What jurisdiction is this? I've never before heard of such a payment structure.

Several rules apply. In the USA, there is no such thing as a "small time" contractor when it comes to following the rules and laws regarding taxation.

Subcontractors do not pay a tax to the General Contractor. There is a colloquial reference to subs paying "taxes" to the organized crime syndicates but this is not the same as federal, state and local taxes imposed by government.

In the USA, in Texas, if a General Contractor is building and subsequently selling a project to an owner, several rules apply regarding the taxes paid:

1) If the GC is building the project for a tax-exempt owner (church, government, charitable tax-free organization) then there is no sales tax to be paid by the GC, so there is no tax to collect from the owner at the sale of the project.

2) All materials purchased by the GC for the project are taxed at the time of incorporation into the project so the SubContractor providing materials and labor for improvements would charge sales tax to the General Contractor. The General Contractor reports these taxes paid as part of the expense of the project.

3) All materials purchased by a subcontractor and intended for resale to the General Contractor are therefore exempt from sales tax at the location when the subcontractor makes the purchase - provided the Sub Contractor has proper paperwork on file with the state - including a resale tax certificate and comapany ID on file with the secretary of state as either a "doing business as" or a corporation, etc.

4) Labor paid by the SubContractor is subject to Federal Tax, FICA, FUTA, etc.

5) Labor paid by the GC is subject to Federal Tax, FICA, FUTA, etc.

6) The labor taxes paid by the SubC are charged as an expense to the GC, but the GC is not required to pay additional taxes on this labor charge.
Of course there are many more laws and rules and these will vary from location to location.
For a more complete reference for Texas, and most of the USA, see this link

http://info.sos.state.tx.us/pls/pub/readtac$ext.ViewTAC?tac_view=5&ti=34&pt=1&ch=3&sch=O&rl=Y

ultimately the owner of the finished building pays the taxes, no matter how they get buried in the final cost. and if the owner is a commercial entity those taxes are then shoved off onto his or her customers in the form of higher prices. that is the thing so very many peole don't get. businesses don't pay taxes, ultimately they just pass those taxes on to the ultimate consumer. like fecal matter, taxes flow downhill....