                                The Attormy              General of Texas

JIM MAlTOX                                          C,ctober 4, 1984
Attorney General


Supreme Court Bulldin          Honorable Bob Bul:lf,ck                          Opinion   NO.     ~~-207
P. 0. Box 12549                Comptroller of PuMic      Accounts
Aus!in,TX. 7571% 2545          LB.7 State Office :3uilding                      Re:    Whether section  151.311
5121475-2501                   Austin, Texas     7i3.174                        of the Tax Code unconstitu-
Telex 9101874.1287
Telecopier 51214750266
                                                                                tionally  discriminates against
                                                                                the federal government

714 Jackson. Suite 700         Dear Mr. Bullock:
Dallas. TX. 752024M6
214/742-0944
                                      Chapter 151 oE the Tax Code imposes limited sales, excise and use
                               taxes on businesses         which operate within this state and engage in
4824 Alberta Ave.. Suite 180   certain specified      activities.      Subchapter H of chapter 151 sets forth
El Paso, TX. 79305.2793        specific     exemptions     to the imposition        of such a tax.         One such
915153534a4                    exemption, set forth in section 151.311, removes from the ambit of the
                               tax tangible personal property purchased by a contractor                and used for
1001 Texas. Suite 700          the improvement c’f realty belonging to entities               which themselves are
“ouston.TX. 77CQ2C3111         exempt from the inposition         of the tax.     Legislation   enacted during the
713/2235895                    recent special      aculsion amended section        151.311 to remove     the United
                               States,    its   ager:cies.    and its    instrumentalities       from the list      of
                               organizations     receiving     the section     151.311 exemption.      Accordingly.
808 Broadway, Suite 312
LubbOEk. TX. 794013479         you ask us the following         tvo questions:
808/747-5238
                                               I he:r,eby request your opinion      on whether the
                                           recent anendment to section 151.311, V.T.C.S.,        the
 4339 N. Tenth. Suite B
 McAllen. TX. 78501.lB95
                                           Tax Code, discriminates    unconstitutionally    against
 5121882.4547                              the Un:lzed States,     its agencies     and instrumen-
                                           talities.     If you conclude    that it does not,       I
                                           hereby request your further opinion on whether the
 200 Main Plaza, Suite 400
                                           amendment unconstitutionally    discriminates    betveen
 Ssn Antonio, TX. 782052797
 51212254191
                                           contractors     who improve realty     for the federal
                                           government under lump sum contracts        and those who
                                           do so under separated contracts.
 An Equal OppOrtUnitYI
 Affirmative Action Employer   We answer both your questions      in the negative.       Section 151.311, as
                               amended, does not impermissibly discriminate       against either the United
                               States,   its agencies.  and its instrumentalities    or between contractors
                               who improve realty       for  the federal    government under “lump sum”
                               contracts    and those who do so under “separated”     contracts.

                                     Section   151.311   of the Tax Code now provides           the following:




                                                               p. 930
Honorable   Bob Rullock    - Page! 2     (JM-207)




                Sec. 151.311.   PROPERTYUSEDFOR IMPROVEMRNT     OF
            REALTY OF AN IGMPT ORGANIZATION. Tangible
            personal   property Purchased by a contractor      for
            use in the perfo:naance       of a contract  for   the
            improvementof recif.ty for an organization   exempted
            from the taxes imposed by this chapter by Section
            151.309(4)   or (5) L>r Section 151.310 of this code
            is exempted from 1:he taxes imposed by this chapter
            to the extent      01’ the value    of  the tangible
            personal property used or consumed or both in the
            performance of the! contract.    0hnphasis added).

Acts 1983, 68th Leg., 2nd C.S.,   ch. 31. art. XII, 51, at 551.   The
second portion of the underscored language was added by the amendment.
Section 151.309 of the Tax Code sets forth the following:

               1151.309.     Govt!rnmental Entities

                A taxable item sold,    leased, or rented to, or
            stored. used, or c:onsumed by, any of the following
            governmental entitles    is exempted from the taxes
            imposed by this chapter:

               (1) the United !Itates;

               (2) an uninco~:porated        instrumentality    of   the
            United States;

                (31 a corporation       that    is   an agency    or
            instrumentality    of the United States and is wholly
            owned by      the    United  States    or  by   another
            corporation   wholllr owned by the United States;

               (4) this    state;   or

                 (5) a county, city,   special district,       or other
            political   subdivis:.on of this state.

Section 151.310 of the Tax Code acts to exempt religious,             educational,
and public service organizat:.ons as defined therein.

      Prior    to its   amendment, section       151.311    exempted from the
impoeition    of the tax tangible personal property used by a contractor
for the improvement of realty belonging to all organizations             listed as
exempt in section 151.309.      With the amendment to section        151.311. the
only contractors    of governmental entities      so exempted are those which
contract    with the state    a:?,! all its   political    subdivisions.       Con-
tractors    of the United States,   its agencies,    and its instrumentalities
are no longer exempted.



                                                                                      .
Bonorable   Bob Bullock     - Paglr 3        (JM-207)




       your first    concern is l:hat the statute as amended impermissibly
discriminates     against the federal government and its instrumentalities
and thereby violates       the Ur;ited States Constitution.         Section 151.311
does not affect         the tratl:.tional      immunity from taxation        afforded
political   entities     and impose a tax directly         on political    entities;
all that is involved is the tax on tangible personal property used by
a contractor     to improve rei.1, property.        The federal government is not
being singled out for the imposition             of the tax; it is simply being
treated in the same way thz.t, entities           in the private sector similarly
situated are treated.        The amendment then does not impose a new tax on
the federal       government.    It serves        merely to remove the federal
government from its heretcfore            favored status.      The significance      of
these two aspects of the tz.), will be readily apparent when two recent
United States Supreme Court decisions            are analyzed.

       It has long been held that a state may not impose a tax directly
upon the United States      or any of its instrumentalities.     Mayo v.
United States,    319 U.S. 441 (1943).   Such immunity from taxation    is
grounded in the Supremacy Clause of the United States Constitution,
article   VI, clause 2. --
                         McCulloch v. Maryland, 4 Wheat. 316 (1819).   No
such direct tax is imposed here.

      A corollary      to this   principle     is that

            a tax may be InvLid    even though it, does not fall
            directly  on the lnited States if it operates so as
            to discriminate   against  the Government or those
            with whom it deals.    (Emphasis added).

United States V. Detroit,     355 U.S. 466. 473 (1958); see also Memphis
Bank 6 Trust Co. v. Garner,
                     ~~~~~-    459 U.S. 392 (1983).     A tax-is not invalid
on the basis     of   pr:ohit 1ted  discrimination      simply  because    its
imposition has an effect    urcn the United States or because the federal
government shoulders the en,:ire burden of the economic levy.         Alabama
v. King & Boozer. 314 U.S. 1 (1941).      Specifically,

             state taxes on :)ntractors         [performing work for
             the     federal    gclvernment]   are     constitutionally
             invalid     if they t,iscriminate    against the Federal
             Government. or substantially          interfere    with its
             activities.

 United States      v. New Mexicc!, 455 U.S. 720, 735 n.11       (1982).    Moreover,

             the economic burc:en on a federal    function   of A
             state   tax imposed on those who deal with the
             Federal    Governm,r,lt does  not render    the   tax
             unconstitutional    so long as the tax is imposed
                                                                                           e


Bonorable   Bob Bullock    - Pae;e 4     (a-207)




            equally      on    th!   other         similarly     situated
            constituent8    of tbe State.

United States v. County <If’ Freano. 429 U.S. 452, 462 (1977).     At
Issue, then, la whether th;federal   government or those with whom it
does business have been a:btgled out for imposition  of the tax.   We
conclude that they have not.

        The proper teat to be invoked in order to determine dlscrimina-
tioa    has not always been dear,         nor have the cases been consistent.
The Supreme Court itself         :~a recently      indicated     that cases in this
field    have “been marked from the beginning by inconsistent                decisions
and excessively      delicate    &!cisions.”      United States v. New Mexico,
sllprs,    at 730.     --See Anna ea. 2 L.Ed.2d         441,    96 L.Ed.     263;    see
generally,    Annot. 44 L.Ed.27692.          For example, one line of cases set
forth an “economic burden” teat, under which the validity                  of the tax
 turned upon whether a tax i,muoaed on a contractor                was a substantial
burden ;pon       the governmc!nt*.       See,    e.g.,    Helvering    v.    Mountain
Producers Corporation,       303 U.S. 376 (1938); James v. Dravo Contracting
Company. 302 U.S. 134 (1937).          Other cases imposed a “legal        incidence
teat,    which determined whether the interest               taxed is that of the
federal     government or that of the contractor.                 See, e.g.,     United
States     V. County of Allegheny,         322 U.S. 174 (1944);          Trinltyfana
Construction     Company v. GrczJ,         291 U.S. 466 (1934).        Regardless of
the teat imposed, It is cL!ar that “in recent years the Supreme Court
has curtailed     sharply the doctrine        of implied delegated      immunity.”
United States v. County of’ Alle g(heny, supia,                at 177.    See United
States v. Detroit,        355 U.% 466        1958); Oklahoma Tax Commission v.
Texas Company. 336 U.S. 342 (1949).             Two recent Supreme Court cases.
however. have removed much of the confusion                and enunciated      a clear
test.

      In United States v. New Mexico, 455 U.S. 720 (1982).                 the court
restated   the rules that il&lied      constitutional     immunity may not be
conferred merely because the tax has an effect         on the United States or
even because the federal    government bears the entire economic burden
of the levy (citing    Alabama v. King h Boozer. m);
                       --                                           or because the
tax falls   on the earnings of a contractor        providing      services    to the
federal government (citing .lsrnmesv. Dravo Contracting Company, w);
or because the tax is levied on the use of federal property in private
hands (citing   United States-v.    City of Detroit,     supra);     or even in an
instance   in which the pr:.\‘ate entity       is using federal           government
property to provide the government with goods (citing United States v.
Township of Muskegon, w!;          City of Detroit     v. Murray Corporation,
355 U.S. 489 (1958)) or serrices       (citing    Curry v. United States. 314
U.S. 14 (1941);   United Sta,s!a v. Boyd, supra).          Nor may immunity be
conferred   when a contractor     is purchasing property         for the federal
government, even if title      I:O the goods vests in the United States
immediately   upon shipment by the seller             (United      States    v.  New




                                        0.   933
Honorable   Bob Bullock     - Page 5      (JM-207)




bfexico, scrpra. citing  Alabama v. King 6 Boozer, s);          or when the
tax is directly     pafd witl;   federal government ~funds (citing   United
States v. Boyd, supra).     T1.e court in New Mexico concluded:

            What the Court’s        cases leave room for,     then, is
            the conclusion    tt&,t tax immunity la appropriate      in
            only one circumat,snce:        when the levy falls on the
            United States itself,         or on an agency or instru-
            mentality   so closely       connected to the Government
            that the two cannot realistically            be viewed as
            separate    entitial:3,     at   least   insofar   as   the
            activity  being tcu:ed is concerned.

455 U.S. at 592.     This is LI test of legal incidence to be applied when
the taxable entity’s    relat:.cln to the federal government is at issue.

       In Washington V. Un+d             States,    460 U.S. 536 ‘on remand United
States v. Washington, 707 I.2d 381 (9th Cir. 1983), the court upheld
the scheme of sales taxes imooaed bv the state of Washington which
operated in a way seemingl!r mdre disparate in its treatment of federal
contractors       than that prcpoaed for imposition               in Texas.      Prior   to
1941, all building contractsrs            were treated as consumers for purposes
of the state sales tax.            ,411 sales of tangible         personal property      to
contractors,        such as goodzi and materials          used in construction,        were
subject to the tax regardless            of the identity      of the organization       for
which the construction          WZE performed,          The legal     incidence     of the
taxes fell       on the contract.,ra;       the suppliers      who sold the materials
collected      the taxes and I:c!mitted them to the state.                  In 1941, the
state     altered      the way :ln which its            sales     tax system affected
contractors       by amending its definition         of “consumer.”        The landowners
who purchased construction            work from the contractor,          rather than the
contractor      himself, were placed within the ambit of the statute.                   The
legal incidence         of the tax fell      on the landowner, who paid a tax on
the full price of the conr;truction               project    rather than just on the
price of the materials         us& to constmct           the project.       The effect    of
the amendment was that contractors’                  labor costs      and markups were
included in the tax base, rather than merely the cost of the tangible
personal property sold to :he contractors.                 Obviously, this new system
could     not be applied         t,, construction         projects     for   the federal
government because, as we coted above, the Supremacy Clause precludes
any such imposition directly            upon the federal government.           Therefore,
when the federal government was the landowner or “consumer”, the state
was not permitted to collz:t             any tax on the sale either of tangible
personal property to the cYltractor              or of the finished building to the
 federal     government.      In 1975, the state            sought to eliminate         the
effective       tax exemption       E.,r construction      purchased by the federal
 government by re-imposing          tie pre-1941 tax on contractors          who work for
 the federal       government.      [:I other words, the tax was imposed on the
                                                                                         .
                                                                                             I


Honorable   Bob Bullock   - Page 6      (Jl4-207)




sale of non-federal                by the contractor  to the landowner and on
the sale of                            contractors.  See 460 U.S. at 538-540.

       The court upheld this richeme of taxation against an argument that
it violated    the Supremacy Clause.         The federal government’s principal
argument was that the a::ilte singled               out a federal      activity    for
different    tax treatment; b(?:auae the state did not impose a sales tax
on contractors       who did r,ct work for the federal              government,    the
argument ran,      it  diacriml.nated     against     the   federal  government    and
those with whom it dealt.          Cts focal point was the legal incidence          of
the tax and the disparity       ::n where that incidence fell.         In support of
its    argument, the United States           relied     principally   upon Phillips
Chemical Company v. Dumaa Independent School District,                  361 U.S. 376
 (1960).   The Supreme Court ;,ejected       the argument in Phillips         that the
tax was invalid       merely because       it treated      those dealing     with the
federal government differeul:ly        from those not dealing with the federal
government.     Because it has been suggested that Phillips              controls  the
result in this opinion, we ~111 turn to a discussion of that case.

       In Phillips       ChemicsJ    Company v.        Dumaa Independent       School
District,     supra, the Suprese Court struck down a Texas statute which
taxed lessees of property owned by the United States on the full value
of the premises, while lessees           of property owned by the state were
taxed under another statute          on the value of the leasehold          interest
only.     The statute govemi,rg lessees         of state-owned property,       on its
face, reached the lessees        of all property exempt in the hands of its
owner. As a result,        only Lzaaz      of federal property were singled out
for imposition       of a greater       tax burden.      The court rejected       the
argument that the tax was invalid           simply because it treated those who
deal with the federal government differently             from the manner in which
it    treated    others.     Id.  at 379-81.        The court declared        that a
determination       whether7        tax     is   discriminatorv     “requires      ‘an
examination of the whole tax structure              of the state.“’     ‘Id. at 383
 (quoting Tradesmen6 Nationpl Bank v. Oklahoma Tax Commission, 309 U.S.
560, 568 (1940)).        The Court, considering      the effect of the entire tax
scheme, declared:

             Here, Phillips     is taxed . . . on the full value of
             the real property which it leases from the Federal
             Government, while businesses          with similar leases.
             using exempt property owned by the State ard its
             political    subdirtsiona.       are not taxed . . . at
             all.    The differences     .  .  . seem too impalpable to
             warrant such a (:roaa differentiation.           It follows
             that [the statlce],          as applied     in this    case,
             discriminates        unconstitutionally       against     the
             United States and its lessee.

-Id.   at 387.
Aonorable   Bob Bullock    - Pags 7      (JM-207)




       In rejecting     the argunsnt that Phillips  controlled   and required
the overturning of the Washington tax statute,       the Court in Washington
distinguished     Phillips;    unlike the tax scheme attacked    in Phillips,
which effectively       singled out for adverse treatment those engaged in
business    with the federal government, the Washington statute merely
placed the federal governmslt in a similar position          as every private
entity engaged in a conatrtction       transaction.  The court declared:

            In this case, fe,il:ral contractors  are required to
            pay no greater     tax than that placed   on private
            buyers of constrl:tion    work or passed on by them
            to their contract,crs.  . . .

               The important :onsiderstion,    therefore,     is not
            whether the Sta!:o differentiates     in determining
            what entity shall bear the legal incidence of the
            tax. but whethex the tax is discriminatory           with
            regard to the economic burdens that result.         . . .
            The State    does not   discriminate      against     the
            Federal Government and those with whom it deals
            unless  it treats   someone else     better    than it
            treats them.

460   U.S. at 544.     And the court    added in a footnote:

                The United SNtea argues that it is inappro-
            priate   to consider    the economic burden on the
            contractor   and t’se owner together.    and that we
            should focus solely     on the tax the contractor   is
            required to pay.     When the case is viewed in this
            light,   we are told it is apparent that federal
            contractors   pay more than other contractors.     The
            Court    of   Appc!r.ls   apparently  accepted    this
            argument.   [654  F:!dl at 576.

                This      wav   0::   lookinn       at   the   problem   is




             tax on the-materisls  he buys.  The’contractor will
             count the tax auong his costs in setting a price
             for the Govemmsznt. Depending on his bargaining
             power, he may p.s.;s some or all of the tax on to
             the Federal Government when he sets his price.    If
             he works for a Ilrivate party,   the contractor   is
             required to collect  the tax from the purchaser and




                                         D.     936
Honorable   Bob Bullock   - Page 8    (JM-207)




            remit  it to the State.     The purchaser will count
            the tax as part of the price of the building.
            Depending on his bargain.ing power, the contractor
            may reduce his price    to make UD for some or all of
            the tax the purchaser must pay:     If the tax is the
            same. and the p.irtlea     have the same bargaining
            power,   the amoulz:a the purchasers     pay and the
            amounts the contl?ctors    receive will be identical
            in the two cases.    Thus, it makes no difference    to
            the contractor     (& to the purchasers)      which of
            them is required ‘:o pay the tax to the State, as
            long as they have: the opportunity    to allocate   the_
            burden among themselves by adjusting       the price.
             (Emphasis added).-

Id. at 536 n.4.     Thus,   the Court shifted the issue for resolution   from
oiaparity     in legal       inc:.tlence -- an indisputable   element of the
Washington tax scheme         --    to  a question of  whether there was an
impermissible   disparity     in the economic incidence of the tax.

       Such a method of analysis        is instructive     in considering     the
effect    of the amendment I:O section       151.311.    Prior to the recent
amendment, all      contractor:3   paid sales    taxes on tangible      personal
property,   except that purchased for use in improving the real property
of organizations     which were! themselves exempt.        The three kinds of
organizations   which were exempt were:       (1) the state and its political
aubdivisiona;    (2) the feda!ral government and its instrumentalities;
and (3) religioua,      educatlcnal,   and public service     organizations    as
defined by the code.

       Unlike the tax schemz attacked        in Phillips,   which effectively
singled out for adverse eccnomic treatment those engaged in business
with the federal government, the recent amendment to section             151.311
simply removed the federal government and its instrumentalities             from
the list of exempt organizations      for the limited purpose of imposing a
tax already imposed on con!:::actora engaged in business in the private
sector.     The amendment to :rl!ction 151.311. like the 1975 amendment to
the Washington tax scheme. simply removes the federal           government and
those with whom it deals From favored status and treats               them like
similarly    situated    entities in the private    sector.   Insofar as this
change involves       only the lenal    incidence   of the tax.     it is not
determined under the-court’s      teat in Washington v. United-States.

      In Washington, the Cou1.t compared the federal government and its
contractors  with the priva,:l! sector and its contractors  and concluded
that if the burdens imposed on each, direct as well as indirect,       are
equal, no problem of impernissible     discrimination will arise.  As the
opinion states:




                                     0.   937
Eonorable   Bob Bullock     - Page 9    (JM-207)




            [T]he opportunity    for the parties to allocate   the
            economic    burden of the tax among themselves [is]
            sufficient.      No uore should be required      here.
            (Rmphaais in orlgisal).

Id. at 460 U.S. at 544.       I?he amendment to section  151.311.   like the
 statute in Washington, imposes exactly the same burden, direct as well
es indirect,      on the fedeM    government and its fontrectors      that it
places on private businesses      and their contractors.   Accordingly,    we
 conclude    that   the amendneat does not impermiaaibly       discriminate
 against either the federal government or those with whom it deals,         in
 violation   of the Supremacy Clause of the United States Constitution.

      Your second question          asks whether the amendment unconstitu-
tionally   diacriminatea     betrrc:en contractors who improve realty for the
federal   government under “:lump sum” contracts          and those who do so
under “separated”      contracts.     “Separated contract”   is defined in your
regulations    as follows:

                (5)   Separate*-contract      -- A contract      in which
            the agreed      contract    price     is   divided     into    a
            separately     stated    agreed      contract     price     for
            materials   and a separately stated agreed contract
            price for skill and labor.         If prices of materials
            and labor are aererately      stated,     the fact that the
            charges are addeji together and a sum total given
            is irrelevant.      Coat-plus contracts        are generally
            regarded as aepar,ated contracts.

34 Tex. Adm. Code $3.291(a)(S).          “Lump sum contract”       is defined   as:

                (4)   Lump-sum contract -- A contract   in which
            the agreed contrzct     price is one lump-sum amount
            and in which the charges for materials       are not
            separate    from tlu! charges for skill   and labor.
            Separated invoicc!r, issued to the customer will not
            change    a lump-sus     contract into  a separated
            contract unless c:he invoices are incorporated   into
            the contract    and specifically  amend the original
            contract.

Comptroller  of Public Accounts, 8 Tex. Reg. 1585 (1983) adopted,                     8
Tex. Reg. 2280 (1983) (ameutling 34 Tex. Adm. Code 03.291(a)(4)).

       The court        in Washingl:on has made clear that any distinction
between these          two types of contract   is a distinction without    a
difference:

            The important   consideration,    therefore,   is not
            whether the Stat.? differentiates      in determining
            what entity shall bear the legal incidence of the
            tax, but whether the tax is discriminatory        with
            regard to the economic burdens that result.      . . .
                                                                              9



Ronorable   Bob Bullock   - Pagl 10      (JM-207)




            The State     does    not  discriminate      against   the
            Federal Governmcrt and those with whom it deals
            unless  it   treaI:tI someone else      better    than it
            treats them.    (Fa,,tnote omitted].

460.U.S. at 544-545. --- See also Washington. supra (dissenting   opinion),
at 274.      We conclude    thul: section   151.311 does not impermisafbly
discriminate   between contractors      who improve realty for the federal
government under “lump a&’ contracts            and those who do so under
"separated"   contracts.

                                  SUMMARY

                Section   151.311 of the Tax Code, as amended,
            does not impermi~~ribly discriminate    against either
            the United States.     its agencies,  and its instru-
            mentalities    or tetween contractors     who improve
            realty     for the federal    government under "lump
            sum" contracts       and those     who do so     under
            “separated” cont’cxts.
                                               I  Very I truly   you/

                                             &/b          MATTOX
                                                  JIM
                                                  Attorney General of Texas

TOMGREEN
First Assistant    Attorney   G(?neral

DAVID R. RICHARDS
Executive Assistant Attornq       General

Prepared by Jim Moellinger
Assistant Attorney General

APPROVED:
OPINION COMMITTEE

Rick Gilpin,   Chairman
Colin Carl
Susan Garrison
Tony Guillory
Jim Moellinger
Nancy Sutton




                                         p. 939
