A contractor building a new manufacturing plant under a lump-sum contract asked a comprehensive set of questions: who can issue manufacturing exemption certificates, how lump-sum vs. separated contracts are taxed differently, what a direct payment permit is, and what Texas's sales tax rate and permit procedures are -- what's the full picture?

Plain-English summary

A contractor building a new manufacturing plant under a lump-sum contract asked the Comptroller a broad set of practical questions about how Texas taxes contractors. The response is an unusually comprehensive, FAQ-style primer:

1. Manufacturing exemption certificates. A manufacturer-customer does NOT become a general tax-exempt entity, and the Comptroller doesn't issue exemption certificates to manufacturers. Instead, a manufacturer may claim an exemption when purchasing QUALIFYING manufacturing machinery and equipment by issuing the vendor its own exemption certificate (Rule 3.300(h)(1)); since January 1, 1995, such equipment is 100% exempt from state and local tax (Rule 3.300(f)(1)). Critically, only the manufacturer itself may issue this certificate -- contractors and subcontractors may never issue manufacturing exemption certificates on the owner's behalf.

2. Lump-sum vs. separated contracts. A lump-sum contract bundles materials and labor into one price; issuing separate invoices doesn't convert it to a separated contract unless the contract terms require that. Under a lump-sum contract, the contractor is the CONSUMER of all materials, consumables, and equipment (including manufacturing equipment) -- it owes tax at purchase (or accrues use tax on out-of-state purchases lacking Texas tax collection), may NOT issue resale certificates for job materials, and the lump-sum charge billed to the customer is not itself taxed. A separated contract states materials and labor prices separately (even if summed to one total); cost-plus contracts generally count as separated. Under a separated contract, the contractor is a RETAILER reselling incorporated materials -- it must hold a Texas sales tax permit, may buy materials/equipment tax-free via resale certificate, must collect tax from the customer on the agreed materials price, and may accept an exemption certificate in lieu of collecting tax on qualifying manufacturing equipment. Separated contractors may also resell certain taxable SERVICES tax-free via resale certificate (e.g., landscaping, surveying, final site clean-up/janitorial) but may NOT do so for services they themselves consume (security services, telecommunications, daily janitorial). Subcontractors don't need to match the general contractor's contract type -- each subcontractor's own contract governs its own tax responsibilities (e.g., a separated subcontractor collects tax from the general contractor even under an overall lump-sum prime contract).

3. No advance state approval process. There's no requirement to identify exempt items and submit them to the state for acknowledgment or approval in advance.

4. No refund for the customer. Under a lump-sum contract, a customer cannot recoup the tax the contractor paid on qualifying manufacturing machinery/equipment incorporated into its realty (Rule 3.291(b)(3)(A)) -- there is no applicable refund procedure.

5. Direct payment permits. A direct payment permit lets a qualified consumer self-assess and pay tax directly to the state instead of paying vendors, and covers all branches/divisions of the permit-holding legal entity (but can't be loaned to other firms). A direct payment exemption certificate must NEVER be issued to a lump-sum contractor (doing so risks permit revocation) -- but MAY be issued to a separated contractor, who purchases items for resale and accepts the certificate in lieu of charging tax on items resold to the permit holder; the contractor still can't use the certificate to avoid tax on its own consumables/equipment.

6. Tax rate. Texas's state sales/use tax rate is 6.25%, local taxes can add up to 2%, for a combined maximum of 8.25%.

7. Permit and filing procedures. Applying for a Texas sales tax permit is a simple application-and-mail process; returns and tax collected are due by the 20th of the month following the reporting period (Rule 3.286 covers additional filing requirements).

What this means for you

Contractors deciding between lump-sum and separated contract structures

This is one of the clearest single-letter breakdowns of how contract structure drives your tax obligations: lump-sum shifts the tax burden onto YOUR material purchases with no customer-facing tax collection, while separated contracts make you a retailer who collects tax from the customer but can buy materials/services tax-free for resale. Choose (or negotiate) your contract type with this tradeoff in mind.

Manufacturers building new plants

Only you, as the manufacturer, can issue an exemption certificate for qualifying manufacturing machinery/equipment -- your general contractor and its subcontractors cannot do this on your behalf, regardless of contract type. And if your contractor is on a lump-sum basis, you generally cannot recover any tax the contractor paid on equipment incorporated into your building.

Businesses using or considering a direct payment permit

Never let a lump-sum contractor accept your direct payment exemption certificate -- it risks your permit's revocation. Reserve that certificate for separated contractors who are genuinely reselling to you.

Accountants and tax professionals

Bookmark this letter as a general-reference primer covering contractor tax basics (lump-sum vs. separated, manufacturing exemption certificate authority, direct payment permits, tax rates, and permit filing) -- useful as a first-pass answer whenever a client raises any of these foundational contractor tax questions.

Common questions

Q: Can a contractor issue a manufacturing exemption certificate on behalf of the plant owner?
A: No, per this letter -- only the manufacturer itself may issue that certificate; contractors and subcontractors never can.

Q: What's the core tax difference between a lump-sum and a separated contract?
A: Per this letter, under lump-sum the contractor is the consumer (pays tax on materials, no tax collected from customer); under separated the contractor is a retailer (collects tax from the customer on the materials price, can buy materials tax-free for resale).

Q: Can a customer recover tax a lump-sum contractor paid on manufacturing equipment?
A: No, per this letter and Rule 3.291(b)(3)(A) -- there is no refund procedure available to the customer in that scenario.

Q: Can a direct payment permit be given to a lump-sum contractor?
A: No, per this letter -- doing so can result in the permit being revoked; direct payment exemption certificates may only go to separated contractors.

Q: What is Texas's combined maximum sales tax rate?
A: 8.25%, per this letter -- 6.25% state plus up to 2% local.

Citations and references

Rules:

• 34 Tex. Admin. Code Rule 3.300(f)(1), (h)(1), (f)(2)(B) (manufacturing machinery/equipment exemption and certificate authority)
• 34 Tex. Admin. Code Rule 3.291 (Contractors -- lump-sum vs. separated contracts, direct payment permits)
• 34 Tex. Admin. Code Rule 3.291(b)(3)(A) (no customer recoupment of contractor-paid tax on manufacturing equipment)
• 34 Tex. Admin. Code Rule 3.286 (sales tax permit filing requirements)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9706531L

Original ruling text

June 18, 1997

Dear ***:

Thank you for your letter of June 17, 1997. You stated that you are a
contractor constructing a new manufacturing plant under a lump-sum contract for
a customer and asked that we address the following questions.

(1) Given that the owner qualifies for tax exemption and is issued a tax
exempt certificate by the state, is a certificate also issued or passed on to
our company? Thus does our company issue tax exempt certificates to
subcontractors and vendors?

Response: As a manufacturer, your customer does not become an exempt entity.
This office does not issue tax exempt certificates to manufacturers. However,
manufacturers may claim a tax exemption when purchasing qualifying
manufacturing machinery and equipment. When a manufacturer purchases
qualifying machinery and equipment, he may issue the vendor an exemption
certificate in lieu of paying tax. Please refer to subsection (h)(1) of Rule
3.300. [Note: Effective January 1, 1995, qualifying manufacturing machinery
and equipment became totally exempt from state and local taxes. See subsection
(f)(1) of Rule 3.300.] It is important to point out that this exemption is
only available when the purchase is made by the manufacturer and only the
manufacturer may issue an exemption certificate for the purchase of
manufacturing machinery and equipment. Contractors may not claim the
manufacturing exemptions when purchasing manufacturing machinery and equipment.
Therefore, your company and subcontractors may not issue manufacturing
exemption certificates on behalf of the owner.

(2) Please explain the difference pertaining to the execution of sales and use
tax exemptions in lump-sum and separated contracts. Under either contract
method, can our company be issued a resale certificate, which is to be provided
to subcontractors in lieu of payment of tax. Also, the customer would provide
one to our company in lieu of payment of taxes. Based on the above scenarios,
is it logical to assume that tax for identified exempt items would not be
included in the lump-sum or separated contract amount? If this is not the
case, please explain.

Lump-sum Contract - A lump-sum contract is a contract in which the agreed
contract price is one lump-sum amount and in which the charges for incorporated
materials are not separate from the charges for skill and labor. Separated
invoices issued to the customer will not change a lump-sum contract into a
separated contract unless the terms of the contract require separated invoices.
Under a lump-sum contract, a contractor is considered the consumer of all
materials, consumable items, and equipment (including manufacturing machinery
and equipment) used or incorporated into a customer's property. A contractor
owes tax on the materials at the time of purchase or may accrue tax on
materials removed from a valid tax-free inventory. If the materials are
purchased from an out-of-state seller, a contractor must accrue and remit use
tax on the materials unless Texas use tax was collected by the out-of-state
seller. The lump-sum contractor also owes tax on all materials and equipment
bought, leased, or rented for use on the job. The lump-sum charge to the
contractor's customer is not taxable. A contractor purchasing items
specifically for use in a lump-sum contract may not issue resale certificates
in lieu of tax for taxable items.

Separated Contract - A separated contract is a contract in which the agreed
contract price is divided into a separately stated agreed contract price for
incorporated materials and a separately stated agreed contract price for skill
and labor. If the prices of incorporated materials and labor are separately
stated, the fact that the charges are added together and a sum total given is
irrelevant. Cost-plus contracts are generally regarded as separated contracts.
Under a separated contract, the contractor is considered a retailer reselling
the incorporated materials. As such, the contractor may issue a resale
certificate to purchase, tax free, materials, consumable items, and equipment
(including manufacturing machinery and equipment) that will be incorporated
into the customer's realty. As a retailer, the contractor must obtain a Texas
sales and use tax permit and collect and remit Texas tax from his customer
based upon the agreed contract price of the incorporated materials. The
contractor may accept a properly completed exemption certificate in lieu of
collecting tax on qualifying exempt manufacturing machinery and equipment.
Under a separated contract, the contractor owes tax on all consumable materials
and equipment bought, leased, or rented for use on the job. Local taxes are
due based on the location of the jobsite. Contractors performing separated
contracts may issue suppliers resale certificates in lieu of tax for taxable
services that are resold to the contractor's customer. Examples of taxable
services that may be resold are landscaping, surveying, and the final clean-up
(janitorial services) of the construction site. Contractors may not issue
resale certificates for taxable services that the contractor uses or consumes,
such as security services, telecommunication services, and daily janitorial
services.

For tax purposes, it is not required that all subcontractors use the same type
of contract as the general contractor. For example, a general or prime
contract may be lump-sum, while some or all subcontracts may be separated.
Each subcontractor's individual contract governs the subcontractor's tax
responsibilities. For example, the separated subcontractors would collect
sales tax from the general contractor.

The general contractor would not collect any tax from the general contractor's
customer. In the alternative, if the general or prime contract were a
separated contract, while some of the subcontracts were lump-sum, the prime or
general contractor would not collect tax from the prime contractor's customer
on those charges from lump-sum subcontractors.

(3) What are Texas' required methods/procedures for accountability of these
tax exempt items?

Does our company and our customer identify tax exempt items and submit a report
to Texas for acknowledgment and/or approval?

Response: No.

What records and reports are required to be submitted to Texas. Type of
report, report period, etc. (By both contractor and customer).

Response: Under a lump-sum contract, your company will not be required to
obtain a Texas sales and use tax permit. Rather, you will pay tax on all
materials, consumable items, and equipment (including manufacturing machinery
and equipment) used or incorporated into a customer's property. Your company
may not issue resale certificates in lieu of paying tax on these items. Your
company may not accept exemption certificates from its customer for
manufacturing machinery and equipment incorporated into the customer's realty.
Please refer to subsection (f)(2)(B) of Rule 3.300.

Under a separated contract, your company must obtain a Texas sales and use tax
permit. You will then be able to issue resale certificates to suppliers of all
materials, consumable items, taxable services resold to your customer, and
equipment (including manufacturing machinery and equipment) used or
incorporated into your customer's property. As a retailer, you must collect
tax from your customer based upon the agreed contract price of the incorporated
materials. You will able to accept an exemption certificate in lieu of
collecting tax on qualifying manufacturing machinery and equipment.

(4) If taxes for exempt items are included in the contract and therefore paid
by our company to subs and in turn paid by the customer through the lump sum
contract progress payments, how and when does the customer recoup these taxes?
Response: The customer may not recoup the taxes paid by the contractor on
qualifying machinery and equipment incorporated into the customer's realty.
Please refer to subsection (f)(2)(B) of Rule 3.300 and subsection (b)(3)(A) of
Rule 3.291. Does the customer apply for a refund? Response: No. If so what
are the procedures for this? Response: Not applicable.

5. In general, what other tax knowledge, reports, procedures, etc. should we
   be cognizant of in order to effectively operate under the Texas Tax Code for
   tax issues on this project?

Response: I have enclosed all rules referenced in this letter for your review.
In addition, under separate cover, I have mailed you an application for a
Texas sales and use tax permit. The packet contains general information on a
seller's and purchaser's tax responsibilities.

(6) What is a "direct payment permit?" Does this apply in any way to our
contract methods?

Response: A direct payment permit is issued to a legal entity, including all
branches and divisions purchasing taxable items. A direct payment exemption
certificate issued to a supplier by one branch or division applies to purchases
made by all branches or divisions from the same supplier. Direct payment
permit holders may not authorize any other person or firm to purchase any
taxable items under their permit. Use by other persons may result in
revocation of the permit.

Qualified consumers may give a direct payment blanket exemption certificate in
lieu of paying taxes on taxable items they purchase for their own use and which
items will not be resold in any manner.

Under no circumstances should a direct payment exemption certificate be issued
to a contractor performing a lump-sum contract. Direct payment permit holders
persisting in this practice may have their permits revoked.

Direct payment exemption certificates may be issued to contractors performing
separated contracts. The contractor, in this instance, will purchase the
taxable items for resale and accept the direct payment exemption certificate in
lieu of charging tax on the items resold to the direct payment permit holder.
The contractor may not accept a direct payment exemption certificate in lieu of
paying tax on consumables or equipment.

For a discussion of lump-sum and separated contracts, see Rule 3.291 concerning
Contractors.

(7) What is the sales and use tax rate in Texas?

Response: The state tax rate is 6.25%. Local taxes may be as much as 2%. The
maximum state and local tax rate may not exceed 8.25%.

(8) What are the procedures for a contractor in obtaining a Texas sales tax
permit and filing of required returns?

Response: Complete the application and return it to us for processing. We
will then mail you a Texas sales and use tax permit. You will receive a sales
tax return in the mail near the end of the month. The report and the tax
collected will be due on or before the 20th of the following month. Additional
filing requirements may be found in Rule 3.286 in the application packet.

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

You may call me toll free at 1-800-531-5441, ext. 5-0037. The direct line is
512/475-0037. You also may write to Sales Tax Policy Division, Comptroller of
Public Accounts.

Sincerely,

Lindey Osborne
Sales Tax Policy Division