Is a general contractor's payment to an excavation subcontractor a taxable equipment rental, or an exempt service that's part of a capital improvement?

Plain-English summary

Fortunato Sons, Inc., a general contractor performing capital improvements, subcontracts part of the work — engaging an excavating firm to excavate, grade, and fill. The excavating firm determines its own equipment and methods, and the contractor does not direct or control the heavy equipment or its operators. It asked whether its payments to the excavator are taxable.

The Department held the payments are not taxable: they buy a service that is part of a capital improvement.

• Rentals are sales, but "with operator" turns on control. A "sale" is a transfer of title or possession for consideration (§ 1101(b)(5)), which reaches equipment rentals. But under 20 NYCRR 526.7(e)(6), when a lease of equipment includes an operator, possession is deemed transferred (making it a taxable sale of property) only where the lessee has the right to direct and control the use of the equipment.
• No control here → it's a service. Because Fortunato Sons has no right to direct and control the excavating firm's equipment or operators, the transaction is not a taxable rental of property. What is sold is a service.
• The service rides the capital-improvement umbrella. Excavation by itself is not a capital improvement. But since the contractor is performing a capital improvement of which the excavation is a critical element, the excavation falls under the capital-improvement umbrella (Building Contractors Association v. Tully, 87 A.D.2d 909), so the receipts from the excavation service are not subject to tax.

What this means for you

"Equipment with operator" is a service — not a taxable rental — when you don't control the machine. The dividing line under New York's rule is the right to direct and control the equipment's use. If the subcontractor decides the equipment and runs it their own way, you're buying a service, not renting property.

Services that are a critical part of a capital improvement inherit its exempt treatment. Excavation, grading, and filling aren't capital improvements standing alone, but as an integral part of a larger capital-improvement job they're covered by the same exemption. This is the same umbrella principle behind other capital-improvement rulings (e.g., TSB-A-85(7)S Brooklyn Union Gas, which also cites Building Contractors v. Tully).

Watch the control facts in your contracts. If your agreement gives you the right to direct and control the operator's use of the equipment, the deal can flip into a taxable rental. Structure and document it consistently with how the work is actually run.

Common questions

Q: I pay a sub for excavation using their machines and operators. Is that a taxable equipment rental?
A: Not if you don't have the right to direct and control the equipment's use. When the sub chooses and runs the equipment, you're buying a nontaxable service, not renting property.

Q: Excavation isn't a capital improvement by itself — so why is it exempt?
A: Because it's a critical part of your overall capital improvement, it falls under the capital-improvement umbrella (Building Contractors Association v. Tully), so those receipts aren't taxed.

Q: What if my contract lets me direct and control the operator and equipment?
A: Then the transaction can be treated as a taxable transfer of possession (a rental) under 20 NYCRR 526.7(e)(6). The right to direct and control is the key fact.

Citations and references

Statutes:

• Tax Law § 1105(a) — tax on receipts from retail sales, including rentals
• Tax Law § 1101(b)(5) — definition of "sale" (transfer of title or possession for consideration)
• Tax Law § 1105(c)(5) — tax on maintaining/servicing/repairing real property, as distinguished from capital improvement

Regulations:

• 20 NYCRR 526.7(a)(1); 526.7(e)(6) — sale/possession; equipment-with-operator direct-and-control test

Cases:

• Building Contractors Association v. Tully, 87 A.D.2d 909

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1984.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a84_24s.pdf

Original ruling text

New York State Department of Taxation and Finance
TSB-A-84(24)S
Sales Tax
October 15, 1984

Taxpayer Services Division
Technical Services Bureau
STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. S840529A

On May 29, 1984 a Petition for Advisory Opinion was received from Fortunato Sons, Inc.,
150 Knickerbocker Avenue, Bohemia, New York 11716.
The issue raised is whether certain payments made by a contractor are subject to tax under
the circumstances described below.
Petitioner is a general contractor which, in the course of performing capital improvements,
subcontracts certain portions of the work. In particular, Petitioner engages an excavating firm to
excavate, grade and fill. The excavating firm itself determines the type of equipment to be used and
the manner in which the job is to be performed. Petitioner does not direct and control the use of the
heavy equipment and the operators thereof do not take instructions from Petitioner's personnel.
Section 1105(a) of the Tax Law imposes a sales tax on the receipts from retail sales
(including rentals) of tangible personal property. The term "sale" refers to a transfer of title or
possession for a consideration. Tax Law, §1101(b)(5); 20 NYCRR 526.7(a)(1). The term "sale"
would thus extend to equipment rentals. However, it is provided at 20 NYCRR 526.7(e)(6)that when
"... a lease of equipment includes the services of an operator, possession is deemed to be transferred
[and the transaction thus constituted a sale] where the lessee has the right to direct and control the
use of the equipment."
In the present matter the requisite right to direct and control being absent, the transaction does
not constitute a sale of property the receipts from which are subject to tax. What is sold, rather, is
a service. Section 1105(c)(5) of the Tax Law imposes a sales tax on the receipts from the sale of the
service of "maintaining, servicing or repairing real property.., as distinguished from adding to or
improving such real property . . . , by a capital improvement . . . . " The excavation performed by the
Petitioner's subcontractor would not in and of itself constitute the performance of a capital
improvement. However, since Petitioner is performing a capital improvement of which the
excavation work is a critical element, the same falls under the umbrella created with respect to
capital improvements. Building Contractors Association v. Tully, 87 A.D. 2d 909. Accordingly, the
receipts from the sale of the excavation service to Petitioner would also not be subject to tax.

DATED: September 24, 1984

s/FRANK J. PUCCIA
Director
Technical Services Bureau

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.
RODERICK G. W. CHU, COMMISSIONER
TP-8 (3/83)

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR