When a city leases a public facility to a private management company that pays for capital improvements and the city reimburses the company, are the improvements exempt from Texas sales tax?

Plain-English summary

A Texas city built a convention/event center and, under a long-term lease running to 2034, turned over its day-to-day management and operations to a private limited partnership (LP). The lease requires the city to reimburse LP for a defined category of "Capital Improvements Expenses" — repairs, restorations, or replacements needed when equipment or facilities deteriorate — on a schedule that grows from 0% to 100% reimbursement over the lease term. The city asked whether these capital-improvement purchases are exempt from sales tax, both when LP contracts directly with vendors and gets reimbursed by the city, and in the reverse scenario where the city contracts directly and LP reimburses the city.

Texas ruled the answer depends entirely on who signs the contract, not who ultimately pays. Texas has an exemption for construction materials and services used to improve real property that primarily benefits a governmental entity like a city — but that exemption only applies where the improvement genuinely benefits the exempt entity, not just where the exempt entity happens to be paying part of the bill. Here, the lease gives LP "full and exclusive control of the management and operation" of the center and lets LP keep "all revenues of any source" it generates — facts that squarely establish LP, not the city, as the primary beneficiary of any improvements LP contracts for. So when LP is the contracting party, LP's purchases are taxable (materials incorporated under a separated contract are taxable; a lump-sum new-construction contract makes the contractor, not LP, the taxable purchaser of materials; nonresidential repair/remodeling charges are always taxable), regardless of the city's reimbursement.

But when the city is the contracting party — even for the identical scope of work, later reimbursed in part by LP — the purchases qualify for the governmental exemption, because the city (an entity exempted under Section 151.309) is directly buying the improvement. The ruling also confirms LP is not the city's "agent" under the lease (the lease explicitly disclaims any partnership/joint-venture relationship), so LP's purchases can't piggyback on the city's exempt status even when the city foots most of the bill.

What this means for you

Cities and other governmental entities leasing facilities to private operators

If you want capital-improvement purchases at a leased public facility to be tax-exempt, have the city (not the private operator) sign the construction/vendor contracts directly, even if the private operator will ultimately reimburse some or all of the cost. Simply agreeing to reimburse an operator's already-signed contracts doesn't transfer the exemption.

Private management companies and LPs operating leased public facilities

Don't assume your capital improvements to a publicly-owned facility are automatically tax-exempt just because the government landlord is reimbursing you — if you hold operational control and keep the facility's revenue, you (not the government) are treated as the primary beneficiary, and your contracts are taxable regardless of reimbursement.

Accountants and tax professionals structuring public-private facility deals

This ruling is a clean illustration of the "primary use and benefit" test cutting the other way from a straightforward exempt-entity case — useful alongside PLRs 202007018L and 202012011L (both found the exempt entity as primary beneficiary) as a contrasting example where operational control and revenue retention shifted the benefit to the private party. Consider restructuring the contracting party on future capital-improvement work based on this distinction.

Common questions

Q: Would the outcome change if the city approved LP's construction plans or supervised the work?
A: The ruling doesn't test that scenario, but based on the multi-factor "primary use and benefit" analysis used in companion rulings, more city control and approval rights could support a different conclusion — the key facts here were LP's full operational control and revenue retention.

Q: Is LP considered the city's agent because the lease requires reimbursement?
A: No. The lease explicitly states it doesn't create a partnership, joint venture, or other business relationship between LP and the city, and the Comptroller treated LP purely as an independent tenant, not an agent making purchases on the city's behalf.

Q: Are LP's purchases of tangible personal property (not installed into the realty) treated the same way?
A: Yes — the same logic applies. City purchases of tangible personal property are tax-exempt; LP's purchases are taxable even when reimbursed by the city, and regardless of how LP uses the property.

Q: Does this ruling apply to my public-private facility management arrangement?
A: Not automatically. This is a private letter ruling binding only on the Comptroller as to this taxpayer's specific facts. A lease that gives the government more control, or fewer LP revenue rights, could shift the primary-use-and-benefit analysis.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.051, § 151.010 (sales tax imposition; taxable item)
• Tex. Tax Code § 151.309 (governmental entity exemption)
• Tex. Tax Code § 151.311 (exemption for improvements to realty of an exempt entity)
• Tex. Tax Code § 151.056 (contractor responsibilities for lump-sum vs. separated contracts)
• Tex. Tax Code § 151.0047; § 151.0101(a)(13) (real property repair and remodeling as a taxable service)
• 34 Tex. Admin. Code § 3.291(a)(5), (a)(13), (b)(4) (Contractors; exempt contract; separated-contract materials)
• 34 Tex. Admin. Code § 3.357(b), (d)(6) (Nonresidential Real Property Repair, Remodeling, and Restoration)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/202006008L

Original ruling text

June 2, 2020

**, City Attorney

RE: Private Letter Ruling No. PLR 20181002084908

Dear **:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters. [ENDNOTE 1] We are responding to your request dated Sept. 27, 2018. You also submitted supplemental information on Nov. 9, 2018; Sept. 18, 2019; and Sept. 19, 2019. In addition, you provided information via teleconference on Aug. 19, 2019. Detrimental reliance relief is provided in accordance with Rule 3.10, Taxpayer Bill of Rights.

** (“City”) seeks a determination as to whether the **, Limited Partnership (“LP”) may make certain exempt purchases in connection with the ** (“Center”) during the term of an existing lease of the Center executed between City and LP. City also requests guidance for situations in which City is the party that enters into a contract with the vendor and LP reimburses the City.

Facts Presented

As part of its submissions, City provided copies of contracts, invoices, and memoranda. All documents are incorporated herein by reference.

In 2008, City completed construction of Center (formerly called “Center's First Name”). City contracted directly for the construction of this project. See Construction Management-at- Risk Agreement, spec. §2.11. On Feb. 20, 2008, City and **, LLC (“Center's Second Name”) executed a Lease and Development Agreement (“Lease”) for the management and operations of the Center by Center's Second Name. The Lease was eventually supplanted by a second Lease and Development Agreement (“Lease-2”) reached between the City and LP. The lease expires Sept. 2034.

Lease-2 requires the City, as landlord, to reimburse LP for certain Capital Improvements Expenses (CIE’s). Lease-2 defines “Capital Improvements” as “any work of a capital nature required to repair, restore or replace any equipment, facility or structure at the (Center) that has deteriorated or becomes dysfunctional beyond remedied by maintenance.” City has enumerated certain of these expenditures, which include purchases of tangible personal property, as well as the performance of certain improvements to realty.

Lease-2, §3.2.4 states that LP has full and exclusive control of the management and operation of the Center. Furthermore, LP “owns all revenues of any source generated by or from the premises or the management or operation thereof ”

City states that, to date, LP has made CIE purchases with reimbursement by City for its proportionate share pursuant to Lease-2. However, City also states “the purchases have not been specifically for construction materials; instead they have been to contractors for a lump- sum price covering both the performance of the service and the furnishing of the necessary incidental material.” (See correspondence of Nov. 9, 2018, P. 2 at 3.) City also states that CIEs “will also include tangible personal property that is not ‘physically incorporated into’

the Center...... and will remain tangible personal property.” (See correspondence of Nov. 9, 2018, P. 4 at c.)

City provides reimbursements in accordance with a staggered schedule. During the period from Dec. 15, 2014, through Sept. 24, 2017, City reimbursed none of the CIEs. From Sept. 25, 2017 through Sept. 24, 2025, City must reimburse one-third of the CIEs. Finally, from Sept. 25, 2025, to Sept. 24, 2034, City must reimburse 100% of the CIEs.

Lease-2, §14.1.5 notes that certain areas in the Center are used exclusively by LP, and that City is not required to reimburse LP for CIEs associated with these areas. The areas include offices used by the COMPANY A, LP, and affiliates, as well as any locker room or “other facilities” used exclusively by COMPANY A.

Lease-2, Appendix B, §19, notes that the relationship between LP and City is that of independent parties. Lease-2, then, specifically establishes that Lease-2 does not “create or evidence, a partnership, joint venture or other business relationship or enterprise between (LP) and (City).”

Question, Ruling, and Analysis

Our restatement of your question is shown below, followed by our response and analysis.

Question: Are the City’s and LP’ purchases exempt from sales and use tax for their respective portions of CIE purchases when:

LP is the party that enters into a contract with the vendor and City reimburses LP in accordance with Lease-2; or

City is the party that enters into a contract with the vendor and LP reimburses the City in accordance with Lease-2.

Ruling: CIEs may be either contracts for the improvement of real property or the purchase of tangible personal property. LP’ contracts for the improvement of real property are for the primary use and benefit of LP and are not exempt contracts, even when City reimburses LP. Purchases of tangible personal property by LP are taxable, even when City reimburses all or part of the purchase price.

City’s contracts for the improvement of real property are exempt contracts. City’s purchases of tangible personal property are not taxable.

Analysis: Texas imposes a tax on each sale of a taxable item in this state. Section 151.051 (Sales Tax Imposed). The term “taxable item” includes tangible personal property and taxable services. Section 151.010 (Taxable Item).

Section 151.309 (Governmental Entities) provides an exemption for taxable items sold to governmental entities including cities. City suggests that all purchases associated with CIEs are exempt, under provisions of Sections 151.309 and Rule 3.291 (Contractors).

Contracts to Improve Realty

There are two types of service providers who improve nonresidential realty−contractors performing new construction and others providing nonresidential real property repair and remodeling.

Section 151.056 (Property Consumed in Contracts to Improve Real Property) and Rule 3.291 (Contractors) explain the responsibilities of contractors improving realty under either separated or lump-sum contracts. A contractor performing new construction (e.g., adding new square footage to an existing facility) under a lump-sum contract is the consumer of all items, including incorporated materials, used in performance of the contract and owes tax on the items at the time of purchase. The lump-sum charge to the customer is not taxable.

A contractor performing new construction under a contract that includes separated charges for labor and incorporated materials is a seller of the materials. The separate charge for the materials is taxable. See Rule 3.291(a)(13) and (b)(4).

A service provider repairing or remodeling nonresidential realty under Section 151.0047 (“Real Property Repair and Remodeling”) and Rule 3.357 (Nonresidential Real Property Repair, Remodeling, and Restoration; Real Property Maintenance) is providing a taxable service and must collect tax on all charges, regardless of whether the charges are lump-sum or separated. See Section 151.0101(a)(13) (“Taxable Services”) and Rule 3.357(b).

Section 151.311 (Taxable Items Incorporated into or Used for Improvement of Realty of an Exempt Entity), however, provides exemptions for incorporated materials, consumable items, and certain services purchased by contractors or other service providers performing improvements to realty for entities exempted from tax under either Section 151.309 or 151. 310 (Religious, Educational, and Public Service Organizations).

A city is an entity exempted from tax under Section 151.309. A contractor or other service provider performing an improvement to realty for a city may issue an exemption certificate in lieu of tax for materials and services enumerated under Section 151.311. A contractor or service provider does not collect tax on these contracts.

According to Rule 3.291(a)(5) and Rule 3.357(d)(6) (Nonresidential Real Property Repair, Remodeling, and Restoration; Real Property Maintenance), the exemptions under Section 151 also apply to a project, performed for a non-exempt entity, when the project is constructed for the “primary use and benefit” of an exempt entity.

City asks whether LP’ payments for CIE purchases are exempt from sales tax. As noted, a contractor or service provider performing improvements for a non-exempt entity could purchase certain materials and services exempted under Section 151.311, but only when the contract is for the primary use and benefit of an exempt entity. LP must establish whether the contract is for the primary use and benefit of City.

Regarding LP contracts, Lease-2, §3.2.4 states that LP has full and exclusive control of the management and operation of the entire Center. LP “owns all revenues of any source generated by or from the premises or the management or operation thereof ” Lease-2 clearly establishes that the facility is for the primary use and benefit of LP and any improvements to the Center are not for the primary use and benefit of City. See, again, Rule 3.291(a)(5) and Rule 3.357(d)(6).

Contracts entered into by LP, therefore, do not qualify for the exemptions under Section 151.311. LP owes tax on contractor’s charges for separately stated incorporated materials for new construction performed under any separated contracts, as well as on all charges for nonresidential repair and remodeling. Lump-sum charges for any new construction are not taxable. As noted earlier, a contractor performing a lump-sum contract owes tax on the purchase of all incorporated materials.

Contracts entered into directly with City qualify for Section 151.311 exemptions. No tax should be charged to City in such cases.

Finally, LP does not stand as City’s agent in entering into real property improvement agreements. Lease-2 does not “create or evidence, a partnership, joint venture or other business relationship or enterprise between (LP) and (City)” (emphasis added). See Lease- 2, Appendix B, §19. LP is a tenant and has no other business relationship with City, including that of agent in making purchases.

Tangible Personal Property

Certain CIEs are purchases of tangible personal property that will not be installed into the realty. These purchases are taxable or exempt based upon whether they are made by LP or City.

As an entity exempted under Section 151.309, City may directly purchase tangible personal property tax-free. LP, however, is not an exempt entity, and must pay tax on its purchases, even when the purchases are partially or wholly reimbursed by City and regardless of use.

As noted earlier, the relationship between LP and City is that of independent parties. LP is not City’s agent in purchases of tangible personal property. See, again, Lease-2, Appendix B, §19.

The Texas Tax Code and Texas Administrative Code are accessible at www.comptroller.texas.gov/taxes/. If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/web-forms/tax-help/ and reference Private Letter Ruling No. PLR 20181002084908.

Sincerely,

Tax Policy Division – Direct/Indirect Taxes

Texas Comptroller of Public Accounts

ENDNOTE:

1. Unless otherwise indicated, all references to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code.