

With regard to the sales tax issue, our Auditing Division reviewed the approaches taken by some other states. They found that Arizona, Hawaii, New Mexico and Washington impose sales tax on the entire real property contract, with certain deductions. Nevada�s law is similar to Utah�s in that sales tax applies only to the cost of materials under scenario 1. The cost of fabrication labor under scenarios 2 and 3 is taxable. However, the Nevada law imposes tax on producing and fabricating tangible personal property even if the consumer furnishes the materials. That is, if the contractor purchases the raw materials, then gives the materials to an outside party who manufacturers the fabricated item, the cost of the outside labor is taxable.

If you have other questions, please let me know.

For the Commission,

Joe B. Pacheco,

Commissioner

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