BEFORE THE UTAH STATE TAX COMMISSION
Petitioner, : FINDINGS OF FACT,
: CONCLUSIONS OF LAW,
v. : AND FINAL DECISION
AUDITING DIVISION OF THE : Appeal No. 87-1920
UTAH STATE TAX COMMISSION, : Account No. XXXXX
STATEMENT OF CASE
This matter came before the Utah State Tax Commission for a formal hearing on XXXXX. Paul F. Iwasaki, Presiding Officer, and Joe B. Pacheco, Commissioner, heard the matter for and on behalf of the Commission. Present and representing the Petitioner was XXXXX, Attorney at Law. Present and representing the Respondent was XXXXX, Assistant Utah Attorney 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, a XXXXX, an XXXXX corporation doing business in the state of Utah, and XXXXX, a Utah corporation, and XXXXX, a body corporate and politic of the State of Utah, entered into an Agreement for Project Management Services. The contract provided that XXXXX and XXXXX, would act as the project manager of the facilities for the construction of the XXXXX on XXXXX.
4. Thereafter XXXXX entered into direct contractual agreements with many sub-contractors.
5. On XXXXX, XXXXX entered into a contract with XXXXX, for the XXXXX to furnish millwork at an agreed price of $$$$$.
6. Thereafter there was an Addendum to the Contract which increased the amount of the contract to $$$$$ because of various change orders.
7. All payments for the contract, including the materials required to perform the contract were paid for directly by XXXXX to Petitioner. Payments were not made by XXXXX directly to the suppliers of the materials.
8. All payments for materials and supplies used by XXXXX in performing the contract were made by XXXXX directly to the supplier.
9. The furnish and install contract of XXXXX had provisions in the contract for changes through change orders.
10. XXXXX managed the project pursuant to the contract. There was no general contractor employed by XXXXX on the project.
11. The contract between XXXXX and XXXXX for the XXXXX required the Petitioner to provide labor, materials and equipment.
12. On XXXXX, XXXXX entered into contract with XXXXX for cabinets and casework for the new XXXXX for the sum of $$$$$.
13. All payments pursuant to the contract were paid for directly by XXXXX to Petitioner. Payments were not made by XXXXX directly to the suppliers of materials.
14. All materials and supplies were ordered by XXXXX will using its own purchase orders. In fact, when Petitioner bought the materials for the XXXXX and the XXXXX projects, those materials were commingled with the materials which Petitioner purchased for all of its projects. Those materials combined with the other materials of Petitioner to constitute the inventory of Petitioner. When materials were needed for the XXXXX or XXXXX projects, materials were withdrawn from the inventory of Petitioner to be used on those projects.
15. All payments for materials and supplies used by XXXXX in performing the contract were made by XXXXX directly to the suppliers.
16. Neither XXXXX nor XXXXX (referred to herein as the owners) ever acquired title to the materials, because the title passed directly from the vendors to the Petitioner. The owners did not have designated representative inspect the materials upon receipt. Purchase Orders were not issued by the owners, checks were not issued by the owners, and the vendors did not look to the owners for payments. The materials were delivered to the Petitioner and not to the job site. The owners did not even see the materials prior to the time they were installed on the projects. The owners could not have rejected defective materials, they were not responsible for enforcing warranties, and there is no evidence that they provided insurance coverage for the materials. The risk of loss was on Petitioner and not on the owners. Petitioner, not the owners retained any surplus materials and was responsible to make up any shortages of materials.
17. Neither of the owners issued separate contracts or purchase orders for materials.
18. The contracts with XXXXX were lump sum and included pre-fabrication, manufacturing and installation of the cabinetry at the XXXXX and XXXXX.
19. Although the contracts contained provisions permitting change orders, the parties did not execute change orders to permit either of the owners to purchase or provide the materials. Instead, the contract continued to require the Petitioner to provide the materials and the Petitioner in fact provided the materials.
20. Title to the materials passed from the vendors to Petitioner. The owners did not acquire title to the materials until they had already been attached to the real property and the jobs were completed by Petitioner.
21. The contracts were furnish and install contracts. Those contracts required the Petitioner to furnish the materials and to install the materials. The Petitioner did furnish the materials and install the materials. No change orders were issued to change them from furnish and install contracts, and they were completed by both parties as furnish and install contracts.
22. The vendors looked to Petitioner for payment for the materials. Vendors did not look to the owners for payment. The bills were sent to Petitioner for payment.
23. The warranties on the materials ran to the Petitioner and not directly to the owners.
24. The owners did not count, inspect or review the materials prior to the time they were attached to real property.
25. The owners did not assume the risk of loss on the materials.
26. Sales tax was not paid by Petitioner on any of the materials it used on either of the jobs.
27. If there were any defects or shortages in the materials received, it was the responsibility of Petitioner to work with the vendors to have the matter corrected.
28. Petitioner was not an agent for either of the owners.
29. The audit shows that there is due and owing sales tax in the sum of $$$$$ from XXXXX as a result of XXXXX transaction, and there is sales tax due and owing from XXXXX on XXXXX in the sum of $$$$$.
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 (Rule R865-19S-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 exempt entity (school district or county) 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 exempt entity was the party that converted the tangible personal property into real property then the exempt entity 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 neither of the owners raised to the level of the real property contractor because they did not assume the burdens, risks, responsibilities and incidents of ownership of the materials being converted to real property. It is also evident that the Petitioner, and not the owners, was the purchaser of the materials and supplies on which the Auditing Division has made an assessment of sales and use tax. The Petitioner, instead of the owners, issued its own purchase orders to acquire the materials and it wrote its own checks to pay for the materials. The materials were co-mingled with the inventory of Petitioner, and were never in any way treated by the parties as the property of the owners. The risks and burdens of ownership
all remained with Petitioner. The furnish and install contracts never had change orders executed.
The Petitioner had total control of and responsibility for the materials during the construction process. The Petitioner purchased the materials, put those materials into its inventory, paid for those materials with its own checks, and then consumed those materials by converting them into real property. During that time the 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 purchased those materials and then converted them from tangible personal property into real property. The owners did not have any of the burdens, risks or incidents of ownership. The owners had nothing to do with those materials until after they had been consumed by being converted to real property. Therefore, Petitioner was the purchaser and the real property contractor for those materials and pursuant to RuleR865-19S-58 was liable for the sales and use tax on those materials.
Counsel for Petitioner has argued that by imposing a tax on a party that provides materials to a tax exempt entity under a furnish and install contract makes taxation depend on whether the exempt entity contracts with one party or two parties. His position is that under a furnish and install contract the exempt entity contracts with only one party to provide the materials as installed, whereas if it is not a furnish and install contract the exempt entity must contract with one party to provide the materials and another party to provide the labor to install the materials.
What this argument fails to consider is that if there are two separate contracts with the exempt entity, one for materials and one for installation, the contract for materials is exempt because it is a sale of tangible personal property to an exempt entity, and the contract for installation is exempt because it is a contract to provide labor. If the entity was not exempt, then tax would be imposed when the tangible personal property was converted into real property. However, when materials are installed by the contractor which has also provided those materials, that contractor, and not the exempt entity, has converted those materials from tangible personal property into real property. By converting those materials into real property, that contractor has consumed the tangible personal property and the use tax has been imposed on the contractor for the consumption of the materials prior to any sale to the exempt entity. The contractor is subject to a use tax for the consumption or use of the materials. The later sale to the exempt entity is still exempt, because not only was it a sale to an exempt entity, but it was also a sale of an improvement which is real property at the time of the sale.
Counsel for Petitioner has also argued that Petitioner meets all of the guidelines of the Commission set forth in its letter of XXXXX, interpreting the XXXXX case. However, the facts show otherwise. This Petitioner did not meet any of the four tests set forth in that letter.
Based upon the foregoing, it is the order of the Utah State Tax Commission that the Petition for Redetermination of Tax and Repayment of Amount so Paid 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 S. Blaine Willes*