Did orgotein lose the prescription-medicine exemption because it was used in a paid clinical study?

Plain-English summary

San Jose audit staff asked about orgotein and related materials that a drug company bought under a resale certificate and later charged to research and development. In 1975 the company contracted with hospitals and clinics for a 16-week, double-blind, placebo-controlled rheumatoid-arthritis study, with at least 24 patients planned at each clinic and an all-inclusive fee of $1,675 per patient, prorated for dropouts.

The company supplied coded single-use vials containing orgotein or placebo, special diluent and propoxyphene for possible participant use. Investigators kept propoxyphene distribution and use records, patients kept propoxyphene diaries, and study information returned to the company for evaluation.

The memorandum found no resale to the clinics because the study materials were furnished free of charge and were essential to the experiment. The resale certificate therefore was improper. Separately, experimental status did not prevent orgotein from qualifying as medicine. The paid study doctors acted as the company's agents, so their prescribing and furnishing of orgotein to their own patients was attributable to the company and the sale of orgotein to the company was exempt under the historical rule.

Live annotation and source posture

The current live annotation matches the memorandum's orgotein holding, physician-agency analysis and exempt-sale conclusion. It states that no charge was made to patients. The source separately says each patient's participation was voluntary without payment by either DDI or the hospital, which addresses participant compensation, and says the materials were furnished free to clinics. This page preserves those distinct statements rather than treating them as identical.

The conclusion is product-specific. Counsel assumed that orgotein and related materials meant orgotein, sucrose solution and diluent, and the source also discusses placebo and propoxyphene. But its ultimate exemption sentence says only that the sale of orgotein to the company was exempt. It does not separately classify the placebo, sucrose, diluent, propoxyphene, cartons or vials. The page therefore does not extend the orgotein conclusion to every study input.

The memorandum cites an attorney's analogy to Annotations 425.0040 and 425.0140, saying both involved companies contracting with physicians to treat employees. The current official 425.0140 page supports that house-physician proposition. The current 425.0040 page, however, is an unrelated esophageal-dilator opinion dated October 6, 1993—fifteen years after this memorandum. The supplied official records do not identify the intended 1978 cross-reference, so this page preserves the mismatch without borrowing facts from current 425.0040.

Counsel independently compared the study with Annotation 425.0440, whose current page concerns employer-purchased influenza vaccine administered to employees who consented to become the employer doctor's patients. The distinct vaccine and employment facts are not imported into this drug study.

The source also prints Regulation 1521 once when asking whether orgotein's experimental nature defeated medicine classification. Every surrounding discussion, quotation and conclusion applies Regulation 1591. No supplied record explains the isolated number, so it remains unchanged below.

The July 14 audit memorandum, taxpayer-client correspondence, clinic contracts, Protocol Art. 3-02(H), purchase documents and audit workpapers are absent. The source supplies no quantities purchased, allocation among orgotein and other materials, tax amount, assessment, refund or final audit result.

The official five-page PDF has a complete native text layer and no raster images, so no OCR was required. Two fresh direct PDF downloads and two live-page downloads were byte-identical; duplicate default text extractions also matched.

CDTFA's Annotated Legal Opinions collection says the opinion letters are summarized as annotations and statutory law controls when a statute and annotation conflict.

What this means for you

Experimental status alone did not disqualify orgotein under this historical analysis. The result depended on paid study doctors acting as the company's agents, prescribing for specific patients and furnishing the medicine to their own patients for treatment.

That exempt-use theory was different from resale: free clinic transfers did not become sales merely because the company paid investigators and received research information. For a current study, document title, consideration, every material supplied, investigator agency, prescribing authority, patient relationship, furnishing method and actual allocation before classifying purchases.

Common questions

Q: Did experimental status alone make orgotein taxable?

A: No. The memorandum treated orgotein as commonly recognized for medicinal use despite its limited human use.

Q: Did the company resell the study materials to the clinics?

A: No. It supplied them free for work essential to the experiment, so the source found no sale under section 6006 and said the resale certificate was improper.

Q: Why could the company's orgotein purchase still be exempt?

A: The paid investigators acted as company agents and prescribed and furnished orgotein to their own patients for treatment.

Q: Did the exemption cover every related material?

A: The final holding names orgotein only. The source does not separately resolve the placebo, sucrose, diluent, propoxyphene, cartons or vials.

Q: Was the arrangement treated like free samples given to independent doctors?

A: No. The memorandum said an independent doctor's later sample use would not be attributable to the manufacturer, while the study doctors' use was attributable to the company through agency.

Missing evidence and references

• July 14, 1978 San Jose audit memorandum — referenced but absent
• Taxpayer and client correspondence — reviewed by counsel but absent
• Clinic and hospital investigator contracts — described but absent
• Protocol: Art. 3-02(H) Orgotein vs. Placebo in Rheumatoid Arthritis — reviewed but absent
• Purchase invoices, resale certificate, research-and-development charges and product quantities — not supplied
• Allocation among orgotein, placebo, sucrose, diluent, propoxyphene, vials and cartons — not supplied
• Participant enrollment, prescriptions, investigator records and patient diaries — described but absent
• Audit adjustment, tax amount, taxpayer response, assessment, refund and final outcome — not supplied
• Intended 1978 authority behind the current 425.0040 cross-reference — unresolved

Verbatim support

From the official September 8, 1978 Headquarters-Legal memorandum:

We have concluded that the experimental nature of the drug, orgotein, does not preclude its classification as a substance or preparation intended for use by external or internal application to the human body in the diagnosis, cure, mitigation, treatment or prevention of disease and which is commonly recognized as a substance or preparation intended for such use.

We are of the opinion that these items were not “resold” since they were furnished free of charge to the clinics for use in the experiment and were in fact essential to the success of the experiment.

In the case of DDI, the doctors being paid to participate in the orgotein study can be considered to be agents of DDI.

Thus the sale of orgotein to DDI was of a “medicine” in the manner prescribed in 1591(a)(1) and (2) and tax will not apply to such sales.

Citations and references

• California Revenue and Taxation Code § 6006 — sale definition applied to the claimed resale to study clinics
• California Revenue and Taxation Code § 6369 and historical California Sales and Use Tax Regulation 1591(a)(1)-(5) — prescription-medicine provisions quoted and applied in the memorandum
• Annotation 425.0040 — current official page is later and unrelated, as disclosed above
• Annotation 425.0140 — house-physician guidance cited through the taxpayer's attorney
• Annotation 425.0440 — employer-purchased influenza-vaccine guidance used by counsel's analogy

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 425.0050
• Original supporting opinion: 425.0050 PDF
• Cited live authority: Annotation 425.0140
• Cited live authority: Annotation 425.0440

Original ruling text

State of California

Board of Equalization

Memorandum

To:

Mr. Frank Holby
San Jose District Principal Auditor

From:

Mary Armstrong
Headquarters - Legal

Subject:

D--- D---, Inc.

425.0050

September 8, 1978

SR – XX XXXXXX

This is in response to your memorandum of July 14, 1978 concerning a problem which arose in your audit of the referenced taxpayer. In the interim we have also received copies of correspondence between taxpayer and its clients, as well as a document entitled “Protocol: Art. 3-02(H) Orgotein vs. Placebo in Rheumatoid Arthritis.” DDI is a retailer and wholesaler of animal feed and medicine. It is also involved in substantial research and development in the area of drugs for the treatment of human beings. Your audit revealed that DDI has purchased a drug called orgotein and other related materials under a resale certificate. These were later charged to research and development for clinical testing. You wish to know the correct application of tax to the orgotein and related materials. Our examination of taxpayer’s letters and the Protocol reveal the following fact situation: In 1975, DDI contracted with various hospitals and clinics to serve as investigators in DDI’s study “Orgotein vs. Placebo in Rheumatoid Arthritis.” The fee contracted for was an allinclusive fee per patient of $1,675 with dropouts prorated appropriately. The fee amount was designed to cover an initial examination of the patient, sixteen weeks of injections, reappraisal examinations, all laboratory work, three ophthalmological examinations by a consultant, and miscellaneous expenses such as mailing forms, laboratory samples, etc.

Mr. Frank Holby

-2-

September 8, 1978
425.0050

The drug involved in the study, Orgotein, has been widely used for the treatment of arthritis in horses. It has had limited use in humans for the treatment of both rheumatoid arthritis and osteo-arthritis. The primary purpose of the study proposed by DDI was to demonstrate, in patients with active rheumatoid arthritis, the anti-inflammatory efficacy of orgotein either as primary therapy or as concomitant therapy with aspirin, aspirin and corticosteroid, or gold plus aspirin. The study proposed by DDI was a 16 week double-blind, placebo controlled study. At least 24 patients were to be studied at each clinic. During the course of the study, DDI supplied medication in 4mg single use vials, to be reconstituted in DDI special diluent (sodium chloride injection USP, without preservative ph 6.57.0). All vials supplied by DDI were code labeled and contained either orgotein (4mg of orgotein and 8mg sucrose) or a placebo (8mg sucrose). The orgotein and placebo were supplied in cartons. Each patient participating in the study was assigned a carton which contained the medication to be given that patient during the course of the study. In addition to the orgotein or placebo, DDI also supplied propoxyphene (Darvon) to the clinincs for the participant’s use if necessary. Each investigator was required to maintain records of its distribution and use and patients were required to keep a diary of their daily propoxyphene consumption. Each patient’s participation in the study was on a voluntary basis without payment by either DDI or the hospital. DDI’s attorney, Mr. D--- B---, contends that orgotein qualifies as a “medicine” under Regulation 1591 despite its experimental usage since it is administered by physicians under contractual agreement with DDI. It is Mr. B---’s opinion that the adminstration of drugs to participants of DDI’s study, by doctors who have been paid by DDI to perform this function is similar to situations found in Business Taxes Law Guide Annotations 425.0040 and 425.0140. Both of these annotations deal with the situation where medicines are sold to companies which contract with physicians who administer the medicines in the medical treatment of other employees. It has been the Board’s position that the sale of “medicines” to the companies in this type of situation qualifies as a sale of “medicines” furnished by a licensed physician to his own patients and therefore would be exempt from tax under Regulation 1591(a)(1) through (5). In our opinion, there are three problems which must be resolved in order to determine the correct application of tax in this situation. The first question is whether or not the experimental nature of the drug, orgotein, precludes its classification as a “medicine” under Regulation 1521. Secondly, it must be determined whether it was proper for DDI to purchase the drugs in question under a resale certificate and finally we must determine whether the drugs were sold, stored, consumed or used in the manner prescribed in Regulation 1591(a)(1) through (5).

Mr. Frank Holby

-3-

September 8, 1978
425.0050

We have concluded that the experimental nature of the drug, orgotein, does not preclude its classification as a substance or preparation intended for use by external or internal application to the human body in the diagnosis, cure, mitigation, treatment or prevention of disease and which is commonly recognized as a substance or preparation intended for such use. Although, according to the information contained in the “Protocol” orgotein has not been widely used, we are of the opinion that it can still be considered a substance or preparation “commonly recognized” for use as a “medicine.” As such, when “orgotein” is sold in the manner prescribed in Regulation 1591(a)(1) through (5), it will be exempt from tax as a “medicine.” In order to determine whether the orgotein was sold, stored, used or consumed in the manner prescribed in Regulation 1591(a)(1) through (5), the various transfers of property must be broken down. As we understand it, DDI purchased “orgotein and related materials combined for experimental purposes” from W--- C--- Corporation under a resale certificate. These purchases were later changed to research and development when they were used in the course of the orgotein study. The orgotein and placebo, as well as the diluent, were then sent to the various clinics participating in the study. Each clinic was paid an agreed upon fee to administer orgotein or the placebo and perform other duties as required. We have assumed for purposes of analysis that what is meant by “orgotein and related materials” is the orgotein, sucrose solution and the dilutent. The question arises as to whether DDI can be considered to have resold the orgotein and related supplies to anyone under these facts. We are of the opinion that these items were not “resold” since they were furnished free of charge to the clinics for use in the experiment and were in fact essential to the success of the experiment. All information concerning the volunteers who were being treated was sent to DDI for evaluation. Thus under the facts presented, a “sale” within the meaning of Revenue and Taxation Code Section 6006 did not take place and the drugs and related materials should not have been purchased under a “resale” certificate. If the sale of orgotein and related supplies to DDI was not a sale for resale, it is necessary to determine whether the sale, storage, use or other consumption of these items was in a manner prescribed in Regulation 1591(a)(1) through (5) so as to make the sales to, and use by, DDI exempt sales and purchases of “medicines.” Regulation 1591 (a)(1) through (5) provides: “Tax does not apply to sale of medicines for the treatment of a human being which medicines are: (1) prescribed for the treatment of a human being by a person authorized to prescribe the medicines, and dispensed on

Mr. Frank Holby

-4-

September 8, 1978
425.0050

prescription filled by a registered pharmacist in accordance with law, or (2) furnished by a licensed physician and surgeon, dentist or podiatrist to his own patient for treatment of the patient, or (3) furnished by a health facility for treatment of any person pursuant to the order of a licensed physician and surgeon, dentist or podiatrist, or (4) sold to a licensed physician and surgeon, dentist, podiatrist or health facility for the treatment of a human being, or (5) sold to this state or any political subdivision or municipal corporation thereof, for use in the treatment of a human being; or furnished for the treatment of a human being by a medical facility or clinic maintained by this state or any political subdivision or municipal corporation thereof.” We are of the opinion that this situation is similar to one in which a company may purchase medicine to be administered to its employees by a contracting physician. Although in the case of DDI the reason orgotein and related supplies were purchased was for experimental purposes, the situation is somewhat similar to that described in Annotation 425.0440. There it was found that when influenza vaccine was purchased under a general prescription and given to employees who desired to be vaccinated and consented to be patients of the doctor with whom the center contracted to prescribe and administer or supervise the administration of the vaccine, the vaccine was considered to be prescribed for the treatment of human beings by a person authorized to do so and furnished by a licensed physician to his own patients for treatment of such patients. In the case of DDI, the doctors being paid to participate in the orgotein study can be considered to be agents of DDI. Therefore, when orgotein was purchased from W--- by DDI for the purpose of being given to the doctors participating in the study to be prescribed for specific patients, it is our opinion that the “medicine” was “prescribed for the treatment of a human being…” and “furnished by a licensed physician and surgeon…to his own patient for treatment of the patient.” Thus the sale of orgotein to DDI was of a “medicine” in the manner prescribed in 1591(a)(1) and (2) and tax will not apply to such sales. We do not consider this situation to be similar to one in which a manufacturing company gives away samples and is considered to have self-consumed the samples. In the situation before us, the use of the property made by the physician (furnishing “medicines” to the patient) is attributable to the company, for whom he is acting as agent. In the situation involving samples, the use of the property by the physician is not attributable to the company and the company’s use

Mr. Frank Holby

-5-

September 8, 1978
425.0050

of the property in transferring the property to the physician is not a use described as exempt under paragraphs (a)(1) through (5) of the regulation. If you have further questions concerning this matter, I will be happy to discuss them with you.

MCA:ba

425.0050.doc