Were a medical practice's bulk purchases of knee viscosupplementation devices, splints, and other durable medical equipment exempt from Virginia sales tax?

Subject

Bulk medical-device and durable-equipment purchases were taxable

Plain-English summary

Virginia taxed the medical practice's bulk purchases of knee viscosupplementation devices, splints, braces, ankle locks, and other durable medical equipment. The FDA classified the knee-injection products as medical devices, so the prescription-drug exemption did not apply.

The durable-medical-equipment exemption also failed because the practice bought inventory in bulk and later dispensed items to patients. Virginia required the purchase itself to be made for a specific identified individual. Proof that the items ultimately were used only by individual patients was not enough, and the invoices did not identify specific patients at purchase.

Virginia removed the audit penalty associated with the knee devices because that was a new issue not covered in prior audits. It kept the penalty on splints and other bulk equipment because the same issue had appeared in an earlier audit and the practice's use-tax compliance ratio was below the regulatory threshold. The related amnesty penalty was also removed only for the knee-device issue.

What this means for you

• FDA classification can determine whether a product is treated as a drug or a medical device.
• Bulk medical-equipment inventory generally does not qualify as a purchase for an individual patient.
• Patient-identifying purchase documentation matters at the time of purchase.
• When a supplier does not collect tax on taxable bulk purchases, the practice must accrue and pay consumer use tax.
• Penalty treatment can depend on prior audit coverage and compliance ratios.

Common questions

Were the knee-injection products exempt as prescription drugs?

No. The FDA classified them as medical devices.

Did later use by individual patients make bulk purchases exempt?

No. The items had to be bought for specific individuals, supported by purchase documentation.

Was all penalty removed?

No. Penalty was removed for the new knee-device issue but retained for splints and other durable equipment previously covered in an audit.

Citations and references

• Va. Code §§ 58.1-609.10(9), 58.1-609.10(10), and 58.1-1840.1(F)(1).
• 23 VAC 10-210-940(G), 23 VAC 10-210-2060(B), and 23 VAC 10-210-2032(A)(2).
• P.D. 03-1, P.D. 00-215.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 09-6

Original ruling text

February 4, 2009

Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear *:

This is in response to your letter in which you seek correction of the retail sales and use tax assessment issued to * (the "Taxpayer") for the period January 2002 through September 2007. I note the assessment has been paid in full. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer operates as a medical practice that provides treatment for arthritis and rheumatic diseases. The Taxpayer was audited and assessed the tax on bulk purchases of knee joint injected viscosupplementation devices, splints and other durable medical equipment. The Taxpayer argues that the bulk purchases of knee injected devices, splints, and other durable medical equipment quality for exemption when the sale of such items is for use by individual patients under prescription of a physician. In addition, the Taxpayer contests the penalty assessed on the contested items.

DETERMINATION

Virginia Code § 58.1-609.10 9 (formerly Va. Code § 58.1-609.7 1) provides an exemption from the retail sales and use tax for medicines and drugs dispensed by or sold on prescriptions or work orders of licensed physicians and other licensed practitioners.

Virginia Code § 58.1-609.10 10 (formerly Va. Code § 58.1-609.7 2) provides an exemption from the retail sales and use tax for:

Wheelchairs and parts therefor, braces, crutches, prosthetic devices, orthopedic appliances, catheters, urinary accessories, other durable medical equipment and devices, and related parts and supplies specifically designed for those products . . . when such items or parts are purchased by or on behalf of an individual for use by such individual. Durable medical equipment is equipment that (i) can withstand repeated use, (ii) is primarily and customarily used to serve a medical purpose, (iii) generally is not useful to a person in the absence of illness or injury, and (iv) is appropriate for use in the home.

Title 23 of the Virginia Administrative Code (VAC) 10-210-940 interprets the above statute and in section G states, "in order to be deemed a purchase on behalf of an individual, the item must be specifically bought for the individual. If items are purchased in bulk and then dispensed to individual patients, no exemption is applicable even if the item is modified or fitted for a specific individual."

Title 23 VAC 10-210-2060 B further states:

Purchases by a licensed physician of wheelchairs, braces, crutches, prostheses, orthopedic appliances, durable medical equipment, and similar items are subject to the tax, unless purchased on behalf of a specific patient. Other purchases, including bulk purchases, of such items are subject to the tax, even if items from a bulk inventory are subsequently dispensed to or modified for specific patients.

Knee Joint Viscosupplementation Devices

The Taxpayer asserts that it should not have been assessed tax on these devices, contending that the devices are considered drugs by physicians and Medicare.

Based on the United States Food and Drug Administration (FDA) guidelines reviewed by the Department, the knee joint injected viscosupplementation devices are classified by the FDA as medical devices. Accordingly, the exemption found in Va. Code § 58.1-609.10 9 for medicines and drugs does not apply to the purchase of these devices by the Taxpayer.

This determination is consistent with Public Document (P.D.) 03-1 (1/15/03). In that case, the taxpayer was the manufacturer and distributor of medical devices. The taxpayer distributed a joint fluid therapy device (the "device") that is used in the treatment of pain in patients suffering from osteoarthritis of the knee. The FDA classified the device as a medical device. The taxpayer made bulk sales of the device to its customers, including hospitals, medical clinics, or other licensed medical practitioners. The taxpayer requested that the Department exempt the sale of the device to its customers as a drug prescribed by a licensed person. The Department determined that the exemption found in Va. Code § 58.1-609.7 1 did not apply because the device was not considered a drug by the FDA, but instead was classified as a medical device. In addition, the exemption in Va. Code § 58.1-609.7 2 did not apply because the devices were sold in bulk to the taxpayer's customers, and not by or on behalf of an individual for such use by the individual, as required by the statute.

The Department has previously ruled in P.D. 00-215 (12/7/00) that a taxpayer's purchase documentation (in this case the invoice) must include patient identification information at the time of purchase in order for the purchase to be deemed made on behalf of an individual. The Taxpayer in this instance has not presented invoices to substantiate that each knee joint viscosupplementation device purchased was ordered for a specific individual. Rather, the evidence provided indicates the devices are withdrawn from a bulk inventory for use by individual patients. Consistent with P.D. 00-215, the fact that the Taxpayer can prove that the knee joint viscosupplementation device is used only for individuals does not mean the device is purchased by or on behalf of a specific individual for use by such individual, as required by the exemption statute and regulation. Accordingly, the Taxpayer's bulk purchases of the knee joint viscosupplementation devices do not qualify for exemption and were properly taxed in the audit.

Splints and Other Durable Medical Equipment

The Taxpayer was assessed tax on bulk purchases of splints, braces, and ankle locks. The Taxpayer claims that the contested items are used only by individuals and should be exempt of the tax.

In accordance with Va. Code § 58.1-609.10 10 and Title 23 VAC 10-210-940, durable medical equipment must meet the four criteria provided above and the products must be purchased by or on behalf of an individual for use by such individual in order to qualify as exempt. Because the contested items are purchased in bulk and then dispensed to individual patients, no exemption is applicable. Accordingly, the auditor correctly assessed the tax on the bulk purchases of splints and other durable medical equipment.

Compliance Penalty

The Taxpayer claims the assessed penalty suggests that there was purpose, forethought, and attempt at deceit in the avoidance of the tax. The Taxpayer did not consider the knee joint viscosupplementation devices as such and could not be expected to know that there is an applicable sales tax, particular since the wholesaler did not charge a tax.

Title 23 VAC 10-210-2032 A 2 provides that on third and subsequent audits, the use tax compliance ratio must meet or exceed 85% to avoid the assessment of penalty. The use tax compliance ratio on this third generation audit of the Taxpayer is 73%, therefore penalty was properly applied. This regulation also states that penalty will not be applied to audit deficiencies occurring in new areas not covered in prior audits. Because the knee joint viscosupplementation device is a new area not covered in the previous audits, I will agree to remove the audit penalty associated with this one issue.

The application of the tax to the bulk purchases of splints and other durable medical equipment is clearly established under existing law, regulations and other public documents. The Taxpayer should be aware of the proper application of the tax based on these documents, which are available to the public. Further, a review of the prior audit reveals that bulk purchases of splints, braces, and other durable medical equipment was assessed in that audit. Accordingly, the Taxpayer's request for abatement of the compliance penalty in connection with splints and other durable medical equipment is denied.

Amnesty Penalty

Virginia Code § 58.1-1840.1 F 1 provides that "[i]f any taxpayer eligible for amnesty under this section and under the rules and guidelines established by the Tax Commissioner retains any outstanding balance after the close of the Virginia Tax Amnesty Program because of the nonpayment, underpayment, nonreporting or underreporting of any tax liability eligible for relief under the Virginia Tax Amnesty Program, then such balance shall be subject to a 20 percent penalty on the unpaid tax. This penalty is in addition to all other penalties that may apply to the taxpayer." Because the 30% compliance penalty applies, the 20% amnesty penalty applies to the 16 months of the audit. However, the application of the amnesty penalty associated with the knee joint viscosupplementation device will be removed from the audit.

Future Compliance

In the future, the Taxpayer should pay the tax on bulk purchases of knee joint viscosupplementation devices and other durable medical equipment. If the supplier fails to collect the tax, the Taxpayer must accrue and pay the tax directly to the Department using a Consumer's Use Tax Return, Form ST-7.

CONCLUSION

Based on the determination above, the penalty assessed on the knee joint viscosupplementation devices will be removed from the assessment and a refund of plus applicable interest will be issued shortly.

The Code of Virginia sections, regulations and public documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the department's web site. If you have any questions about this determination, please contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-2241616139.T