Is a company that assembles custom sterile and non-sterile medical/dental/first-aid packs a 'manufacturer' for Texas sales tax purposes, and how is tax figured on the packs themselves?

Subject

Custom Medical/Dental/First-Aid Packs — Manufacturer Status And Taxability Of Packages With Taxable And Exempt Items

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9308L1254A10

Plain-English Summary

The taxpayer manufactures custom-designed sterile and non-sterile packs for doctors, hospitals, and other medical facilities. The packs are assembled from medical supplies and related components, and the selling price includes the cost of the medical products, corrugated boxes, shrink wrap, direct labor, overhead, sterilization costs, and a markup. The sterile packs are assembled and then sent out to be sterilized. The taxpayer must follow the FDA's "Regulations Establishing Good Manufacturing Practices" (Part 820), under which it qualifies as a "manufacturer" (a definition that specifically excludes companies that only distribute a finished device rather than manufacture it).

The taxpayer asked the Comptroller for a letter confirming it is a "manufacturer," since vendors sometimes request such a letter to support invoicing for raw materials without charging sales tax.

The Comptroller's response draws a line based on sterilization: the taxpayer is considered a manufacturer, but only of the sterile packs, because sterilization is "processing" under Rule 3.300 (Manufacturing; Custom Manufacturing; Fabricating; Processing). The taxpayer is not considered a manufacturer when it produces the non-sterile packs. As a manufacturer of the sterile packs, the taxpayer may issue a properly completed resale certificate to vendors in lieu of tax on items that will be resold, such as the medical products themselves — but the corrugated boxes, shrink wrap, direct labor, and overhead are not resold, so tax is owed on those items at the time of purchase.

The letter also volunteers guidance the taxpayer didn't ask for: when a package mixes taxable and exempt medical items, the composite cost of the items determines the taxability of the whole package. If the cost of the taxable items is greater than the cost of the exempt items, the whole package is taxable; if the cost of the exempt items is greater, the whole package is exempt (citing Rule 3.284 on drugs and medicines). The letter also notes that exempt organizations may provide an exemption certificate in lieu of sales tax (citing Rule 3.322 on exempt organizations).

The letter closes with the standard caveat that the opinion is based on the facts presented, and different facts, though similar, may result in different answers.

What This Means For You

Sterilization is what triggers manufacturer status here. The Comptroller didn't treat the taxpayer as a manufacturer across the board — only for the sterile packs, because the sterilization step qualifies as "processing" under Rule 3.300. The same company was found not to be a manufacturer for its non-sterile packs, even though the assembly process was otherwise similar.

Manufacturer status affects how you buy your inputs. Because the taxpayer is a manufacturer of the sterile packs, it can give vendors a resale certificate for components that get resold as part of the pack (such as the medical products), avoiding tax at the time of purchase. But packaging and overhead items that aren't resold — corrugated boxes, shrink wrap, direct labor, overhead — are still taxable to the manufacturer when purchased.

Bundled taxable-and-exempt packages are taxed by comparing costs. If you sell a package that combines taxable items with exempt items (like drugs/medicines under Rule 3.284), this letter says the deciding factor is which set of items costs more. Taxable-cost-greater means the whole package is taxable; exempt-cost-greater means the whole package is exempt. This is a practical rule of thumb worth applying to any bundled kit or package you sell.

Selling to exempt organizations still requires an exemption certificate. The letter reminds the taxpayer that entities that qualify for a sales-tax exemption can give an exemption certificate instead of paying tax, and points to Rule 3.322 on exempt organizations for reference.

Q&A

Q: Is the company that assembles these medical packs a "manufacturer" for Texas sales tax purposes?
A: Only for the sterile packs. The letter states the taxpayer is considered a manufacturer of the sterile packs because sterilization is processing under Rule 3.300, but it is not considered a manufacturer when producing the non-sterile packs.

Q: Why does sterilization matter for manufacturer status?
A: The letter explains that sterilization is processing as defined in section (a)(10) of Rule 3.300, Manufacturing; Custom Manufacturing; Fabricating; Processing — and processing is what makes the taxpayer a manufacturer for the sterile packs.

Q: Can the taxpayer buy the medical products that go into the packs tax-free?
A: Yes, for items that will be resold — a properly completed resale certificate may be issued to vendors in lieu of tax on items such as the medical products. But the corrugated boxes, shrink wrap, direct labor, and overhead are not resold, and tax is owed on those at the time of purchase.

Q: How is tax figured when a package contains both taxable and exempt medical items?
A: The letter says the composite cost of the items determines taxability: if the cost of the taxable items is greater than the cost of the exempt items, the package is taxable; if the cost of the exempt items is greater, the package is exempt.

Q: Can sales to exempt organizations avoid sales tax on these packs?
A: Yes — the letter notes that entities that qualify for exemption from sales tax may give an exemption certificate in lieu of the sales tax, and points to Rule 3.322 on exempt organizations.

Q: Does this letter apply to any company making similar packs?
A: No. The letter states the opinion is based on the facts presented, and different facts, though similar, may result in different answers.

Original ruling text

August 24, 1993

Dear **:

This is in response to your letter dated July 9, 1993, regarding tax
as it applies to custom designed sterile and non-sterile packs made
for doctors, hospitals and other medical facilities. Thank you for the
additional information provided in your second letter dated August 4,
1993.

FACTS PRESENTED: ** manufactures custom-designed
sterile and non-sterile packs for doctors, hospitals and other medical
facilities. Material for the packs include medical supplies and
related components. The selling price of completed packs includes the
cost of the medical products, corrugated boxes, shrink wrap, direct
labor, allocation of overhead, sterilization costs, and a markup.

The sterile packs are manufactured from different types of products
and medical devices, assembled into the custom-designed packs that
must be sent out to be sterilized.

** must adhere to the FDA's "Regulations Establishing
Good Manufacturing Practices" (Part 820). **** falls under the
definition of "manufacturer" in those regulations which specifically
excludes companies who only distribute a finished device vs.
manufacture the device.

QUESTION: We request a letter from your office indicating ** is
a manufacturer. From time to time a vendor will request such a letter
for their file to allow them to invoice for raw materials without
charging sales tax.

RESPONSE: ** is considered a manufacturer but only of the
sterile packs. Sterilization is processing as defined in section
(a)(10) of the enclosed Rule 3.300, Manufacturing; Custom
Manufacturing; Fabricating; Processing.

** will not be considered a manufacturer when the non-sterile
packs are produced. A properly completed resale certificate may be
issued to vendors in lieu of tax on the items that will be resold such
as the medical products. The corrugated boxes, shrink wrap, direct
labor, and overhead are not resold and **** owes tax on these
items at the time of purchase.

Although you did not ask, I would be remiss if I did not briefly
mention the taxability of the packs. When a package of medical items
is sold, the composite cost of the items will determine the taxability
of the package. If the cost of the taxable items is greater than the
cost of the exempt items, the package is taxable. If the cost of the
exempt items is greater, the package will be exempt. Rule 3.284 on
drugs and medicines is enclosed for your reference.

Entities that qualify for exemption from sales tax may give you an
exemption certificate in lieu of the sales tax. If you have a question
about whether an entity is exempt, please call our toll free number
for verification. Enclosed is Rule 3.322 covering exempt
organizations.

This opinion is based on the facts presented. Different facts, though
similar, may result in different answers. If you have any questions or
need more information, please write or call me at 1-800-531 -5441,
extension 50330, or 512-475-0330.

Sincerely,

Bettie Peterson
Tax Administration Division

NOTE: Previous Accession Number 93070063L.5 and/or 9307063L