Is a subcontractor's back-hoe excavation taxable, and does it matter whether the prime contractor is doing a repair or a capital improvement?

Plain-English summary

Michael A. Wargula does back-hoe excavation as a subcontractor for prime contractors and asked whether his charges are taxable. In one job the prime repairs a broken water main (Wargula digs it out, the prime fixes it, Wargula backfills). In another, the prime installs new water pipe (Wargula digs the trenches, the prime lays pipe, Wargula covers it over). He bills the prime with separate charges for the operator and the equipment.

The Department held the answer depends on the prime contractor's end result.

• The end-result test governs. Under § 1105(c)(5) and § 527.7(b)(4), work on real property is taxable if its end result is a repair or maintenance, but not taxable if its end result is a capital improvement.
• Repairing a water main → taxable repair, but resold. When the prime is repairing the water main, Wargula's excavation is a repair of real property — a taxable service. But he performs it for the prime, who resells it, so under § 526.6(c)(1) Wargula does not collect tax from the prime, provided he obtains a completed Contractor Exempt Purchase Certificate (Form ST-120.1).
• Laying new pipe → capital improvement, not taxable. When the prime lays new water pipe, that's a capital improvement, so Wargula's excavation is part of a capital improvement and is not taxable at all — regardless of resale. He should obtain a Certificate of Capital Improvement (Form ST-124).
• Separate operator/equipment billing isn't automatically a rental. Billing labor and equipment separately does not by itself make the deal a back-hoe rental. Only if Wargula relinquishes the right to direct and control the back-hoe to the prime does it become a taxable equipment lease under § 526.7(e)(5) — in which case the operator's wages are excludible from the taxable receipt if separately stated and at prevailing rates (regulation Example 11).
• Customer status is irrelevant. Whether the underlying property is owned by a private corporation, a hospital, or a government entity has no bearing on the result.

What this means for you

Ask what the prime is ultimately doing. The same excavation can be taxable or not depending entirely on the prime contractor's end result. Digging for a repair is taxable service work; digging for a new installation that's a capital improvement is not.

Collect the right certificate for each job. For repair-type work you resell to a prime, take a Contractor Exempt Purchase Certificate (ST-120.1). For capital-improvement work, take a Certificate of Capital Improvement (ST-124). Those certificates are what document why you didn't charge tax.

Separate line items don't turn a service into a rental. You can bill operator and equipment separately and still be selling a service — what flips it to a taxable equipment lease is handing over direction and control of the machine. If you keep control, it stays a service.

Who owns the site doesn't change your answer. A government or hospital customer up the chain doesn't make your excavation exempt (or taxable); the end-result test controls.

Common questions

Q: My back-hoe sub work — is it taxable?
A: It depends on the prime contractor's end result. Excavation for a repair is a taxable service (though resold to the prime with an ST-120.1); excavation for a new capital improvement isn't taxable (take an ST-124).

Q: I bill the operator and the machine separately. Is that a rental?
A: Not by itself. It only becomes a taxable equipment lease if you give the prime the right to direct and control the back-hoe. If you keep control, it's a service, and separate billing doesn't change that.

Q: The site is owned by a hospital / the government. Does that make it exempt?
A: No. The Department said the customer's status has no bearing; the end-result test decides taxability.

Citations and references

Statute and regulations:

• Tax Law § 1105(c)(5) — tax on maintaining, servicing, or repairing real property, as distinguished from a capital improvement
• Sales and Use Tax Regulations § 527.7(b)(4) — taxability of services on real property depends on the end result (repair = taxable; capital improvement = not taxable)
• Sales and Use Tax Regulations § 526.6(c)(1) — purchase for resale is not taxed until transferred to the customer
• Sales and Use Tax Regulations § 526.7(e)(5) — equipment lease including an operator; possession transferred where the lessee can direct and control the equipment; operator's wages excludible if separately stated (Example 11)

Forms referenced:

• Form ST-120.1 — Contractor Exempt Purchase Certificate (repair work resold to a prime)
• Form ST-124 — Certificate of Capital Improvement

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1983.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a83_2s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-83(2)S
Sales Tax
January 31, 1983

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. S820331A

On March 31, 1982 a Petition for Advisory Opinion was received from Michael A. Wargula,
128 Sherburn Drive, Hamburg, New York 14075.
The issue raised is whether Petitioner's back-hoe services are subject to sales tax when
Petitioner acts as a subcontractor to a prime contractor who is performing repairs or capital
improvements.
In one instance, the prime contractor telephones Petitioner and requests Petitioner to excavate
earth from around a water main break. The prime contractor arrives after Petitioner has performed
the excavation and proceeds to make the necessary repairs to the water main. Petitioner then backfills
the excavation.
In another instance Petitioner is hired by a prime contractor to dig trenches at a new
construction project for the installation of water pipes. After reviewing specifications and blue prints
supplied by the prime contractor, Petitioner excavates the trenches. After the prime contractor has
installed the water pipes, Petitioner covers over the pipes in the trenches and the job is completed.
Both of the jobs here described are performed from time to time on real property owned by a private
corporation, a hospital or a governmental entity. In each instance Petitioner provides the contractor
with an estimate prior to commencing a job, and subsequently submits a bill showing separate
charges for the operator and the equipment:.
Section 1105(c)(5) of the Tax Law imposes a tax on the following service:
"Maintaining, servicing or repairing real property, property or land, as such terms are defined
in the real property tax law, whether the services are performed in or outside of a building, as
distinguished from adding to or improving such real property, property or land, by a capital
improvement as such term capital improvement is defined in paragraph nine of subdivision (b) of
section eleven hundred one of this chapter . . . "
Section 527.7(b)(4) of the Sales and Use Tax Regulations provides as follows:
"The imposition of tax on services performed on real property depends on the end result of
such service. If the end result of the services is the repair or maintenance of real property such
services; are taxable. If the end result of the same service is a capital improvement to the real
property such services are not taxable."

ROBERT W. BOUCHARD, ACTING COMMISSIONER
GABRIEL B. DiCERBO , DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR
TP-8 (8/82)

-2­
TSB-A-83(2)S
Sales Tax
January 31, 1983

Section 526.6(c)(1) of the Sales and Use Tax Regulations provides as follows:
"Where a person, in the course of his business operations, purchases tangible personal
property or services which he intends to sell, either in the form in which purchased, or as a
component part of other property or services, the property or services which he has purchased will
be considered as purchased for resale and therefore not subject to tax until he has transferred the
property to his customer."
The term "sale" is defined, in section 1101(b)(5) of the Tax Law, to include the following:
"Any transfer of title or possession or both, exchange or barter, rental, lease or license to use
or consume, conditional or otherwise, in any manner or by any means whatsoever for a
consideration, or any agreement therefor, including the rendering of any service, taxable under this
article, for a consideration or any agreement therefor."
It should be noted at the outset that if Petitioner relinquishes to the prime contractor the right
to direct and control the use of the back-hoe such transaction would constitute a "sale", within the
meaning of the above-quoted statutory provision, and Petitioner would be required to collect and
remit sales tax on the receipts, in accordance with section 526.7(e)(5) of the Sales and Use Tax
Regulations, which provides as follows:
"(5) When a lease of equipment includes the services of an operator, possession is deemed
to be transferred where the lessee has the right to direct and control the use of the equipment. The
operator's wages, when separately stated, are excludible from the receipt of the lease, provided they
reflect prevailing wage rates.
Example 11:

A company enters into an agreement to lease a crane, together with the
services of the operator of the crane. The operator will take instructions from
the company’s foreman, and the company determines the working hours and
locations. The operator's wages are separately stated. This transaction is
within the definition of sale, and the transfer of possession has occurred by
reason of the company's right to direct and control the use of the equipment
by the operator. The taxable receipt excludes the operator's wages." 20
NYCRR 526.7(e)(5)

Assuming that there is no such relinquishment of direction and control, the following applies.
Whether the excavation work performed by Petitioner constitutes a repair service or capital
improvement depends on the end result of the service performed by the prime contractor. 20 NYCRR
527.7(b)(4) When the prime contractor is repairing a water pipe, the service performed by Petitioner
is a repair of real property. Such a service is taxable unless performed for resale. Since Petitioner
provides this service to prime contractors for resale, Petitioner is not required to collect sales tax
from the prime contractors under these circumstances. 20 NYCRR 526.6(c)(1) Petitioner should,
however, obtain a completed Contractor Exempt Purchase Certificate (Form ST-120.1) from the
prime contractor in order to establish the status of the charge.

-3­
TSB-A-83(2)S
Sales Tax
January 31, 1983

When a prime contractor lays water pipes it is making a capital improvement to real property.
In this case, the excavation service performed by Petitioner is a capital improvement. Petitioner's
service in this case, then, is not taxable under section 1105(c)(5) of the Tax Law, irrespective of
whether or not it is sold for resale. Petitioner should obtain a completed Certificate of Capital
Improvement (Form ST-124) from the prime contractor, in order to establish the status of the
charges.
It should be noted that the fact that Petitioner's billing reflects separate charges for equipment
and labor does not of itself establish a rental of the back-hoe. Absent a transfer of direction and
control to the prime contractor, the transaction remains the sale of a service. Finally, the status of the
prime contractor's customer, whether private corporation, hospital or governmental entity, has no
bearing whatever on the conclusion arrived at herein.

DATED: January 14, 1983

s/FRANK J. PUCCIA
Director
Technical Services Bureau