Court Issues Favorable Sales Tax Decision for Government Contractor

June 17, 2013

On June 7, 2013, the Supreme Court of Texas issued its ruling in Combs v. Health Care Services Corporation, which upheld a government contactor’s refund claim for sales taxes paid on purchases of tangible personal property used by the contractor in performing nontaxable services for the government. The decision should cause similarly situated contractors to consider if they have potential refund claims for open tax periods. However, the decision’s impact is limited by the Texas legislature’s enactment of legislation in 2011 narrowing the types of service contracts for which a government contractor can make tax-free purchases. The refund claims at issue in the case were for tax periods prior to 2011.

The main issue in Combs v. Health Care Services Corporation was whether the taxpayer’s purchases of tangible personal property, such as chairs, printers, and office supplies, were exempt from sales tax because the purchases were nontaxable sales for resale. The taxpayer’s contract with the federal government stipulated that title to the property purchased by the taxpayer passed directly to the federal government. Despite the title-passing language, the Comptroller argued that because the “essence of the transaction” with the government was the sale a service, the items purchased by the contractor were used by the contractor and not resold to the government. The Court disagreed because the statutory definition of “sale for resale” did not require an inquiry to the essence of the transaction. The statute only required that the property be resold in the same condition in which it was acquired. Naturally, the automatic title-passing provision made it impossible for any alteration to the property to occur before the government obtained title to the property.

The decision in Combs v. Health Care Services Corporation dealt with an issue that many states address differently. A number of states do not allow a government contractor to purchase tangible personal property tax-free if the true object of the contract is the performance of a service. This is often the case despite the contract including title-passing language. Indeed, Texas now follows a similar rule and only contractors performing services for a national security-related agency can now make tax-free purchases.

Understanding the variation in how states address these types of sales tax issues can be critical to minimizing risk and accurately pricing a government contract.

If you have any questions, please contact your Aronson tax advisor or Michael L. Colavito at 301.231.6200.