How did Texas tax commercial air-conditioning contracts combining scheduled maintenance, parts, and repairs?

Plain-English summary

The requester offered three types of commercial central-air-conditioning contracts combining scheduled maintenance, parts, service calls, and repairs.

A lump-sum scheduled-maintenance contract was not taxed to the customer. The contractor paid tax on included parts or accrued tax on parts taken from tax-free inventory. Separately billed parts were taxable to the customer, and separately billed repair services were taxable on both parts and labor.

For a lump-sum contract that combined maintenance and repair, the entire price was taxable unless the contractor could document that repairs were 5% or less of the total. At 5% or less, the contract was treated as nontaxable maintenance and the contractor paid tax on consumed parts. Above 5%, the letter treated it as a repair contract, taxable on the total price, with a resale certificate available for parts transferred to the customer's care, custody, and control.

The letter also allowed the contractor to develop a documented allocation between repair and maintenance instead of taxing the entire mixed contract. The repair percentage could be based on prior-year aggregate receipts or calculated contract by contract, supported by time sheets or other records and reevaluated annually. Tax was collected on the repair portion, not the maintenance portion.

STAR now directs readers to the amended Rule 3.285 for current care-custody-and-control guidance.

What this means for you

Contract wording, separate billing, the repair percentage, and business records drove the historical result. A mixed agreement was not automatically treated like maintenance merely because maintenance was its main component.

Common questions

Was a maintenance-only lump sum taxable to the customer? No.

Were separately billed repairs taxable? Yes, on parts and labor.

What happened when repairs were 5% or less of a mixed lump sum? With documentation, the contract was treated as nontaxable maintenance.

Could the contractor allocate a mixed contract? Yes, using a supported repair percentage and collecting tax on that portion.

Who paid tax on parts consumed in maintenance? The contractor.

Citations and references

• 34 Tex. Admin. Code Rule 3.357 — rule enclosed for the repair-and-maintenance analysis
• 34 Tex. Admin. Code Rule 3.285 — current resale and care-custody-and-control guidance identified by STAR's alert

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9105L1107D05

Original ruling text

ALERT: For specific guidance relating to the care, custody and control of TPP when providing a taxable service, please see Rule 3.285, Resale Certificates; Sales for Resale (amended 11/01/2017.

May 9, 1991

Dear **:

Thank you for your recent letter. Your specific questions involve three
different types of central air conditioning system maintenance and repair
contracts for commercial properties. You ask which charges are taxable to your
customer, and which items are taxable to you, under the following
circumstances.

1. Maintenance contract that contains, (1) Labor and material to maintain
   equipment, change filters, oil motors, wash condensers, etc. example #1
   enclosed.

Answer: This contract appears to be lump-sum contract for parts and
labor used in scheduled, periodic maintenance of a central air conditioning
system. The contract calls for certain repair services to be billed separately
to the customer "when provided at our preferred customer rate for labor and
material".

You should charge no tax to the customer on the lump-sum contract price.
You must pay tax on parts supplied to the customer under this contract, or
accrue tax on parts pulled from a tax-free inventory to provide maintenance
services under this contract. You must collect tax from the customer on any
parts billed separately, in addition to the contract price. Parts billed
separately may be purchased tax-free with a resale certificate.

You must collect tax from the customer on the total separately billed
charges for repair service, including both parts and labor. Parts transferred
to the customer in repair may be purchased tax-free with a resale certificate.

2. Maintenance contract that contains all items in #1 with an addition
   for labor to be covered under their contract for any service calls or repairs
   performed; example #2 enclosed.

Answer: This contract appears to be a lump-sum contract for both
scheduled, periodic maintenance (labor and some parts included) and for repair
labor, subject to certain restrictions. There is a provision for additional
repairs to be billed separately at a preferred customer rate.

Since the charges for repair and maintenance are not separately
identified in the contract, the entire contract price is taxable to the
customer unless the charge attributable to repairs constitutes 5% or less of
the total contract price. You must be able to document this fact through your
business records, to overcome the presumption that the entire contract is
taxable.

If repair is 5% or less:

If you can show that the repair charges are 5% or less of the total
lump-sum contract price, then the contract is a nontaxable maintenance
contract. In this case, you are responsible for paying tax on parts consumed
under the contract, or for accruing tax on parts pulled from a tax- free
inventory and used under the contract.

Additional parts, billed separately, are taxable. The total charge for
additional repairs, billed separately, is taxable to the customer. Parts
transferred to the customer in these additional repairs may be purchased tax-
free with a resale certificate.

If repair is more than 5%:

If repairs constitute more than 5% of the lump-sum contract price, then
the entire contract is a repair contract. In this case, the customer must pay
tax on the total contract price, and you would be entitled to purchase tax-free
with a resale certificate parts that will be transferred to the customer's
care, custody and control under the contract.

The total charge for additional repairs, billed separately, is also
taxable to the customer. Parts transferred to the customer in these additional
repairs may be purchased tax- free with a resale certificate.

3. Maintenance contract that contains all items in #1 with an addition to
   provide labor and material for any service calls or repairs performed, example

3 enclosed.

Answer: This contract is a lump-sum contract for both maintenance (parts
and labor) and repair (parts and labor). Therefore, the answer is the same as
Answer 2.

General observations:

Instead of having to collect tax on the entire lump-sum contract for
maintenance and repair (where repair is more than 5%), you may develop for such
contracts a percentage
allocated to repairs and a percentage allocated to maintenance. You would
then collect tax from your customers on the percentage of the lump-sum price
attributable to repairs, but not the percentage attributable to maintenance.

The percentage should be derived from the total receipts for repairs
performed under such contracts divided by the total receipts for repairs and
maintenance combined. Daily time sheets or other documentation that details
time spent on repairs vs. time spent on maintenance may be used to develop the
allocation. The percentage should be taken from an aggregate of all contracts
from the preceding year, and should be reevaluated annually to adjust for any
changes.

You may also calculate a percentage for each contract individually,
rather than for the aggregate. On original repair/maintenance contracts, you
may use a reasonable estimate (supported by business records) to calculate the
percentage.

You would be required to pay tax on parts, or accrue tax on parts pulled
from a tax-free inventory, that are used to perform maintenance under the
contract. You would be required to collect tax from the customer for parts
billed separately, but you could issue a resale certificate to buy such parts
tax-free.

You would be required to collect tax on the entire percentage of the
lump-sum price attributable to repairs. Parts transferred to the care, custody
and control of the customer as part of repair may be purchased tax-free with a
resale certificate. Of course, separately billed repairs remain taxable to the
customer.

I have enclosed a copy of our Rule 3.357 for your reference, as well as a
copy of a recent taxability response that discusses the same issues.

This opinion is based on the facts presented. Different facts, though
similar, might lead to different answers. If you have further questions, feel
free to write or call 1-800-252-5555. My direct extension is 3-3889.

Sincerely,

John Christian
Attorney
Tax Administration