Can a pharmacy's contract with an insurance company override Tennessee sales tax collection rules?

Subject

Opinion No. 11-55, Invalidity of Contracts that Contravene Obligation to Collect and Pay Sales Tax, July 11, 2011

Plain-English summary

The director of the Fiscal Review Committee asked two questions. Could the State of Tennessee waive sales tax for a particular purchaser by contract? And could a private insurance company contractually prohibit a pharmacist from collecting sales tax on an otherwise taxable transaction?

The AG said no to both. The Retailers' Sales Tax Act levies a tax on the sale of tangible personal property at retail, and the act unambiguously assigns the collection obligation to the retailer ("the tax shall be collected by the retailer from the consumer insofar as it can be done"). The General Assembly's choice to tax a transaction is an expression of public policy. Tennessee courts hold that contracts that violate public policy are void and unenforceable. So neither the state through its contracting authority nor a private third party through a contract with a pharmacy can override the statutory collection duty.

The backdrop, which the opinion does not name directly but is the obvious subject, is pharmacy reimbursement contracts. Pharmacy benefit managers (PBMs) and insurance companies sometimes use form contracts with retail pharmacies that bar the pharmacy from charging the patient anything beyond the agreed copay. Read literally, that prohibition would bar the pharmacy from collecting state sales tax on items like over-the-counter drugs or supplies that are taxable in Tennessee. The AG's opinion is that any such contractual provision is unenforceable as against public policy under McDaniel v. McCall. The pharmacy retains the legal duty (and right) to collect sales tax at the point of sale; the contract terms that say otherwise cannot make the pharmacy break Tennessee law.

The opinion also notes the only legitimate way to create a sales tax exemption: a statute from the General Assembly. Tenn. Code Ann. §§ 67-6-301 et seq. catalog the existing exemptions. Anyone wanting a new exemption needs to lobby the legislature, not negotiate it into a contract.

Currency note

This opinion was issued in 2011. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

The core legal proposition (a contract cannot require a party to break the law) is durable. But specific sales tax exemptions in Tenn. Code Ann. §§ 67-6-301 et seq. are revised regularly, and the categories of pharmacy items that count as taxable tangible personal property versus exempt prescription drugs change over time. A pharmacist evaluating a present-day PBM contract should check the current exemption list before deciding whether a particular line item is taxable in Tennessee.

Background and statutory framework

The base tax. Tenn. Code Ann. § 67-6-201 levies the sales tax on "the privilege of engaging in the business of selling tangible personal property at retail in this state." The rate is seven percent at the state level. Tangible personal property includes property "that can be seen, weighed, measured, felt, or touched" and certain enumerated items including electricity, water, gas, steam, and prewritten computer software. Tenn. Code Ann. § 67-6-102(92)(A).

Who has the collection duty. Tenn. Code Ann. § 67-6-501 makes "every dealer making sales … of tangible personal property … liable for the tax." Tenn. Code Ann. § 67-6-502 says: "The tax shall be collected by the retailer from the consumer insofar as it can be done." A "dealer" includes every person who sells at retail or who has property in their possession for sale at retail. Tenn. Code Ann. § 67-6-102(25)(C).

Where exemptions come from. Tenn. Code Ann. §§ 67-6-301 et seq. spell out the statutory exemptions. The AG notes that only the General Assembly can carve out an exemption.

The public-policy doctrine. A statute is an expression of public policy. Stein v. Davidson Hotel Co., 945 S.W.2d 714, 717-18 (Tenn. 1997). Contracts that violate public policy are invalid and unenforceable. Baugh v. Novak (Tenn. 2011) (cited as 2011 WL 1935839). McDaniel v. McCall, 655 S.W.2d 155, 157-58 (Tenn. Ct. App. 1983), held that a contract under which a mining operator agreed to pay an excavating contractor for activities conducted without a permit was unenforceable as a violation of public policy underlying the permitting statute. By the same logic, a contract requiring a pharmacist to skip statutorily mandated sales tax collection is unenforceable.

Common questions

A PBM contract says I can't charge the patient more than the copay. Doesn't that override sales tax?

According to this opinion, no. The contract clause is unenforceable to the extent it requires you to violate Tennessee's sales tax collection statute. You retain the duty to collect sales tax on taxable items, and the PBM cannot legally compel you to absorb it or refuse to collect it.

Is the pharmacy supposed to add sales tax to a copay then?

That is a contract-interpretation and operational question the opinion does not directly answer. The opinion's holding is that the state law obligation to collect sales tax controls; how to operationalize collection inside a copay-driven contract is something the pharmacy, the PBM, and the patient sort out, subject to the underlying statutory duty.

What if the State of Tennessee signs a contract that purports to grant a sales tax holiday or exemption to a vendor?

The opinion says that contract cannot create the exemption. Only the General Assembly can. State officials lack the unilateral power to waive sales tax by contract.

Are prescription drugs taxable in Tennessee?

The opinion does not catalog specific exemptions. Tennessee historically has had a prescription-drug exemption in Tenn. Code Ann. §§ 67-6-301 et seq.; non-prescription items, supplies, and certain other pharmacy line items are typically taxable. Anyone parsing a particular PBM line should look at the current exemption list and at Department of Revenue guidance.

Could the parties to a void contract be sued for the sales tax obligation?

The pharmacist is still the statutory collector and still liable to the state for sales tax not collected. A contract clause that purports to relieve the pharmacist of that duty does not bind the state. Whether the PBM is liable to the pharmacist (for indemnification, for example) when the pharmacist nonetheless collects tax in defiance of the contract is a separate contract-law question outside this opinion.

Citations

• Tenn. Code Ann. §§ 67-6-101 et seq. (Retailers' Sales Tax Act)
• Tenn. Code Ann. §§ 67-6-102(25)(C), 67-6-102(92)(A), 67-6-201, 67-6-501, 67-6-502
• Tenn. Code Ann. §§ 67-6-301 et seq. (exemptions)
• Stein v. Davidson Hotel Co., 945 S.W.2d 714 (Tenn. 1997)
• Baugh v. Novak, 2011 WL 1935839 (Tenn. May 20, 2011)
• McDaniel v. McCall, 655 S.W.2d 155 (Tenn. Ct. App. 1983)

Source

• Landing page: https://www.tn.gov/attorneygeneral/opinions.html
• Original PDF: https://www.tn.gov/content/dam/tn/attorneygeneral/documents/ops/2011/op11-055.pdf

Original opinion text

July 11, 2011
Opinion No. 11-55
Invalidity of Contracts that Contravene Obligation to Collect and Pay Sales Tax

QUESTIONS

1. May the State of Tennessee, by contract, waive the obligation of a purchaser to pay sales tax on an otherwise taxable item that is not statutorily exempt from taxation?

2. May a private insurance entity, by contract, obligate a pharmacist to violate state law by prohibiting the collection of sales tax on an otherwise taxable item that is not statutorily exempt from taxation?

OPINIONS

1. No. State statutes obligating sellers to collect sales tax from purchasers of tangible personal property at retail cannot be waived by contract.

2. No. Contracts that require the violation of state law are void as against public policy.

ANALYSIS

1. Pursuant to the Retailers' Sales Tax Act, Tenn. Code Ann. §§ 67-6-101 et seq., Tennessee levies a tax "on the sales price of each item or article of tangible personal property when sold at retail in this state." Tenn. Code Ann. § 67-6-201. The sales tax is a tax on "the privilege of engaging in the business of selling tangible personal property at retail in this state." Id. The rate of the tax is seven percent. Id. Tenn. Code Ann. § 67-6-501 provides, in pertinent part, that

(a) Every dealer making sales, whether within or outside the state, of tangible personal property, for distribution, storage, use, or other consumption in this state, or furnishing any of the things or services taxable under this chapter, is liable for the tax imposed by this chapter.

(b) The tax shall be collected from the dealer as defined in § 67-6-102 and paid at the time and in the manner as provided for in this part.

(c) The tax imposed in this part shall be at the rate provided by law of the retail sales price, as of the moment of sale, or of the purchase price, as of the moment of purchase, as the case may be, shall be collectible from all persons, as defined in § 67-6-102, engaged as dealers, as defined in § 67-6-102, in the sale at retail, the use, the consumption, the distribution, and the storage for use or consumption in this state, of tangible personal property, or in the furnishing of any of the things or services taxable under this chapter.

"Dealer" includes "every person … who … [s]ells at retail, or who offers for sale at retail, or who has in such person's possession for sale at retail, or for use, consumption, distribution, or storage to be used or consumed in this state, tangible personal property as defined in this section." Tenn. Code Ann. § 67-6-102(25)(C). "Tangible personal property" is defined as "personal property that can be seen, weighed, measured, felt, or touched, or that is in any other manner perceptible to the senses" and "includes electricity, water, gas, steam, and prewritten computer software." Tenn. Code Ann. § 67-6-102(92)(A). The sales tax "shall be collected by the retailer from the consumer insofar as it can be done." Tenn. Code Ann. § 67-6-502.

The question presented presupposes that the item being purchased is taxable tangible personal property and that no statutory exemption from the sales tax applies. A statute enacted by the General Assembly is an expression of the public policy of this State. See Stein v. Davidson Hotel Co., 945 S.W.2d 714, 717-18 (Tenn. 1997). The General Assembly has unambiguously declared that the retail sale of tangible personal property is subject to tax and that retailers are responsible for collecting the tax from purchasers at the point of sale. See Tenn. Code Ann. §§ 67-6-201; 67-6-501; 67-6-502. The State cannot contravene this legislative directive by contract, because contracts that violate public policy are invalid and unenforceable. See Baugh v. Novak, ___ S.W.3d ___, 2011 WL 1935839, at *7-8 (Tenn. May 20, 2011). If State officials wish to waive the requirement that purchasers of certain items of tangible personal property pay sales tax at the point of sale, only the General Assembly can achieve that result by enacting a statutory exemption. See Tenn. Code Ann. §§ 67-6-301 et seq. The State cannot create such an exemption by contract.

2. For similar reasons, the answer to the second question is likewise no. A private insurance entity cannot, by contract, obligate a pharmacist to violate state law by prohibiting the pharmacist from collecting tax on sales of tangible personal property. The Retailers' Sales Tax Act requires retailers to collect sales tax from purchasers of tangible personal property. See Tenn. Code Ann. § 67-6-502. A contract that requires a party to violate Tennessee law is void as against public policy. See McDaniel v. McCall, 655 S.W.2d 155, 157-58 (Tenn. Ct. App. 1983) (holding that contract under which mining operator agreed to pay excavating contractor for his mining activities conducted without a permit was unenforceable as violation of public policy underlying statute requiring mining operators to obtain permits). A contract prohibiting pharmacists from collecting tax on retail sales of taxable tangible personal property would thus be unenforceable as a violation of the public policy behind the Retailers' Sales Tax Act.

ROBERT E. COOPER, JR.
Attorney General and Reporter

JOSEPH F. WHALEN
Associate Solicitor General

R. MITCHELL PORCELLO
Assistant Attorney General

Requested by:
The Honorable James W. White
Executive Director
Fiscal Review Committee
Tennessee General Assembly
320 Sixth Avenue, North – 8th Floor
Nashville, Tennessee 37243-0057