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Sales and Use Tax Memorandum Opinions

Nickols Concrete Co., Inc.

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A hiring of personal property occurs when the owner gives another temporary possession and use of the property for a consideration with the provision that the property will be returned to the owner at a future date. Property hired with an operator may be possessed and used by exercising fundamental control over the operator. However, the continued exercise of control by the owner over the details of operating the property indicates the existence of an independent contract for the operation of the property.

In determining the nature of the taxpayer's agreements with its customers, the labels used by the parties are not necessarily controlling, and consideration should be given to the circumstances under which the contract was made as well as the parties' conduct while the work was being performed. The right to hire and fire the equipment operator is an important consideration in deciding who exercised fundamental control over the operation of the equipment.

BEFORE THE STATE BOARD OF EQUALIZATION OF THE STATE OF CALIFORNIA

In the Matter of the Petition of NICKOLS CONCRETE CO., INC. Petitioner

Appearances:

MEMORANDUM OPINION

The petitioner has protested determination of deficiencies for sales and use taxes of $11,735.05, under account No. SR DHA 28 100082 for the period 10/1/67 to 2/28/70, and additional sales and use taxes of $24,930 determined for operations conducted under account No. SY AC 22 628525.

The protested taxes were measured by receipts received by the taxpayer under contracts entered into with the J. H. Pomeroy & Co. (Pomeroy), The Morrision-Knudsen Company, Inc. (Morrison-Knudsen), and the City of Los Angeles Department of Water and Power (City).

Pursuant to separate agreements the taxpayer contracted to sell dry concrete and certain other mixing supplies to Pomeroy and Morrison-Knudsen f.o.b. jobsite, to rent the equipment required for mixing and to furnish the labor services required to produce and deliver the ready-mix concrete.

The purchase orders issued by the contractors for the concrete each recited that the operation and mixing of the concrete was to be performed in such manner as may be directed by the purchaser.

The taxpayer declared tax on the amounts charged for the concrete materials and for the labor services required to operate the concrete-mixing equipment. It claimed an exemption for the separately stated amounts billed for the rental of the concrete-mixing equipment. The staff recommended a deficiency measured by the charges for equipment rental on the basis that the amount was merely reimbursement for an item of costs and expense incurred by the taxpayer in the course of producing and selling ready-mix concrete.

The two contracts for the rental of the ready-mix equipment contained the following common provisions:

1. The batch plant was to be erected and removed at the sole cost and expense of lessor (petitioner).

2. The lessor was to pay all expenses of operating and maintaining the batch plant.

3. The lessor was to keep the plant insured at its own cost and pay all taxes assessed with respect to the plant.

4. The lessor was to save and hold the lessee harmless from any obligation or liability in connection with operation of the batch plant other than liability arising from the sole negligence of lessee or its authorized agency.

5. The rental was for a fixed term at a specified monthly rental with an option to extend the lease on a monthly basis for an additional sum.

6. The lease contract was associated with an agreement for the sale of material and a breach of the agreement for the sale of materials was specified to be a breach of the lease agreement.

7. The lease agreement was not assignable without the prior written consent of the other party.

The contract with the City of Los Angeles provided separate lump-sum charges for the installation and removal of the concrete batch plant and for the monthly repair, maintenance and other fixed charges relating to the batch plant. It also included specific amounts for the services of operating the plant equipment.

The charge for the services of operating the batch plant, including all labor costs and profit was a lump-sum amount "per plant shift" with provision for overtime.

The contract contained provisions requiring the granting of employment preferences to residents of the City of Los Angeles and qualification of workmen to be employed by the taxpayer in performing the contract.

The taxpayer agreed to save harmless and indemnify the City of Los Angeles for any damage, loss or injury to persons or property of others on or adjacent to the worksite resulting directly or indirectly:

"From the work of the Contractor [taxpayer] or his subcontractors, in the performance of this contract, or from his or their failure to comply with any of the provisions of this contract."

The taxpayer was required to pay all applicable manufacturing, sales, use or excise taxes and all taxes assessed against his equipment or property used in connection with the work and to bear all expenses of all factory tests on all equipment furnished by it.

The City of Los Angeles had the right of inspection of material for conformance with specifications and its engineer was given the authority to give the orders, lines, grades, and directions, as provided in the specifications; to determine the adequacy of the contractor's methods, plant, and appurtenances; to determine within the limitations of the specifications, the amount, quality, acceptability, and fitness of the various kinds of work and materials to be paid for.

The agreement of the parties further provided:

"If the Contractor, at any time, fails to comply with these specifications in any way, the Engineer shall have the power to order all further work stopped. Such 'Stop Work' order shall be in writing only from the Engineer, and shall allow the Contractor three working days in which to comply with its demands. Any such work on which 'Stop Work' order is issued shall be corrected to the entire satisfaction of the Engineer.

"Any such interruption shall not act to relieve the Contractor of his obligation to complete the work. …"

The staff concluded that all of the charges rendered pursuant to the contract were for the cost, expenses and profit incurred in fabricating customer-owned property, and therefore includible in gross receipts. The taxpayer contends that all amounts billed to the City of Los Angeles was either for rental of equipment or exempt labor service.

In support of its contention, the taxpayer has offered the affidavit of Louis E. Nickols, the president of taxpayer corporation which attests that the City of Los Angeles has at times furnished workmen to operate certain of the batch plant equipment and provided certain supervisory personnel. It is claimed that the taxpayer was back-charged for these services and that in practical effect the mixing operation was operated and controlled by the taxpayer.

THE MORRISON-KNUDSEN AND POMEROY CONTRACTS

In ruling on the gross receipts received from these contracts, we must decide whether the receipts were derived from the rental of property or were merely payment for the use of the equipment by the taxpayer in performing a processing or fabrication of ready-mix concrete. Since the taxpayer paid California sales tax reimbursement at the time it purchased the equipment and had not altered its form, a bona-fide rental of the property would be excluded from classification as a taxable leasing sale (Revenue and Taxation Code section 6006(g)(5)). On the other hand, if the ready-mix concrete were produced or fabricated by the taxpayer for the customer, the transaction would constitute a sale of the ready-mix concrete (R.T.C. section 6006(f)), and amounts received for the use of the equipment by the taxpayer would be includible in gross receipts as reimbursement for a cost or expense of the sale (Revenue and Taxation Code section 6012).

A hiring of personal property occurs when the owner gives another the temporary possession and use of the property for a consideration with the proviso that the property will be returned to the owner at a future date (Cal. Civil Code section 1925).

Property hired with an operator may be possessed and used by exercising fundamental control over the operator (Service Tank Lines v. Johnson, 61 Cal.App.2d 67; Lowell v. Harris, 24 Cal.App.2d 70). However, the continued exercise of control by the owner over the details of operating the property indicates the existence of an independent contract for operation of the property (Entremont v. Whitsell, 13 Cal.290, 296).

In determining the nature of the taxpayer's agreements with its customers, the labels used by the parties are not necessarily controlling, and consideration should be given to the circumstances under which the contract was made as well as the parties' conduct while the work was being performed (Automatic Canteen Co. v. State Board of Equalization, 238 Cal.App.2d 372). Thus the entire agreements, the actual operation thereunder, and the related activities must all be examined to determine the true nature of the operations.

The right to hire and fire the equipment operator is an important consideration in deciding who exercised fundamental control over the operation of the equipment (Entremont v. Whitsell, 13 Cal.2d 290, 296, supra). Other factors considered by the courts to indicate that a purported "rental" agreement is in fact an independent contract are: the fact that the equipment owner maintains and supplies fuel to the machinery; that the equipment owner carries the operator on his employment records and payroll and carries compensation insurance on the operator; that the equipment owner assumes responsibility for damage to or caused by operation of the machinery; that the agreement would be illegal if construed to be a lease (see Entremont v. Whitsell, supra); and that the actual activities of the parties are substantially unchanged following substitution of a "lease" for a contract of hauling (see Service Tank Lines v. Johnson, supra).

Relating these guiding principles to the operations carried out under the Morrison-Knudsen and Pomeroy contracts, we find that in each instance the equipment was operated by workmen carried on the payroll of the taxpayer and in its general employment. The taxpayer was contractually responsible to the customer for any obligation incurred, or liability arising in connection with the operation of the batch plant, except liability arising from the sole negligence of the customer (form lessee). There is no evidence that would support a finding that the customer exercised fundamental control over the workmen. Indeed, it is virtually conceded that the customer did not exercise such control because the taxpayer has voluntarily declared and paid sales taxes on the amounts received for the labor services of the taxpayer's workmen in operating the batch plant equipment.

While the purchase orders recited that mixing operations were to be carried out as directed by the customers, this must be held to have been limited to instructions as to the results to be obtained, in view of the absence of a right to direct the details of accomplishing the work. This type of instruction is most indicative of an independent contract because fundamental control over the workmen and the means of accomplishing the result remains with the general employer (see Billig v. Southern Pacific Co., 189 Cal.477, 483).

The taxpayer was also required to pay all expenses of operating and maintaining the batch plant equipment. This is contrary to the usual application of the law to rental property which requires the hirer to bear such expenses during the time he uses the property (see Cal.Civil Code section 1956).

Finally, we note that the form rental of equipment was an integral part of a contractual arrangement whereby the taxpayer provided the raw materials and created the end product using workmen in its general employment. The unitary nature of the agreements to sell raw materials and mix the concrete is demonstrated by the fact that a breach of one agreement was expressly made a breach of the other. Thus, in actual practice and legal effect, the arrangement was the same as if the taxpayer had contracted to produce and deliver the ready-mix concrete under a single agreement.

Viewing the whole agreement and the actual operations conducted thereunder, we conclude that the taxpayer did not effectively surrender possession of the property and that the payments cast in the form of rentals were in substance amounts received by the taxpayer for its use of the property to produce and deliver ready-mix concrete as an independent contractor.

THE CITY OF LOS ANGELES CONTRACT

We also conclude that the amounts received pursuant to the contract with the City were received for the production, fabrication or processing of ready-mix concrete, which constituted a sale within the meaning of Revenue and Taxation Code section 6006(b). While the taxpayer has strenuously argued that the agreement was a rental, the agreement was not cast in this form. The performances contracted for were to "INSTALL, MAINTAIN, OPERATE AND REMOVE A CONTRACTOR-OWNED CONCRETE BATCH PLANT".

Nor can we agree that the transaction was a rental or exempt service in actual operation.

The taxpayer was required by the terms of the contract to install, operate and maintain the property as an independent contractor utilizing its own workmen. It remained responsible for all of the actions of the workmen and it expressly agreed to indemnify and hold the City harmless for their activities in installing, operating and maintaining the property.

All of the amounts received relate to services, which were, in fact, performed by the taxpayer's workmen. Since the services were not performed as employees of the City, they must have been performed on behalf of the taxpayer in the course of an independent contract for processing the concrete. One may not be both an employee and an independent contractor with respect to a single activity (Automatic Canteen Co. v. State Board of Equalization, 238 Cal.App.2d 348, 386).

While the city had the right to exercise a high degree of control over the quality of the product, this extended only to the results of the work and not the means of obtaining it. This type of control has been held to be consistent with an independent contractor relationship (see discussion in Automatic Canteen Co. v. State Board of Equalization, supra).

With reference to the claim that the city has at times furnished workmen to supplement the taxpayer's work force, we note that the City would be authorized to take such action under the provisions of paragraph 10 of the contract if the city's engineer determined that there was a material breech of the "progress of work clause" found in paragraph 23. We do not regard such temporary action as operating to change the relationship of the parties and the obligation of the taxpayer under the contract. We understand that any amounts back charged to the taxpayer for labor services were not included in the audited measure of tax deficiency.

All of the services were steps or processes required to fabricate or produce ready-mix concrete and as such, changes for those services were properly includible in gross receipts (Revenue and Taxation Code, section 6006(b); sales and use taxes regulation 1526).

The determination, accordingly, is hereby redetermined without change.

Done at Sacramento, California, this 18th day of September, 1973.

William M. Bennett, Chairman

George R. Reilly, Member

John W. Lynch, Member

Richard Nevins, Member

Attested by: W. W. Dunlop, Executive Secretary