Does a pathology-testing company that analyzes patient specimens for physicians qualify for Connecticut's biotechnology sales-and-use-tax exemption on its purchases?

Plain-English summary

Connecticut gives the biotechnology industry a sales-and-use-tax break: Conn. Gen. Stat. § 12-412(89) exempts purchases of machinery, equipment, tools, materials, supplies, and fuel used directly in the biotechnology industry. The statute defines "biotechnology" as applying technologies (recombinant DNA, biochemistry, molecular and cellular biology, genetics, genetic engineering, cell fusion, new bioprocesses) using living organisms to produce or modify products, to improve plants or animals, to develop microorganisms, to identify targets for pharmaceutical development, or to transform biological systems into useful processes and products.

The company here runs a pathology testing lab. It tests blood, tissue, and other patient specimens and gives physicians and managed-care organizations a report used to screen for cancer, forecast its course, or test for recurrence in specific patients. It wanted to make exempt purchases as a biotechnology business.

DRS said no. Every verb in the statutory definition — produce, modify, improve, develop, identify, transform — points toward research and development that advances biotechnology and produces products, not toward diagnosing illness in individual patients. Reviewing the legislative history, DRS found the exemption was part of an initiative to promote "cluster-based development" of biotechnology as one of Connecticut's "industries of the future" — aimed at R&D companies producing products, not at diagnostic testing services.

Two settled tax principles sealed it. Exemptions are strictly construed against the taxpayer, and ambiguities are resolved in the Department's favor (United Illuminating Co. v. Groppo). And DRS applied its longstanding "true object" test: the true object of the company's service is testing specimens so doctors can diagnose or form a prognosis, not conducting research to discover or create new products or processes. So the lab is not in the "biotechnology" defined by § 12-412(89) and can't make exempt purchases under it.

The same company, same facts produced a companion ruling on the income-tax side: Ruling No. 97-6 held the lab is not a "biotechnology company" for the corporation business tax research-and-experimental-expenditure credit either. (Named here in prose, not linked.)

What this means for you

Diagnostic labs and testing services

Performing tests on patient specimens to support clinical diagnosis, prognosis, or monitoring is generally not "biotechnology" for the § 12-412(89) exemption, even when the testing uses sophisticated molecular or cellular techniques. The exemption targets R&D that produces or improves products, not the delivery of diagnostic results about specific patients. Don't assume that "using biotech methods" equals "being in the biotechnology industry" for tax purposes.

Genuine biotech R&D companies

If your business actually produces or modifies products, develops microorganisms, identifies pharmaceutical targets, or transforms biological systems into useful products/processes, your purchases of machinery, equipment, materials, and supplies used directly in that work may qualify. Keep documentation tying purchases to qualifying R&D activity, because DRS reads the definition narrowly and construes the exemption against you.

Accountants and tax professionals

Two doctrines drive the analysis: strict construction against the taxpayer for exemptions (United Illuminating Co. v. Groppo) and the Department's "true object" test (American Totalisator, Dine Out Tonight Club; Ruling Nos. 96-2, 94-22). Identify the true object of the service; if it's diagnostic rather than product-producing R&D, § 12-412(89) won't apply. Expect DRS to look to legislative history where the definition is arguably ambiguous.

Common questions

Q: What does the biotechnology exemption cover?
A: Under § 12-412(89), purchases of machinery, equipment, tools, materials, supplies, and fuel used directly in the biotechnology industry — where "biotechnology" means using biological techniques to produce/modify products, improve plants or animals, develop microorganisms, identify pharmaceutical targets, or transform biological systems into useful products and processes.

Q: Why doesn't a pathology lab qualify?
A: Because the "true object" of its service is testing specimens so physicians can diagnose or monitor disease in specific patients — not R&D that produces or improves products. The statutory verbs all point to product-producing biotechnology, and exemptions are read narrowly against the taxpayer.

Q: Does using advanced molecular techniques make a company "biotechnology"?
A: Not by itself. What matters is what the company is doing with those techniques. Diagnostic testing to serve individual patients falls outside the definition even if the methods are sophisticated.

Q: Is there a related ruling?
A: Yes. On the same facts, Ruling No. 97-6 held the same lab is not a "biotechnology company" for the corporation business tax research-and-experimental-expenditure credit (§ 12-217j).

Citations and references

Statutes:

• Conn. Gen. Stat. § 12-412(89) (sales and use tax exemption for machinery, equipment, tools, materials, supplies, and fuel used directly in the biotechnology industry; statutory definition of "biotechnology")

Case law and administrative authority cited by the ruling:

• United Illuminating Co. v. Groppo, 220 Conn. 749 (1992) (exemptions strictly construed against the taxpayer; ambiguities resolved for the Department)
• Petco Insulation Co. v. Crystal, 231 Conn. 315 (1994) (statutory construction seeks legislative intent)
• American Totalisator Co. v. Dubno, 210 Conn. 401 (1989); Dine Out Tonight Club v. Dept. of Revenue Services, 210 Conn. 567 (1989) (the "true object" test)
• Ruling Nos. 96-2 and 94-22 (prior applications of the "true object" test)

Companion ruling:

• Ruling No. 97-6 (same facts; lab not a "biotechnology company" for the corporation business tax research credit under § 12-217j)

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 97-7

Original ruling text

Ruling 97-7, Sales and Use Taxes / Biotechnology Exemption

FACTS:

A company (the "Company") provides pathology testing services to physicians and managed care organizations. The Company tests blood, tissue and other specimens furnished by the service recipients and prepares a comprehensive report which it provides to the service recipients. The Company’s services are used by physicians who are screening for cancer, forecasting the course of an existing cancer or testing for the recurrence of a previously treated cancer in a specific patient.

ISSUES:

Whether the pathology testing services rendered by the Company are considered to be "biotechnology" within the meaning of Conn. Gen. Stat. §12-412(89), thus qualifying the Company to make exempt purchases under such statute.

DISCUSSION:

Purchases of machinery, equipment, tools, materials, supplies and fuel used directly in the biotechnology industry are exempted by Conn. Gen. Stat. §12-412(89), which defines the term "biotechnology" as:

the application of technologies, such as recombinant DNA techniques, biochemistry, molecular and cellular biology, genetics and genetic engineering, biological cell fusion techniques, and new bioprocesses, using living organisms, or parts of organisms, to produce or modify products, to improve plants or animals, to develop microorganisms for specific uses, to identify targets for small molecule pharmaceutical development, to transform biological systems into useful processes and products or to develop microorganisms for specific uses.

(Emphasis added.) The highlighted verbs -- "to produce or modify," "to improve," "to develop," "to identify" and "to transform" -- indicate that the exemption was intended for activities that would lead towards progress in the area of biotechnology, as opposed to merely diagnosing illnesses in specific patients.

To the extent that the language of the exemption may be ambiguous, it is appropriate to review the intent of the General Assembly in enacting it. ("It is fundamental that statutory construction requires us to ascertain the intent of the legislature and to construe the statute in a manner that effectuates that intent." Petco Insulation Co. v. Crystal , 231 Conn. 315, 321, 649 A.2d 790 (1994).) The legislation enacting the exemption was part of an initiative to promote the "cluster-based development" of the biotechnology industry, as one of the "new industries of the future." 39 H.R. Proc., Pt. 14, 1996 Sess., pp. 4742-4744 (remarks of Rep. Merrill, who introduced the bill). According to Representative Merrill, "cluster-based development" is a "broad-based range of industries that interact together, both in terms of market, in terms of product development, in terms of research and development." Id. at p. 4744. The biotechnology "cluster" was chosen as one of the first industries to receive a legislative incentive, because Connecticut already possesses the "synergism" to attract biotechnology companies in its quality of life, its educational institutions and the pharmaceutical manufacturers already located here. Id . at pp. 4759-4760 (remarks of Rep. Ward). It appears from the legislative history, as well as the General Assembly’s choice of the types of activities listed in the statute, that the exemption was intended to exempt purchases made by companies that engage in biotechnology research and development focusing on producing products (whether or not such production will be done by the business engaging in the research and development).

It is well established that statutes which grant exemptions from sales and use taxes must be strictly construed against the taxpayer, and any ambiguities in such statutes must be resolved in favor of the Department. See, e.g. , United Illuminating Co. v. Groppo, 220 Conn. 749, 752-3 (1992). The Department has long used a "true object" test to assist it in determining the proper application of sales and use taxes to a particular service. American Totalisator Co. v. Dubno , 210 Conn. 401, A.2d 414 (1989); Dine Out Tonight Club v. Dept. of Revenue Services, 210 Conn. 567, 556 A.2d 580 (1989); see also Ruling Nos. 96-2, 94-22. The Company’s services are directed at testing patient specimens for medical practitioners to assist them in making diagnoses of or forming a prognosis for their patients. Because the true object of the Company’s services is not to conduct research to discover or create new products or processes or to improve existing ones, it cannot be considered to be "biotechnology" as that term is defined in Conn. Gen. Stat. §12-412(89).

RULING:

The medical testing services rendered by the Company are not activities included in the definition of "biotechnology industry" in Conn. Gen. Stat. §12-412(89) that would qualify the Company to make exempt purchases under such statute.

LEGAL DIVISION

Issued December 31, 1997