Does a citrus de-greening unit that becomes part of a packing shed still qualify for Texas's manufacturing equipment sales tax exemption?

Subject

Equipment (Walk-In Freezers/Refrigerators) — Becomes Improvement To Realty — Installation Must Be Under Separated Contract/Billing Before Manufacturer Can Claim Exemption

Plain-English summary

A taxpayer wrote to the Comptroller about a citrus fruit de-greening unit -- equipment that ripens the skin color of citrus fruit by applying ethylene gas over a few hours, so green-skinned but ripe grapefruit can be sold looking the way customers expect. The unit was built as a stand-alone structure inside a packing house, bought as a complete package and installed by an outside company.

The Comptroller answered in two parts.

First, on the exemption itself: the de-greening unit qualifies for the manufacturing equipment exemption under Texas Tax Code Section 151.318(h), which exempts machinery and equipment used in manufacturing or processing tangible personal property for sale.

Second, on a wrinkle the taxpayer's own letter raised: although the taxpayer described the unit as a stand-alone structure, the Comptroller noted it "may be substantially affixed or attached to or integrated into the packing shed" -- which would make it an improvement to realty. If that happens, how the installation is contracted determines whether the exemption survives:

• Lump-sum contract: if the unit becomes an improvement to realty and is installed under a lump-sum contract, the manufacturing exemption cannot be claimed at all. The installation is instead treated as taxable real property repair and remodeling service.
• Separated contract or billing: if the unit becomes an improvement to realty but is installed under a separated contract (materials billed separately from labor), the exemption applies to the separately stated materials charge, but the labor to install it is still taxable, because sales tax law does not exempt labor to remodel nonresidential realty (citing Section 3.300(f)(2)(B)).
• Remains tangible personal property: if the unit stays personal property after sale and installation (i.e., it is not incorporated into the realty), both the unit and the installation/set-up charges qualify for exemption. However, any modifications made to the packing shed itself to accommodate the unit are still taxable as real property remodeling service.

The letter closes with the Comptroller's standard caveat that the opinion is based on the facts presented and could change with different facts.

What this means for you

Manufacturers and processors installing custom equipment

If you are buying processing equipment that will be built into or attached to a building (not just sitting on the floor), don't assume the manufacturing exemption automatically covers the whole job. Whether the equipment becomes "an improvement to realty" is the threshold question, and if it does, your contract structure controls the tax result.

Contractors and equipment installers

Use a separated contract that states the materials/equipment charge separately from the installation labor charge whenever equipment might be classified as an improvement to realty. Under a lump-sum contract, the entire job can lose the manufacturing exemption and be taxed as real property repair and remodeling. Under a separated contract, at least the materials charge stays exempt even though labor is taxable.

Accountants and tax professionals

Walk clients through the three possible outcomes in this letter: (1) equipment remains personal property -- unit and installation both exempt; (2) equipment becomes realty, separated contract -- materials exempt, labor taxable; (3) equipment becomes realty, lump-sum contract -- exemption lost entirely, taxed as real property repair and remodeling. Also flag that any building modifications made to accommodate the equipment are taxable as remodeling regardless of how the equipment itself is billed.

Common questions

Q: Does the citrus de-greening unit qualify for a sales tax exemption?
A: Yes. The Comptroller ruled it qualifies for the manufacturing equipment exemption under Texas Tax Code Section 151.318(h), which exempts machinery and equipment used in manufacturing or processing tangible personal property for sale.

Q: What happens if the equipment becomes attached to the building?
A: Then it may be an "improvement to realty," and the exemption outcome depends on the contract type: it's lost entirely under a lump-sum contract, or preserved for the materials charge only (not labor) under a separated contract or billing.

Q: Is installation labor ever exempt?
A: Only if the equipment remains tangible personal property (never becomes part of the realty). If it becomes an improvement to realty, installation labor is taxable because Texas sales tax law does not exempt labor to remodel nonresidential realty.

Q: Are building modifications made to fit the equipment taxable?
A: Yes. The letter states that any modifications made to the packing shed to accommodate the unit will be taxable as real property remodeling service, regardless of how the unit itself is taxed.

Q: Could this outcome change under different facts?
A: Yes -- the letter explicitly says the opinion is based on the facts presented, and the opinion may change if there are additional or different facts.

Citations and references

Statutes and rules:

• Texas Tax Code Section 151.318(h) (manufacturing equipment exemption)
• Section 3.300(f)(2)(B) (concerning manufacturing exemptions and taxable labor to remodel nonresidential realty)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9610L1441G06

Original ruling text

October 2, 1996

Dear ***:

Thank you for your letter of September 3, 1996, and the accompanying binder of
information on the citrus fruit de-greening unit (unit).

The unit causes the skin of citrus fruit to mature in a few hours by applying
ethylene gas while the fruit is in the unit. The de-greening unit provides a
means of de-greening large quantities of fruit without adding chemicals to the
skin of the fruit.

The inside of grapefruit may be fully matured and the sugar and acid ratio very
good and tasty while the skin of the fruit is green. Customers will not buy a
grapefruit that looks green.

The unit is built inside the packing house. It serves one purpose only -- to
bring about a beautiful natural color to a very green piece of grapefruit. The
unit is a stand-alone structure inside a completed packing shed. This unit does
not add to the value of the packing shed structure because it is nothing more
than a capsule used to do a single job that is a process. This unit or capsule
cannot be used for anything other than what it is designed for. It cannot be
used for a cold room because it is not insulated. Storage can be used anywhere
inside the packing shed, but not inside this unit. There is a great deal of
very hi-tech equipment that is part of the unit.

The de-greening is a process much like the waxing which follows the
de-greening. It is a process that is necessary to bring a raw agriculture
product of little value to a commercial marketable item. The entire unit is
bought as a complete package from a Florida company and is installed by Florida
installers with Florida technology and engineering.

Question: Does the de-greening unit qualify for tax exemption.

Answer: The unit qualifies for the manufacturing equipment exemption under
Texas Tax Code Section 151.318(h). This provision exempts from sales and use
tax machinery and equipment property used in manufacturing or processing
tangible personal property for sale.

You state that the unit is a stand-alone structure inside the packing shed.
However, it appears that the unit may be substantially affixed or attached to
or integrated into the packing shed. If this is the case, the packing unit
may become an improvement to realty.

If the unit becomes an improvement to realty after installation and the unit is
installed under a lump-sum contract, the manufacturing exemption may not be
claimed. The installation may constitute real property repair and remodeling
service. The manufacturing exemption does not apply to real property repair and
remodeling services.

If the unit becomes an improvement to realty and it is installed under a
separated contract or billing, the manufacturing exemption will apply to the
separately stated charge for the materials used to fabricate the unit. The
labor to install the materials will be taxable because the sales tax law does
not exempt labor to remodel nonresidential realty. See Section 3.300(f)(2)(B)
concerning manufacturing exemptions.

If the unit remains tangible personal property after the sale and installation
or set up, the unit and the installation or set up charges will qualify for
exemption. However, any modifications made to the packing shed to accommodate
the unit will be taxable as real property remodeling service.

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change.

You may call me toll free 1-800-531-5441, extension 3-4683. The direct line is
512/463-4683. You may also write to Tax Policy Division, Comptroller of Public
Accounts.

Sincerely,

Eddie C. Washington
Tax Policy Division

NOTE: Previous Accession Number 9610786L