A nonprofit college runs a federally mandated proficiency testing program for pathology laboratories, charging labs a single subscription fee that bundles the testing service with disposable test-specimen materials the college buys and ships in. Is the college's subscription fee a taxable sale of the specimen materials, or a nontaxable service charge -- and does the college owe Texas use tax on specimens it ships into Texas from out of state?

Plain-English summary

A nonprofit membership college (tax-exempt under IRC Sec. 501(c)(6), headquartered in Illinois with no Texas office) runs a federally mandated proficiency testing program for pathology laboratories. Under the Clinical Laboratory Improvement Amendments of 1988 (42 U.S.C. 263a), every U.S. pathology lab must be periodically accredited, and one requirement is participating in proficiency testing: the college ships each lab an unknown biological specimen ("PT Materials," typically spiked human serum), the lab analyzes it and reports results back, and the college evaluates the lab's accuracy and reports results to the lab and its accreditation body. The college charges a single bundled subscription fee — no separate charge for the materials versus the service — even though the materials themselves historically cost the college roughly 35-45% of what it billed labs.

The college had already registered to collect Texas use tax under a Multistate Tax Commission voluntary disclosure agreement, initially agreeing to treat the PT Materials transfer as a taxable sale, but reserved the right to seek a ruling on the correct treatment — prompted by a customer who argued the materials transfer was just incidental to a nontaxable service.

The Comptroller agreed with the college's own "true object" analysis on the first question: the true object of the program is the testing/accreditation service, not a sale of the PT Materials, so the college's charges to labs for program participation are not subject to sales or use tax, and the college itself is treated as the consumer of the PT Materials (i.e., the college — not the labs — is the one who effectively "uses" the materials it purchases from manufacturers). But the Comptroller disagreed with the college's second request: the college IS subject to Texas use tax under Rule 3.346 on specimens it ships to Texas labs by common carrier from outside Texas, because being the deemed "consumer" of materials it brings into Texas triggers its own use tax liability. On the college's fallback third request, the Comptroller confirmed a credit: Texas will credit the college's use tax liability for any legally imposed sales/use tax it already paid another state (or that state's subdivision) on the same property — and that credit applies even if the other state isn't itself a member of the multistate tax compact.

What this means for you

Nonprofit or professional organizations bundling materials with a mandated service

If your true business is providing a service (testing, certification, accreditation) and materials are just a means to deliver that service — especially where you bear their cost and customers have no independent use for them — a single bundled fee can be treated entirely as a nontaxable service charge under the "true object" doctrine, even though materials make up a meaningful share of your cost.

Out-of-state nonprofits shipping materials into Texas

Being deemed the "consumer" of materials for true-object purposes doesn't make you exempt from use tax on those same materials — you can still owe Texas use tax on specimens or supplies you ship in from elsewhere, separate from whatever you charge your Texas customers.

Multistate organizations managing tax paid to multiple states

If you already paid sales/use tax to another state on property you then use in Texas, you can generally credit that against your Texas use tax liability, even if the other state doesn't participate in the multistate tax compact.

Accountants and tax professionals

A clean worked example of the "true object" test applied to a bundled materials-plus-service transaction, paired with the separate (and easy to overlook) point that a "true object = service" finding doesn't eliminate the provider's own use tax exposure on materials it imports into the state.

Common questions

Q: Is a bundled subscription fee for a testing service (with materials included) taxable if the materials are a big share of the cost?
A: Not necessarily — if the true object of the transaction is the service, the whole charge can be treated as a nontaxable service fee, with the provider deemed the consumer of the materials.

Q: Does being deemed the "consumer" of materials shipped into Texas exempt the provider from Texas use tax on those materials?
A: No — the provider can still owe Texas use tax under Rule 3.346 on materials shipped into Texas from another state, separate from the sales/use tax treatment of what it charges its customers.

Q: Can a multistate organization get credit for use tax owed in Texas if it already paid tax on the same property to another state?
A: Yes — Texas allows a credit for legally imposed sales/use tax already paid to another state (or its subdivision) on the same property, even if that state isn't a member of the multistate compact.

Q: Can I rely on this letter for my own bundled-service business?
A: No. It's rendered based on the specific facts presented and can be relied on only by the taxpayer to whom it was issued; other facts, even if similar, may produce a different result.

Citations and references

Statutes and rules:

• 34 Tex. Admin. Code Rule 3.346 (Use Tax)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9908622L

Original ruling text

August 9, 1999

Dear Mr. **:

Thank you for your recent letter which is restated in part with response below.

This letter requests a ruling regarding the proper sales and use tax treatment
of certain proficiency testing materials (PT Materials) that are transferred by
the ** (the "College") to pathology laboratories in Texas in
connection with proficiency testing services provided by the College to such
laboratories. Most of the College's proficiency testing services are subscribed
to in the early fall. Hence, there is some urgency to this request.

The College is a membership organization exempt from payment of federal income
tax under section 501(c)(6) of the Internal Revenue Code of 1986, as amended
(the "Code"). The College is a not-for-profit corporation formed under the laws
of Illinois and is headquartered in Illinois. It also has an office in
Washington, D.C. The College has no office or other facility in Texas.

The College recently registered with Texas to collect use tax pursuant to a
voluntary disclosure agreement reached through the Multistate Tax Commission's
National Nexus Program. A copy of the executed agreement is attached as
Exhibit B. One of the terms of the College's proposal was that it would treat
the transfer of PT Materials as a taxable retail sale.

However, the College reserved the right to file a follow-up ruling request
seeking guidance as to the proper tax treatment of such testing.

At least one customer has now asserted to the College that the transfer of such
materials is incident to the sale of a nontaxable service, i.e., the
proficiency testing service, and is therefore not properly treated as subject
to a sales tax. The purpose of this ruling request is to obtain a ruling as to
(i) whether the College's transfer of PT Materials are retail sales of tangible
property or transfers of property incident to nontaxable service sales, and
(ii) if such transfers are incident to nontaxable service sales, the proper tax
treatment of the transfer of the PT Materials as an incident thereto. The
College is filing a substantially identical ruling request in each of the
states with which it entered into a voluntary disclosure agreement.

The proficiency testing program (formally referred to as the Interlaboratory
Comparison Program) consists of the testing of pathology laboratories to
determine whether the laboratories meet certain standards required by federal
law and by the College. Under the Clinical Laboratory Improvement Amendments of
1988, 42 U.S.C. 263a, every pathology laboratory in the United States must be
accredited periodically by the Department of Health and Human Services ("HHS")
or another organization recognized by HHS as having standards that are
equivalent to or more stringent than federal accreditation standards. Id. at
263a(e). The only entities that HHS has recognized for these purposes are the
College, other not-for-profit organizations, and agencies of a few state
governments.

In order to obtain accreditation, a laboratory must, inter alia, participate in
a proficiency testing program. A proficiency testing program evaluates the
ability of participating laboratories accurately to perform diagnostic services
for patients. Specifically, the proficiency testing program involves (i) the
transfer to a participating laboratory of a specimen (i. e., the PT Materials)
the composition of which is unknown to the laboratory, (ii) the analysis of the
PT Materials by the laboratory and transmission of the laboratory's findings to
the College, and (iii) the processing and evaluation of the laboratory's
findings by the College. By federal law, the furnishing of the PT Materials to
the laboratory must be by a government agency or a not-for profit entity. See
42 U.S.C. 263a(f).

Most of the PT Materials consist of a human serum or other biologic base that
is "spiked" with the analytes for which each participating laboratory must
test. The College purchases the PT Materials from various manufacturers.

The manufacturer generally delivers the PT Materials by common carrier to a
third party repackager retained by the College or ships the PT Materials by
common carrier directly to each participating laboratory. The manufacturer
invoices the College for the PT Materials at the time the manufacturer ships
the PT Materials to the repackager or directly to the laboratories. The
repackager breaks down the manufacturer's bulk shipment into individual
packages for shipment to the laboratories, adds printed instructions supplied
by the College, and then ships the materials by U. S. Mail or by common carrier
to the participating laboratories.

The laboratory has no independent use for the PT Materials apart from
participating in the testing program. Once a participating laboratory has
concluded its analysis of the PT Materials, the laboratory generally disposes
of those materials. The laboratory sends a report of its analysis to the
College at its headquarters in Illinois, where the College reviews the
laboratory's report. The College evaluates the laboratory's analysis, and it
provides its findings to the laboratory and to the government accreditation
organization designated by the laboratory. When the College provides the
laboratory with its results for each test, the College also provides the
laboratory with the mean result for that test, the standard deviation, the
number of laboratories that participated in the test, the standard deviation
index, the lower and upper limits of acceptability, and a plot of the relative
distance of the laboratory's results from the established target as a
percentage of the allowed deviation.

The College charges laboratories a single subscription amount for participating
in the proficiency testing program. No separate charge is made for the PT
Materials and for the testing service. On average, the cost to the College of
the PT Materials was historically about 45% of the amount it invoiced customers
for providing the proficiency testing service. That percentage has been
decreasing recently, and this year is expected to be approximately 35%. From
time to time, the College also sells PT Materials to laboratories (without
providing testing services) as replacements of samples that were lost or broken
prior to or during a test. The total sales of PT Materials apart from the
testing program are equal to approximately 0.6% of the

College's total receipts from the proficiency testing program.

The specific proficiency testing modules in which a laboratory will enroll
depends on the scope of the work done at the laboratory. Thus, a laboratory
performing a wide range of analyses will participate in a larger number of
modules than a laboratory doing only basic testing. Each specific proficiency
testing module is priced separately.

RULINGS REQUESTED

I. The "true object" of the College's proficiency testing program is the
administration of a proficiency testing service rather than the provision of
the PT Materials; therefore, the College's charges for participation in the
proficiency testing program are not subject to sales or use tax, and the
College is deemed to be the consumer of the PT Materials.

Response: I agree, the College's charges for participation in the proficiency
testing program are not subject to sales or use tax, and the College is deemed
to be the consumer of the PT Materials.

II. The College is not subject to use tax on specimens shipped to Texas
laboratories by common carrier from outside Texas.

Response: Under Rule 3.346, the College owes use tax on specimens shipped to
Texas laboratories by common carrier from outside of Texas.

III. If the College is subject to use tax on specimens shipped to Texas
laboratories by common carriers from outside Texas, the College is entitled to
a credit for tax properly paid to the state from which such materials were
shipped.

Response: As a member of the multistate compact, Texas will allow as a credit
against Texas use tax due any combined amounts of legally imposed sales or use
taxes paid on the same property to another state or any subdivision of another
state. Credit will be allowed even though the other state may not be a member
of the multistate compact.

This opinion is rendered based on the facts presented. If there are additional
or different facts, the opinion may change.

You may call me toll free at 1-800-531-5441, ext. 3-4680. The direct line is
512/463-4680. You may also write to Tax Policy, Comptroller of Public
Accounts. The email address is .

Sincerely,

Al Van Allen
Tax Policy Division