If an electric cooperative buys items tax-free under a valid exemption certificate but then uses them in a way that isn't actually exempt (divergent use by a for-profit entity), how is the tax calculated -- on the fair market rental value or the original purchase price?

Plain-English summary

An electric cooperative asked about the tax consequences when items it bought tax-free under a valid exemption certificate end up being used in a way that doesn't actually qualify for the exemption -- what the Comptroller calls "divergent use."

Key points from the response:

• Rule 3.287(e) governs: when items purchased under a valid exemption certificate are used in a divergent manner, tax is due on the fair market rental value (FMRV) of the items, not automatically the original purchase price. Any use of the property or a taxable service by a for-profit entity counts as divergent use.
• This FMRV-based tax is ongoing -- it accrues on a recurring basis for as long as the divergent use continues, not as a single one-time assessment.
• The user has a choice: at any time, they may elect to stop paying tax on FMRV and instead pay sales tax on the item's original purchase price. But this election is a one-way door for past payments: no credit is given for tax already paid based on value once the switch is made.
• Rule 3.286(f) (Seller's and Purchaser's Responsibilities) governs the filing periods for reporting this tax, and the Comptroller specifically warned that no method of accruing/reporting the tax other than what's detailed in these rules will be accepted.
• Separately (and more simply): vehicles purchased by and titled in the cooperative's own name are exempt from motor vehicle tax.

The letter notes it couldn't quantify exactly how much tax liability the cooperative's specific facts would generate -- this is a framework letter on the mechanics, not a dollar-amount ruling.

What this means for you

Electric cooperatives and similar exempt entities with mixed-use property

If your organization holds items under an exemption certificate that get used in ways a for-profit entity would use them, expect an ongoing FMRV-based tax liability under Rule 3.287(e), not a one-time assessment. You can switch to paying tax on the original purchase price instead, but understand that switch doesn't refund or credit tax you already paid based on value.

Entities weighing FMRV vs. purchase-price tax treatment for divergent-use property

Think carefully before switching methods -- once you elect to pay tax on purchase price, you give up any credit for taxes already paid under the FMRV method. Model out both approaches before committing.

Accountants and tax professionals

Useful for advising co-ops, exempt entities, and similar organizations with mixed exempt/for-profit uses of property on the ongoing (not one-time) nature of FMRV-based divergent-use tax, the specific filing-period rule (3.286(f)) governing reporting, and the no-credit consequence of switching to purchase-price-based tax mid-stream.

Common questions

Q: How is tax calculated when exempt-purchased property is put to divergent (for-profit) use?
A: Tax is due on the fair market rental value of the property on an ongoing basis, under Rule 3.287(e).

Q: Can we switch to paying tax on the original purchase price instead of FMRV?
A: Yes, at any time -- but no credit is given for tax already paid based on value once you switch.

Q: Are electric cooperative vehicles exempt from tax?
A: Vehicles purchased by and titled in the cooperative's own name are exempt from motor vehicle tax.

Q: Can I rely on this letter for my own organization?
A: No. It is based on the specific facts presented and can only be relied on by the taxpayer to whom it was issued.

Citations and references

Statutes and rules:

• 34 Tex. Admin. Code Rule 3.287(e) (divergent use / fair market rental value)
• 34 Tex. Admin. Code Rule 3.286(f) (Seller's and Purchaser's Responsibilities; filing periods)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9906504L

Original ruling text

June 23, 1999

Dear **:

Thank you for your recent letter to Adina Christian regarding the tax treatment
of purchases made by the ** Electric Cooperative doing business as
**. I have been asked to respond. Your facts are included by
reference.

Regarding sales tax, Rule 3.287(e) is clear that tax is due on the fair market
rental value of the items when items purchased under a valid exemption
certificate are used in a divergent manner. Any use of tangible property or
taxable services by for-profit entities constitutes divergent use. I should
also point out that the tax is due on an on-going basis and not as a one-time
event.

At any time the person using tangible personal property or a taxable service
purchased under a valid exemption certificate may stop paying tax on the value
of tangible personal property or the value of a taxable service and instead pay
sales tax on the original purchase price. When the person elects to pay sales
tax on the purchase price, credit will not be allowed for taxes previously paid
based on value.

It is not clear from your letter how much tax liability your client will incur.
Rule 3.286(f) deals with Seller's and Purchaser's Responsibilities and
explains the periods in which returns must be filed. Methods of accruing and
reporting the tax other than those detailed in the rules mentioned will not be
acceptable.

Vehicles purchased by and titled in the name of the client electric cooperative
are exempt from motor vehicle tax.

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

You may call me toll free at 1-800-531-5441, ext. 3-4680. The direct line is
512/463-4680. You may also write to Tax Policy, Comptroller of Public
Accounts. The email address is .

Sincerely,

Al Van Allen
Tax Policy Division