Is professional 'proficiency testing' of Connecticut labs a taxable service, and does the out-of-state provider owe Connecticut use tax on the test materials it ships into the state?

Plain-English summary

An out-of-state organization of pathologists ran a federally required "proficiency testing" program for Connecticut pathology laboratories. (Under 42 U.S.C. § 263a, labs must be periodically accredited, and participating in a proficiency-testing program is part of that.) The organization sent testing specimens into Connecticut by common carrier; the labs analyzed the unknown specimens and reported their results back for scoring. The organization bought the specimen materials from retailers and did nothing with them except supply them to the labs, which discarded them after testing. It asked DRS two questions: (1) is its testing service taxable, and (2) does it owe Connecticut use tax on the materials it ships in?

DRS split the answer:

• The testing service is not taxable. Proficiency testing isn't on the list of enumerated taxable services, but DRS acknowledged it looks like taxable "business analysis" under Conn. Gen. Stat. § 12-407(2)(i)(J) — the organization examines a lab's performance and gives conclusions and recommendations about the lab's core business of detecting disease. What saves it is the professional-services exclusion in Conn. Agencies Regs. § 12-407(2)(i)(J)-1(c)(3): services performed by a profession — an occupation requiring a degree, license or specialized training — are excluded. Because the work is done by pathologists acting as pathologists, the charges are not subject to sales and use tax.
• But the provider owes use tax on the materials. Connecticut's use tax (Conn. Gen. Stat. § 12-411) reaches tangible personal property used in the state, and "use" (§ 12-407(5)) means exercising any right or power over property incident to ownership. DRS relied on Sharper Image Corp. v. Miller, 240 Conn. 531 (1997) — where a retailer that directed catalogs to be printed and mailed to Connecticut addresses owed use tax on them. Here, the organization directs specimens into Connecticut, and those materials are an essential aspect of the testing service — without them there is no test. So the organization uses the materials in Connecticut and owes use tax on its purchase price. It does, however, get a credit for sales or use tax properly paid to the state where it bought the materials (§ 12-430(5)).

The pairing is the lesson: the service escapes tax as professional work, but the tangible materials the professional ships in to deliver that service are still caught by the use tax.

What this means for you

Professional service providers (in-state or out-of-state)

If your service is delivered by members of a profession (degreed, licensed, or specially trained) acting in that capacity, Connecticut's business-analysis/consulting services tax generally doesn't apply — even if the work resembles taxable "business analysis." But don't stop there: if you buy tangible goods and bring them into Connecticut to perform the service, you can owe use tax on those goods, because you're "using" them in the state. The service being tax-free doesn't make the supplies tax-free.

Out-of-state businesses shipping goods into Connecticut to serve customers here

Directing materials into Connecticut — specimens, catalogs, samples, equipment consumed in delivering a service — can create a use-tax liability on those materials even if you have no store here and even if your service isn't taxable. Track what you send in, self-assess Connecticut use tax on your cost, and claim the § 12-430(5) credit for tax you already paid elsewhere to avoid double taxation.

Accountants and tax professionals

Two independent analyses: (1) service taxability under § 12-407(2)(i), where the professional-services exclusion in Reg. § 12-407(2)(i)(J)-1(c)(3) can pull otherwise-taxable "business analysis" back out; and (2) use tax on materials under §§ 12-411 and 12-407(5), applying the Sharper Image "exercise of a right or power" / "essential aspect" reasoning to property the taxpayer directs into the state. Don't forget the reciprocal credit under § 12-430(5).

Common questions

Q: Is professional testing or analysis taxable in Connecticut?
A: Generally not when it's performed by a profession — an occupation requiring a degree, license or specialized training — acting in that professional capacity. That's the exclusion in Conn. Agencies Regs. § 12-407(2)(i)(J)-1(c)(3), which here covered pathologists' proficiency testing.

Q: If my service is tax-free, are my supplies tax-free too?
A: Not necessarily. Here the service was exempt, but the provider still owed Connecticut use tax on the testing materials it purchased and shipped into the state to perform the service.

Q: Why did an out-of-state company owe Connecticut use tax?
A: Because it directed the materials into Connecticut and those materials were essential to performing the service there — that counts as "using" the property in Connecticut under § 12-411, following Sharper Image Corp. v. Miller.

Q: Can the company avoid paying tax twice on the materials?
A: Yes. Under Conn. Gen. Stat. § 12-430(5), it gets a credit for sales or use tax properly paid to the jurisdiction where it bought the materials.

Citations and references

Statutes:

• Conn. Gen. Stat. § 12-407(2)(i) (enumerated taxable services); § 12-407(2)(i)(J) (business analysis and related services)
• Conn. Gen. Stat. § 12-411(1) (use tax); § 12-407(5) (definition of "use")
• Conn. Gen. Stat. § 12-430(5) (credit for tax paid to another jurisdiction)

Regulations, cases and federal law:

• Conn. Agencies Regs. § 12-407(2)(i)(J)-1(c)(3) (exclusion for services performed by a profession)
• Sharper Image Corp. v. Miller, 240 Conn. 531, 692 A.2d 774 (1997) (use tax on property directed into the state)
• 42 U.S.C. § 263a (federal laboratory accreditation / proficiency testing requirement)

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 2000-2

Original ruling text

Ruling 2000-2, Sales and Use Taxes / Pathology Proficiency Testing Services / Use Tax on Materials

FACTS:

An out-of-state company (the "Company") is an organization consisting of pathologists. The Company provides "proficiency testing" of Connecticut pathology laboratories. Under 42 U.S.C. §263a, the United States Department of Health and Human Services, or another organization designated by the federal government, must periodically accredit every pathology laboratory in the United States. The Company is one of the organizations designated by the federal government to provide such accreditation.

In order to obtain accreditation, a pathology laboratory must participate in a proficiency testing program. The Company charges the laboratories to participate in its program. In conducting its proficiency testing program, the Company transfers testing materials (specimens) into Connecticut by common carrier. The composition of the testing materials is unknown to the laboratories. The laboratories analyze the materials and report their findings to the Company for processing and evaluation.

The Company purchases testing materials from various retailers and makes no use of them other than providing them to laboratories for analysis. The laboratories dispose of the materials when the analysis is completed.

ISSUES:

Whether the Company’s "proficiency testing" is a taxable service enumerated in Conn. Gen. Stat. §12-407(2)(i); and whether the Company is subject to use tax under Conn. Gen. Stat. §12-411 for its purchases of testing materials shipped to Connecticut laboratories as part of its services.

RULING:

The Company’s proficiency testing is not subject to sales and use taxes under Conn. Gen. Stat. §12-407(2)(i). However, the Company is subject to Connecticut use tax on its purchases of testing materials it uses in providing the services to its Connecticut service recipients.

DISCUSSION:

Taxability of Services

Conn. Gen. Stat. §12-407(2)(i) defines "sale" and "selling" as "the rendering of certain services for a consideration…."

The term "proficiency testing" is not among the list of services enumerated in Conn. Gen. Stat. §12-407(2)(i). However, there is a question as to whether the Company’s services are taxable "business analysis" services enumerated in Conn. Gen. Stat. §12-407(2)(i)(J).

The purpose of the Company’s testing is to assess the ability of a laboratory to perform pathological examinations. Based on the results of the testing, the Company provides conclusions and recommendations to a laboratory on its ability to perform its core business activity of detecting disease; thus, the Company’s services could be viewed as business analysis services under Conn. Gen. Stat. §12-407(2)(i)(J).

However, because the Company’s membership is comprised of pathologists performing pathological testing, the testing services are excluded from tax under Conn. Agencies Regs. §12-407(2)(i)(J)-1(c)(3) because they are performed by a "professional" service provider. Pathologists are members of a "profession" within the meaning of Conn. Agencies Regs. §12-407(2)(i)(J)-1(c)(3) because they are members of an occupation "requiring a degree, license or specialized training…." The Company’s services are rendered by members of a profession, acting in such members’ professional capacity as pathologists, and are commonly associated with pathology. Therefore, the charges for such services are not subject to Connecticut sales and use tax.

Use Tax on Materials

Conn. Gen. Stat. §12-411(1) imposes use tax on the "storage, acceptance, consumption or any other use in this state of tangible personal property purchased from any retailer for storage, acceptance, consumption or any other use in this state…."

"Use" is defined in Conn. Gen. Stat. §12-407(5) as including "the exercise of any right or power over tangible personal property incident to the ownership of that property, except that it does not include the sale of that property in the regular course of business."

Connecticut courts have held that use tax is properly imposed on taxpayers who have "exercised a ‘right or power’" over items of tangible personal property coming into Connecticut from outside the state. See Sharper Image Corp. v. Miller , 240 Conn. 531, 692 A.2d 774 (1997), where the Supreme Court of Connecticut held that a retailer that directed catalogs to be printed, addressed and sent to Connecticut addresses via the United States Postal Service was liable for Connecticut use tax on the retailer’s purchase price for the catalogs.

In this case, at the Company’s direction, a common carrier delivers testing materials to locations within the state. The testing materials provide the means for the Company to administer the testing service to Connecticut pathology laboratories. If not for the use of the testing materials, the Company would be unable to provide the testing and the laboratories would not receive the benefit of obtaining a proficiency rating. The use of the testing materials in Connecticut is an essential aspect of the testing services, without which the services would not exist. Therefore, the materials are used by the Company in Connecticut.

To the extent that the Company purchases testing materials outside the state, and the materials are sent into Connecticut, the Company is entitled to a credit for taxes properly paid to the jurisdiction where the purchases were made. Conn. Gen. Stat. §12-430(5).

LEGAL DIVISION

February 2, 2000