04-116 | Virginia Tax

Tax Type

Retail Sales and Use Tax

Description

Untaxed bulk purchases of controlled drugs and nonprescription drugs

Topic

Collection of Delinquent Tax

Collection of Tax

Exemptions

Date Issued

09-14-2004

September 14, 2004

Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear *****:

This is in reply to your letter in which you seek correction of the sales and use tax assessment issued to ***** (the "Taxpayer"), for the period January 1999 through October 2000. I apologize for the Department's delay in responding to your letter.

FACTS

The Taxpayer is a medical management company. In 1998, the Taxpayer entered into an agreement with a group of licensed physicians to provide management and administrative services regarding the operation of a medical clinic (the "Clinic") owned by the physicians. For its services, the Taxpayer is paid a monthly fee based on a percentage of the Clinic's net revenues. In addition, the Taxpayer is reimbursed for all clinic expenses that it incurs.

As a result of the Department's audit, the auditor assessed the tax on the Taxpayer's untaxed bulk purchases of controlled drugs and nonprescription drugs. The Taxpayer disputes the tax on the controlled drugs on the basis that it makes such purchases as the agent of the licensed physicians, and, therefore, the purchases are exempt in accordance with Va. Code § 58.1-609.7(1). Further, the Taxpayer disputes the tax on the nonprescription drugs and contends that these purchases are exempt in accordance with Va. Code § 58.1-609.7(15). Lastly, the Taxpayer seeks waiver of the penalty attributable to the purchases of controlled drugs and the nonprescription drugs.

DETERMINATION

Controlled Drugs

Virginia Code § 58.1-609.7(1) provides an exemption from the sales and use tax for "controlled drugs purchased for use by a licensed physician, optometrist, licensed nurse practitioner, or licensed physician assistant in his professional practice,..."

The auditor assessed the tax on the Taxpayer's untaxed purchases of the controlled drugs because the purchases were made by the Taxpayer. The purchases were paid for out of the Taxpayer's funds and taken as an expense in the accounting records of the Taxpayer. In addition, the Taxpayer claimed the drug expenses as a deduction for federal income tax purposes. Further, the auditor disagrees with the Taxpayer's position regarding the issue of agency relationship based on Article 1 of the Taxpayer's agreement that states that the agreement is not intended to create an agency relationship, except where expressly provided.

The Taxpayer raises the issue that federal and state laws govern the sale and distribution of controlled drugs and argues that 21 U.S.C. § 842 and Va. Code § 58.1-3415 restrict the sale of controlled drugs to a limited class of purchasers that includes licensed physicians. Further, 21 U.S.C. § 822 and Va. Code § 54.1-3422 authorize an agent of such purchasers to purchase controlled drugs when such agent is acting in the usual course of his business or employment. Based on these authorities, the Taxpayer contends that it can only purchase the controlled drugs as the authorized agent of the Clinic's licensed physicians. As such, the controlled drugs are purchased for use by the physicians in their professional practice and should qualify for the exemption.

The Taxpayer's agreement does not completely rule out the existence of an agency relationship as assumed by the auditor. In Article 5, the Taxpayer is authorized to purchase inventory and supplies, including drugs, that are necessary in the operation of the Clinic. Given the federal and state prohibitions, the Taxpayer can make these purchases only as the agent of the Clinic and its licensed physicians. Therefore, the agreement appears to authorize the Taxpayer to act as the agent of the Clinic and its licensed physicians for the purpose of making purchases of inventory and supplies, including controlled drugs.

In addressing issues of agency relationship, the Department looks to the ruling in United States v. Forst, 442 F. Supp. 920 (W.D. Va. 1977), aff'd, 569 F.2d 811 (4t" Cir., 1978), which sets forth the factors necessary to establish an agency relationship for purposes of the Virginia retail sales and use tax. Based on the guidelines set out by the court in Forst, the key factor in making the determination that an agency relationship exists, in order to determine who is actually making the purchase, is whose credit is bound by the transaction. The Taxpayer's invoice includes the Clinic, the Taxpayer and a physician of the Clinic as the purchasers. This indicates that the credit of the Taxpayer, the Clinic and a licensed physician is bound by the purchase transaction. Because a licensed physician of the Clinic is a purchaser on the invoice, the transaction is deemed a purchase of controlled drugs for use by a licensed physician in his professional practice, and all such purchases would qualify for the exemption. This is true regardless of the fact the purchases are paid for out of the Taxpayer's funds.

Nonprescription Drugs

Virginia Code § 58.1-609.7(15) provides an exemption for "any nonprescription drugs and proprietary medicines purchased for the cure, mitigation, treatment, or prevention of disease in human being ...." Public Document 98-98 (5/15/98) explains the application of the exemption and states that the exemption is applicable regardless of the nature of the purchaser. Based on these authorities, the nonprescription drugs held taxable in the audit will be removed.

Conclusion

The audit will be adjusted to reflect the removal of the controlled drugs and the nonprescription drugs, as well as the associated penalty and interest. Because the uncontested portion of the audit assessment has not been paid, the Taxpayer will receive an updated bill that should be paid within 30 days of the date of receipt to avoid the accrual of additional interest and penalty charges.

The Code of Virginia sections and the public document cited are available on-line in the Tax Policy Library section of the Department of Taxation's web site, located at www.tax.state.va.us. If you have questions regarding the determination in this letter, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****. Questions regarding the audit adjustments should be directed to *****, Audit Supervisor, in the ***** at *****.

- - - - Sincerely,

- - - - Kenneth W. Thorson
        Tax Commissioner

AR/43581J

Rulings of the Tax Commissioner