Tennessee Contractor is Allowed to Purchase Water Treatment Equipment Without Paying Sales Tax

By: Tina M. Chunn, SALT Senior Manager

At a glance

• The main takeaway: A Tennessee ruling examines the factors that determine if a purchase of equipment qualifies for the state’s industrial machinery exemption and whether a contractor constructing a manufacturing facility can purchase that qualifying equipment on behalf of its manufacturing customer without paying sales tax.
• Assess the impact: State rules vary both with regard to the types of equipment or machinery that can be exempt, and whether a contractor will be allowed to purchase equipment for its customer that would otherwise qualify for the exemption.
• Take the next step: Aprio’s State and Local Tax (SALT) team can help manufacturers and contractors understand how the sales tax rules will apply to a particular project.

Schedule a free consultation today to learn more!

The full story

When a contractor engages with a manufacturer to build a manufacturing/industrial facility, the contractor may also purchase and install equipment that will be used by the manufacturer. Whether a contractor can purchase that equipment without paying sales tax requires an analysis of the sales tax rules addressing two key questions:

1. Whether the equipment qualifies for an exemption; and if so
2. If the exemption can be claimed by the contractor.  

A recent Tennessee ruling addressed these issues in the context of certain piping purchased by a contractor for use by its customer in a water treatment facility.[1]

In this ruling, the contractor was constructing a water treatment facility for a local utility. The facility processes non-potable water into drinkable water that it sells to its customers. The specific piping at issue in this ruling is used to transport water from an initial intake facility near the water supply to the utility’s main processing facility. At the intake facility, the water is initially screened, and large and small solids are removed through a process that is integral to the overall water treatment process. The piping also serves as a geothermal temperature moderation heat exchange contactor to aid in temperature stabilization of the preliminary treatment process.

Unpacking the ruling

As an initial matter, the ruling explains that although a contractor generally is required to pay sales and use tax on its purchase of tangible personal property for use in the performance of a contract, there is an exemption when the tangible personal property would otherwise be exempt.

Therefore, whether the contractor can purchase the piping without paying tax will depend on whether the piping itself meets the state’s exemption for “industrial machinery.”[2] Under Tennessee’s definition, the piping must meet four requirements to qualify as exempt industrial machinery. 

1. The piping must be used by a manufacturer, who engages in fabrication or processing of tangible personal property for resale or consumption off premises as principal business. The ruling determined that water is tangible personal property, and that the process of converting raw water into potable water is a manufacturing process.
2. The piping must be machinery, apparatus, or equipment. The ruling notes that prior state guidance interprets this requirement to include items that “[convey] the materials and components from one part of the manufacturing or fabricating process to another.”[3] In this case, the piping qualifies because it conveys preliminarily treated water from the intake structure, which is where the manufacturing process begins and the incoming raw water is filtered to the facility where another manufacturing process takes place.
3. The piping must be necessary to the manufacturing process. The ruling explains that although the term “necessary” is not defined in Tennessee guidance, its common definition is absolutely needed or required. The piping is required to transport the water through the manufacturing process, and it also serves as a geothermal temperature moderation heat exchange contactor to aid in temperature stabilization of the preliminary treatment process.
4. The piping must be primarily used in the manufacturing process. This requirement is met because the piping is used exclusively to move raw water through the treatment and screening system and to the facility where it can be fully processed into potable water.

Accordingly, the ruling concluded that the contractor may purchase the piping without paying sales tax. To do so, the contractor must apply for an industrial machinery exemption authorization number on a per project basis.

The bottom line

State rules vary both with regard to the types of equipment or machinery that can be exempt under a state’s manufacturing or industrial equipment exemption, and whether a contractor will be allowed to “step into the shoes” of its customer when purchasing equipment that would otherwise qualify for the exemption. 

Aprio’s SALT team has experience with manufacturing sales tax exemptions and the application of those rules to contractors that construct manufacturing facilities. We can assist both manufacturers and contractors in understanding how the sales tax rules will apply to a particular project, which is crucial to achieving the most favorable economics. For example, if a state will not allow a contractor to purchase exempt machinery on behalf of the manufacturer, then the project agreement and pricing should be structured to provide that the manufacturer will purchase those items directly. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

---

[1] Tennessee Department of Revenue Rev. Rul. 24-07 (August 21, 2024).
[2] Tenn. Code Ann. $§ 67-6-206(a) and 67-6-102(46)(A)(i).
[3] See Eastman Chemical Co. v. Johnson, 151 S.W.3d 503, 509-510 (Tenn. 2004).