Texas Appeals Court Denies For-Profit Correctional Facility’s Use of Government Exemption 

A Texas appeals court has denied a refund claim brought by a private operator of correctional and detention facilities, holding a lower court’s decision that the company does not act as a instrumentality of the state or federal government while operating state and federal prisons. The refund request was filed in opposition to an audit that assessed sales tax on the business’s purchases of electricity, computers, furniture, and food, and was escalated to the courts when the refund request was denied by the Texas Comptroller.

The taxpayer argued that, under the exemption from sales tax for the “unincorporated agencies and instrumentalities” of the state of Texas and the federal government, the qualified because performing a quintessential governmental function, operating correctional facilities, made them an instrumentality of the state qualified for exemption. The appeals court determined this argument also made every independent contractor performing work for the government an instrumentality of the government, and did not line up with the way the state’s law was written. The taxpayer also used a Vermont Supreme Court case that determined another private entity was subject to a public record’s law as evidence that they operate as an instrumentality of the government, which the court rejected, clarifying that the Vermont case was under different standards, and that under Texas law an entity may be considered a government unit in some contexts and not a government unit in others.

Finally, the state rejected the taxpayer’s argument that they were a government entity under a test established under the U.S. Supreme Court case United States v. New Mexico, 455 U.S. 720 (1982). The decision determined that federal contractors did not automatically have tax exempt status unless they were “so closely connected to the Government that the two cannot realistically be viewed as separate entities, at least insofar as the activity being taxed is concerned.” The Texas court determined that this standard extended beyond whether or not the contractor helped the government to achieve an end or fulfill an obligation. The court also pointed out that the taxpayer operated independently, for profit, and with control over the means, methods, and details of their work.

One of the few rules that holds true across states in sales and use tax is that states are not permitted to impose tax on the United States government. When you do business under contract with the federal government, states mostly have the ability under their own laws and rules to determine when you qualify for exempt status, and when you are treated like any other taxpayer. These rules can be complex, but before you claim exemption under them, research extensively to determine if you qualify.

(The GEO Group Inc. v. Hegar; No. 07-22-00005-CV; Travis County District Court, No. D-1-GN-19-002600)

Posted on February 6, 2023