Applicability of Pennsylvania Sales and Use Tax on Public and Nonprofit Construction Projects-May 2000

The Pennsylvania General Assembly has enacted legislation designed to clarify the treatment of sales and use tax in the context of construction projects for exempt public and nonprofit entities. Act 45 of 1998 (1) altered the substantive and procedural aspects of the sales and use tax treatment of construction contracts with exempt entities by (1) eliminating the former, difficult-to-apply distinctions as to which components of a project were taxable and which were not; and (2) making the entity responsible for paying the tax (normally the contractor) entitled to any refund of overpaid tax. Entities treated as exempt from the application of sales and use tax generally have nonetheless not enjoyed full and automatic exemption from the application of sales tax on their construction projects. Both public and nonprofit entities possessing a sales tax exemption and their contractors should take the time to attain a clear understanding of how Act 45 changes the application of their sales tax exemptions in the context of their construction projects.

Act 45 changes the substantive law governing which components of a public or nonprofit project were taxable. Fixed contract bids received and negotiated construction contracts entered into prior to Act 45's effective date (July 1, 1998), were governed by the general rule that a construction contractor was required to pay sales and use tax on equipment and material that in the course of the construction (2) became permanently attached to real estate, even where the owner was otherwise sales tax exempt. Clear examples of permanent "attachment" in the course of construction work include structural steel, concrete, ductwork, conduit, drywall and flooring. The attachment of equipment and material is a permanent improvement to the real estate and was therefore, somewhat arbitrarily, treated under prior law as taxable. On the other hand, property transferred by a construction contractor to an exempt entity, even though a part of the contract work, that nevertheless remained "unattached" tangible personal property after installation, was treated as nontaxable. The example of property not "attached" often cited is a wall clock. (3) Thus, whether property transferred pursuant to a construction contract with an exempt entity was taxable was based on the often-difficult factual determination of whether property became permanently attached or affixed or whether the property remained unattached, tangible personal property.

The Pennsylvania Supreme Court provided guidance regarding how to make that factual determination in Commonwealth v. Beck Electric Construction, Inc., 485 Pa. 604, 403 A.2d 553 (1979). In that case, the Court determined that property retained its identity after transfer and installation if it was easily removed or readily replaceable. The Pennsylvania Department of Revenue and construction contractors each had their own opinions as to what easily removed meant and, therefore, there were a significant number of assessments issued by the Department and refund applications filed by contractors regarding this issue. There was significant uncertainty as to what would be considered easily removed and therefore nontaxable.

Act 45 clarified the application of sales and use tax when public entities and nonprofit corporations do construction projects. Under the new legislation, the definition of taxable "use" was changed to include the obtaining by a construction contractor (4) of tangible personal property and obtaining services to (e.g., doing construction work on) tangible personal property used pursuant to a construction contract, (5) whether or not transferred. In plain English, and as a general proposition, contractors must pay use tax on all construction work. Under Act 45, a construction contractor's acquisition of materials and services for a construction contract entered into after July 1, 1998 will be taxable regardless of how or whether tangible equipment and materials are attached. However, there is an exception to this rule of considerable significance to public and nonprofit entities possessing a sales and use tax exemption.

Under Act 45, and for exempt entities, (6) "building machinery and equipment" used pursuant to a construction contract is nontaxable. "Building machinery and equipment" is defined under the new legislation as generation equipment, storage equipment, conditioning equipment, distribution equipment, and termination equipment if part of the following systems:

a) air conditioning limited to heating, cooling, purification, humidification, dehumidification and ventilation;

b) electrical;

c) plumbing;

d) communications limited to voice, video, data, sound, master clock and noise abatement;

e) alarms limited to fire, security and detection:

f) control system limited to energy management, traffic and parking lot and building access;

g) medical system limited to diagnosis and treatment equipment, medical gas, nurse call and doctor paging;

h) laboratory system;

i) cathodic protection system; and

j) furniture, cabinetry and kitchen equipment.

In addition, the new legislation specifically includes within the term, "building machinery and equipment," the following:

boilers, chillers, air cleaners, humidifiers, fans, switchgear, pumps, telephones, speakers, horns, motion detectors, dampers, actuators, grills, registers, traffic signals, sensors, card access devices, guardrails, medial devices, floor troughs and grates, and laundry equipment, together with integral coverings and enclosures.

The new legislation specifically excludes from the term, "building machinery and equipment," the following items:

guardrail posts, pipes, fittings, pipe supports and hangers, underground tanks, wire, conduit, receptacle and junction boxes, insulation, ductwork and covering thereof.

Act 45 also changes the statutory framework for the allocation of responsibility over sales tax matters. Prior to Act 45, and during the period of roughly 1993 to 1998, contractors were required to make payment of sales and use tax and include their projections of the amount of such payment on each project in their bids. However, and as a general proposition, only the public and non-profit owners were entitled to the refunds. Under Act 45, only the entity or person who actually has paid the tax is permitted to file a claim for refund. Therefore, and as an initial matter, the statute creates a framework in accordance with which, by default and unless the construction contracts provide differently, contractors need to assess tax, prepare bids, pay tax and seek recoveries for overpayment if appropriate. Owners can remain passive and let the statutory framework operate. (7)

The proper interpretation and application of these "bright-line" tests on public and nonprofit construction projects using construction contracts entered into on or after July 1, 1998, will be essential in order to avoid the improper payment of tax and disputes regarding refunds in the Pennsylvania Department of Revenue's Board of Appeals and Board of Finance and Revenue and in the courts.

This Update was prepared by William W. Warren, Jr., Partner in Saul Ewing's Business Department and Local Government Construction Planning Group, and Kevin M. Scott, Esquire, a member of Saul Ewing's Tax Department. If you have any questions or would like additional information, please contact Mr. Warren at 717-257-7698 or by e-mail at [email protected] or Mr. Scott at 717-257-7551 or by e-mail at [email protected].


  1. See Act 45 of April 23, 1998, codified at 72 P.S. §§ 7201, 7202 and 7204.
  2. The operative term for the tax implicated in a construction contract is arguably "use" since contractors use equipment and material in the course of performing construction work.
  3. Use of the wall clock example does not imply that the distinction is a trivial one. As a general "rule of thumb," the amount of the property that public nonprofit owners argued ought to be treated as unattached and therefore tax exempt often would represent a substantial percentage of construction cost, and the resultant tax savings, about 1% of the total cost of the project.
  4. In Act 45 the construction contractor is defined as: "A person who performs an activity pursuant to a construction contract, including subcontractor."
  5. In Act 45 the construction contract is defined as: "1) a written or oral contract or agreement for 2) the construction, reconstruction, remodeling, renovation or repair of any real estate structure."
  6. An exempt entity can be a Purely Public Charity under applicable law, the United States, the Commonwealth of Pennsylvania, and its instrumentalities and political subdivisions.
  7. Owners which are exempt are being advised that a more aggressive stance with respect to sales and use has benefits. Those public and nonprofit entities which do not trust the statutory framework to yield fair bidding and avoid "windfalls" to contractors could, we believe, fashion a program to assure minimal payment of sales and use tax, combining a provision in the bidding documents for a sales tax allowance or breakout in the bid form, with an assignment of statutory rights and "collection-facilitation" clauses in general conditions.