One of the thorniest issues in Texas sales and use tax is the distinction between the rental of tangible personal property (which is subject to tax) and the provision of a service (which is only taxable if the service is taxable). This distinction not only affects the taxability of charges for the rental or service but also that of equipment that is purchased to provide the rental or service.
What’s a Rental?
The rental of tangible personal property in Texas is subject to sales or use tax.[1] A rental occurs when possession but not title to tangible personal property is transferred for consideration.[2] A person acquires possession of tangible personal property when that person acquires operational control over that property.[3] Operational control, in turn, means that the customer can use, control, or operate the tangible personal property.[4]
What are Taxable Services?
Only the following services are subject to Texas sales or use tax:
- amusement services;
- cable television services;
- personal services;
- motor vehicle parking and storage services;
- the repair, remodeling, maintenance, and restoration of tangible personal property (with certain exceptions);
- telecommunications services;
- credit reporting services;
- debt collection services;
- insurance services;
- information services;
- real property services (including landscaping, lawn maintenance, waste removal, and so on);
- data processing services;
- nonresidential real property repair and remodeling;
- security services;
- telephone answering services;
- Internet access service; and
- a sale by a transmission and distribution utility of transmission or delivery of service directly to an electricity end-use customer whose consumption of electricity is subject to tax.[5]
How are Rentals and Services Distinguished?
Things get complicated when a person transfers possession of tangible personal property with an operator, because then it becomes unclear whether the person is renting tangible personal property or providing a service or both. Thus, the sales and use tax treatment of rentals varies based on whether: 1) whether an operator is provided as part of the rental, and 2) charges for any such an operator are separately stated.
An operator is defined as a person who actively guides, drives, pilots, or steers tangible personal property.[6] A person who only provides maintenance, repair, or supervision is not an operator.[7]
If an operator is not provided as part of the rental, then all charges associated with the rental are subject to sales or use tax.[8] Examples of charges that are subject to tax include:
- charges for the tangible personal property being rented;
- charges for labor or services rendered in installing, applying, remodeling, servicing, or repairing the item being leased;
- damage waiver fees are subject to tax and charges after the rental for repair of a damaged rental item;
- transportation charges (unless billed directly to lessee by third-party carriers);
- charges for supervision, set-up, hook-up, assembly, disassembly, erection, and dismantling;
- charges for early termination of lease; and
- any interest charges (unless clearly imposed for late payment or other defaults under the lease).[9]
A lump-sum charge for the transfer of possession of tangible personal property with an operator is presumed to be the sale of a service and therefore not taxable unless the service is taxable.[10] This presumption can be rebutted if the customer exercised direct control or supervision over the operator and the intent of the agreement was to lease a piece of tangible personal property and separately furnish an operator.[11]
On the other hand, if an operator is provided as part of the transfer of possession of tangible personal property and the customer is charged separately for the tangible personal property and the operator, then the transaction is presumed to be a rental of tangible personal property and the separate furnishing of an operator, with the charge for the operator being nontaxable unless the operator is providing a taxable service.[12]
There’s a lot of tension between the definition of an operator as a person who actively guides, drives, pilots, or steers tangible personal property and the Texas Comptroller’s interpretation of the definition of a rental of tangible personal property as the transfer of “operational control” over tangible personal property. Thus, even if a charge for an operator is separately stated from a charge for the transfer of possession of tangible personal property, the Texas Comptroller may find that the transaction overall is the provision of a service and not a rental, because operational control over the vehicle was not transferred to the customer (which may cause issues with taxes on the lessor’s purchase of the tangible personal property).[13]
How does this Characterization Affect Tax on Purchases?
The purchase of tangible personal property for the purpose of renting the property to customers likely will be exempt from sales and use tax under the sale for resale exemption.[14] However, the purchase of tangible personal property for one’s own use or to perform a service may be subject to sales or use tax (unless some other exemption applies).[15] If someone purchases tangible personal property for the purpose of renting it to customers under the sale for resale exemption and then later performs (or is determined by the Comptroller to perform) a service using that equipment, then they have to pay sales tax on the fair market rental value of the equipment.[16]
Freeman Law works with tax clients across all industries, including manufacturing, services, technology, oil and gas, financial services, and real estate. State and local tax laws and rules are complex and vary from state to state. As states confront budgetary deficits due to declining tax revenues and increased government spending, tax authorities aggressively enforce state tax laws to recapture lost revenues.
At Freeman Law, our experienced attorneys regularly guide our clients through complex state and local tax issues—issues that are frequently changing as states seek to keep pace with technology and the evolution of business. Staying ahead requires sophisticated legal counsel dedicated to understanding the complex state tax issues that confront businesses and individuals. Schedule a consultation or call (214) 984-3000 to discuss your local & state tax concerns and questions.
[1] See Tex. Tax Code §§ 151.005(1), (2), 151.010, 151.051(a), 151.101(a).
[2] See 34 Tex. Admin. Code § 3.294(a)(2).
[3] Comptroller’s Decision No. 40,812 (2013).
[4] Id. For example, an administrative law judge has found that a taxpayer hadn’t transferred operational control over oilfield equipment to its customers when the taxpayer’s personnel powered and guided the equipment. Comptroller’s Decision No. 117,602 (2022).
[5] Tex. Tax Code §§ 151.0047, 151.0048, 151.010, 151.0101(a), 151.051(a), 151.101(a).
[6] 34 Tex. Admin. Code § 3.294(a)(3).
[7] 34 Tex. Admin. Code § 3.294(a)(4).
[8] See Tex. Tax Code § 151.007(a); 34 Tex. Admin. Code § 3.294(b).
[9] Tex. Tax Code § 151.007(a).
[10] 34 Tex. Admin. Code § 3.294(c)(3).
[11] 34 Tex. Admin. Code § 3.294(c)(2)(A).
[12] 34 Tex. Admin. Code § 3.294(c)(3).
[13] See STAR Accession No. 202005018L (May 5, 2020).
[14] 34 Tex. Admin. Code § 3.294(j)(1).
[15] See Tex. Tax Code §§ 151.006(c), 151.058.
[16] 34 Tex. Admin. Code §§ and 3.285(e), 3.294(c)(3)(B).
