Can an out-of-state seller deduct sales of sales-tax-exempt health care supplies from Texas receipts when the goods are shipped to Texas reps and sold to hospitals only later on a consignment basis?

Plain-English summary

An out-of-state manufacturer/distributor of orthopedic devices (products exempt from sales and use tax under Tax Code Section 151.313 and Rule 3.284(d)(1)) sold predominantly to Texas hospitals. It shipped most products to independent Texas sales reps/distributors, who delivered them to the hospitals within a day or two; the reps did not take title or warehouse the goods. The hospitals held the products on a consignment-style basis and were invoiced only as the products were used, so the sale (and gross receipts) happened after the goods arrived in Texas. The taxpayer asked whether it could deduct these sales from its Texas receipts (taxable capital component) under Tax Code Section 171.104. The Comptroller said no.

• The general rule. Each sale of tangible personal property delivered or shipped to a Texas buyer is a Texas receipt (Tax Code Section 171.103(1)).
• The deduction. Section 171.104 lets a corporation deduct receipts (otherwise includable under 171.103(1)) from sales of health care supplies that are shipped from outside Texas and exempt from sales/use tax under Section 151.313.
• The catch - simultaneity. The Comptroller has long held that Section 171.104 requires the sale and the shipment to occur simultaneously (Rule 3.549(e)(20); Comptroller's Decision Nos. 10,062 and 34,485), a position upheld by the Texas Third Court of Appeals in Nabisco, Inc. and Planters/LifeSavers Co. v. Rylander, 992 S.W.2d 678 (Tex. App.-Austin 1999, pet. denied).
• Why these facts fail. Shipping the products to the reps/distributors was not a sale (no gross receipts under 171.103). By the time the sale actually occurred and gross receipts were recognized, the items were already located in Texas (at the customer's location). So the transaction was not "shipped and sold from a point outside Texas" as Section 171.104 requires - the deduction does not apply, and the receipts are Texas receipts.

Currency note: This applies the pre-2008 franchise tax and the Section 171.104 deduction as then interpreted, part of the taxable-capital/earned-surplus regime replaced by the current margin tax (House Bills 3 and 3928) effective January 1, 2008. Treat as historical.

What this means for you

Out-of-state sellers of exempt health care supplies

The health-care-supply deduction was narrower than it looked. It rewarded a genuine out-of-state, ship-and-sell-at-once transaction - not a distribution model where product is pre-positioned with Texas reps or consigned to hospitals and sold later. If title and the sale transferred after the goods were already sitting in Texas, the receipts stayed Texas receipts.

Accountants and tax professionals

Test the Section 171.104 deduction against the simultaneity requirement (Rule 3.549(e)(20); Nabisco v. Rylander): the sale and the out-of-state shipment must coincide. Consignment, bill-as-used invoicing, or pre-delivery to in-state reps generally breaks simultaneity because the taxable sale occurs in Texas. Sales-tax-exempt status under Section 151.313 is necessary but not sufficient.

Common questions

Q: Are sales of sales-tax-exempt health care supplies always deductible from Texas receipts?
A: No. Section 171.104 also requires the goods to be shipped from outside Texas with the sale and shipment occurring simultaneously.

Q: Why did the consignment model fail the test?
A: Because the sale (and gross receipts) occurred after the goods were already in Texas, so it was not a sale shipped and sold from a point outside Texas.

Q: Does shipping to my Texas reps count as the sale?
A: No. Shipping to the reps/distributors is not a sale that generates gross receipts under Section 171.103.

Citations and references

Statutes, rules, and cases:

• Tex. Tax Code Sec. 171.104 (deduction for health care supplies shipped from outside Texas and sales-tax exempt)
• Tex. Tax Code Sec. 171.103(1) (sales of tangible personal property delivered to a Texas buyer are Texas receipts)
• Tex. Tax Code Sec. 151.313 (sales/use tax exemption for health care supplies)
• 34 Tex. Admin. Code Sec. 3.549(e)(20) (sale and shipment must be simultaneous for the Sec. 171.104 deduction)
• 34 Tex. Admin. Code Sec. 3.284(d)(1) (orthopedic devices exempt from sales and use tax)
• Comptroller's Decision Nos. 10,062; 34,485
• Nabisco, Inc. and Planters/LifeSavers Co. v. Rylander, 992 S.W.2d 678 (Tex. App.-Austin 1999, pet. denied)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200302779L

Original ruling text

February 19, 2003

Re: Texas Tax Code Section 171.104

Dear **:

Thank you for your letter to Mr. Jerry Bobbitt regarding the deduction from
Texas receipts of health care products shipped from outside Texas. You ask if
under the circumstances described below your client may deduct from its Texas
receipts on the taxable capital component, the sales of health care products
shipped from outside the state to customers in Texas.

According to your letter, your client is an out-of-state manufacturer and
distributor of orthopedic devices and supplies. The products are exempt from
sales and use taxes under Tax Code Section 151.313 and Comptroller Rule
3.284(d)(1). Your client sells its products directly to its customers who are
predominantly Texas hospitals. The sales are solicited by independent sales
representatives or distributors. Your client primarily ships its products to
sales representatives or distributors in Texas who then deliver the products to
the client's purchasers. Your client does have a limited amount of shipments
that are shipped directly to its customers. The sales representatives or
distributors do not take title or store these products at a storage facility in
Texas. Delivery to the purchaser by the sales representative or distributor
generally occurs either the same day or within the next day or two after the
product is shipped to Texas. A sales representative or distributor may retain
limited amounts of product at their home or in their car for more extended
periods of time before delivery is made to the purchaser. The hospitals'
inventory your client's products to ensure availability. Your client invoices
the hospital for the sales price of the product as the products are used.
Thereby resulting in a time delay between the shipment/delivery to the
purchaser and when the purchaser is actually billed and issued an invoice for
the sale of the product. Your client is not charged any storage fee for the
time the products are consigned to the purchaser. Under normal circumstances
the healthcare products do not get diverted and shipped to different hospitals
or different purchasers once they are delivered to the initial Texas hospital.

Under Texas Tax Code Section 171.103(1), each sale of tangible personal
property that is delivered or shipped to a buyer in Texas is considered a Texas
receipt. However, under Tax Code Section 171.104 a corporation may deduct from
its receipts includable under Tax Code Section 171.103(1) receipts from the
sales of health care supplies that are shipped from outside this state and are
exempt from sales and use tax under Tax Code Section 151.313.

In interpreting Tax Code Section 171.104 the Comptroller's Office has held that
the sale and shipment of the products must occur simultaneously. Rule
3.549(e)(20), Comptroller Decision No. 10,062 and Comptroller Decision No.
34,485. This position was upheld by the Texas Third Court of Appeals in
Nabisco, Inc. and Planters/Lifesavers Co. v. Rylander, 992 S.W.2d 678 (Tex.
App.-Austin 1999, pet. denied).

The shipment of the healthcare products to the sales
representatives/distributors is not a sale that generates gross receipts under
Texas Tax Code Section 171.103. Additionally, once the products are delivered
to the customer, there may be a delay in time until the sale is actually made
and gross receipts recognized.

Based on the facts above, at the time the sale is made and gross receipts
recognized the items are located in Texas, usually at the customer's location.
The transaction, therefore, does not meet the criteria of being shipped and
sold from a point outside Texas as required by Tax Code Section 171.104.

This response is based on the facts presented and current law. If there are
different or additional facts, the response may change.

If you have questions about this, please call me at 1-800-531-5441, extension
59952. You may write me at Tax Policy Division, Comptroller of Public
Accounts, Austin, Texas 78774.

Sincerely,

Teresa Bostick
Tax Policy Division