1. (a) Definitions. The following words and terms, when used in this section, shall have the following meanings, unless the context clearly indicates otherwise.

   1. (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, markup, or handling charges related directly to the materials charge are includable in the agreed contract price. A charge calculated as a percentage of the total contract cost will not be considered a part of the material's selling price. The agreed contract price of incorporated materials cannot be less than the price the contractor paid for materials.
   2. (2) Consumable items--Tangible personal property, other than machinery and equipment, that is not physically incorporated into the property of a customer and that, after being used for its intended purpose, is substantially used up, or is not retained or reusable by the contractor.
   3. (3) Contractor--Any person who builds new improvements to real property or repairs, restores, or remodels residential real property, and who, in making the improvement, incorporates tangible personal property into the property being improved. The term includes subcontractors but does not include material men and suppliers. Persons who repair, restore, or remodel nonresidential real property are providing taxable services under §3.357 of this title (relating to Real Property Repair and Remodeling).
   4. (4) Improvements to realty--See §3.347 of this title (relating to Improvements to Realty).
   5. (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.
   6. (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. Cost-plus contracts are generally regarded as separated contracts.
   7. (7) Tangible personal property--See the Tax Code, §151.009.

2. (b) Tax responsibilities of contractors improving real property belonging to nonexempt customers.

   1. (1) Equipment. Tax must be paid by a contractor at the time of purchase on tools, machinery, and equipment used to perform a contract. A contractor must accrue and remit use tax on machinery, tools, and equipment purchased from an out-of-state seller unless Texas use tax was collected by the out-of-state seller.

   2. (2) Consumable items. Except as provided by subparagraph (B) of this paragraph, tax must be paid by a contractor at the time of purchase on items used to perform a contract which are not physically incorporated into the property of the customer.

      1. (A) A contractor may not collect tax from the customer on a charge for consumable items except as provided by subparagraph (B) of this paragraph.
      2. (B) A contractor may issue a resale certificate to suppliers in lieu of tax for consumable items, if title to the consumable items transfers to the contractor's customer at the time the contractor takes possession or before, and the consumable items are immediately marked, labeled, or otherwise physically identified as the customer's property, where practicable. The contractor must separately state the charge for these consumable items to the customer and must collect sales tax from the customer unless the customer qualifies for exemption under the Tax Code, §151.309 or §151.310.

   3. (3) Lump-sum contracts.

      1. (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. If the materials are purchased from an out-of-state seller, a contractor must accrue and remit use tax on the materials unless Texas use tax was collected by the out-of-state seller. A contractor shall not collect tax from a customer on a lump-sum charge or on any portion of the charge.
      2. (B) Contractors who, in addition to performing lump-sum contracts, sell taxable items over the counter or who also perform separated contracts, may maintain a tax-free inventory of items held for resale. Items purchased exclusively for resale may be purchased tax free by issuing a resale certificate to suppliers in lieu of tax. A contractor must hold a sales tax permit to issue a resale certificate, and must collect, report, and remit tax to the comptroller as required by §3.286 of this title (relating to Seller's and Purchaser's Responsibilities) when items purchased for resale are sold.
      3. (C) Persons who resell taxable items as part of taxable services under §3.357 of this title (relating to Real Property Repair and Remodeling) may maintain a tax-free inventory of items held for resale.
      4. (D) If the contractor incorporates materials from the resale inventory into a lump-sum contract, the contractor must accrue and remit tax based on the purchase price of the materials. The tax should be remitted to the comptroller for the reporting period in which the materials were used. A contractor purchasing items specifically for use in a lump-sum contract may not issue resale certificates in lieu of tax for such items.
      5. (E) Contractors performing lump-sum contracts for persons having direct payment permits may not accept a direct payment exemption certificate from those persons. When performing lump-sum contracts for a direct payment permit holder, the contractor must pay sales tax to the supplier or accrue and remit sales tax on incorporated materials removed from a tax-free inventory for incorporation into the direct payment permit holder's realty. Direct payment permit holders cannot authorize the contractor or any other person to purchase any taxable item using their permit. See §3.288 of this title (relating to Direct Payment Procedures and Qualifications).

   4. (4) Separated contracts.

      1. (A) Except as otherwise provided in this section, 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.
      2. (B) Contractors performing separated contracts must hold sales tax permits and collect, report, and remit the tax as required by §3.286 of this title (relating to Seller's and Purchaser's Responsibilities). Contractors purchasing materials specifically for incorporation into realty under separated contracts may issue suppliers a resale certificate in lieu of tax. See §3.285 of this title (relating to Resale Certificate; Sales for Resale). The purchase, rental, or lease of equipment for use in performing a nonexempt contract is subject to tax. Also see paragraph (2)(B) of this subsection.
      3. (C) A contractor may maintain an inventory of materials upon which tax was paid to suppliers at the time of purchase. If these materials are incorporated into realty under a separated contract or are sold over the counter, the contractor shall collect tax from the customer based upon the agreed contract price of the materials. Tax is due and must be remitted to the comptroller on any difference between the price paid by the customer and the price paid by the contractor. See §3.338 of this title (relating to Allowance of Credit for Tax Paid to Suppliers).
      4. (D) Contractors performing separated contracts for persons having direct payment permits may accept a direct payment exemption certificate from those persons in lieu of tax for all tangible personal property incorporated into customer's realty. A direct payment exemption certificate may not be accepted for tax liability incurred by the contractor on machinery or equipment rented or leased by the contractor and used in the performance of the contract. See §3.288 of this title (relating to Direct Payment Procedures and Qualifications). Contractors may not accept direct payment exemption certificates in lieu of tax for consumable supplies unless the provisions of paragraph (2)(B) of this subsection are met.
      5. (E) Contractors performing separated contracts may issue suppliers resale certificates in lieu of tax for taxable services that are resold to the contractor's customer. Examples of taxable services that may be resold are landscaping, surveying, and the final clean-up (janitorial services) of the construction site. Contractors may not issue resale certificates for taxable service that the contractor uses or consumes, such as security services, telecommunication services, and daily janitorial services.
   5. (5) Contracts versus bids and change orders. For tax purposes, the terms of a contract control over the terms of a bid. For example, if the bid is lump-sum, but the terms of the contract are separated, the contract determines the tax responsibilities of the parties, and the customer is liable for tax on incorporated materials. The terms of a contract also control change orders. If the contract is lump-sum, change orders will be treated as lump-sum even if the change orders show charges for incorporated materials separate from other charges. If the contract is a separated contract, and change orders are for lump-sum amounts, the lump-sum amounts will be treated as though for incorporated materials only unless the contractor can show the portion attributable to labor.
   6. (6) Different types of contracts between contractors and subcontractors. For tax purposes, it is not required that all subcontractors use the same type of contract as the general contractor. For example, a general or prime contract may be lump-sum, while some or all subcontracts may be separated. Each subcontractor's individual contract governs the subcontractor's tax responsibilities. In the example given, the separated subcontractors would collect sales tax from the general contractor. The general contractor would not collect any tax from the general contractor's customer. In the alternative, if the general or prime contract were a separated contract, while some of the subcontracts were lump-sum, the prime or general contractor would not collect tax from the prime contractor's customer on those charges from lump-sum subcontractors.
   7. (7) Materials provided by customers. A contract may specify that a customer will provide materials and the person performing improvements will provide the skill and labor necessary to perform the contract. Under this type of contract, the person providing the skill and labor will not incur tax liability on the materials. The customer is liable for the tax on the materials. The tax should be paid to the supplier when the materials are purchased.
   8. (8) Noninstalled items. A person who manufactures an item for sale but does not install the item as an improvement to realty is a manufacturer subject to provisions of §3.300 of this title (relating to Manufacturing; Custom Manufacturing; Fabricating; Processing). Example: cabinetmakers or drapery makers who do not affix the cabinets or draperies to realty as a part of a construction contract.
   9. (9) Local tax. A contractor's responsibility for local sales and use taxes depends on the type of contract used. See §3.379 of this title (relating to Contractors) and §3.329 of this title (relating to Enterprise Projects).

3. (c) Tax responsibilities of contractors improving real property for school districts and nonprofit and public hospitals. For the purposes of this section, school districts are those defined by the Education Code, §19.001. Nonprofit hospitals are hospitals licensed under the Health and Safety Code, Chapter 241 or 577.

   1. (1) Contractors improving realty for school districts or nonprofit and public hospitals, should obtain a properly completed exemption certificate to substantiate the exemption. If the validity of the exemption is not clear, a contractor cannot accept the exemption certificate in good faith and should request additional evidence of the exempt status of the organization. A sales tax letter of exemption from the comptroller addressed to an organization is evidence of its exempt status and will relieve a contractor from further inquiry, except under the circumstances set out in paragraph (2) of this subsection. If a contractor claims an exemption in lieu of paying tax on a purchase by reason of performing a contract with a school district or a nonprofit or public hospital and the comptroller subsequently determines the organization is not exempt, the contractor will be liable for all taxes, penalties, and interest accruing upon such purchase unless the contractor accepted in good faith a properly completed exemption certificate at the time the contract was entered into. See §3.287 of this title (relating to Exemption Certificates).
   2. (2) A prime contract with a private party to improve real property belonging to an exempt entity, other than those listed in paragraph (1) of this subsection, for the primary use and benefit of the private party or that would benefit the exempt entity is not exempt from sales or use tax. Materials to be incorporated into the realty may be purchased tax free under a separated contract (or under a lump-sum contract with exempt entities listed in paragraph (1) of this subsection) when a prime contractor has a contract with an exempt entity to improve realty for the exempt entity provided that if the exempt entity is listed under the Tax Code, §151.310(a)(1) or (2), the improvement must be related to the purpose of the organization.
   3. (3) Materials provided by exempt customers. A contract may specify that a customer that is a school district or a nonprofit or public hospital will provide the materials and the contractor will provide the skill and labor necessary to perform the contract. Under this type of contract, the contractor will not incur tax liability on the materials. The customer may issue exemption certificates to suppliers in lieu of tax when purchasing the materials, unless the improvements are to be used in activities unrelated to the activity that qualifies the customer for exemption. If the improvements are to be used in activities unrelated to the activity that qualifies the customer for exemption, the exempt customer must pay tax to suppliers at the time the materials are purchased. See also §3.322 of this title (relating to Exempt Organizations).
   4. (4) Transactions exempt from sales and use taxes include the purchase, rental, or lease by a contractor of all materials, consumable items, equipment, or other taxable items incorporated into the property being improved or used in the performance of the contract with a school district or nonprofit or public hospital.
   5. (5) An exemption certificate may be issued to suppliers for the purchase, rental, or lease by a contractor of those items identified in paragraph (4) of this subsection and must identify the exempt entity and the project for which the equipment, materials, and supplies are being purchased, leased, or rented. See §3.287 of this title (relating to Exemption Certificates).

4. (d) Uses of equipment; tax due; method of computation.

   1. (1) Purchase of equipment. Contractors improving realty for school districts or nonprofit or public hospitals may purchase equipment from suppliers tax free by issuing an exemption certificate as described in subsection (c)(5) of this section in lieu of paying sales or use tax. When equipment is used on a job other than as described in subsection (c)(4) of this section, tax should be computed using either the specific identification method or the aggregate method described in paragraphs (9) and (10) of this subsection.
   2. (2) Refund or credit for tax paid. A contractor purchasing equipment for use in the performance of a contract with a customer other than a school district or a nonprofit or public hospital must pay sales or use tax to the supplier at the time of purchase or, in the case of a direct payment permit holder, accrue the tax on the direct payment return. If at a later date the equipment is used on a job as described in subsection (c)(4) of this section, the contractor may obtain a refund or credit for sales tax directly from the state only by obtaining a written assignment of the right to the refund from the supplier to whom the tax was paid. Direct payment permit holders may take credit on subsequent returns.
   3. (3) Computation of credit. If an assignment is received and if the contractor's records are accurate and complete as required by this subsection, credit will be allowed for equipment purchased for use on a taxable job and subsequently used on an exempt job. The credit should be computed using either the specific identification method or the aggregate method described in paragraphs (9) and (10) of this subsection.
   4. (4) Consumable items and supplies. If a contractor purchases, rents, or leases materials or supplies tax free for use in performing a contract with a school district or a nonprofit or public hospital and uses the items in some manner or for some purpose other than as described in subsection (c)(4) of this section, the contractor is, at the time of the nonexempt use, liable for tax based upon the purchase price of the items. The tax should be reported and remitted to the comptroller for the reporting period in which the taxable use occurred. For local tax responsibilities, see §3.377 and §3.427 of this title (relating to Divergent Use of a Direct Payment, Resale, or Exemption Certificate; Divergent Use of a Direct Payment, Resale, or Exemption Certificate).
   5. (5) Equipment. Contractors must select either the specific identification method or the aggregate method to obtain credit or to report tax on equipment use. The methods may not be used interchangeably and permission to change methods must be requested in writing from the comptroller at least 45 days before the effective date of the change. Such permission will only be granted once each fiscal year and will not be granted retroactively. Contractors who perform contracts to improve realty in other states may not use the aggregate method.
   6. (6) Failure to elect method. A contractor who fails to elect either the specific identification or aggregate method will be presumed to have chosen the aggregate method.
   7. (7) Four-year statute of limitations. No tax will be assessed on equipment purchased tax free if the use in performing a nonexempt contract occurs more than four years from the date of purchase. No credit for tax paid will be allowed for a period of exempt use occurring more than four years from the date of purchase. If the equipment was purchased out of state, the four-year period begins when the equipment enters Texas. See §3.346 of this title (relating to Use Tax) for information on tax due on equipment purchased out of state and brought into Texas for use.

   8. (8) Repairs to equipment.

      1. (A) Repair, replacement parts, and third-party repair labor which are capitalized and depreciated for federal income tax purposes must be handled in the same manner as the equipment on which they are placed. The capitalized repair, replacement parts, and third-party labor may be treated as if it were a separate piece of equipment and depreciated over its own four-year period. A shorter period may be used if the item's useful life is less than four years.
      2. (B) Repair, replacement parts, and third-party labor which are expensed are not depreciated. Tax is due at the time of purchase if the third-party labor and parts are purchased while the equipment is on a nonexempt job. Tax is not due if the parts and labor are purchased while the equipment is on an exempt job. In situations where the contractor takes equipment off the job to repair it before sending it to another job, the contractor may attribute the repairs to the job from which the equipment came or to the job to which the equipment is going. The contractor must treat these repairs consistently.

   9. (9) Specific identification method of reporting tax due or obtaining credit for tax paid.

      1. (A) To qualify for exemption from tax on equipment claimed to have been used in the performance of exempt contracts using the specific identification method, a contractor must keep records which clearly substantiate such exempt use. The records must identify the item claimed to be exempt, and designate each job upon which it has been used. To qualify for a partial exemption from tax on equipment claimed to have been used on both exempt and nonexempt jobs, the records must identify the equipment, designate each job upon which it has been used, and indicate the date of use and the length of time the equipment was used on each exempt or nonexempt job. Contracts, job specifications prepared for bids, or other estimates are not acceptable records of the use of equipment. Refund requests based on samples are not acceptable. Tax is due on the full purchase price of the equipment unless these records are maintained.
      2. (B) Equipment purchased for use on an exempt job and subsequently used on a nonexempt job is subject to tax for the period of nonexempt use. Credit may be claimed for tax paid on equipment purchased for use on a nonexempt job and later used on an exempt job for the period of exempt use. The amount of tax or credit due will be based on the equipment's value, as determined by straight line depreciation for a period of four years from the date of purchase, during the period of nonexempt or exempt use. A shorter period may be used if the equipment's useful life is less than four years.
      3. (C) The time equipment is in storage is calculated as taxable or exempt use in the same proportion that the equipment is used on taxable and exempt jobs. Storage time for equipment that is only used on exempt jobs is treated as an exempt use.

   10. (10) Aggregate method of reporting tax due or obtaining credit for tax paid.

       1. (A) The aggregate method is based on the assumption that all equipment is used equally on all jobs. The contractor must keep verifiable records which substantiate the progress or other contract billings for each contract, the exempt or nonexempt status of the entity for which the contract is performed, and the location of the job site. The records concerning location must include whether or not the job site is within a taxing city or metropolitan transit authority.
       2. (B) Progress or other contract billings for nonexempt contracts must be totaled for the previous fiscal year and divided by progress or other contract billings for all contracts for the previous fiscal year.
       3. (C) Progress or other contract billings for exempt contracts must be totaled for the previous fiscal year and divided by progress or other contract billings for all contracts during the previous fiscal year.
       4. (D) The total purchase price of all equipment on which an exemption certificate was issued should be totaled and divided by the number of report periods in four years (16 if a quarterly filer, 48 if a monthly filer, four if a yearly filer). If less than four years, the equipment's actual life may be used. This amount should be multiplied by the percentage obtained in subparagraph (B) of this paragraph to obtain the amount subject to tax for the report period.
       5. (E) The total purchase price of all equipment on which tax was paid to the supplier should be totaled and divided by the number of report periods in four years. If less than four years, the equipment's actual life may be used. This amount should be multiplied by the percentage obtained in subparagraph (C) of this paragraph to determine the amount subject to credit for the return period.
       6. (F) The amount obtained in subparagraph (E) of this paragraph should be subtracted from the amount obtained in subparagraph (D) of this paragraph to determine the net amount subject to tax or the net amount subject to credit for the report period.
       7. (G) Equipment purchased during the fiscal year must be added to the aggregate total beginning with the report period in which it was purchased. Each piece of equipment will remain in the aggregate total for a period of four years from the date of purchase. If a piece of equipment has an actual useful life of less than four years, the actual useful life may be used.

5. (e) Tax responsibilities of contractors and subcontractors improving real property for organizations listed under the Tax Code, §151.309 and §151.310, other than school districts and nonprofit hospitals.

   1. (1) Consumable items and equipment. See subsection (b)(1) and (2) of this section.
   2. (2) Materials incorporated into the property of the customer by lump-sum contractors and subcontractors. See subsection (b)(2)(A) of this section. A lump-sum contractor may not issue exemption certificates to suppliers nor accept an exemption certificate in lieu of tax from organizations listed under the Tax Code, §151.309 or §151.310.
   3. (3) Material incorporated into the property of the customer by separated contractors and subcontractors. A resale certificate may be issued to suppliers by separated contractors and subcontractors for those items incorporated into the property being improved. The contractor may then accept an exemption certificate in lieu of tax for those incorporated materials sold under separated contracts to organizations listed under the Tax Code, §151.310. Contractors performing separated contracts for organizations listed under the Tax Code, §151.309, must have signed contracts with the government agency, official government purchase vouchers, or an exemption certificate signed by the government agency.
   4. (4) Separated contracts that benefit private parties. See subsection (c)(2) of this section.
   5. (5) Materials provided by organizations listed under the Tax Code, §151.309 or §151.310. See subsection (c)(3) of this section.

6. (f) Development work. For the purposes of this subsection, development work means improving real property for a private party that will ultimately be dedicated to and accepted by a governmental entity. Sales tax is due on all tangible personal property used to improve real property belonging to a private party that has been dedicated to and will be accepted by a governmental entity unless:

   1. (1) the contract between the contractor and the private party is a separated contract. See subsection (b) of this section for a discussion of lump-sum and separated contracts;
   2. (2) the contract provides that title to the materials used to perform the contract passes to the private party at the time the materials are delivered to the job site and before they are incorporated into the realty or used by either the contractor or the private party; and
   3. (3) the contract provides that the private party intends to donate the property to the governmental entity before it is incorporated into the realty or used by the contractor. The private party must provide the contractor with a letter of intent or other document from the governmental entity stating its intent to accept the property.

Source Note:The provisions of this §3.291 adopted to be effective January 1, 1976; amended to be effective November 28, 1976, 1 TexReg 3248; amended to be effective July 1, 1980, 5 TexReg 2401; amended to be effective December 31, 1980, 5 TexReg 4991; amended to be effective July 13, 1983, 8 TexReg 2280; amended to be effective November 10, 1986, 11 TexReg 4430; amended to be effective July 23, 1992, 17 TexReg 4955.