Can a lab that tests blood plasma samples for infectious diseases before its client manufactures medicine claim Texas's manufacturing exemption on its testing equipment and supplies?

Plain-English summary

A company built a Texas laboratory to test and screen source blood plasma for infectious diseases — required by FDA regulation before pharmaceutical companies can use donated plasma to manufacture medicines like clotting factors and immunoglobulins. Clients extract plasma from donors and send small samples to the lab. Positive or unsatisfactory results disqualify a donor's entire plasma supply from use; passing samples clear the way for the client to manufacture medicine from that donor's plasma. To run its tests, the lab uses sophisticated equipment, antigens, reagents, and other consumable supplies, plus lubricants to maintain the equipment. It asked whether these purchases qualify for Texas's manufacturing sales tax exemption.

The Comptroller ruled they do not qualify. The manufacturing exemption covers equipment that directly causes a chemical or physical change to a product being manufactured for ultimate sale (or to quality-control testing performed during that same manufacturing process) — but the lab itself doesn't manufacture, process, or fabricate anything. It tests a small sample and reports results back to the client; the client is the one that later manufactures medicine from the donor's plasma (assuming it passes). Because the lab's equipment doesn't cause any chemical or physical change to plasma that eventually gets manufactured into medicine — the lab only tests a sample and returns a result — its purchases don't fit either the general manufacturing exemption or the quality-control-testing exemption. The lab must pay tax on its testing equipment and supplies at purchase and cannot collect tax from its clients (testing/screening isn't an enumerated taxable service either).

What this means for you

Contract testing labs and diagnostic service providers serving manufacturers

Testing or screening a sample on behalf of a manufacturing client is not itself "manufacturing," even when the test is a legally required gatekeeping step before your client's manufacturing process can proceed. The manufacturing exemption is reserved for equipment that changes the actual product being manufactured (or tests it during the manufacturing process itself) — testing a separate sample and reporting results doesn't qualify, regardless of how essential that testing is to the client's regulatory compliance.

Pharmaceutical and biologics manufacturers using outside testing labs

If you contract out FDA-required screening to a separate testing company, don't assume that company's equipment gets manufacturing-exemption treatment just because your own manufacturing can't proceed without a passing test result. The exemption follows who's doing the actual manufacturing/processing, not who's performing a prerequisite step.

Accountants and tax professionals

The ruling cleanly separates Section 151.318(a)(2)'s general chemical/physical-change exemption from (a)(8)'s narrower quality-control-testing exemption (which only covers testing performed during the actual manufacturing of the item being tested) — a useful two-part checklist for any lab-services business evaluating exemption eligibility.

Common questions

Q: Is testing that's legally required before manufacturing can happen automatically part of "manufacturing"?
A: No — this ruling shows that even FDA-mandated screening, essential to the client's ability to manufacture at all, doesn't make the testing company's own equipment eligible for the manufacturing exemption if the testing company itself never processes or fabricates the product for sale.

Q: Does the lab owe sales tax on its charges to clients for testing services?
A: No — testing and screening services aren't an enumerated taxable service under Section 151.0101, so the lab doesn't collect tax from clients. But it does have to pay tax on its own equipment and supply purchases, since those don't qualify for any exemption either.

Q: Would the answer change if the same company also manufactured the medicine itself?
A: Possibly — this ruling addresses only a standalone testing/screening service. A company that also manufactures the ultimate product from passing samples could have a different exemption analysis for its manufacturing-side equipment.

Q: Can another lab or testing company rely on this ruling?
A: No. It's a private letter ruling binding on the Comptroller only for the taxpayer and facts submitted, and it cannot be relied on by any other taxpayer.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.318(a)(2) (general manufacturing exemption — chemical/physical change to the product for ultimate sale)
• Tex. Tax Code § 151.318(a)(8) (quality-control testing exemption — testing during actual manufacturing)
• 34 Tex. Admin. Code Rule 3.300(a)(9) (Manufacturing; Custom Manufacturing; Fabricating; Processing)
• Tex. Tax Code § 151.0101 ("Taxable Services" — testing/screening not enumerated)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201807011L

Original ruling text

July 12, 2018

RE: Private Letter Ruling No. PLR2017010172

*, Taxpayer No. *

Dear ***:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters.[ENDNOTE: 1] We are responding to your request dated June 21, 2017. Detrimental reliance relief is provided in accordance with Rule 3.10, Taxpayer Bill of Rights.

You requested guidance on whether **** (Taxpayer) is eligible to claim the manufacturing sales tax exemption on its purchases of equipment and related supplies used to test or screen source plasma.

Facts Presented

Taxpayer recently created a laboratory in CITY, Texas where Taxpayer offers services to test and screen source plasma for infectious diseases.

Taxpayer’s clients manufacture medicines, including clotting factors, immunoglobulins, albumin, and other special therapies, from source plasma. The U.S. Food and Drug Administration’s (FDA) regulations require all source plasma donations to be tested for transfusion transmitted infectious diseases. Taxpayer performs this testing and screening service for its clients.

Taxpayer’s clients operate plasma collection and processing centers to collect source plasma from donors. Clients’ technicians extract source plasma from donors using plasmapheresis. Clients’ technicians take a small sample from each donor’s source plasma to send to Taxpayer to determine whether the client can use the plasma for manufacturing.

Taxpayer tests the blood plasma samples and returns the results to the client. Positive, reactive, or unsatisfactory test results will disqualify the donor's source plasma from use in manufacturing, and such donor's plasma will be destroyed in compliance with FDA regulations. Clients will manufacture source plasma with negative, non-reactive, and satisfactory test results into various medicines.

In order to perform its testing services, Taxpayer uses sophisticated testing equipment and antigens, reagents, chemicals, supplies, and other consumable products. In addition, Taxpayer purchases certain lubricants and other chemicals for use to prevent the decline, failure, lapse, or deterioration of the equipment.

Questions, Rulings, and Analysis

Our restatement of your question is shown below, followed by our response and analysis.

Question: Do the tests Taxpayer performs on clients’ source plasma constitute manufacturing, as that term is defined in Rule 3.300(a)(9) (Manufacturing; Custom Manufacturing; Fabricating; Processing (Tax Code, §§151.005, 151.007, 151.318, and 151.3181)), so that Taxpayer can claim the manufacturing exemption on its purchases of equipment and supplies used to performing the tests?

Ruling: Taxpayer provides testing and screening services for clients. Taxpayer does not use the equipment and supplies it purchases to manufacture, process, or fabricate tangible personal property for ultimate sale. Therefore, Taxpayer cannot claim a sales and use tax exemption on its purchase of the Equipment or the Supplies under Section 151.318 (Property Used in Manufacturing).

Analysis:

Taxpayer provides testing services to its clients to screen the clients’ source plasma for transfusion transmitted infectious diseases, as required by FDA regulations. Clients send small source plasma samples to Taxpayer, and Taxpayer returns the results of its tests to the clients.

In relevant part, Section 151.318(a) states that the following items are exempt if sold, leased, or rented to, or stored, used, or consumed by a manufacturer:

“(2) tangible personal property directly used or consumed in or during the actual manufacturing, processing, or fabrication of tangible personal property for ultimate sale if the use or consumption of the property is necessary or essential to the manufacturing, processing, or fabrication operation and directly makes or causes a chemical or physical change to:

(A) the product being manufactured, processed, or fabricated for ultimate sale; or

(B) any intermediate or preliminary product that will become an ingredient or component part of the product being manufactured, processed, or fabricated for ultimate sale;…” and

“(8) tangible personal property used or consumed during the actual manufacturing, processing, or fabrication of tangible personal property for ultimate sale if the use or consumption of the property is necessary and essential to a quality control process that tests tangible personal property that is being manufactured, processed, or fabricated for ultimate sale…”

The equipment and supplies Taxpayer uses to perform its testing services does not qualify for the exemption from sales tax in Sections 151.318(a)(2) or 151.318(a)(8). Taxpayer’s equipment and supplies do not make a chemical or physical change to any source plasma that is manufactured into medicine. Rather, Taxpayer performs tests on a small sample of source plasma provided by the client, and shares the results of that test with the client. Taxpayer does not manufacture, process, or fabricate source plasma or other tangible personal property for ultimate sale.

Taxpayer’s testing and screening service is not an enumerated taxable service under Section 151.0101. Taxpayer must pay tax at the time of purchase on all taxable items used in providing its testing and screening services, and Taxpayer should not collect tax from its clients for the testing and screening services it performs.

Comptroller’s Decisions and STAR documents cited can be found on the Comptroller’s State Tax Automated Research (STAR) system. The Texas Tax Code, Texas Administrative Code, and the STAR system are accessible at www.comptroller.texas.gov/taxes/.

If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/web-forms/tax-help/ and reference Private Letter Ruling No. 2017010172.

Sincerely,

Tax Policy Division – Indirect Taxes

Texas Comptroller of Public Accounts

ENDNOTES:

1. Unless otherwise indicated, all references to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code.