Texas Comptroller of Public Accounts    STAR System


HEARING NO. 24,368

IN RE: **************

TAXPAYER NO.: **************
AUDIT OFFICE: **************
AUDIT PERIOD: November 1, 1983 through December 31, 1987


Administrative Law Judge

Representing Tax Division

Representing Petitioner



Oral arguments and evidence were presented on March 16, 1989. The Tax Division 
called the auditor, Ms. Rolle Welch, as its only witness. Petitioner called Mr. 
**************, an officer of the corporation, and Mr. **************, tax 
advisor, as witnesses. Both parties submitted proposed findings of fact and 
conclusions of law. The following decision constitutes the Administrative Law 
Judge's ruling on the proposed findings.

Prior to the hearing, Petitioner and the Tax Division reached an agreement 
concerning a duplication of transactions and certain out of state sales that 
will be deleted from the audit. The remaining issue concerning lump sum vs. 
separated contracts is disposed of below.

Petitioner filed Exceptions to the Proposed Decision reasserting its claim of 
insolvency and seeking a compromise and settlement of the liability. The Tax 
Division agreed to review Petitioner's financial condition and make at 
recommendation concerning its ability to pay all or a portion of the liability.


1. Petitioner contends that it is not liable for tax on materials used in 
separated contracts performed for ************** a direct payment permit 
holder. Petitioner contends in the alternative that the Comptroller is estopped 
from assessing tax against it because Petitioner accepted an exemption 
certificate from ************** in good, faith, and Petitioner should be able 
to rely on the assumption that ************** would accrue and pay the tax.

2. Petitioner contends that it is insolvent and will be unable to pay the 
deficiency if it is upheld. Petitioner therefore requests relief under the 
compromise and settlement provisions contained in Section 111.102 of the Tax 


1. ************** ("Petitioner") is a family-owned business that provides floor 
coverings for general contractors. Petitioner began doing business with 
************** in 1982. Petitioner and ************** executed a separate 
contract for each subdivision. (The issue in this case is whether Petitioner 
was a lump-sum contractor or its sales to ************** from November 1, 1983 
to October 31, 1987.)

2. Petitioner was audited for sales and use tax compliance for the period from 
November 1, 1983 through December 31, 1987. The deficiency assessed pursuant to 
that audit is the subject of this hearing.

3. The Tax Division recommended deletions in its position letter dated 
September 30, 1988 to correct duplications.

4. The audit was divided into two parts because Petitioner began doing business 
only with ************** in 1986.

5. The only records available for the auditors review were Petitioner's files 
for the subdivisions and a paid and a non-paid file. Petitioner's invoices had 
three copies -- it used one copy for the work order, one for the bill to the 
home builder, and one for Petitioner's internal file.

6. The auditor assessed tax on materials purchased by Petitioner because she 
interpreted the applicable contracts to be lump-sum contracts.

7. The form contracts signed by Petitioner and ************** were standardized 
forms drafted by **************. ************** used this same form of contract 
with all of its subcontractors. The terms of the ************** form contact do 
not specify whether ************** was to be charged sales tax on its purchase 
of materials from Petitioner.

8. Petitioner billed ************** on a weekly basis. Each week, Petitioner 
would prepare the invoices and submit them to the supervisor of the particular 
************** subdivision. Until December of 1982, Petitioner's invoices to 
************** always separated the charge for material, labor and freight, and 
the invoices also separately stated a 6% sales tax on the materials.

9. In November 1982, ************** told Petitioner to stop charging tax on its 
invoices to ************** because ************** was going to accrue tax and 
remit it to the state under a direct-pay permit. ************** accompanied 
this request with a direct payment exemption certificate. The certificate was 
valid and included ************** direct payment authorization number.

10. Pursuant to ************** request, Petitioner changed its billing invoices 
under existing contracts to reflect only a single amount, with no breakdown of 
labor, freight, materials, and tax. This total amount did not change, however, 
from the total amount billed before ************** issued its direct payment 
exemption certificate. Petitioner kept the amount previously charged as tax as 
a "windfall" until ************** renegotiated the various contracts.

11. The Comptroller issued Direct Payment Authorization No. ************** to 
**************, on July 1, 1980. This Direct Pay Permit was valid and effective 
when ************** issued the certificate to Petitioner.

12. The Exemption Certificate issued by ************** to Petitioner remained 
valid and effective during the entire period in issue in this case.

13. ************** issued direct payment exemption certificates to it various 
subcontractors so that ************** could accrue and pay sales taxes on its 
taxable purchases.

14. Neither of the two ************** contracts that Petitioner introduced in 
evidence shows a breakdown of the prices of the components that made up the 
total agreed-upon price. The October 15, 1982 contract referred to a "Price 
List." Petitioner considered the hand-written prices at the bottom of that 
contract to be that price list. This stated "$7.75/square yard," and had the 
total price calculated for the square yardage required by the various floor 
plans. "Labor + Materials & Profit = Total Amount" appears above the price 
list, and is a part of the contract form. The June 7, 1986 contract states that 
the agreement and any change orders "constitute the agreement." The prices 
typed in a space provided in the contract are based on a price per square yard, 
with different total prices depending on the type of carpet and the square 
yardage to be used. The component costs are not broken out or itemized.

15. If the prices were changed, Petitioner and ************** would execute new 
contracts. This might occur in the middle of a subdivision project.

16. Petitioner submitted documentation in support of its insolvency claim as 
requested by the Tax Division subsequent to the hearing.

17. Petitioner's assets have been liquidated, and some creditors have been 
paid. Petitioner suffered a major setback when its primary customer, 
**************, took bankruptcy subsequent to the audit period.

18. Petitioner has discontinued business operations and is insolvent.

19. Petitioner has offered to settle the audit deficiency for $**************. 
The Tax Division has agreed to accept this offer, and has recommended that the 
audit deficiency be compromised and settled for $**************.


The issue here is whether Petitioner operated as a lump-sum contractor or 
separated contractor during the audit period. Based on the evidence, it is 
concluded that Petitioner operated as a lump-sum contractor, for the 
improvement to realty and as such, is liable for sales tax on its purchases of 
materials. It is specifically held that Petitioner's contracts with 
************** were lump-sum contracts because they did not separate labor and 
materials under the terms of the written contracts. Comptroller's Rule 3.291 
(a) (4) defines a lump-sum contract as:

A contract in which the agreed contract price is one lump-sum amount and in 
which the charges for materials are not separate from the charges for skills 
and labor. Separated invoices issued to the customer will not change at 
lump-sum contract into a separated contract unless the terms of the contract 
required separated invoices.

It is clear from a review of the sample contracts in evidence, that a lump-sum 
price per square yard (depending on the grade of carpet) was agreed to by the 
parties. Petitioner offered parole evidence that the parties to the contracts 
knew the basic cost components of the stated price per square yard, but knowing 
the breakdown of the total sum does not make a separated contract out of a 
lump-sum contract. No doubt many contractors, working under a lump-sum 
agreement have a basic knowledge or understanding of the component costs and 
profit margins, but elementary contract law dictates that the clear terms of 
the written agreement control over parole testimony as to what was intended by 
one party to the contract. Furthermore, intent of the parties cannot overcome 
the four corners of the contract and compromise the rights and remedies of the 
state. Comptroller's Decision No. 18,934 (1987).

Rule 3.291 (b) (2) (D) specifically prohibits lump-sum contractors from 
accepting direct payment exemption certificates from their customers. 
Petitioner therefore was not entitled to accept the certificate in the first 
place. Its actions based on the erroneous belief that ************** was liable 
for the tax, cannot be the basis for forgiving the tax liability it incurred as 
a result of installing carpet.

Although Petitioner argues it was misled into believing that ************** 
would accrue tax under its direct payment permit, the issuance of an exemption 
certificate by the purchaser does not exonerate a lump-sum contractor. See 
Comptroller's Decision No. 18,060 (1985). The issue is not whether Petitioner 
accepted ************** certificate in good faith, but rather, whether the 
contracts were lump-sum or separated.

It is also concluded that the Comptroller is not estopped ************** from 
assessing tax, penalty and interest against Petitioner by reason of having 
issued a direct payment permit to **************. ************** did not incur 
a tax liability by virtue of its contracts with Petitioner, and the fact that 
************** might have misled Petitioner into believing the tax would be 
paid by the general contractor should not serve to defeat the state's claim for 
tax on Petitioner's purchases of materials.

With respect to Petitioner's second contention, it is concluded that Petitioner 
is insolvent, out of business, and unable to pay the audit deficiency as 
originally assessed. It is therefore recommended that the audit be compromised 
and settled for $**************.

Signed this 30th day of November, 1989.

Administrative Law Judge


The above decision of the Administrative Law Judge, resulting in Petitioner's 
liability as set out in Attachment "A" which is incorporated by reference, is 
approved and adopted in all respects. This decision becomes final twenty (20) 
days from the date of this Order, and the total sum of the tax amount is due 
and payable within twenty (20) days thereafter. If such sum is not paid within 
such time, a penalty of ten percent of the taxes due will accrue, and interest 
will continue to accrue.

If a rehearing is desired, a Motion for Rehearing must be filed with the Clerk 
of the Administrative Law Judges twenty (20) days from the date of this Order, 
and must state the grounds upon which the motion is based.

RENDERED and ISSUED this the 24th day of January, 1990.

Comptroller of Public Accounts
of the State of Texas

DATE: 01/01/1990