Texas Comptroller of Public Accounts STAR System
HEARING NO. 40,445
TAXPAYER NO.: **************
AUDIT OFFICE: **************
AUDIT PERIOD: 10/01/96 through 01/31/00
LIMITED SALES, EXCISE AND USE TAX/RDT
BEFORE THE COMPTROLLER
OF PUBLIC ACCOUNTS
OF THE STATE OF TEXAS
ANNE K. PEREZ
Administrative Law Judge
Representing Administrative Hearings Section
An oral hearing was held at the Comptroller's ************** Audit office on
January 18, 2002. ************** represented the Petitioner, and presented the
testimony of **************, Petitioner's president. Assistant General Counsel
Diane Brown represented the Administrative Hearings Section (AHS). Ms. Brown
presented the testimony of John Diaz, the examining auditor.
The Administrative Law Judge (ALJ) took official notice of all records of the
Comptroller's office that pertain to the Petitioner and the issues involved in
the case. Unless otherwise indicated, all Section references are to Title 2,
Texas Tax Code Ann. (Vernon 1992). References to Rules are to sections of
Title 34, Texas Administrative Code.
On April 4, 2002, the Administrative Hearings Section filed Exceptions to the
March 22, 2002 Proposed Comptroller's Decision. Petitioner did not file a
response. The ALJ and the Comptroller have considered the Administrative
Hearings Section's Exceptions, and this Comptroller's Decision represents the
Petitioner contends that its agreement with ************** (GROCERY SUPPLIER)
is a lump-sum contract. Consequently, while Petitioner was required to pay tax
on its purchase of materials used in the job, it was not responsible for
collecting and remitting tax on the materials portion of the contract.
FINDINGS OF FACT:
1. The ************** (Petitioner) is a roofing subcontractor.
2. Petitioner's physical location is in CITY A, Texas. However, most of
Petitioner's jobs are performed out-of-state.
3. Petitioner was audited for limited sales, excise and use tax compliance for
the period covering October 1, 1996 through March 31, 2000. The audit contains
adjustments for disallowed deductions. On November 15, 2000, the Comptroller
issued Petitioner a Texas Notification of Audit Results that showed an amount
due that included tax and interest. Penalty was waived. Petitioner timely
requested a redetermination of that audit, resulting in this proceeding.
4. On March 8, 1998, Petitioner issued a bid proposal to **************
(GROCERY SUPPLIER), located in CITY B, Texas. Petitioner proposed to install
single-ply roofing for a 225,000 square foot expansion of GROCERY SUPPLIER'S
CITY C facility (the "GROCERY SUPPLIERS EXPANSION" project). Petitioner agreed
to furnish "... all materials, labor, equipment, and supervision" for the
lump-sum price of $**************. This price specifically included certain
types of insulation and roofing materials, e.g., a Johns Manville (JM) roof
system and a 10-year JM warranty on workmanship and materials. Sales tax was
included in the proposal.
5. The parties were in negotiations for the GROCERY SUPPLIERS EXPANSION
project throughout the CITY A of 1998. Petitioner had a verbal commitment from
GROCERY SUPPLIER for the contract by late April or early May. Prior to
awarding the contract, however, GROCERY SUPPLIER required Petitioner to perform
testing on the roof system, and to submit a "schedule of values." The schedule
allowed the parties to estimate the project's "percentage of completion,"
directly impacting the amount of GROCERY SUPPLIER'S progress payments. The
schedule assisted GROCERY SUPPLIER in allocating the necessary funds for the
6. On May 18, 1998, Petitioner issued a revised bid proposal to GROCERY
SUPPLIER. [FOOTNOTE: The revised bid proposal also specifically included sales
tax.] The revised proposal required Petitioner to install a Carlisle roof
system, complete with a 15-year Carlisle warranty on workmanship and materials,
as well as other minor changes to the initial proposal. A more significant
revision in the second proposal was the inclusion of a "schedule of values,"
set forth below:
* Schedule of values are as follows:
(1) Roofing materials $**************
(2) Roofing labor $**************
(3) Sheetmetal materials $**************
(4) Sheetmetal labor $**************
(5) Misc. Expense $**************
The above-referenced items, together, total $**************.
7. On June 15, 1998, Petitioner and GROCERY SUPPLIER entered into a contract
for the GROCERY SUPPLIERS EXPANSION project. Pursuant to Article 1.1 of the
agreement, Petitioner agreed to execute the work described in the Contract
Documents ... or ... "[i]n accordance with the bid drawings dated 11-20-1997,
the bid specifications dated 2-10-98, and [Petitioner's] revised bid proposal
dated May 18, 1998 (attached hereto)."
8. Article 7.1 of the agreement provides, in relevant part, that, "[t]he
Contract Documents consist of this Agreement with Conditions of the Contract
..., Drawings, Specifications, addenda issued prior to the execution of this
Agreement, other documents listed in this Agreement and Modifications issued
after execution of this Agreement. The intent of the Contract Documents is to
include all items necessary for the proper execution and completion of the Work
by the [Petitioner]."
9. Article 3.1 of the agreement provides that GROCERY SUPPLIER shall pay
Petitioner the Contract Sum of $**************, as consideration for
Petitioner's performance of the contract. In addition, Article 21 of the
contract states that the contract sum includes "... all labor, supervision,
tools, construction equipment, insurance, materials necessary to perform the
work and Texas State and Local Sales or Use Tax."
10. Petitioner issued four separate "Applications and Certificates for
Payment" to GROCERY SUPPLIER, pursuant to Article 4.1 of the contract. Each
payment application references work completed for a one-month period, and
breaks out the monthly charges for materials and labor, as well as materials
presently stored on the job. The charges for materials and labor per the
payment applications tie in with the schedule of values and the contract's
lump-sum price. The payment applications do not include sales tax on the
11. Petitioner paid tax to its suppliers for the materials used in the GROCERY
12. The audit adjusts for the agreed contract price of the materials (per the
schedule of values and the payment applications), less tax Petitioner paid to
its suppliers on the materials.
CONCLUSIONS OF LAW AND DISCUSSION:
Petitioner's contention should be denied.
Petitioner argues that its agreement with GROCERY SUPPLIER is a lump-sum
contract. Petitioner notes that, consistent with the intent of the parties,
its initial bid proposal to GROCERY SUPPLIER was lump-sum, and the contract
itself contains a lump-sum price for materials and labor. The schedule of
values that breaks out materials and labor charges was prepared simply to
accommodate GROCERY SUPPLIER'S internal accounting needs; the schedule does not
change the nature of the contract. [FOOTNOTE: Petitioner also makes a
distinction between the term "labor" used in the schedule of values and Section
151.056's use of the term "performance of the service." Petitioner contends
that the charge for its services (which could also be characterized as
Petitioner's gross profit) is reflected in the mark-up of the materials, not
the separately stated labor charges that appear in the schedule of values.]
That is, Petitioner would receive only the lump-sum contract price from GROCERY
SUPPLIER, even if its costs for performance of the contract increased during
the contract term. Since the agreement qualifies as a lump-sum contract,
Petitioner had no obligation to collect and remit tax on the materials charge
to GROCERY SUPPLIER.
The AHS argues that the GROCERY SUPPLIER agreement is a separated contract.
The AHS asserts that the schedule of values is part of the contract, and since
it breaks out labor and materials costs, the agreement meets Rule 3.291(a)(6)'s
definition of a separated contract. Furthermore, the facts emphasized by
Petitioner - that the contract itself contains an agreed-upon lump-sum price,
that the initial bid proposal was lump-sum, and that the schedule of values was
prepared only for accounting purposes - have no bearing on the contract's
classification as separated or lump-sum. The contract is separated, and
Petitioner was required to charge tax on the agreed contract price of the
Section 151.056 is the statute applicable to this issue. Section 151.056(d)
defines a contractor as one who makes an improvement to realty and incorporates
tangible personal property into the improvement. See also, Rule 3.291(a)(3).
[FOOTNOTE: A contractor's labor charges are not taxable because he is either
performing new construction or repair/remodeling of residential property,
neither of which is taxable.] The addition of square footage to the CITY C
facility was a new improvement to real property. Petitioner was acting as a
contractor when it installed roofing for this project.
The next question is whether Petitioner's contract with GROCERY SUPPLIER was a
lump-sum contract or a separated contract under Section 151.056. Subsections
(a) and (b) of the statute read as follows:
Sec. 151.056. Property Consumed in Contracts to Improve Real Property.
(a) A contractor is the consumer of tangible personal property furnished by him
and incorporated into the property of his customer if the contract between the
contractor and his customer contains a lump-sum price covering both the
performance of the service and the furnishing of the necessary incidental
material. (Emphasis supplied).
(b) A contractor is the seller of tangible personal property furnished by him
and incorporated into the property of his customer, from whom he shall collect
the tax, if the contract between the contractor and his customer contains
separate amounts for the performance of the service and for the furnishing of
the necessary incidental material. The tax rate is applied to the price of the
materials as agreed in the contract or the price of the materials to the
contractor, whichever is the greater. (Emphasis supplied).
* * * * *
Section 151.056(c) in addition provides that a separated contractor who,
pursuant to subsection (b), pays tax on incorporated materials and subsequently
resells them and collects tax on the agreed contract price of the materials,
may take a credit for tax paid to the vendor.
Rule 3.291 contains the Comptroller's interpretation of Section 151.056.
Several subsections of the Rule that are particularly relevant here are set
Rule 3.291. Contractors
(1) Agreed contract price of materials incorporated into the realty - The price
specified in the contract for the incorporated materials, i.e., tangible
personal property that becomes a part of the real property, plus any additional
charges directly attributable to the incorporated materials. For example,
profit calculated as a percentage of the cost of materials, cost of
transporting the materials, mark-up, or handling charges related directly to
the materials charge are includable in the agreed contract price ... (Emphasis
* * * * *
(5) Lump-sum contract - A contract in which the agreed contract price is one
lump-sum amount and in which the charges for incorporated materials are not
separate from the charges for skill and labor. Separated invoices issued to
the customer will not change a lump-sum contract into a separated contract
unless the terms of the contract require separated invoices. (Emphasis
(6) Separated contract - A contract in which the agreed contract price is
divided into a separately stated agreed contract price for incorporated
materials and a separately stated agreed contract price for skill and labor.
If prices of incorporated materials and labor are separately stated, the fact
that the charges are added together and a sum total given is irrelevant ...
* * * * *
In addition, Rule 3.291(b) sets forth in general the tax responsibilities of
contractors improving realty for non-exempt customers, irrespective of whether
the contract is lump-sum or separated. A contractor must pay tax on his
purchase of machinery, tools, and equipment. A contractor must also pay tax to
the vendor on all consumable items used to perform a contract, but he may not
collect tax from his customer on the charge for consumable items, with one
exception. [FOOTNOTE: A contractor is permitted to issue a resale certificate
in lieu of paying tax on consumable items only if title to the consumables
transfers to the contractor's customer at the time the contractor takes
possession, and if the items are physically identified as the customer's
property. The contractor must also separately state the charge for the
consumables and charge his non-exempt customers tax. Rule 3.291(b)(2)(B).]
Rule 3.291 (b)(1) and (2)(A).
Finally, Rule 3.291(b)(3) and (4) contrast the tax responsibilities of lump-sum
contractors versus separated contractors:
(3) Lump-sum contracts.
(A) Contractors performing lump-sum contracts are consumers of all materials,
consumable items, and equipment used or incorporated into a customer's
property. As a consumer, a contractor must pay tax to suppliers at the time
the materials are purchased ... A contractor shall not collect tax from a
customer on a lump-sum charge or on any portion of the charge. (Emphasis
* * * * *
(4) Separated contracts.
(A) Except as otherwise provided in this rule, contractors performing separated
contracts are considered retailers of all materials physically incorporated
into the realty being improved. As a retailer, a contractor must collect tax
from the customer based upon the agreed contract price of the incorporated
materials. (Emphasis supplied).
* * * * *
The facts establish that Petitioner's agreement with GROCERY SUPPLIER is a
separated contract. Although Petitioner's initial bid proposal was lump-sum,
it was superceded by the revised bid proposal of May 18, 1998, which breaks out
charges for materials and labor. Fact Nos. 4 and 6. The contract between the
parties specifically incorporates the revised bid proposal, i.e., it is part of
the contract. Fact Nos. 7 and 8. And indeed, the amounts set forth in the
revised bid proposal tie in with the payment applications and the lump-sum
price set forth in the contract. Fact Nos. 6, 9, and 10. These particulars
are sufficient to make the agreement a separated contract for sales and use tax
purposes. Comptroller's Decision No. 24,582 (1992).
It is true that the contract also provides a lump-sum price, inclusive of
materials, labor, and other items. Fact No. 9. Petitioner urges that the
contract's lump-sum price, as well as the initial bid proposal, is evidence of
the parties' intent to enter into a lump-sum contract; the schedule of values
was prepared merely for billing purposes. However, Rule 3.291(a)(6) expressly
addresses this situation: "If prices of incorporated materials and labor are
separately stated, the fact that the charges are added together and a sum total
given is irrelevant ..." Likewise, the Comptroller has consistently held that
it is immaterial why a contract includes separate charges for materials and
labor; the inquiry is only whether it does so. If the materials costs can be
accurately determined, this is sufficient to make the contract a separated
contract. Comptroller's Decision No. 24,582, citing Decision Nos. 20,029
(1987) and 17,985 (1987).
Petitioner also argues that its charge for the "performance of the service" is
contained in the materials portion of the contract, not the labor portion,
thereby making the contract lump-sum. Certainly, when Petitioner's cost of
materials is compared to the materials charge paid by GROCERY SUPPLIER, it
appears that Petitioner derived its gross profit from the materials mark-up.
But Section 151.056's use of the term "performance of the service," taken in
context, can only mean "labor." And, as observed by the AHS, Rule 3.291(a)(1)
provides that the mark-up on materials is part of the agreed contract price of
materials incorporated into the realty. Since the agreement is a separated
contract, Petitioner was required to collect and remit tax on this amount.
The facts of Comptroller's Decision No. 36,556 (1998) are virtually identical
to the facts of Petitioner's case. In Decision No. 36,556, the disputed
contract contained a lump-sum price, but an attachment incorporated into the
contract separated the charge for labor from the charge for materials. The
only purpose of the attachment was to establish the customer's progress
payments. The contract was nevertheless held to be a separated contract.
Examples of similar reasoning and results are found in Comptroller Decision
Nos. 32,196 (1995), 36,552 (1998), and 37,383 (1999).
One other decision is worth noting, primarily because it would seem to require
a different result. Comptroller's Decision No. 39,325 (2001) considered two
very similar contracts, both of which contained a lump-sum price for materials
and labor, but which incorporated an exhibit that separated the cost of labor
from materials. However, neither contract separated the cost of materials
incorporated into the realty from the cost of materials consumed in the
construction. On this basis, the ALJ concluded that the contracts were
lump-sum rather than separated contracts.
After carefully examining the language of Section 151.056 and Rule 3.291, I
conclude that Decision No. 39,325 should be overruled to the extent it
concluded the two contracts were lump-sum contracts. Section 151.056(a) and
(b) provide, respectively, that a contractor is either the consumer or the
seller of "... tangible personal property furnished by him and incorporated
into the property of his customer ... if the contract contains (lump-sum or
separate amounts) for the performance of the service and the furnishing of the
necessary incidental material." In other words, the contractor is the consumer
of both materials furnished by him and materials incorporated into the realty
under a lump-sum contract. The contractor is the seller of both materials
furnished by him and materials incorporated into the realty under a separated
contract. [FOOTNOTE: Technically, however, a separated contractor cannot
"resell" consumables to his customer; like the lump-sum contractor, he is
making a "use" of the consumables.]
The Rule is in fact consistent with the statute. Under both lump-sum and
separated contracts, a contractor is generally required to pay tax on all
consumable items, and may not collect tax from his customer on these items.
Rule 3.291(b)(2)(A) and (B). The difference in tax treatment results from how
incorporated materials are taxed. A lump-sum contractor may not charge his
customer tax on incorporated materials. Rule 3.291(b)(3). In contrast, a
separated contractor is required to charge tax on the agreed contract price for
incorporated materials. Rule 3.291(b)(4).
Rule 3.291(a)(1) defines "agreed contract price of materials incorporated into
the realty" as "the price specified for the incorporated materials ..."
Decision No. 39,325 appears to concentrate on the definition of "separated
contract" in Rule 3.291(a)(6), to require that a separated contract separately
state the cost of consumables used in the construction from the cost of
materials incorporated into the realty. This interpretation is unwarranted,
however, given that a separated contractor must generally pay tax up-front on
consumable items, and is not permitted to charge his customer tax. Rule
3.291(b)(2)(A) and (B). Furthermore, Rule 3.291(a)(1)'s definition of "agreed
contract price of materials incorporated into the realty" plainly contemplates
that the contractor will mark-up the price of the incorporated materials with
additional charges, including profit. In reality, the contractor must pay for
consumables as well as other expenses out of any gross profits.
This interpretation of Rule 3.291 is consistent with the Comptroller's
long-standing policy. That is, when contract costs are separated between
materials and labor, the Comptroller views the materials charge as
"incorporated materials." See, e.g., Comptroller's Decision No. 14,469 (1986).
In conclusion, Petitioner's contention should be rejected. Its agreement with
GROCERY SUPPLIER is a separated contract. Petitioner's audit correctly adjusts
for the agreed contract price of the materials, less tax Petitioner paid to the
vendor on the materials. Comptroller's Decision No. 39,325 is also hereby
overruled to the extent that it concluded that the two contracts at issue in
that case were lump-sum contracts.
Based upon the findings of fact, conclusions of law, and discussion contained
herein, the ALJ recommends that the audit liability be upheld.
SIGNED May 30, 2002.
ANNE K. PEREZ
Administrative Law Judge
HEARING NO. 40,445
ORDER OF THE COMPTROLLER
The above decision of the Administrative Law Judge, resulting in Taxpayer'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-three
(23) days from the date of this Order, and the total sum of the tax, penalty,
and interest amounts is due and payable within twenty (20) days thereafter. If
such sum is not paid within such time, an additional 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
Administrative Law Judge no later than twenty-three (23) days after the date of
this Order, and must state the grounds upon which the motion is based.
RENDERED and ISSUED May 30, 2002.
CAROLE KEETON RYLANDER
Comptroller of Public Accounts
of the State of Texas
ACCESSION NUMBER: 200205246H
DOCUMENT TYPE: H
TAX TYPE: SALES