Can a medical diagnostic laboratory buy reagents used to test blood and urine samples exempt from Virginia sales tax under the medicines-and-drugs exemption for hospitals and clinics?

Plain-English summary

A company that runs medical diagnostic laboratories in Virginia requested a sales and use tax refund, arguing it had overpaid tax on several kinds of purchases. The auditor granted most of the refund, but denied two categories: tax accrued on reagents used to test human blood, urine, and other specimens, because the auditor questioned whether the reagents qualified for the medicines-and-drugs exemption, and tax paid or accrued on certain service and maintenance transactions where the taxpayer hadn't provided enough documentation.

On the reagents, the taxpayer argued they met the Virginia Drug Control Act's definition of a "drug" -- and the Department agreed they likely did, since the Act broadly covers substances intended for diagnosing, curing, treating, or preventing disease. But meeting the drug definition alone isn't enough. The sales tax exemption in Va. Code § 58.1-609.10(9) is narrower: it exempts medicines and drugs purchased by a hospital, nursing home, clinic, or "similar corporation," and Virginia courts require sales tax exemptions to be strictly construed. The Department explained that the entities the statute covers all directly provide medical or surgical treatment, nursing care, or outpatient treatment to patients. A diagnostic laboratory is different: it performs testing and analysis on specimens so that other medical providers can use the results to diagnose and treat their own patients -- it doesn't itself administer or consume the reagents on patients, and it doesn't provide direct treatment or care. The Department also distinguished a prior ruling the taxpayer relied on, P.D. 15-242, which had extended the exemption to a for-profit family medical practice -- a practice that, unlike a diagnostic lab, actually provides medical care and treatment to patients. So the reagent refund was properly denied.

On the service and maintenance transactions, though, the taxpayer supplied substantial additional documentation with its appeal that hadn't been available to the original auditor, and the Department found at least one transaction likely eligible for a refund on review. Rather than deciding that issue outright, the case was remanded: the taxpayer must reconcile its appeal documentation with the amounts originally claimed and submit it to the auditor, who will issue a written decision on each item, with a fresh 90-day right to appeal if the taxpayer disagrees with that follow-up determination.

What this means for you

Medical labs, testing companies, and other health-adjacent businesses

Don't assume that because a purchased item is chemically or legally a "drug" or "medicine," your business automatically qualifies for Virginia's medicines-and-drugs sales tax exemption. The exemption turns on what your business does -- whether you directly provide medical or surgical treatment, nursing care, or outpatient care to patients -- not just on what you're buying.

Anyone appealing a refund denial for lack of documentation

Bring your full documentation to the appeal even if the original audit denied a refund for insufficient support. Here, supplemental documentation submitted only at the appeal stage got at least one transaction reconsidered for a refund, remanded back to the auditor for a fresh look.

Common questions

Q: Does a substance qualifying as a "drug" under Virginia's Drug Control Act automatically qualify for the sales tax medicines-and-drugs exemption?
A: No -- meeting the Drug Control Act's definition is necessary but not sufficient. The purchaser must also be a hospital, nursing home, clinic, or "similar corporation" as defined for purposes of Va. Code § 58.1-609.10(9).

Q: Does a diagnostic testing laboratory count as a "similar corporation" to a hospital or clinic?
A: No, according to this ruling -- a lab that tests specimens for other providers to use in diagnosis and treatment, without itself administering treatment or consuming the reagents on patients, isn't a "similar corporation" under the exemption.

Q: Can a refund claim still succeed on some items even after an audit denies part of it?
A: Yes -- submitting more complete documentation at the appeal stage can get individual transactions reconsidered and remanded to the audit staff for a fresh determination, as happened here with the service and maintenance transactions.

Citations and references

• Va. Code § 58.1-609.10(9) (exemption for medicines and drugs purchased by hospitals, nursing homes, clinics, and similar corporations)
• Va. Code § 54.1-3401 (Virginia Drug Control Act definition of "drug")
• 23 VAC 10-210-940 (medicines and drugs exemption regulation)
• 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 qualified as controlled drugs for licensed prescribers)
• P.D. 15-242 (12/23/2015) (for-profit family medical practice qualified as a "similar corporation"; distinguished here)

Subject

Exemption: Medicine and Drugs - Reagents/Medical Diagnostic Lab; Virginia Medical Control Act; Hospitals, Clinics, Nursing Homes and Similar Corporations Requirements Not Met Audit: Refund - Separately Stated Labor

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 23-22

Original ruling text

March 1, 2023

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 March 2015 through December 2015. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer, an operator of medical diagnostic laboratories in Virginia, timely submitted a refund request for the period at issue and received a refund credit for tax paid on several transactions because tax was either accrued or remitted on exempt transactions, or use tax was paid on transactions for which the vendor charged sales tax on the invoice. However, the auditor denied the Taxpayer a 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 or accrued on certain service or maintenance transactions 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 the transactions for certain service or maintenance transactions.

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 was not a “similar corporation” to a licensed hospital, nursing home or clinic.

Regarding P.D. 15-242, cited by the Taxpayer, 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.

Service or Maintenance Transactions

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.

The Taxpayer provided substantial documentation with its appeal, alleging it is entitled to a refund on various transactions unrelated to reagents. A review of the documentation provided indicates that tax on at least one of these transactions may be eligible for a refund.

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.

However, the tax on at least one of the service and maintenance transactions cited by the Taxpayer may be eligible for a refund. Accordingly, this case will be remanded to the appropriate audit staff to fully consider the Taxpayer’s claims and issue any necessary refund. The Taxpayer should review the documentation provided on appeal to ensure they reconcile with amounts claimed in the refund request and submit them to the auditor, *, who can be contacted at , or **. The Taxpayer must provide the auditor with sufficient information to reconcile the information provided on appeal with the information provided in the original refund request. The auditor will review the Taxpayer’s claims and issue a refund, as warranted.

Once the auditor’s review is completed, she will issue a written summary explaining which portions of the refund request have been approved and refunded, which have been denied, and the basis for such decisions. If the Taxpayer disagrees with the auditor’s determination with regard to the service and maintenance transactions, it will have ninety days from the date of the auditor’s updated report to file an appeal pursuant to Virginia Code § 58.1-1821.

The Code of Virginia sections, regulations, and the public documents cited are available online at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s website. If you have any questions about this determination, you may contact * in the Department’s Office of Tax Policy, Appeals and Rulings, at , or via email at **.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/2219-C

Related Documents

01-52

15-242

22-132