Tax Type
Retail Sales and Use Tax
Description
For-profit hospitals in Virginia exemptions
Topic
Exemptions
Date Issued
08-13-2004
August 13, 2004
Re: Ruling Request: Retail Sales and Use Tax
Dear *****:
This is in reply to your letter in which you request a ruling on the application of the sales and use tax to sales by "Company A" to for-profit hospitals in Virginia. I apologize for the Department's delay in responding to your letter.
FACTS
Company A is an out-of-state corporation that entered into a pharmaceutical services agreement with a number of for-profit hospitals and one for-profit nursing home (collectively, "the hospitals") in Virginia. Company A is a separate corporate entity from the hospitals. Under the terms of the agreement, Company A agrees to provide pharmacy services to the hospitals. As part of these services, Company A sells prescription drugs, nonprescription drugs, and medical and pharmaceutical supplies (collectively, "drugs and supplies") to the hospitals that are dispensed to the hospitals' patients on prescriptions or work orders of licensed physicians. The hospitals' personnel then administer the drugs and supplies to the patients. Company A bills the hospitals a monthly baseline fee for the pharmacy services and the drugs and supplies provided under the agreement. In addition to the baseline fee, Company A bills the hospitals on a cost-plus basis for two types of drugs provided by Company A.
You raise two issues with regard to Company A's agreement with the hospitals. First, you contend that the "true object" of the agreement is the sale of the drugs and supplies; therefore, Company A's purchase of the drugs and supplies is an exempt purchase for resale. Second, you contend that a number of exemptions apply to the drugs and supplies provided under the agreement, and that only 2% to 10% of the monthly fee charged by Company A to the hospitals is taxable. Accordingly, you propose an allocation formula for determining the taxable portion of the fee. To support your position, you cite a number of authorities.
RULING
Pharmaceutical Services Agreement
Virginia Code § 58.1-609.5(1) provides an exemption from the sales and use tax for “[p]rofessional, insurance, or personal service transactions which involve sales as inconsequential elements for which no separate charges are made ...."
Title 23 of the Virginia Administrative Code (VAC) 10-210-4040 addresses the tax on services and in Section D provides that "[i]n order to determine whether a particular transaction which involves both the rendering of a service and the provision of tangible personal property constitutes an exempt service or a taxable retail sale, the ‘true object' of the transaction must be examined." If the object of the transaction is to secure a service and the tangible personal property which is transferred to the customer is not critical to the transaction, then the transaction may constitute an exempt service. However, if the object of the transaction is to secure the property which it produces, then the entire charge, including the charge for any services provided, is taxable.
I agree that the object sought by the hospitals is to obtain the drugs and supplies. Without them, it would be almost impossible for the hospitals to operate and provide medical services. Since the "true object" of the agreement is the drugs and supplies, the monthly charge by Company A to the hospitals is taxable, including any services provided. Company A may purchase the drugs and supplies sold pursuant to the agreement under the resale exemption provided in the definition of "retail sale" in Va. Code § 58.1-602.
Applicable Exemptions
You contend that a number of exemptions apply to the drugs and supplies sold by Company A to the hospitals under the agreement. A discussion of the applicable exemptions follows.
Prescription Drugs: You state that Company A sells prescription drugs to the hospitals. These drugs are dispensed on prescriptions or work orders of licensed physicians. Virginia Code § 58.1-609.7(1) provides an exemption for medicines and drugs dispensed by or sold on prescriptions or work orders of licensed physicians. In addition, the regulation in 23 VAC 10-210-940(C)(3) provides that "[s]ales of medicines and drugs to hospitals and nursing homes conducted for profit are subject to the tax unless the sales are made as a result of a written prescription of a licensed physician for a particular patient under the care of the hospital or nursing home." Based on the statute and the regulation, such sales by Company A to the hospitals are exempt of the tax.
Effective July 1, 2000, the exemption in Va. Code § 58.1-609.7(1) applies to purchases of medicines and drugs for use or consumption by for-profit licensed hospitals. As of the effective date, Company A may sell medicines and drugs exempt of the tax to the hospitals, regardless of whether they are dispensed on prescriptions or work orders of licensed physicians. This expansion of the exemption does not apply to Company A's sales of medicines and drugs to the nursing home.
Nonprescription Drugs: You contend that Company A's sale of nonprescription drugs are exempt of the tax, citing Va. Code § 58.1-609.7(15a). Effective July 1, 1998, the statute provides an exemption for nonprescription and proprietary medicines purchased for the cure, mitigation, treatment or prevention of disease in human beings. The Department's Tax Bulletin in Public Document (P.D.) 98-98 (5/15/98) interprets the exemption and sets out a listing of exempt nonprescription drugs and proprietary medicines. The exemption is applicable regardless of the nature of the purchaser. In other words, nonprescription drugs and proprietary medicines may be purchased tax exempt by individuals, physicians, medical facilities, and all other entities. In accordance with the statute, Company A may sell nonprescription drugs and proprietary medicines exempt of the tax as provided in P.D. 98-98.
Dialysis Drugs and Supplies: You contend that Company A's sales to the hospitals of drugs and supplies used in hemodialysis and peritoneal dialysis are exempt. Virginia Code § 58.1-609.7(3) provides an exemption for "[d]rugs and supplies used in hemodialysis and peritoneal dialysis." The regulation in 23 VAC 10-210-940(E)(2) explains that the exemption is applicable regardless of the nature of the purchaser. Based on the statute and the regulation, Company A may sell these drugs and supplies to the hospitals exempt of the tax.
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- Supplies: Virginia Code § 58.1-609.7(2) provides an exemption for:
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- [w]heelchairs and parts therefor, braces, crutches, prosthetic devices, orthopedic appliances, catheters, urinary accessories, other durable medical equipment and devices, and related parts and supplies specifically designed for those products; and insulin and insulin syringes, and equipment, devices or chemical reagents which may be used by a diabetic to test or monitor blood or urine, when such items or parts are purchased by or on behalf of an individual for use by such individual. Durable medical equipment is equipment which (i) can withstand repeated use, (ii) is primarily and customarily used to serve a medical purpose, (iii) generally is not useful to a person in the absence of illness or injury, and (iv) is appropriate for use in the home.
To the extent that the above items meet all of the stated criteria and are purchased by the hospitals for specific patients, Company A may sell such items to the hospitals exempt of the tax.
Hypodermic syringes and artificial eyes: Included in Va. Code § 58.1-609.7(1) is an exemption for hypodermic syringes and artificial eyes dispensed by or sold on prescriptions or work orders of licensed physicians. Company A may sell hypodermic syringes and artificial eyes to the hospitals exempt when such items are dispensed on prescriptions or work orders of licensed physicians.
Allocation formula
Many of the items sold under Company A's agreement with the hospitals qualify for the exemptions as previously discussed. As such, the fee charged by Company A to the hospitals is not fully taxable. In order to determine the portion of the monthly fee that represents the taxable drugs and supplies sold by Company A to the hospitals, you propose an allocation formula that computes the ratio of taxable drugs and supplies to all drugs and supplies multiplied by the monthly fee charged to the hospitals to yield the portion of the payment that is taxable.
In reviewing the agreement, Section 5.11 titled "Taxes" provides that 82.5% of the Company A's revenue (derived from the monthly fees) is allocated to sales of drugs for resale to patients. It is assumed that sales of supplies are included in this category: The remaining 17.5% is allocated to professional services. This suggests that a portion of the monthly fee represents a charge for services that are taxable in accordance with 23 VAC 10-210-4040(D). It does not appear that the proposed allocation formula applies the tax to the taxable service component of the monthly fee. Because of this inconsistency, I cannot accept the allocation formula you propose. Company A must make a determination of the drugs and supplies that do not qualify for the exemptions discussed in this letter and apply the tax accordingly.
Independent Pharmacies
The rulings in this letter are based on the information provided and the fact that the pharmacies are truly independent of the hospitals. As recognized in Northern Virginia Doctors Hospital v. Department of Taxation, 213 Va. 504, 193 S.E.2d 684 (1973) and discussed in P.D. 97-322 (7/29/97), a pharmacy must be truly independent of a medical service provider (e.g., hospital, nursing home) in order to qualify for the exemption in Va. Code § 58.1-609.7(1) regarding its sales to such providers.
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 in Va. Code § 58.1-609.7(1), regardless of the fact that the hospital's nurses administered the drugs.
In accordance with the decision in Northern Virginia Doctors Hospital, P.D. 97-322 set forth criteria for determining when a pharmacy is independent of a hospital. The ruling provides that in order for the pharmacy to qualify as truly independent of the 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).
The rulings in this letter assume that the pharmacy operations provided by Company A meet the above criteria and are truly independent of the hospitals. If, however, a pharmacy does not meet the criteria set forth in P.D. 97-322, the pharmacy's sale of the drugs and supplies to a hospital would not qualify for the exemption in Va. Code § 58.1-609.7(1) based on Department of Taxation v. Bluefield Sanitarium, Inc., 216 Va. 686, 222 S.E.2d 526 (1976).
In Bluefield Sanitarium, a hospital maintained its own pharmacy that 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 medicines and drugs that were dispensed from the hospital pharmacy to patients on physicians' prescriptions and charged to patients. In this case, the pharmacy's purchase of drugs and supplies would be deemed purchases for the use and consumption of the hospital in the rendition of its medical services. Therefore, the hospital would be required to pay the use tax on such purchases consistent with Bluefield Sanitarium.
In the event that a pharmacy operated by Company A is not truly independent, the hospital was required to pay the tax on its purchases of drugs and supplies for all purchases prior to July 1, 2000. The tax would not apply to such purchases effective July 1, 2000, as previously discussed.
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 additional questions, please contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
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- Sincerely,
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Kenneth W. Thorson
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AR/29842J
Rulings of the Tax Commissioner