Was a prescription-drug manufacturer's equipment sale exempt because all of its drug sales qualified for the medicine exemption?

Plain-English summary

A manufacturer sold only human prescription antibiotics and claimed that its plant equipment sale was exempt as an occasional sale. It argued that prescription drugs were inherently a kind of property never taxable at retail, so it should not have been required to hold a seller's permit.

The Appeals recommendation disagreed. The medicine exemption depended on how the drugs were distributed and had to be supported with evidence. Because medicine sales were presumed taxable unless the statutory conditions were met, sellers of medicines needed permits so claimed exemptions could be audited.

The manufacturer was therefore a seller required to hold a permit even if all its actual drug sales qualified for exemption. Its $2,995,012 equipment transfer did not qualify as an occasional sale, and the recommendation denied a tax adjustment.

Proceeding, exemption analysis, citations, and source limits

The petition challenged an unreported equipment-sale measure of $2,995,012 for July 1, 1985 through May 21, 1986. Rachelle Laboratories, Inc. manufactured and sold human antibiotics at a Los Angeles plant and, by an April 27, 1986 contract, sold the equipment used in that business to a third party. The source says additional background appeared in a July 17, 1989 original Decision and Recommendation incorporated by reference, but that decision is not included.

An oral Board hearing was set for June 20, 1990, then postponed at the petitioner's request to allow more evidence and argument. Hearing Officer James E. Mahler held a supplemental appeal hearing July 19 in Van Nuys. Attorneys Frederick A. Richman, Linda F. Nelson, and Gerald A. Koris appeared for the petitioner; Supervising Tax Auditor James Lehmann appeared for the Department of Business Taxes.

The petitioner actually held a seller's permit but argued it did not need one because all its products were human prescription drugs and thus property of a kind never taxable at retail. Two employee or former-employee affidavits said it made and sold only prescription drugs, and the Department accepted those affidavits as true.

The Department relied on Annotation 410.0250, which said medicine sellers needed permits even when all sales might qualify under section 6369. The petitioner divided medicines between over-the-counter drugs, whose treatment depended on distribution, and prescription drugs that federal law allowed to be distributed only through exempt methods. It said its antibiotics were not subject to abuse, no evidence showed that kind had been sold illegally, and hypothetical illegal sales or changing federal rules were too remote to justify a permit.

Mahler treated the exemption as circumstance-dependent. Illegal nonprescription sales would not qualify, federal prescription classifications could change, and medicine sellers needed records and audits to establish exemption. He said Annotation 410.0250 came from a November 1971 legal-staff opinion involving a pharmacy that sold taxable and nontaxable items. Although the recommendation says a redacted copy was attached as an exhibit, CDTFA's eight-page PDF ends with the recommendation and does not include that exhibit.

The recommendation cited American Hospital Supply Corp. v. State Board of Equalization, 169 Cal. App. 3d 1088, for giving weight to contemporaneous administrative interpretations unless clearly erroneous; that reporter citation resolves to the named case. It distinguished Annotation 410.0320's no-permit rule for fish markets. Under Annotations 245.0960 and 245.0520, food ordinarily intended for people was deemed nontaxable absent evidence of another use, while food not ordinarily so intended was presumed taxable. Thus no transaction-by-transaction exemption proof was needed for ordinary human food, unlike medicine.

The PDF prints Purdue Fredrick Co. v. State Bd. of Equalization, 281 Cal.App.3d 1021 at 1029 for the proposition that a medicine seller had met its section 6369 burden. Explicit citation verification does not resolve 281 Cal. App. 3d 1021. A separate case-name search finds Purdue Frederick Co. v. State Board of Equalization, 218 Cal. App. 3d 1021 (1990). This page reports that research result but does not silently replace the reporter volume or spelling in the preserved official text.

Mahler remained of the view that the petitioner needed a permit and recommended redetermination without adjustment. His signed date, January 11, controls this page; the recommendation headers say January 1, and the cover letter is January 23. The cover said the petitioner's Board-hearing request was already on file, recommended restoring the matter to the hearing roster, and allowed a request for reconsideration with new evidence or contentions within 30 days. It does not establish that the Board adopted the recommendation.

The PDF does not include the April 27 contract, equipment list, consideration or allocation, permits, sales records, prescriptions, distribution records, affidavits, federal classifications or regulations, returns, audit, tax calculation, assessment, payment, original July 17, 1989 recommendation, November 1971 opinion exhibit, referenced annotations' supporting sources, reconsideration request, hearing notice or transcript, Board minutes or order, redetermination, refund or collection record, or later appeal.

The live annotation preserves the prescription-only business, property of a kind dispute, circumstance-dependent exemption, taxable asset-sale result, and January 11, 1991 date. It omits the named petitioner and counsel, audit period and amount, sale date, original and supplemental procedure, competing illegal-market and federal-policy arguments, accepted affidavits, four cited annotations and missing exhibit, food comparison, two case citations and Purdue error, date layers, pending Board hearing and reconsideration process, recommendation posture, missing records, and absent final action.

What this means for you

Pharmaceutical manufacturers and wholesalers

Having only exempt prescription-drug sales did not eliminate seller status under this historical analysis. The exemption depended on the transaction conditions and documentation.

Accountants and tax professionals

Distinguish property treated as inherently nontaxable from property whose exemption depends on use, distribution, prescription, or other sale conditions.

Common questions

Q: Why was the manufacturer required to hold a seller's permit?
A: Medicine sales were presumed taxable unless the seller established the statutory exemption, making audit verification necessary.

Q: Did it matter that the company sold only prescription drugs?
A: No. The recommendation said prescription status depended on federal classification and did not make the drugs inherently nontaxable property.

Q: Why did the recommendation distinguish fish markets?
A: Food ordinarily intended for human consumption was deemed nontaxable without transaction-by-transaction exemption proof, unlike medicines.

Q: What happened to the equipment sale?
A: It remained taxable because the equipment had been used in a business requiring a seller's permit.

Q: Did the Department dispute that the company sold only prescription drugs?

A: No. It accepted two employee affidavits on that point but maintained that every medicine seller needed a permit to substantiate exemption.

Q: Why were ordinary human-food sellers treated differently?

A: The recommendation said their sales were deemed nontaxable absent evidence of another use, so each customer did not need to supply transaction-specific exemption proof.

Q: Is the printed Purdue reporter citation accurate?

A: 281 Cal. App. 3d 1021 does not resolve. A case-name search finds the named 1990 decision at 218 Cal. App. 3d 1021; the official source's printed text remains preserved unchanged.

Q: Was this the Board's final decision?

A: The source does not show that. The transmittal says the oral-hearing request remained on file and recommends returning the matter to the Board-hearing roster.

Citations and references

• California Revenue and Taxation Code sections 6006.5(a), 6014, 6066, and 6369; California Sales and Use Tax Regulation 1595(a)(1)
• Sales and Use Tax Annotations 410.0250 (November 9, 1971), 410.0320 (October 17, 1950), 245.0960 (September 13, 1957), and 245.0520 (November 25, 1953)
• American Hospital Supply Corp. v. State Board of Equalization (1985) 169 Cal. App. 3d 1088 — reporter citation verified to the named case
• Purdue Fredrick Co. v. State Board of Equalization, printed as 281 Cal. App. 3d 1021 at 1029 — does not resolve; case-name search result is Purdue Frederick Co., 218 Cal. App. 3d 1021
• July 17, 1989 original recommendation and November 1971 legal opinion exhibit — incorporated or described but not included
• Contract, equipment, permit, sales, medicine and exemption evidence, affidavits, tax proceeding, reconsideration, Board hearing and final outcome records — described or implicated but not included

Verbatim support

From the official January 11, 1991 supplemental recommendation and January 23 transmittal:

Petitioner has submitted affidavits from two employees or former employees to the effect that it manufactured and sold only prescription drugs. DBT accepts these affidavits as true.

Persons who sell medicines must therefore report and pay tax to the Board, or retain evidence that the sales qualify for some statutory exemption, and audit verification of any claimed exemptions is necessary.

Since medicines are property “of a kind” which is presumed taxable when sold at retail, persons who sell medicines are “sellers” and are required to hold seller's permits.

Your request for an oral hearing before the Board is already on file. By copy of this letter, I am recommending that this matter be returned to the roster of cases awaiting a Board hearing.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 395.0275
• Original supporting opinion: 395.0275 PDF

Original ruling text

395.0275

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION
1020 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 445-6557

January 23, 1991

--Dear Ms. --:
Re:

XX

Enclosed is a copy of the Supplemental Decision and Recommendation pertaining to the above-referenced petition for redetermination. I have again recommended that the petition be denied. Your request for an oral hearing before the Board is already on file. By copy of this letter, I am recommending that this matter be returned to the roster of cases awaiting a Board hearing. You will be notified when the hearing is scheduled. In the meantime, if you have new evidence or contentions not considered in the Supplemental Decision and Recommendation, you should file a Request for Reconsideration. Any such request must be sent to me within 30 days from the date of this letter, at the address listed above, with a copy to the Principal Tax Auditor at that same address. No special form is required, but the request must clearly set forth any new contentions, and any new evidence must be attached. Very truly yours,

James E. Mahler
Hearing Officer
JEM:ct
Enc
cc:
cc:

XX
(cont’d)
Ms. Janice Masterton
Assistant to the Executive Director (w/enclosure)
Please reschedule the Board hearing.
Mr. Glenn Bystrom
Principal Tax Auditor (file attached)

XX

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Downey – District Administrator (w/enclosure)
Torrance – District Administrator (w/enclosure)

January 1, 1991
395.0275

STATE OF CALIFORNIA

395.0275
BOARD OF EQUALIZATION
APPEALS DIVISION

In the Matter of the Petition
for Redetermination Under the
Sales and Use Tax Law of:

)
)
)
)
RACHELLE LABORATORIES, INC.)
COMPANY, INC.
)
)
Petitioner
)

SUPPLEMENTAL HEARING
DECISION AND RECOMMENDATION

No. SR ADA 16 093193-010

This matter was scheduled for an oral hearing before the Board on June 20, 1990. Prior to that date, petitioner requested and was granted a postponement to present additional evidence and arguments to the Hearing Officer. A supplemental appeal hearing was held for that purpose before Hearing Officer James E. Mahler on July 19, 1990, in Van Nuys, California. Appearing for Petitioner:

Frederick A. Richman
Attorney at Law
Linda F. Nelson
Attorney at Law
Gerald A. Koris
Attorney at Law

Appearing for the Department
of Business Taxes

James Lehmann
Supervising Tax Auditor
Protested Item

The protested tax liability for the period July 1, 1985 through May 21, 1986 is measured by:

Item
A.

Taxable sale of tangible personal
property under Regulation 1595 not
reported

State, Local
County & LATC

$2,995,012

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SR ADA 16 093193-010

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January 1, 1991
395.0275

Petitioner’s Contentions
The products manufactured and sold by petitioner were property “of a kind” never taxable when sold at retail. Summary The petitioner corporation manufactured and sold “human antibiotics” at a plant in Los Angeles, California. By contract dated April 27, 1986, it sold the equipment held or used in this business to a third party. The question is whether that sale was an exempt occasional sale. Additional background information is set out in the original Decision and Recommendation dated July 17, 1989, which is incorporated herein by this reference. The term “occasional sale” as defined in subdivision (a) of Revenue and Taxation Code Section 6006.5 does not include the sale of property held or used in an activity which requires a seller’s permit. The Department of Business Taxes (DBT) argues that petitioner was required to hold and did hold a seller’s permit for its business, so that the sale of equipment was not an occasional sale. Petitioner contends that, while it did in fact hold a seller’s permit, it was not required to do so, and the sale was therefore occasional. Section 6066 of the Code requires a seller’s permit to be held by every person who wishes to engage in business as a “seller in this state. Section 6014 defines “seller” to include: “…every person engaged in the business of selling tangible personal property of a kind the gross receipts from the retail sale of which are required to be included in the measure of the sales tax. “For purposes of this section, the phrase ‘tangible personal property of a kind the gross receipts from the retail sale of which are required to be included in the measure of the sales tax’ includes all tangible personal property of a kind the gross receipts from the retail sale of which is, or would be, required to be included in the measure of the sales tax if sold at retail, whether or not the tangible personal property is ever sold at retail or is suitable for sale at retail.” DBT classified petitioner as a “seller” required to hold a seller’s permit in reliance on Sales and Use Tax Annotation 410.0250 (11/9/71), which provides: “Persons Making Nontaxable Sales. Persons selling ‘medicines,’ as that term is defined in Section 6369(b) of the Revenue and Taxation Code, are required to hold seller’s permits even though all of their sales may be exempt under Section 6369(a) of the code.

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“Medicines’ are not a property of a kind the gross receipts from the retail sale of which are not subject to the tax. It is the circumstances under which the property is sold which may result in an exemption.” Petitioner believes that the annotation should not apply under the facts of this case. In support, petitioner points out that the prescription medicine exemption in Section 6369 has two prerequisites: the property must meet the definition of “medicines” in subdivision (b) of that section; and the property must be distributed by one of the methods specified in subdivision (a), such as sale under prescription from a licensed physician. Thus, drugs which qualify as “medicines” can logically be grouped into two categories: over-the-counter drugs like aspirin, which may or may not be exempt depending on how they are distributed; and prescription drugs, which can legally be distributed only in a manner which qualifies for the sales tax exemption. According to petitioner, federal law restricts the sale of prescription drugs “because of the very nature of the drugs, not because of any ancilliary characteristic or the circumstances under which they are sold.” Thus, prescription drugs are property “of a kind” which is never subject to sales tax, even when sold at retail, and persons who sell only prescription drugs are not “sellers” required to hold seller’s permits. Therefore, petitioner concludes, Annotation 410.0250 must apply only to persons who sell over-the-counter drugs, or some combination of over-the-counter and prescription drugs, but not to persons who sell only prescription drugs. Petitioner has submitted affidavits from two employees or former employees to the effect that it manufactured and sold only prescription drugs. DBT accepts these affidavits as true. However, DBT believes that Annotation 410.0250 applies to all persons in the business of selling medicines, even persons who sell only prescription drugs, and that petitioner was therefore a “seller” required to hold a permit. DBT points out that if prescription drugs are sold illegally (for example, without prescription) the sales do not qualify for exemption under Section 6369. Thus, the exemption does not depend on the nature of the property itself, but rather on the circumstances of the sale. DBT concludes that prescription medicines are property “of a kind” which may be taxable when sold at retail. Persons who sell prescription medicines must therefore be required to hold seller’s permits so they can be audited to verify that claimed exempt sales are in fact exempt. Petitioner responds that the types of drugs it sold were not subject to abuse, and there was accordingly no illegal market for them. There is no evidence that drugs of the type sold by petitioner have ever been sold illegally. Petitioner contends that the hypothetical possibility of taxable illegal sales is so remote that it should not require the holding of a seller’s permit. In this regard, Annotation 410.0320 (10/17/50) was discussed at the hearing. That annotation states that fish markets selling “only fish for human consumption” are not required to hold seller’s permits, apparently on the theory that fish for human consumption is not property “of a kind” which is taxable when sold at retail. Petitioner points out that some customers of fish

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markets may purchase fish for cat food, in which case tax would apply. If the possibility of taxable sales does not require fish markets to hold seller’s permits, petitioner concludes, the remote possibility of illegal drug sales should not require drug manufacturers to hold permits. DBT also notes that the distinction between prescription and over-the-counter drugs depends on federal law. DBT argues that the classification does not depend on the nature of the drug itself, but rather on the interpretation and administration of federal regulations. Since the Federal Government’s policies in this area are subject to change, persons who sell drugs must be required to hold permits so that periodic audits can verify whether their sales continue to be exempt from tax. Petitioner agrees that the federal regulations can change, but states that the classification of the drugs it sold has not changed in the years since the sale at issue. Again, petitioner believes that the bare possibility of changes in federal law is not sufficient to require a drug manufacturer to hold a seller’s permit. Analysis and Conclusions Annotation 410.0250 is based on an opinion letter issued by the Board’s legal staff in November 1971. A copy of that letter, with confidential information deleted, is attached hereto as an exhibit. The opinion dealt with a pharmacy which sold both taxable and nontaxable items. The question was whether a sale of property used exclusively in selling exempt prescription medicines would qualify for the occasional sale exemption. The author of the opinion recognized the distinction between over-the-counter drugs and prescription medicines, but concluded that prescription medicines are not property “of a kind” always exempt from tax, since the prescription medicine exemption depends in part on the conditions of sale and not exclusively on the nature of the property. The annotation based on this letter therefore expressly states that persons who sell medicines must hold seller’s permits “even though all of their sales may” qualify for the prescription medicine exemption. Annotations are not formal regulations. They are nonetheless evidence of how the Board has interpreted and administered the Sales and Use Tax Law. As contemporaneous administrative interpretations, they are entitled to great weight and should be followed unless clearly erroneous. (American Hospital Supply Corp. v. State Bd. of Equalization, 169 Cal.App.3d 1088.) I believe that Annotation 410.0250 is a correct interpretation of the law. The distinction between over-the-counter drugs and prescription medicines depends on federal law, not on the nature of the property itself. The Federal Government regulates sales of some medicines because it believes they are more dangerous than others, but the difference is one of degree and not one of kind. Furthermore, the federal rules as to which medicines may or may not be sold without prescription are continuously updated. I see no reason why the duty to hold a California seller’s permit should depend on changeable policies of the Federal Food and Drug

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Administration, which have nothing to do with our Sales and Use Tax Law. My decision at first glance may appear to conflict with Annotation 410.0320, which allows certain fish markets to operate without seller’s permits. Fish is exempt only when sold for human consumption, not when sold for other purposes. Arguably, therefore, the exemption depends on the circumstances of sale, not on the nature of fish itself, and fish markets should therefore be required to hold permits. The conflict is more apparent than real, however. With certain specific exceptions, the Board has previously decided that tax does not apply to sales of food products of a type ordinarily intended for human consumption, absent evidence that the food product was in fact sold for some purpose other than human consumption. (See Sales and Use Tax Annotation 245.0960 [9/13/57]; compare Sales and Use Tax Annotation 245.0520 [11.25/53], stating that sales of food products of a type not ordinarily intended for human consumption are presumed taxable.) Thus, when food products such as fish are sold, the seller need not charge tax reimbursement or require an exemption certificate from each individual customer; fish is property “of a kind” ordinarily intended for human consumption, and the sales are therefore deemed nontaxable, even though a few customer might purchase fish as pet food. Since the sales are deemed nontaxable, no audit verification of claimed exemptions is necessary, and there is accordingly no reason to require a seller’s permit. In short, food products of a type ordinarily intended for human consumption are property “of a kind” deemed nontaxable when sold at retail. Bakeries, fish markets and similar establishments selling only such food products are therefore not “sellers” required to hold seller’s permits. Sales of medicines, on the other hand, are presumed subject to tax. (See Purdue Fredrick Co. v. State Bd. of Equalization, 281 Cal.App.3d 1021 at 1029, holding that plaintiff had “met its burden of proof” for exemption under Section 6369.) Persons who sell medicines must therefore report and pay tax to the Board, or retain evidence that the sales qualify for some statutory exemption, and audit verification of any claimed exemptions is necessary. Since medicines are property “of a kind” which is presumed taxable when sold at retail, persons who sell medicines are “sellers” and are required to hold seller’s permits. For these reasons, I remain of the opinion that petitioner was required to hold a seller’s permit for its business. The sale of equipment in question therefore does not qualify as a nontaxable occasional sale. At the supplemental appeal hearing, petitioner’s representatives indicated that they may wish to present additional evidence or arguments on some other issues. Any such additional evidence or arguments should be presented to the Hearing Officer by a Request for Reconsideration. The procedures for filing a Request for Reconsideration are set out in the cover letter accompanying this Decision and Recommendation.

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Recommendation
Redetermine without adjustment to the tax.

__________
James E. Mahler, Hearing Officer

1/11/91
____
Date