Tax Type
Retail Sales and Use Tax
Description
Pharmaceutical management company, exemption for medicines and drugs
Topic
Exemptions
Property Subject to Tax
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 September 1998 through June 2000. I apologize for the Department's delay in responding to your letter. I note that the Taxpayer has paid the tax portion of the assessment.
FACTS
The Taxpayer is a pharmaceutical management company and is part of a group of affiliated for-profit entities that provide mental health care services. The Taxpayer operates a pharmacy and entered into a pharmacy management agreement with three of its affiliates, one of which is a treatment center and the other two of which are licensed hospitals. The Taxpayer agreed to provide drugs and related services to the patients of the treatment center and the hospitals. The Taxpayer purchases drugs in bulk and dispenses them to the patients on prescriptions or work orders issued by the physicians at the treatment center and the hospitals. Once the Taxpayer dispenses the drugs, they are delivered to the infirmary or other location at the treatment center and the hospitals and administered to the patients.
The Taxpayer provides monthly statements to the treatment center and the hospitals itemizing each drug that is delivered and the sales price. With regard to the treatment center, the Taxpayer must first seek payment for the drugs from Medicaid and other third-party payers. Any billings for which payment is not received are billed to and paid by the treatment center. In the case of the hospitals, the Taxpayer bills the hospitals directly for payment.
As a result of the Department's audit, the auditor concluded that the Taxpayer is not an independent retail pharmacy, and that its sales of drugs on prescriptions or work orders of licensed physicians to the treatment center and the hospitals do not qualify for the exemption for medicines and drugs provided in Va. Code § 58.1-609.7(1). The Taxpayer disagrees with the auditor's construction of the exemption and disputes the assessed tax. Further, if it is determined that the exemption does not apply to the Taxpayer's sale of the drugs, the Taxpayer contends that the tax should be imposed on the cost price of the drugs.
DETERMINATION
Medicines and Drugs Exemption
In determining whether a pharmacy is operating independently of a hospital, the Department has developed a three-criteria test as a result of the Virginia Supreme Court's decisions in Northern Virginia Doctors Hospital v. Department of Taxation, 213 Va. 504, 193 S.E. 2d 684 (1973) (hereinafter, Northern Virginia Doctors Hospital and Department of Taxation v. Bluefield Sanitarium, Inc., 216 Va. 686, 222 S.E.2d 526 (1976) (hereinafter, Bluefield Sanitarium). In both cases, the Court interpreted the sales and use tax exemption in Va. Code § 58.1-609.7(1) for medicines and drugs dispensed by or sold on prescriptions or work orders of licensed physicians and other specified medical services personnel.
In Northern Virginia Doctors Hospital, the hospital purchased drugs from an independent retail pharmacy. The purchases were made on behalf of specific patients pursuant to work orders of hospital physicians. These purchases satisfied the exemption, notwithstanding the fact that the drugs were administered by the hospital's nurses.
In Bluefield Sanitarium, the hospital maintained its own pharmacy, which purchased bulk quantities of medicines and drugs. Medication was dispensed by the pharmacy to patients on an as-needed basis. The Court held that the hospital was responsible for payment of the use tax on the purchase of the medicines and drugs, which were dispensed from the hospital pharmacy to patients on physicians' prescriptions and charged to the patients.
In Public Document (P.D.) 97-322 (7/29/97), the Department set out the threecriteria test. In order for a pharmacy to qualify as truly independent of a hospital, the pharmacy must (1) be organized as a separate and distinct entity from the hospital, (2) maintain a pharmacist on site, and (3) entertain retail traffic (patients other than those of the hospital).
In the instant case, the Taxpayer does not meet criterion (3) as evidenced by the fact that the Taxpayer's location was in a secured building and no walk-in traffic was permitted. Therefore, the Taxpayer's pharmacy operation is not an independent pharmacy making exempt sales of drugs, as was the case in Northern Virginia Doctors Hospital. Instead, the Taxpayer purchased the drugs for the use and consumption of the treatment center and the hospitals in the rendition of their medical services. This is taxable in accordance with Bluefield Sanitarium.
It is my understanding that, after the audit, the Taxpayer moved to another location and began making sales of drugs to the general public. Based on this activity, the Taxpayer's pharmacy meets the criteria of an independent retail pharmacy and its dispensing of drugs on prescriptions or work orders of licensed physicians would qualify prospectively as exempt sales of medicines and drugs in accordance with Va. Code § 58.1-609.7(1).
Notwithstanding the above, the 1999 Virginia General Assembly amended the exemption for medicines and drugs and allowed any licensed hospital to purchase medicines and drugs for its use and consumption exempt from the tax. This amendment applies to the hospitals in this case, but does not apply to the treatment center because it is not a licensed hospital. Effective July 1, 2000, the Taxpayer is entitled to sell medicines and drugs to the hospitals exempt from the tax regardless of whether the medicines and drugs are sold on prescriptions or work orders of licensed physicians.
Sales Price versus Cost Price
In the alternative, the Taxpayer asserts that based on the cited authorities, the tax should be imposed on the cost price of the drugs instead of on the sales price. The Taxpayer is correct. In effect, the assessment erroneously taxes the sales of drugs from the Taxpayer to the treatment center and the hospitals. Because they were made pursuant to prescriptions or work orders of physicians, these sales are exempt of the tax. In actuality, the taxable transaction in this case is the Taxpayer's purchase of the drugs in bulk (consistent with Bluefield Sanitarium).
Conclusion
The auditor will shortly revisit the Taxpayer to adjust the basis of the assessment to the cost price of the drugs. The Taxpayer has paid the tax portion of the audit bill but not the interest. Any overpayment generated by the adjustment will be applied to the adjusted interest. If the overpayment exceeds the adjusted interest, the Taxpayer will be issued a refund of the difference. Questions regarding the adjustments to the audit should be directed to ***** Audit Supervisor, ***** at *****.
The Code of Virginia sections, regulations and public documents 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 this determination, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
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- Sincerely,
Kenneth W. Thorson
Tax Commissioner
- Sincerely,
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AR/38320J
Rulings of the Tax Commissioner