BEFORE THE UTAH STATE TAX COMMISSION
Petitioner, ) FINDINGS OF FACT,
) CONCLUSIONS OF LAW,
v. ) AND FINAL DECISION
AUDITING DIVISION OF THE ) Appeal No. 87-0435
UTAH STATE TAX COMMISSION, )
STATEMENT OF CASE
This matter came before the Utah State Tax Commission for a formal hearing on XXXXX. XXXXX, Presiding Officer and R. H. Hansen, Chairman, heard the matter for and on behalf of the Commission. Present and representing the Petitioner was XXXXX, Attorney at law, of XXXXX. Present and representing the Respondent was XXXXX, Assistant Utah Attorneys General.
Based upon the evidence and testimony presented at the hearing, the Tax Commission hereby makes its:
FINDINGS OF FACT
1. The tax in question is sales and use tax.
2. The period in question is XXXXX.
3. On XXXXX, XXXXX entered into a "General Contractors Agreement" pursuant to which XXXXX was to act as the general contractor for XXXXX for the construction of XXXXX. The agreement required the general contractor to furnish "all labor and material, tools, implements, and equipment, scaffolding, permits, fees, etc." to build the school in accordance with the plans and specifications.
4. The agreement provided for direct purchases of construction materials by the school district by adherence to certain procedures as follows:
a. The owner (XXXXX) could purchase certain major items and quantities of materials for utilization in the project by writing purchase orders directly to the suppliers.
b. The general contractor and its subcontractors, were required to make a list of materials and the cost for which such materials could be directly purchased.
c. The owner would then provide purchase requisitions upon which the contractor would specifically state its needs and schedules for delivery dates.
d. The purchase orders were then written by the owner from the requisitions.
e. The purchase order amount plus the sales tax amount was deducted from the total contract amount.
f. Invoices received upon receipt of delivery of materials to the project site were sent to the owner for direct payment.
g. The contractor was required to hold the owner harmless for any losses, claims, defects, discrepancy, delays in delivery or other problems relating to the materials except where the failure was attributable to negligent acts or omissions by the owner.
h. All risk of loss or damages to materials resulting from theft, vandalism or any other cause after the delivery of the materials to the project site was assumed by the contractor.
i. The contractor was required to negotiate and administer all direct purchases by the owner and to furnish to the owner a description, source of supply, trade discount information and other information necessary to enable the owner to purchase directly any materials and equipment.
j. The agreement stated that title to all such materials and equipment purchased by the owner passed from the vendor directly to the owner upon delivery to the job site.
k. After delivery, the risk of loss, damage, theft, vandalism, or destruction of or to any materials and equipment purchased directly by the owner were the responsibility of the contractor.
l. Storage of any materials and equipment furnished by the owner was the responsibility of the contractor.
m. The contractor was required to acknowledge receipt and approval of any materials or equipment purchased directly by the owner by signing the invoice for any materials or equipment.
n. The owner was to make payment for any materials or equipment within a reasonable time after the receipt of the signed invoice from the contractor.
o. The owner was not responsible for the loss of a prompt payment discount from the purchase price if the owner made payment within ten business days following the receipt of the signed invoice from the contractor by the owner.
p. The contract price was reduced by the amount actually paid by the owner for materials and equipment and by the sales tax which would have been paid on those materials and equipment had they been supplied by the contractor. Similarly, the amount of any progress payment provided for was adjusted to reflect the direct purchase of any materials and equipment by the owner.
q. The owner was not responsible for the loss of or reduction in any trade discounts available to the contractor as a result of any purchases made by the owner.
r. All bonds and insurance were to remain in full force. There was no reduction in the amount of coverage or any deduction for premiums for bonds and insurance.
s. The provisions for direct purchase by the owner of materials and equipment did not relieve the contractor of any of its duties or obligations under the contract or constitute a waiver of the owner's right to absolute fulfillment of all the terms of the agreement.
t. The contractor was required to provide and pay for all materials and equipment not furnished by the owner and to provide and pay for labor, transportation, services, tools, machinery and all other items and services, necessary for the proper execution and completion of the work on the project.
u. If the contractor put into the work any unsatisfactory material or workmanship, the contractor was required to remove all such materials from the project.
6. Petitioner was the plumbing subcontractor after entering into an agreement with XXXXX and was required to furnish and install plumbing fixtures on the project, subject to provisions for change orders.
7. The owner, reserved the right to award separate contracts to perform work with its own forces if it so desired.
8. The General Conditions of the Contract for Construction also provided that the owner could amend the contract by change order and also subtract a contract sum from the total contract if it so desired.
9. The General Conditions provided for the owner's right to stop the work in the event of default or defalcations by the contractor.
10. The Supplementary Conditions of the Instructions to Bidders contained a statement that the title to all materials purchased directly by the owner on its own purchase orders, passed from the vendor directly to the XXXXX upon delivery to the job site without any vesting in the contractor.
11. On XXXXX, XXXXX, as general contractor, entered into a subcontract agreement with Petitioner XXXXX.
12. Pursuant to the subcontract, the Petitioner was the prime plumbing contractor on the project.
13. The contracting documents provided for change orders.
14. Change orders were made to the subcontract for materials directly purchased by the Petitioner.
15. Pursuant to contract documents, purchase orders were issued by the school district.
16. No surplus materials from the project were retained by the Petitioner. All materials purchased by the owner and installed by the Petitioner became fixtures or a part of the junior high school building.
17. One warranty was provided to the owner by XXXXX, for work performed by the Petitioner in relation to a water heater. The Petitioner installed the water heater as a part of the project, and the warranty covered the installation and performance of the water heater. The warranty recognized the owner as the appropriate claimant for any defects which may occur with the water heater. There were no other warranties on materials installed in the project by the Petitioner.
18. XXXXX was the school district's construction supervisor and representative for the project. XXXXX is and has been an employee of the XXXXX, and has supervised and managed other construction related projects as the school district's construction supervisor.
19. XXXXX completed an apprenticeship as a bricklayer, and is generally familiar with all phases and common methods of construction and of the interfacing relationship between architect, contractor, subcontractor and the school district.
20. XXXXX is familiar with materials that are used in construction and with materials installed on the Project.
21. XXXXX visited the project site in the company of the project architect at least weekly during the construction. He was ultimately responsible to authorize the issuance of purchase orders for construction materials on behalf of the school district. XXXXX, the purchasing agent and an employee of the school district, was directly responsible to fill out purchase orders on behalf of the school district and to send them to suppliers of materials for the project.
22. After delivery, the risk of loss, damage, theft, vandalism, or destruction of or to any such materials and equipment so purchased would lie with the contractor unless the damage resulted from the owner's negligence.
23. The materials on the project were covered by the owner's insurer, XXXXX. The owner provided insurance coverage for owner purchased materials after purchase and through construction of the building.
24. If the owner decided to directly purchase materials through the above described procedure, invoices received upon delivery of materials to the project site were sent to the owner for direct payment to the vendor.
25. The change orders which were executed did not relieve the Petitioner of its duty to furnish materials, so the contract remained a furnish and install contract.
26. The owner did not actively participate in the receipt or inspection of the materials, either by or through XXXXX or any other representative.
27. The Petitioner, and not the owner, was responsible for all claims, shortages and defects in the materials, including those materials purported to have been purchased by the owner. Petitioner also warranted that all materials, including those purported to have been purchased by the owner, were and would be free of defects for a period of at least one year after acceptance of the project by the owner.
28. Even after the change orders had been made, the contract still required the Petitioner to be responsible for "furnishing of all materials and labor required for the job as described, together with all minor items implied or required to finish the entire work . . .." The contract also held
Petitioner responsible for the final result, and provided that "This contractor shall furnish and install all fixtures shown or specified hereinafter and make all parts complete and leave the entire system in perfect working order . . .. Any damaged or cracked fixtures shall be replaced at the contractors expense."
29. The risks of ownership of the materials was never on the owner, but shifted directly from the vendor to the Petitioner.
30. The Petitioner, not the owner, bore the burdens of risk. The contract provided, "The contractor shall, in all cases, hold the owner harmless for any losses, claims, defects, discrepancy, delays in delivery or other problems relating to such materials . . . . all risk of loss or damage to materials resulting from theft, vandalism or any other cause whatsoever, shall be assumed by the contractor. . .."
31. The owner reserved the right to go on the job site "to protect the Board from defects and deficiencies in the work" or even to stop or reject the work, but none of those actions by the owner acted to relieve the Petitioner from full responsibility for not only the labor and installation, but also the materials.
32. When the materials were ordered, the involvement of the owner was minimal. When the materials were received and paid for, the Petitioner was required to "acknowledge receipt and approval of any such materials or equipment directly purchased by the Board by signing the invoice for any such material or equipment." Also, XXXXX was responsible to inspect and notify the owner of receipt, conformance and quality of materials. Thus, payment for the materials was made only after authorization from Petitioner.
33. The Petitioner bore the responsibility and expense of problems with the materials purchased, such as when a boiler had a defective part and the Petitioner, not the owner, called the supplier and had the boiler repaired.
34. The Petitioner, not the owner, had the burdens and benefits of ownership, and possessed control and ownership of the materials and property.
35. Petitioner did not present any evidence that there had been any detrimental reliance upon RuleR865-19S-42.
CONCLUSIONS OF LAW
1. Sales made to the state, its institutions, and its political subdivisions are exempt from sales and use taxes. (Utah Code Ann. §59-12-104(2).)
2. Sales made to or by religious or charitable institutions in the conduct of their regular religious or charitable functions and activities are exempt from sales and use taxes. (Utah Code Ann. §59-12-104(8).)
3. Sales of tangible personal property to real property contractors and repairmen of real property are subject to sales and use taxes. (RuleR865-19S-58).
4. The person who converts personal property into real property is the consumer of the personal property since he or she is the last person to own it as personal property. (RuleR865-19S-58). Utah Concrete Products Corp. v. State Tax Commission, 802 P.2d 408 (Utah 1942); Olson Construction Company v. State Tax Commission, 12 Utah 2d 42, 361 P.2d 1112 (Utah 1961); and Tummurru Trades, Inc. v. Utah State Tax Commission, 802 P.2d 715 (Utah 1990).
5. The contractor or repairman is the consumer of tangible personal property used to improve, alter or repair real property. (RuleR865-19S-58).
6. Sales of materials and supplies to contractors and subcontractors are taxable transactions as sales to final consumers, even if the contract is performed for a religious institution, charitable organization, or governmental instrumentality. (RuleR865-19S-58).
7. Sales of materials to religious institutions, charitable organizations, and governmental instrumentalities are exempt only if sold as tangible personal property and the direct or indirect seller does not install the material as an improvement to realty or use it to repair real property. (RuleR865-19S-58).
8. The contractor must accrue and report tax on all merchandise bought tax-free and used in performing contracts to improve or repair real property. (RuleR865-19S-58).
9. RuleR865-19S-58 is the primary rule governing the sale of materials and supplies sold to owners, contractors and repairmen of real property, and it sets forth the requirements for the taxation of the sale or acquisition of tangible personal property which is to be used to improve, alter or repair real property. That rule provides in relevant part:
A. Sale of tangible personal property to real property contractors and repairmen of real property is generally subject to tax.
1. The person who converts the personal property into real property is the consumer of the personal property since he is the last one to own it as personal property.
2. The contractor or repairman is the consumer of tangible personal property used to improve, alter or repair real property; regardless of the type of contract entered into--whether it is a lump sum, time and material, or a cost-plus contract.
3. The sale of real property is not subject to the tax nor is the labor performed on real property. For example, the sale of a completed home or building is not subject to the tax, but sales of materials and supplies to contractors and subcontractors are taxable transactions as sales to final consumers. This is true whether the contract is performed for an individual, a religious institution, or a governmental instrumentality.
4. Sales of materials to religious or charitable institutions and government agencies are exempt only if sold as tangible personal property and the seller does not install the material as an improvement to realty or use it to repair real property.
10. Sales of materials from a vendor to a contractor or other person or entity for use in the construction, improvement, alteration or repair of real property for a governmental entity, religious institution or charitable organization is not exempt from sales and use tax. The incidents of the tax have been imposed on the contractor and not on the exempt entity. To be exempt, the sale must be from the vendor directly to the governmental entity, religious institution or charitable organization for the use of, and consumption by, the exempt entity.
11. The fact that the burden of the tax may be passed by the contractor on to the exempt entity in the form of higher prices and is thus paid indirectly by the exempt entity does not result in tax exemption for the transaction. (RuleR865-19S-58), Utah Concrete Products Corp. v. State Tax Commission, 101 Utah 513, 125 P.2d 408 (1942), and Ford J. Twaits Co. v. Utah State Tax Commission, 106 Utah 343, 148 P.2d 343 (1944), Olsen Construction Company v. State Tax Commission, 12 U.2d 42, 361 P.2d 1112 (1961).
12. Parties seeking exemptions from the imposition of that tax bear the burden of proving that they qualify and are legally entitled to the exemption. Parson Asphalt Products v. Utah State Tax Commission, 617 P.2d 397 (1980).
13. In order for the sale to the exempt entity to be exempt from sales and use tax it must be a bona fide sale to the exempt entity acting either in the capacity as the final consumer of tangible personal property or the entity which converts the tangible personal property to real property. The sale is such a bona fide sale to an exempt entity only if either:
a. The sale of materials or supplies is to the exempt entity and the exempt entity has its own employees attach the materials and/or supplies to the realty, or
b. The sale of materials and supplies is to the exempt entity, and the exempt entity separately hires a contractor to attach the materials and/or supplies to the realty on a labor only or install only contract, or
c. The sale of materials and supplies is to an exempt entity which acts as the prime contractor by converting the tangible personal property to real property.
14. The sale of tangible personal property is not exempt from sales and use tax if the exempt entity is simply acting as the purchasing agent for the general contractor. It is not merely whether the exempt entity engages in the mechanics of a purchase, but rather the legal status of the exempt entity at the time the purchase is made, i.e., is it purchasing the property as the final consumer of the tangible personal property. If the exempt entity makes the purchase for itself and its own use, consumption, or conversion to real property, the purchase is exempt from sales and use tax. On the other hand, if the exempt entity makes the purchase for another person or entity, or for use, consumption, or conversion to real property by another person or entity, the purchase is not exempt from sales and use tax because the exempt entity has only acted in the capacity of a purchasing agent for the final consumer which is the contractor.
15. If the exempt entity enters into a furnish and install contract with a general or subcontractor which requires the general or subcontractor to furnish and install the materials and supplies, then the exempt entity is not acting as the prime contractor as to the materials and supplies required by contract to be provided by the general or subcontractor.
16. When the general or subcontractor is required by contract to provide materials and supplies and install them on real property, then the contractor is the consumer of that tangible personal property and is liable for the sales and use tax, even if an exempt entity goes through the mechanics of a purchase by issuing a purchase order and a check for payment. The contract is the controlling document, and determines who is the final consumer of tangible personal property, and thus the contract determines upon which party the incidence of taxation falls. Actions taken in noncompliance with the contract may be accepted without objection by the contractor and the exempt entity, but unless the contract is modified or changed by change order to show the consent of the contractor and the exempt entity to the modifications, the actions that are not in compliance with the contract do not shift or change the incidents of taxation. The written terms of the agreement will govern the taxability of the transaction and not the actions of the parties. This is especially so because written documents can be audited by State Tax Commission auditors, but actions, based on only after the fact statements, allegations or representations are impossible to audit.
17. For the exempt organization to be acting as the prime contractor, the exempt organization, by and through its own employees or agents must:
a. Exercise direct supervision over the construction project.
b. Issue purchase orders to the vendors for all materials and supplies for which sales tax is not paid.
c. Make direct payment to the vendors for all materials and supplies for which sales tax is not paid.
d. Have provisions in any furnish and install contracts to permit changes through change orders to make that portion of the contract a labor only or install only contract, and those contractual provisions must be fully implemented and followed during the construction process.
18. For the exempt organizations to act as the prime contractor exercising direct supervision over the construction project it is not necessary to act as the general contractor over the entire project. Instead, the exempt organization must exercise sufficient direct supervision over the purchased materials that there is a change in the legal status of which entity is responsible for those materials. Therefore, the exempt organization may be the prime contractor by exercising sufficient direct supervision over the purchased materials to be the prime contractor for a portion of the total contract. The prime contractor or direct supervision requirement may apply to relationships within the full general contract.
19. To be the prime contractor and exercise sufficient direct supervision, the exempt organization must assume the "burdens of risk" or the "incidents of risk." This requires evidence that the exempt organization has done more than just act as a "purchasing agent" for the general contractor. If a general contractor issues a purchase order on forms of the exempt entity and then later issues authorization for payment by check to the exempt entity, there has just been the creation of a "paper trail" and the direct supervision test has not been met.
20. If the exempt organization and a general contractor enter into a furnish and install contract, the general contractor is contractually required to provide and install those materials. When the contractor provides and installs those materials the contractor is the final consumer of those materials and is required to pay sales or use tax on those materials (RuleR865-19S-58). For the exempt organization to purchase those materials and avoid sales or use tax, the furnish and install contract must contain a provision permitting change orders so the exempt organization may make such purchases, and the parties must then actually execute such change orders in advance of the purchases. The exempt organization, by its own employees or agents, must then issue purchase orders and vouchers or checks for payment, and must exercise direct supervision over the purchased materials. As evidence regarding whether or not the exempt organization exercised direct supervision over the purchased materials, all of the relevant factors should be reviewed, including:
a. Who assumed the burdens or incidents of risk?
b. Who carried the risk of loss in the event of damage or destruction of the materials?
c. Who, if anyone, carried and paid for insurance on the materials after delivery and prior to installation or attachment to the real property?
d. Who physically inspected and counted the materials upon receipt?
e. If there was a shortage in materials upon receipt, who was required to pay for additional materials?
f. If there was an overage in materials upon receipt, who retained the surplus materials?
g. If the materials did not meet specifications or quality standards, who had the right and authority to reject those materials?
h. If materials were rejected for failure to meet quality standards or specifications, and it had resulted in a shutdown of the job, who would have been responsible for the shutdown expenses?
i. Who was responsible for enforcing any warranties on the materials?
j. To whom did recourse go if the materials were faulty or defective?
k. If materials failed after installation, who was responsible for any resulting damages including personal injuries?
l. To whom did the title pass for the purchased materials?
m. Were the bills submitted by the vendor directly to the exempt organization?
n. Did the vendors look only to the exempt organization for payment of the bill?
o. Did the general contractor or the subcontractor have to approve the bills before they were paid by the exempt organization?
p. To whom were the materials delivered, i.e., to the contractor, the exempt organization or one of its employees or agents, or directly to the job site?
21. Under a furnish and install contract, the contractor is required to furnish the materials and install those materials onto real property. Thus, the contractor is required to convert that tangible personal property into real property and the tax is imposed on that consumption of the tangible personal property by the contractor. Therefore, to avoid sales and use tax on materials used for a furnish and install contract, the contract must be modified through the execution and implementation of change orders. When those change orders have been executed and implemented, the modified contract must make it clear that the materials in question have been separately purchased and provided by the exempt organization and that the contractor's only duty with respect to those materials is to provide the labor to install those materials.
22. For the purchases of materials and supplies to be exempt from sales and use tax, the exempt entity must make the purchase and, title to the purchased items must pass to the exempt entity prior to the time it is attached to real property. The exempt entity must deal with the purchased items as its own property and treat those items the same as it would treat items it purchases for its own use and consumption.
DECISION AND ORDER
Sales and Use Tax is imposed not only upon the sale of tangible personal property, but also upon "tangible personal property stored, used or consumed in this state." (U.C.A.59-12-103). In the construction business, when a person uses lumber, bricks, cement, steel, nails, and other materials to construct a building or other improvements to real estate, that person has used those materials and has converted the materials into real property. That conversion of tangible personal property into real property is deemed to be the consumption or use of the tangible personal property, which is the taxable event.
The Utah Supreme Court has consistently held that sales and use tax is imposed upon the party that converts tangible personal property into real property. Utah Concrete Products Corp. v. State Tax Commission, supra, Olson
Construction Co. v. State Tax Commission supra and Tummurru Trades, Inc. v. Utah State Tax Commission, supra. The party that makes that conversion from tangible personal property to real property has used or consumed that property, is the real property contractor, and is taxed on that property. If that conversion to real property is performed by anyone except an exempt entity, the use and consumption of the converted materials is subject to sales and use tax. If the conversion to real property is performed by an exempt entity acting as the real property contractor, the use and consumption of the converted materials is not subject to sales and use tax.
Therefore, the primary issue in this case is to determine whether the Petitioner or the owner was the real property contractor. If a preponderance of the evidence indicates that Petitioner was the party that converted the tangible personal property into real property, then Petitioner was the real property contractor and is liable for the tax assessed by the Auditing Division. However, if a preponderance of the evidence indicates that the owner was the party that converted the tangible personal property into real property then the owner was the real property contractor and was exempt from the sales and use tax.
To determine which party was the real property contractor, it is necessary to review and analyze the full scope of the contract and the legal rights, duties, obligations, and relationships of the parties with respect to the materials converted into real property. The primary evidence available to the Commission to make that determination is the contract and agreement, together with all duly executed change orders and other written documents. Oral testimony is beneficial in interpreting the documents and gaining some insight into the conduct of the parties and, to some extent, their understanding of the requirements of the contract. However, where any inconsistencies may exist between the written contract, including executed change orders, and either the conduct or oral testimony of any person, the written contract must be presumed to govern or prevail.
In this proceeding, a preponderance of the evidence shows that the legal rights, duties and obligations of the owner did not rise to the level of the real property contractor because the owner did not assume the burdens, risks, responsibilities and incidents of ownership of the materials being converted to real property. Except for the paper work involved in the purchase order and the check for payment, the owner had only minimal involvement in the project, during the construction process. The general contractor and the subcontractors had nearly total control of and responsibility for the materials during the construction process. The Petitioner provided lists, specifications and costs of materials to be purchased, and then received, inspected and approved the materials, signed the invoices, carried bonds and insurance on the materials, negotiated and administered the purchases of materials, and was fully responsible for the materials and any problems with the materials. The Petitioner was also required to hold the owner harmless from any problems with the materials. The Petitioner, and not the owner, assumed nearly all of the burdens, risks and incidents of ownership of those materials.
The owner did have a construction supervisor who made weekly visits to the project, but there is no evidence that he had any authority to be involved in the management of that project. It appears that his role was primarily to observe the construction progress and report back to his employer. There is no evidence that the construction supervisor had any responsibility to review or even look at the materials which the Petitioner alleges had been purchased by the school district, and there is no evidence that he was in any way involved with the materials that were converted to real property.
The owner did carry insurance on those materials, but the contractor was also required to carry insurance on those materials. The contractor and subcontractors (including Petitioner) had all other burdens, risks, responsibilities, and incidents of ownership on those materials. The Petitioner was contractually required to provide the materials for its portion of the project. Petitioner installed those materials onto the project, and acted as the owner of those materials by assuming the risks, burdens, responsibilities and incidents of ownership during the construction process. A preponderance of the evidence indicates that Petitioner converted those materials from tangible personal property into real property. Therefore, Petitioner was the real property contractor for those materials and pursuant to RuleR865-19S-58 was liable for the use tax on those materials.
Based upon the foregoing, it is the order of the Utah State Tax Commission that the Petition for Redetermination is hereby denied, and the audit assessment made by the Auditing Division is affirmed. It is so ordered.
DATED this 10 day of March, 1992.
BY ORDER OF THE UTAH STATE TAX COMMISSION.
R. H. Hansen Roger O. Tew
Joe B. Pacheco G. Blaine Davis