Indiana: Tax Court Rules that a Taxpayer was a Service Provider Required to Use COP Apportionment

Listen to a brief overview of state tax developments this week, including Indiana, or read full Indiana development below.

Detailed Indiana Development

The Indiana Tax Court recently addressed whether a pharmacy benefit management company derived income from the retail sale of prescription drugs or from the provision of services. The taxpayer at issue was a corporation whose primary business was administering prescription drug and pharmacy benefits for its health insurer clients. These clients paid a service charge in return for a number of benefits, including but not limited to, access to a network of third-party retail pharmacies that provided discounted prescription drugs, assistance with claims processing and adjudication, and call center services. The service charge included the cost of the drugs dispensed by the local pharmacy, the local pharmacy’s dispensing fees, and the taxpayer’s administrative fee. The taxpayer also received rebates from pharmaceutical manufacturers. For the tax years at issue, the taxpayer sourced its income in accordance with Indiana’s provisions applicable to service providers, which required receipts to be sourced to Indiana when a greater proportion of the income-producing activity was performed within the state. As applied by the taxpayer, no income was apportioned to Indiana because a greater proportion of the taxpayer’s income producing activities occurred outside Indiana. On audit, the Department determined that the taxpayer was selling prescription drugs (i.e., tangible personal property) and therefore should have applied the sourcing rules applicable to such sales. Applying these rules resulted in an assessment that the taxpayer subsequently protested.

Before the Tax Court, the sole issue was whether the taxpayer was selling prescription drugs or whether it was providing services. When the Department filed its motion for summary judgment, it did not present its proposed assessments as evidence for purposes of the motion. As a result, the court had to determine whether the Department’s other evidence presented a prima facie case that there was no genuine issue of material fact (i.e., the taxpayer sold tangible personal property) so that summary judgment was proper. It was here that the Department’s position crumbled.  In sum, the court found that none of the evidence supplied by the Department was competent, and it could not reasonably infer that the taxpayer’s income was derived from the sale of tangible personal property. As support for its position, the Department submitted certain of the taxpayer’s contracts for the court’s review. Noting that it is not required to search for specific facts, the court refused to review two of the contracts because the Department did not identify what part of the document was relevant to its position. With respect to the remaining contract and a provider manual, the court determined that the “mere recitation” of facts by the Department without any accompanying analysis was insufficient to convince the court that the taxpayer was selling prescription drugs. The court also refuted the Department’s assertion that the taxpayer, in forms filed with the Securities and Exchange Commission, as well as positions taken in other taxing jurisdictions, had admitted it sold prescription drugs. In the court’s view, in no instance did the taxpayer describe its business as making sales of goods. Additionally, the court also refused to infer that the taxpayer’s reporting cost of goods sold on its federal returns necessarily dictated that it was selling tangible personal property for apportionment purposes. Rather, the court noted, apportionment is a uniquely state concept. Without a convincing argument that there was a connection between apportionment and the calculation of federal income tax liability, the court declined to make this inference. In conclusion, the court ruled that the Department was not entitled to summary judgment. However, the court found that the evidence presented by the taxpayer and lack of adequate rebuttal by the Department entitled the taxpayer to summary judgment as a matter of law.  For more information on Express Scripts Inc. please contact Marc Caito. 


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Sarah McGahan

Sarah McGahan

Managing Director, State & Local Tax, KPMG US