My lab uses chemical reagents that qualify as drugs to run diagnostic blood and urine tests -- can I buy them exempt from sales tax the way a hospital or clinic can buy its medicines?

Plain-English summary

A company providing diagnostic testing and analytical services -- everything from routine blood tests to complex gene-based and molecular testing, drug and wellness screening for employers, and lab work for clinical drug trials -- requested a sales and use tax refund on purchases it made during 2013. The auditor granted refund credit for several categories (labor charges, freight, nontaxable services, electronically delivered software, and some use tax correctly self-assessed) but denied refund credit for tax accrued on chemical reagents the company used to test blood, urine, and other bodily specimens, questioning whether those reagents genuinely qualified for Virginia's medicines-and-drugs exemption. The company appealed, arguing its reagents met the legal definition of a "drug" and that its business should count as a "similar corporation" to the hospitals, clinics, and nursing homes the exemption explicitly covers.

The Department didn't dispute that the reagents themselves could qualify as "drugs" under the Virginia Drug Control Act's broad definition (which covers substances intended for use in diagnosing, treating, or preventing disease) -- it had reached a similar conclusion about comparable biological and allergy products in an earlier ruling. But qualifying as a drug is only half the test. Virginia's exemption specifically requires the PURCHASER to be a licensed hospital, nursing home, clinic, or a corporation similar to one of those -- entities whose defining role is providing direct medical or surgical treatment, nursing care, or outpatient patient services. Sales tax exemptions are strictly construed under Virginia case law, meaning any ambiguity gets resolved against the taxpayer claiming the exemption, not in its favor.

The company's actual business didn't fit that mold. It doesn't treat or care for patients directly, on either an inpatient or outpatient basis -- it analyzes specimens in a lab setting to generate information that other medical providers then use to diagnose and treat their own patients. And critically, the reagents themselves aren't administered to or consumed by any patient by the company -- they're lab tools used to run tests, not medicines dispensed to a person. The company also pointed to an earlier ruling (P.D. 15-242) that extended the exemption to a for-profit family medical practice, but the Department distinguished that case: a family medical practice does provide direct medical care and treatment to patients, which is exactly what this diagnostic lab does not do. Because the company isn't a "similar corporation" to a qualifying hospital, clinic, or nursing home, its reagent purchases stayed taxable, and the auditor's refund denial on that item was upheld. Separately, the company's additional refund claims for labor charges and vendor-collected tax were also denied for lack of supporting documentation.

What this means for you

Diagnostic testing labs, reference labs, and similar analytical service providers

Don't assume that using drug-classified reagents automatically qualifies your business for the medicines-and-drugs exemption -- the exemption turns on what kind of entity YOU are (a hospital, nursing home, clinic, or a corporation providing comparable direct patient treatment), not just on whether the substance itself would separately qualify as a "drug."

Medical practices considering whether they qualify as a "similar corporation"

The deciding factor is whether your business directly treats or cares for patients -- a for-profit family medical practice can qualify (as in P.D. 15-242), but a lab that only analyzes specimens to inform OTHER providers' diagnoses and treatment does not, because it doesn't administer the medicines/drugs to a patient itself.

Businesses appealing a sales tax refund denial

Make sure to submit actual documentation (invoices, receipts) supporting every item in your refund claim -- here, additional claims for labor charges and vendor-collected tax were denied simply because no supporting records were provided with the appeal, separate from the reagent exemption issue.

Common questions

Q: If a chemical or substance meets the legal definition of a "drug," is it automatically exempt from Virginia sales tax?
A: No -- the medicines-and-drugs exemption also requires the PURCHASER to be a qualifying entity: a licensed hospital, nursing home, clinic, or a corporation similar to one of those, meaning an entity that directly treats or cares for patients. A business that merely uses drug-classified substances as lab tools, without administering them to patients, doesn't qualify even if the substance itself is a "drug."

Q: Why doesn't a diagnostic testing lab count as a "similar corporation" to a hospital or clinic?
A: Because it doesn't provide direct medical or surgical treatment, nursing care, or outpatient patient services -- it analyzes specimens to generate information other medical providers use, and it doesn't administer or consume the reagents in a patient's care the way a hospital or clinic does.

Q: Did an earlier ruling exempt a similar business, and why didn't it apply here?
A: P.D. 15-242 extended the exemption to a for-profit family medical practice, but that practice directly treats and cares for patients -- unlike a diagnostic lab that only performs testing and analysis for other providers, which is why that precedent didn't help this taxpayer.

Citations and references

• Va. Code § 58.1-609.10(9) (exemption for medicines and drugs purchased by hospitals, nursing homes, clinics, or similar corporations)
• Va. Code § 54.1-3401 (Virginia Drug Control Act definition of "drug")
• Title 23 VAC 10-210-940 (regulation consistent with the Drug Control Act's drug definition)
• Va. Code § 58.1-633 (dealer recordkeeping requirements)
• Commonwealth v. Community Motor Bus Co., Inc., 214 Va. 155, 198 S.E.2d 619 (1973) (sales tax exemptions strictly construed)
• P.D. 01-52 (4/30/2001) (biological/allergy products qualifying as controlled drugs)
• P.D. 15-242 (12/23/2015) (for-profit family medical practice qualifies as a "similar corporation" providing direct patient treatment)

Subject

Exemptions : Medicines and Drugs - Chemical Reagents, Eligible Hospitals, Clinics, Nursing Homes and Similar Corporations

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-132

Original ruling text

August 24, 2022

Re: § 58.1-1821 Refund Appeal: Retail Sales and Use Tax

Dear *:

This is in response to your letter submitted on behalf of * (the “Taxpayer”) in which you dispute the denial of a retail sales and use tax refund for the period January 2013 through December 2013. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer is a provider of diagnostic testing and analytical services with locations in Virginia and throughout the United States. The Taxpayer’s services range from routine blood tests to complex gene-based and molecular testing that aid in the diagnosis or detection of diseases, as well as, measuring the progress or recovery from a disease or confirming an individual is free from disease. The Taxpayer also provides drug, health and wellness screening for employers and laboratory services in connection with clinical research trials on new drugs.

The Taxpayer timely submitted a refund request for the period at issue and received a refund credit for tax paid on labor charges, freight charges, nontaxable services, electronically delivered software and use tax accrued on some items correctly taxed by the vendor. However, the auditor denied the Taxpayer refund credit for tax accrued on reagents used in testing human blood, urine, and other bodily specimens because the auditor questioned whether the reagents qualified for the medicines and drugs exemption. In addition, refunds were not granted for tax paid on labor or tax accrued on purchases upon which the vendor collected the tax because sufficient documentation was not provided.

The Taxpayer contests the disallowance of the refund credits for tax accrued on the purchase of reagents claiming the reagents meet the definitional requirements of a drug in accordance with the Virginia Drug Control Act (Chapter 34 of Title 54.1, Virginia Code § 54.1-3400 et seq.). In addition, the Taxpayer asserts it is entitled to the tax refund denied on additional separately stated labor charges and tax accrued by the Taxpayer on additional purchases upon which the vendor properly charged the tax.

DETERMINATION

Medicines and Drugs

Virginia Code § 58.1-609.10 9 provides exemptions related to sales and purchases of medicines and drugs. At issue in this case is the exemption for “medicines and drugs purchased for use and consumption by a licensed hospital, nursing home, clinic or similar corporation not otherwise exempt under this section.” The Taxpayer believes its business operation is a “similar corporation” and, therefore, its purchases of reagents as drugs should qualify for the exemption. In addition to the exemption statute, the Taxpayer cites Public Document (P.D.) 15-242 (12/23/2015) in support of its claims.

The reagents in question are chemical compounds that consist of drugs and other substances. The reagents are used to react with other chemical or biological substances in order to promote a reaction that can help diagnose potential diseases or medical deficiencies.

Virginia Drug Control Act

Virginia Code § 54.1-3401 defines “drug” to mean:

(i) articles or substances recognized in the official United States Pharmacopoeia National Formulary or official Homeopathic Pharmacopoeia of the United States, or any supplement to any of them;

(ii) articles or substances intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease in man or animals;

(iii) articles or substances, other than food, intended to affect the structure or any function of the body of man or animals;

(iv) articles or substances intended for use as a component of any article specified in clause (i), (ii), or (iii); or (v) a biological product.

This definition is consistent with the definition set forth in Title 23 of the Virginia Administrative Code (VAC) 10-210-940. The Taxpayer cites (ii) to support its claim that the reagents are drugs.

In a prior determination issued as P.D. 01-52 (4/30/2001), the Tax Commissioner addressed biological and allergy products as drugs. The Tax Commissioner determined that the products at issue qualified as drugs pursuant to the Virginia Drug Control Act based on the Virginia Pharmacy Board’s classification of the products as Schedule VI controlled drugs for use by licensed physicians and prescriber practitioners. As the products in P.D. 01-52 may be similar to the reagents in this case, the Department does not dispute that the reagents may be defined as controlled drugs. However, in order for the reagents to be purchased exempt (or to qualify for a refund credit of tax), the Taxpayer’s business operation must be similar to that of the qualifying entities stated in Virginia Code § 58.1-609.10 9.

Hospitals, Clinics, Nursing Homes and Similar Corporations

Sales and use tax exemptions are strictly construed pursuant to the decision in Commonwealth v. Community Motor Bus Co., Inc. , 214 Va. 155, 198 S.E.2d 619 (1973). The medical entities cited in Virginia Code § 58.1-609.10 9 qualify for the exemption because their purchases of medicines and drugs are consumed or administered in their perspective roles as providers of (1) medical and surgical treatment to patients, (2) nursing home care for sick or injured persons, and (3) outpatient medical treatment and patient services, respectively. The Taxpayer, however, is engaged in providing diagnostic testing and analytical services in a laboratory setting for the purpose of testing human specimens in order to obtain information for medical providers (such as the stated entities) to use in the diagnosis, treatment and care of their patients. The Taxpayer does not provide direct medical treatment and care to individuals on an inpatient and outpatient basis. In addition, the reagents are not consumed by or administered to individuals by the Taxpayer. Rather they are used by the Taxpayer to perform diagnostic and analytical services. Based on these differences, the Taxpayer cannot be considered a “similar corporation” to a licensed hospital, nursing home or clinic.

Regarding P.D. 15-242, the Tax Commissioner determined that a for-profit family medical practice qualified for the exemption in Virginia Code § 58.1-609.10 9 regarding purchases of medicines and drugs for use in the medical practice. This decision was made in accordance with the 2006 statutory amendment that expanded the exemption to include purchases of medicines and drugs by nursing homes, clinics, and similar corporations. In this instance, the Taxpayer is not similar to a family medical practice engaged in providing medical care and treatment to patients. Therefore, P.D. 15-242 is not applicable to this case.

Taxpayer Records

The Taxpayer also claims the auditor denied refund credits for the tax paid on separately stated labor charges, and the tax accrued by the Taxpayer on purchases upon which the vendor properly charged the tax.

Virginia Code § 58.1-633 requires every dealer “to keep and preserve suitable records of the sales, leases, or purchases . . . . and such other books of account as may be necessary to determine the amount of tax due hereunder, and such other pertinent information as may be required by the Tax Commissioner.” This record keeping requirement is further explained in 23 VAC 10-210-470.

According to the audit report, the auditor gave refund credits for the tax paid on separately stated labor, and for use tax accrued on purchases upon which the vendor properly charged the tax, when documentation was provided to support the payment or overpayment of the tax. The auditor denied only those refund claims lacking documentation to support the payment of the tax.

CONCLUSION

In accordance with Virginia Code § 58.1-609.10 9, the Taxpayer’s purchase of reagents used for diagnostic testing do not qualify for the cited exemption in Virginia Code § 58.1-609.10 9. Therefore, the auditor properly denied the refund of taxes accrued by the Taxpayer on its purchases of biological and chemical reagents used in providing diagnostic testing and analytical services.

Further, the Taxpayer provides no documentation with its appeal to support additional claims of taxes paid on separately stated labor charges, and for use tax erroneously accrued on purchases properly taxed by the vendor. Lacking documentation, there is no basis to grant any additional refund credits for these transactions. Based on the foregoing, the credits granted and the refund determined by the auditor are correct.

The Code of Virginia and regulation sections and the public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s web site. If you have any questions about this response, you may contact * in the Department’s Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/3523.J

Related Documents

01-52

15-242