Texas Comptroller of Public Accounts    STAR System


200205246H



HEARING NO. 40,445


RE:  **************
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 

DIANE BROWN 
Representing Administrative Hearings Section 

**************
Representing Petitioner 

COMPTROLLER'S DECISION


PRELIMINARY DISCUSSION:

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 
ruling thereon.

PETITIONER'S CONTENTION:

Petitioner contends that its agreement with ************** (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 ************** 
(SUPPLIER), located in CITY B, Texas.  Petitioner proposed to install 
single-ply roofing for a 225,000 square foot expansion of SUPPLIER'S 
CITY C facility (the "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 COMPANY A roof 
system and a 10-year COMPANY A warranty on workmanship and materials.  Sales tax was 
included in the proposal.

5.  The parties were in negotiations for the SUPPLIERS EXPANSION 
project throughout the CITY A of 1998.  Petitioner had a verbal commitment from 
SUPPLIER for the contract by late April or early May.  Prior to 
awarding the contract, however, 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 SUPPLIER'S progress payments.  The 
schedule assisted SUPPLIER in allocating the necessary funds for the 
progress payments.

6.  On May 18, 1998, Petitioner issued a revised bid proposal to SUPPLIER. 
[FOOTNOTE:  The revised bid proposal also specifically included sales 
tax.]  The revised proposal required Petitioner to install a COMPANY B roof 
system, complete with a 15-year COMPANY B 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 SUPPLIER entered into a contract 
for the 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 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 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 
materials charges. 

11.  Petitioner paid tax to its suppliers for the materials used in the  
SUPPLIER job.

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:

Petitioner's contention should be denied.

Petitioner argues that its agreement with SUPPLIER is a lump-sum 
contract.  Petitioner notes that, consistent with the intent of the parties, 
its initial bid proposal to 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 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  
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 SUPPLIER.   

The AHS argues that the 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 
materials. 

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 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 
forth below:  

Rule 3.291.  Contractors

(a) Definitions.

(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 
supplied).

* * * * *

(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 
supplied).

(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 ... 
(Emphasis supplied).

* * * * *

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 
supplied).

* * * * *

(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 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 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 
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.   

RECOMMENDATION:

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   
SUPERSEDED: N 
DOCUMENT TYPE: H 
DATE: 05/30/2002 
TAX TYPE: SALES