Does a company that fabricates and installs gas distribution pipelines qualify as a 'fabricator' for the Texas manufacturing exemption?

Subject

Manufacturer And Contractor — Cannot Act As Both In Single Contract Or Transaction

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9402675L

Plain-English Summary

A taxpayer representative asked the Comptroller whether "Company X" — a business that fabricates and installs commercial and residential gas distribution pipelines for utility companies — qualifies as a fabricator for purposes of the Texas manufacturing exemption. Company X cuts, bends, welds, fuses, shapes, and configures PVC pipe using welders, fusers, electric generators, and air compressors to connect gas mainlines to meters, and it argued that this fabrication work fell within Comptroller's Rule 3.300, which defines fabrication as making, building, creating, producing, or assembling components of tangible personal property, or making tangible personal property work in a new or different manner.

The Comptroller disagreed. Assuming that Company X installs the pipelines it fabricates for the utility companies, the Comptroller concluded that the company is a contractor, not a fabricator that would qualify for the manufacturing exemption. The reasoning: the cutting, welding, and shaping Company X does happens in the process of installing the pipe as an improvement to real property. That is true of any contractor's work — the ruling draws a direct analogy to a framer who cuts and nails 2"x4" lumber together. Doing so does not make the framer a manufacturer, and the framer is not entitled to the manufacturing exemption for the compressor that runs the nail gun or the saw that cuts the lumber. The same logic applied to Company X: because its manipulation of pipe occurs as part of installing an improvement to realty, it remains a contractor for tax purposes, and its welders, fusers, generators, and air compressors do not qualify for the manufacturing exemption.

What This Means For You

If your business fabricates materials and then installs them as part of real property (pipelines, ductwork, framing, custom metalwork, etc.), don't assume that cutting, welding, bending, or otherwise manipulating the materials makes you a "manufacturer" or "fabricator" for sales tax exemption purposes. If that manipulation happens as part of installing the item as an improvement to real estate, the Comptroller treats you as a contractor, and equipment used in that work (welders, fusers, generators, compressors, saws, nail guns, etc.) will not qualify for the manufacturing exemption.

The key distinguishing fact is what happens to the item after fabrication. This ruling turned on the Comptroller's assumption that Company X installs the pipelines it fabricates for the utility companies. If a company only fabricates a product for sale — without also installing it as a realty improvement — the analysis could come out differently. The letter itself invites that follow-up: it states that if the facts are different than assumed, the taxpayer should say so and the Comptroller will reexamine the question.

A single contract generally can't wear both hats. A business that both fabricates and installs the same tangible personal property into real property is characterized as a contractor for that work, not as a manufacturer entitled to a manufacturing exemption on the equipment used.

Q&A

Q: We cut, weld, and configure pipe before installing it — doesn't that make us a fabricator entitled to the manufacturing exemption?
A: Not according to this ruling. Even though the work involves fabrication-type steps (cutting, bending, welding, fusing, shaping), the Comptroller ruled that a company that installs the pipe it fabricates as an improvement to real property is a contractor, not a fabricator that qualifies for the manufacturing exemption. The Comptroller compared it to a framer cutting and nailing lumber — that manipulation doesn't turn the framer into a manufacturer either.

Q: Does the manufacturing exemption ever apply to equipment like welders, fusers, generators, or air compressors used on a construction job?
A: Based on this ruling, no — not when that equipment is used to fabricate and then install tangible personal property (like gas pipeline) as an improvement to realty. The company remains a contractor for that work, and its manufacturing equipment doesn't qualify for the exemption.

Q: What if our facts are different — for example, if we fabricate pipe but a separate company installs it?
A: The ruling is explicitly conditioned on the Comptroller's assumption that the company installs the pipelines it fabricates. The letter states that if the facts are other than assumed, the taxpayer should let the Comptroller know so the question can be reexamined — meaning a different fact pattern (such as fabrication without installation) could yield a different result.

Citations

• Comptroller's Rule 3.300 (cited by the taxpayer's request letter as defining "fabrication" and setting out when manufacturing machinery and equipment qualify for a refund or reduction in tax)

Original ruling text

February 7, 1994

Dear **:

I apologize for not answering your letter of January 27, 1994 sooner. You
asked if a company that fabricates and configures commercial and residential
gas distribution pipelines for utility companies is a fabricator for purposes
of the manufacturing exemption.

I am assuming from your letter that the company installs these pipelines for
the utility companies. Based on this understanding, it is my opinion that the
company is a contractor and not a fabricator which would qualify for the
manufacturing exemption.

The examples of the type work the company does involves the manipulation of
tangible property in the process of installing it as an improvement to realty.
The same can be said of any contractor. A framer cuts 2"x4" and nails them
together. This does not make the framer a manufacturer. Consequently, the
framer would not be entitled to the manufacturing exemption for the compressor
used to run the nail gun or the saw to cut the lumber. Similarly, your client
is not entitled to the manufacturing exemption.

If the facts are other than I have assumed, please let me know; and I will
reexamine the question. If you have any other questions, please call me at
1-800-531-5441, extension 3-4004.

Sincerely,

Wade Anderson
Assistant Director
Tax Administration

cc: Chuck Johnstone
Manager Tax Administration

January 27, 1994

Mr. Wade Anderson
Tax Administration Division
Comptroller of Public Accounts
P.O. Box 13528
Austin, Texas 78711

RE: Request for Ruling

Dear Wade:

On behalf of our client, we hereby request a ruling with regard to the sales
and use tax treatment of gas pipeline construction companies hired to fabricate
and install gas distribution pipelines for utility companies. The important
facts regarding the performance of these services are outlined below.

FACTS

Company X, which is qualified to do business in Texas, is primarily engaged in
the fabrication and installation of gas distribution pipelines for utility
companies. Company X fabricates entire configurated systems for commercial and
residential property by using pvc pipe with meters and other equipment to
connect mainlines to meters. The fabrication entails cutting, bending,
welding, fusing, shaping, and configuring pipe to meet required flows and space
restrictions. Company X uses both lump-sum and separated contracts in the
performance of these contracts. The majority of the work is considered to be
new construction when initiating pipelines from mainlines, but there are also
repairs and remodeling done to certain existing systems.

Equipment used by Company X to fabricate the various pipe fixtures include
welders (to weld metal joints), fusers (to permanently melt pipe together),
electric generators (to operate the welders and fusing machines), and air
compressors (to assure there are no leaks). These are the major pieces of
equipment used, but there are also other pieces of equipment used in the
fabrication process.

DISCUSSION

Under Comptroller's Rule 3.300 (a), "fabrication is to make, build, create,
produce, or assemble components of tangible personal property, or make tangible
personal property work in a new or different manner". In addition,
Comptroller's Rule 3.300 (f) addresses machinery and equipment having a useful
life of more than six months. Subsection (2) (A) states that "Manufacturing
machinery, equipment, replacement parts, and accessories qualify for a refund
or a reduction in the amount of tax paid: if it will be used in the actual
manufacturing, processing, fabrication, or repair of tangible personal property
to be sold, and the use of the item is necessary and essential to the
manufacturing, processing, fabrication, or repair operation or a pollution
control process resulting from the operation".

We believe Company X's fabrication of tangible personal property falls within
the scope of this rule. As such, the welders, fusers, generators and air
compressors would qualify as manufacturing equipment.

REQUEST FOR RULING

With regard to the foregoing discussion, we respectfully request your ruling on
the following:

1. Would our client be considered a fabricator under the manufacturing
   definition.

2. If considered a fabricator, would the equipment used as detailed above
   qualify for the manufacturing exemption.

Thank you for your assistance with this matter. Please contact me at
** if you have any questions.

Sincerely,

Taxpayer Representative