Rentals Versus Services Under Texas Sales and Use Tax

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TL Fahring focuses on helping individuals and businesses with a wide variety of matters involving state, federal, and international taxation. He has represented clients in all stages of federal and state tax disputes, including audits, administrative appeals, litigation, and collection matters. Mr. Fahring also has used his tax knowledge to assist clients in planning complex domestic and international transactions, including advising as to potential reporting and withholding requirements.

Mr. Fahring received his J.D. from the University of Texas School of Law, where he graduated with high honors and was inducted into the Order of the Coif and Chancellors honors societies. After clerking for a year at the Texas Eleventh Court of Appeals, he attended New York University School of Law, where he received an LL.M. (Master of Laws) in Taxation and served as a student editor on the Tax Law Review.

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:

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:

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]

 

State and Local Tax Services

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).