Is a deionized-water treatment system installed for a semiconductor (clean-room) manufacturer taxable as an improvement to real property, or exempt as manufacturing equipment?

Plain-English summary

A vendor of deionized-water treatment systems for semiconductor (microchip) clean rooms asked the Comptroller's office how sales tax applies to its equipment. The Comptroller's response covered two separate issues: the manufacturing exemption's phase-in, and whether the water treatment system counts as an "improvement to real property."

On the exemption, the letter notes that the manufacturing equipment exemption was being phased in: a 75-percent state tax reduction applied to qualifying manufacturing equipment purchased from January 1, 1994 through December 31, 1994, rising to a full 100-percent exemption from state and local sales and use tax starting in 1995.

On the improvement-to-realty question, the letter explains the Comptroller's test: a water treatment system is treated as an improvement to real property if, once installed, it loses its identity as a piece of equipment, and its removal would substantially damage either the equipment or the building. If instead the system is only temporarily attached and remains equipment, or can be removed without substantial damage to the property or itself, it is not an improvement to realty.

That classification then drives the tax treatment of labor and parts. If the system is an improvement to realty and is installed in a new building, the fabrication and installation labor is not taxable, provided the contract separately states the charges for parts versus labor; the customer may give an exemption certificate in lieu of tax on the parts. If the same improvement-to-realty system is installed in an existing building, the labor is taxable as real property remodeling — the customer can still use an exemption certificate for the separately stated parts, but tax must be collected on the remaining labor and fabrication charges. If, on the other hand, the equipment is not an improvement to realty, the vendor may accept an exemption certificate covering the whole sale — parts, fabrication, installation, and delivery — sold to a semiconductor manufacturer, and this exemption applies whether the installation is in a new or an existing building.

What this means for you

Vendors selling clean-room or water treatment equipment to semiconductor manufacturers

Whether your system is treated as an "improvement to real property" turns on whether it loses its identity as equipment once installed and whether removing it would substantially damage the equipment or the building. That classification determines whether installation labor is taxable, and whether the labor exemption depends on the building being new construction versus an existing structure.

Businesses installing systems in new vs. existing buildings

If your water treatment (or similar) system becomes an improvement to realty, installing it in new construction keeps the fabrication/installation labor exempt (with a separately stated parts charge eligible for an exemption certificate), while installing the identical system in an existing building makes that labor taxable as real property remodeling.

Accountants and tax professionals advising semiconductor-industry clients

This letter is also a marker for the manufacturing exemption's historical phase-in: 75 percent state tax reduction for qualifying manufacturing equipment purchased in 1994, moving to a full 100 percent state and local exemption in 1995. If equipment is not an improvement to realty and instead qualifies as manufacturing equipment sold to a semiconductor manufacturer, the exemption certificate can cover the entire transaction, including installation and delivery charges, regardless of whether the building is new or existing.

Common questions

Q: Is a deionized water treatment system installed for a semiconductor manufacturer always exempt from sales tax?
A: No. It depends on whether the system is an "improvement to real property" and, if so, whether it's installed in a new or existing building. If it is not an improvement to realty, an exemption certificate can cover the whole sale as manufacturing equipment for a semiconductor manufacturer.

Q: How does the Comptroller decide whether a system is an "improvement to real property"?
A: A system is an improvement to realty if, once installed, it loses its identity as equipment and its removal would substantially damage the equipment or the building. If it stays removable without substantial damage, it is not an improvement to realty.

Q: If the system is an improvement to realty, is the installation labor taxable?
A: It depends on the building. Labor is not taxable when installed in a new building (with parts separately stated and eligible for an exemption certificate). Labor is taxable as real property remodeling when installed in an existing building, though the separately stated parts can still be covered by an exemption certificate.

Q: What was the manufacturing exemption phase-in described in this letter?
A: A 75-percent state tax reduction applied to qualifying manufacturing equipment purchased from January 1, 1994 through December 31, 1994; starting in 1995 the exemption became 100 percent of state and local sales and use tax.

Citations and references

No specific statutes or administrative rules are cited in the text of this letter.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9412L1327B05

Original ruling text

December 14, 1994

Dear **:

Thank you for your letter concerning equipment used for deionized water in clean
rooms. The manufacturer's exemption, the exemption discussed in my letter to
***, has been phased-in in stages. There is a 75-percent state tax reduction
on qualifying manufacturing equipment purchased during the period beginning
January 1, 1994 through December 31, 1994. In 1995 the exemption will be 100
percent of state and local sales or use taxes.

Let me explain how our definition of "improvement to real property" applies to
your product. A water treatment system will be treated as an improvement to
realty if:

a. once it is installed it loses its identity as a piece of equipment and

b. its removal would substantially damage the water treatment equipment
or the building.

However, when equipment is temporarily attached to the realty so that it remains
equipment or can be removed without substantial damage to the property or the
equipment, it is not an improvement to real property.

Use the next two paragraphs as guidelines on your tax responsibilities when the
system is installed as an improvement to realty:

a. When you install a system in a new building, the labor portion of
the bill is not taxable. In this case, your contract must separate
the charges for the parts used to fabricate the system from the
charges for the fabrication and installation labor. Your customer
may give you an exemption certificate in lieu of tax on the parts.

b. When you install a system in an existing building the labor portion
of the bill is taxable as real property remodeling. Your customer
may give you an exemption certificate in lieu of tax on a separate
charge for the parts, and you should collect tax on the remainder of
the bill, including fabrication and installation labor.

On the other hand, if the equipment is not an improvement to realty, then
you may accept an exemption certificate in lieu of tax on a system sold to
a semi-conductor manufacturer. This exemption includes any charges for
installation or delivery of the system and applies even when the system is
installed in an existing building.

I hope this satisfactorily answers your questions. Should you have any
further questions, regarding this matter, please contact me at 1/800-531-5441
extension 3-4004.

Sincerely,

Wade Anderson
Assistant Director Tax Administration

NOTE: Previous Accession Number 9412768L