When a construction contract commingles taxable renovation/remodeling labor with nontaxable new-construction labor and the contract doesn't separately state the two, can a taxpayer's own engineer certify how much labor was new construction in order to claim a tax refund?

Plain-English summary

This letter from the Texas Comptroller's Tax Policy Division answers a refund question raised by an auditor on behalf of a manufacturer ("Company A") that had hired an out-of-state construction company ("Company B") to both renovate an existing plant and build a new expansion to it. The contract was written as a separated contract (labor billed apart from materials), but it did not distinguish between renovation labor and new-construction labor. Tax was paid on the materials. The labor went untaxed until Company B was audited, tax was assessed on the labor and paid, and Company A reimbursed Company B for the tax, penalties, and interest. After the rules on renovation versus new construction were clarified, Company A got an assignment of the refund right from Company B — but Company B refused to certify how much of the contract labor was new construction versus remodeling/renovation. So Company A's own plant construction engineer proposed to study the job and calculate the labor (and profit) split between renovation and new construction.

The Comptroller answered four questions:

1. Can the customer's own engineer certify the labor/profit split on a commingled job? Yes. Rule 3.357(b)(9) allows the service provider or the purchaser to later establish, through documentary evidence, the percentage of a total charge that relates to nontaxable services when that split wasn't separately stated at the time of the transaction.
2. What procedures should the engineer follow? The engineer must base the calculation on the written contracts describing the scope of work, bid sheets, tally sheets, schedules of values, and blueprints, covering all work related to new construction and all work related to renovation. Interior demolition is treated as part of the renovation portion (see Rule 3.357(b)(7)).
3. Can the engineer use the cost of materials as the basis for the labor split? No. Materials used is only a minor indicator of the volume of work performed — renovation materials can cost far more than new-construction materials, and renovation labor (including demolition) can likewise cost more than new-construction labor. Cost of materials alone is not acceptable documentary evidence for the split.
4. Does Company B need to be notified of the refund result? No. The service provider doesn't need to be told the outcome of the refund process, but remains responsible for the tax refunded through the assignment — just as it would be if it had refunded the tax to the customer directly.

What this means for you

Manufacturers and property owners seeking a refund on commingled construction labor

If your contractor won't (or can't) certify how much of a job's labor was new construction versus taxable renovation/remodeling, you are not stuck. Your own engineer or another qualified party can perform that certification using documentary evidence — the contractor's cooperation isn't required to pursue the refund.

Contractors and subcontractors on renovation-plus-new-construction jobs

Separate your contracts (or at least your internal records — bid sheets, tally sheets, schedules of values, blueprints) by scope of work between renovation/remodeling and new construction from the start. Doing so at the time of the transaction avoids the need for a later reconstruction of the split, and protects you from being on the hook for tax refunded to a customer through an assignment.

Accountants and tax professionals preparing refund claims

Don't rely on the relative cost of materials to allocate labor between taxable renovation and nontaxable new construction — the Comptroller specifically rejected that approach as insufficient documentary evidence. Build the allocation from the written contract's scope of work, bid sheets, tally sheets, schedules of values, and blueprints instead, and remember that interior demolition is renovation, not new construction.

Businesses considering taking an assignment of a refund claim

If you take an assignment of a refund claim from your service provider (as Company A did here), you don't need to notify the provider once the refund is processed. But understand that the provider remains liable for the refunded tax — the assignment doesn't shift ultimate responsibility away from them.

Common questions

Q: Can a customer's own engineer certify the new-construction/renovation labor split when the contractor refuses to?
A: Yes. Under Rule 3.357(b)(9), either the service provider or the purchaser may establish the taxable/nontaxable percentage split later through documentary evidence if it wasn't separately stated at the time of the transaction.

Q: What documents should the engineer's calculation be based on?
A: The written contracts describing the scope of work, bid sheets, tally sheets, schedules of values, and blueprints — covering all work tied to new construction and all work tied to renovation.

Q: Is interior demolition treated as new construction or renovation?
A: Renovation. Interior demolition is included in the renovation portion of the work under Rule 3.357(b)(7).

Q: Can the labor split be based on the cost of materials used in each portion of the job?
A: No. The cost of materials is only a minor indicator of the volume of work performed and is not, by itself, acceptable documentary evidence — renovation materials and labor (including demolition) can cost significantly more than the new-construction portion.

Q: Does the original contractor have to be told the result of a refund claim made through an assignment?
A: No. Notification isn't required, but the contractor/service provider remains responsible for the tax refunded through the assignment, the same as if it had refunded the tax to the customer directly.

Citations and references

Regulations:

• 34 Tex. Admin. Code § 3.357(b)(9) — establishing a taxable/nontaxable percentage split through later documentary evidence
• 34 Tex. Admin. Code § 3.357(b)(7) — treatment of renovation work, including interior demolition

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9506377L

Original ruling text

June 21, 1995

TO: Maureen Henley, Auditor, ** Audit

FROM: Tax Policy

RE: Refund Request: Remodeling and New Construction Contracts

SITUATION: A manufacturer (Company A) contracted with an out of state
construction company (Company B) to renovate an existing plant and expansion
with new construction to that existing plant. The contract was written as a
separated contract for labor and materials with no distinction made for the
renovation or new construction. Tax was paid on the material in the contract.
The labor was not taxed until an audit was performed on Company B; tax was
assessed and paid. Company A reimbursed Company B the tax assessed and any
penalties and interest paid. With the clarification of the rule regarding
renovation and new construction, Company A has received an assignment from
Company B for the tax. Company B refuses to certify how much of the contract
labor would be new construction and how much would be remodeling/renovation.
Company A has requested a refund on labor used in the new construction of the
extension of their manufacturing plant. Company A's plant construction engineer
is making a study of the plant and will calculate the percentage of labor
including profit used in the renovation of the original plant and labor
including profit used in the new construction portion of the plant extension.

QUESTIONS: (1) Is it permissible for the construction engineer employed by
Company A to certify the amount of labor and profit used in the new
construction portion of a commingled job?

(2) If so, should any specific procedures be followed in the engineers
calculations?

(3) May the engineer for Company A be allowed to base the new construction
labor and renovation calculation on the cost of materials used in each portion
of the contract?

(4) Should any notification of Company B be made as they have given the
assignment and refused to cooperate with Company A in regards to the amount of
new vs. renovation labor dollar value?

RESPONSES:

(1) Yes; Texas Administrative Section 3.357(b)(9) states, "...however, if the
charge for the taxable portion of the services is not separately stated at the
time of the transaction, the service provider or the purchaser may later
establish for the comptroller, through documentary evidence, the percentage of
the total charge that relates to nontaxable unrelated services."

(2) The engineer must use the written contracts detailing the scope of work,
bid sheets, tally sheets, schedules of values and blueprints. The calculations
should be based upon all work related to new construction and all work related
to the renovation. Interior demolition, etc., is included in the renovation
portion. See 3.357(b)(7).

(3) No; materials used is only one minor indication of the volume of work
performed. Materials used in the renovation portion may be much more costly
than those used in the new construction portion. Cost of materials alone is not
acceptable documentary evidence; likewise, the cost of labor for the
renovation, including interior demolition, may be considerably higher than the
cost of new construction.

(4) No; it is not necessary to notify the service provider of the results of
the refund process. However, the service provider/seller is responsible for the
tax refunded through the assignment of the right to receive the refund just as
they would be if they refunded the tax directly to the customer.