My medical diagnostic lab buys reagents that meet the legal definition of a 'drug' under Virginia's Drug Control Act -- does that mean my purchases qualify for the sales tax exemption on medicines and drugs?

Plain-English summary

A Virginia operator of medical diagnostic laboratories sought a refund of sales and use tax it had accrued on reagents used to test human blood, urine, and other bodily specimens, arguing the reagents were exempt "medicines and drugs" under Va. Code § 58.1-609.10 9.

The reagents probably do qualify as "drugs" -- that wasn't the problem. Virginia's exemption applies to medicines and drugs purchased by a "licensed hospital, nursing home, clinic or similar corporation." The lab argued its reagents met the Virginia Drug Control Act's definition of "drug" (Va. Code § 54.1-3401), which includes substances intended for use in diagnosing, treating, or preventing disease. The Department didn't dispute this -- in a prior ruling (P.D. 01-52), it had found similar biological/allergy products qualified as drugs where classified as controlled substances by the Virginia Pharmacy Board. But qualifying as a "drug" is only half the test.

The real problem: the lab isn't a "similar corporation" to a hospital, nursing home, or clinic. Sales tax exemptions are strictly construed against the taxpayer. The entities named in the exemption statute qualify because their purchases of medicines and drugs are directly consumed or administered as part of providing medical/surgical treatment, nursing care, or outpatient treatment to patients. This laboratory, by contrast, provides diagnostic testing and analytical services -- processing human specimens to generate information that OTHER medical providers (doctors, hospitals, clinics) then use to diagnose and treat their own patients. The lab doesn't provide direct medical treatment or care to patients on an inpatient or outpatient basis, and critically, the reagents aren't consumed by or administered to any individual by the lab -- they're used purely to run diagnostic tests. That functional difference meant the lab wasn't a "similar corporation" within the meaning of the exemption, consistent with the Department's position in two prior rulings on the same distinction (P.D. 23-22, P.D. 22-132).

Why a cited precedent didn't help. The lab pointed to P.D. 15-242, where a for-profit family medical practice qualified for the same exemption. The Department distinguished that case: a family medical practice, unlike a diagnostic lab, directly provides medical care and treatment to patients -- so it fit the "similar corporation" category in a way this lab did not.

Outcome. Because the lab wasn't a qualifying "similar corporation," the auditor's denial of the refund credit for tax accrued on the reagents was upheld.

What this means for you

Medical diagnostic and testing laboratories

Even if the substances you use meet the legal definition of a "drug," Virginia's medicine-and-drugs sales tax exemption for hospitals, nursing homes, and clinics doesn't automatically extend to you if your business provides testing/analytical services rather than direct patient treatment or care. The "similar corporation" test looks at what your business actually does for patients, not just what you buy.

Any business claiming the "similar corporation" medicines-and-drugs exemption

Focus on whether your business directly administers or consumes the medicines/drugs as part of providing medical/surgical treatment, nursing care, or outpatient treatment to patients -- that's the functional test the Department applies, regardless of how the item itself is classified under the Drug Control Act.

Businesses citing a favorable prior ruling to support an exemption claim

Check whether the taxpayer in that prior ruling actually did the same kind of thing your business does. Here, a ruling favoring a family medical practice didn't transfer to a diagnostic lab, because the two businesses' relationship to patients is fundamentally different.

Common questions

Q: If a substance qualifies as a "drug" under Virginia's Drug Control Act, does that make it exempt from sales tax when I buy it?
A: Not by itself. The medicines-and-drugs sales tax exemption also requires the PURCHASER to be a qualifying entity -- a licensed hospital, nursing home, clinic, or similar corporation that directly provides medical treatment or care -- not just that the item purchased meets the drug definition.

Q: Does a medical diagnostic laboratory count as a "similar corporation" to a hospital or clinic?
A: Not based on this ruling. A lab that performs testing and analytical services for other medical providers, without directly treating patients or administering the substances to them, doesn't qualify.

Q: Would a for-profit medical practice that treats patients directly qualify for this exemption?
A: Yes -- the Department has separately ruled that a for-profit family medical practice providing direct medical care and treatment qualifies as a "similar corporation" (P.D. 15-242).

Citations and references

Statutes and regulations:

• Va. Code § 58.1-609.10 9 -- sales and use tax exemption for medicines and drugs purchased by a licensed hospital, nursing home, clinic, or similar corporation
• Va. Code § 54.1-3401 -- Virginia Drug Control Act definition of "drug"
• 23 VAC 10-210-940 -- regulatory definition of "drug" consistent with the Drug Control Act

Cases cited: Commonwealth v. Community Motor Bus Co., Inc., 214 Va. 155, 198 S.E.2d 619 (1973) (sales and use tax exemptions strictly construed against the taxpayer).

Prior rulings referenced (described here, not linked): P.D. 01-52 (4/30/2001) -- biological/allergy products can qualify as drugs; P.D. 15-242 (12/23/2015) -- a for-profit family medical practice qualified as a "similar corporation"; P.D. 23-22 (3/1/2023) and P.D. 22-132 (8/24/2022) -- similar prior rulings distinguishing diagnostic/testing operations from direct-treatment providers.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 24-6

Original ruling text

February 28, 2024

Re: § 58.1-1821 Refund Appeal: Retail Sales and Use Tax

Dear *:

This is in response to your letter submitted on behalf of *, LLC (the “Taxpayer”) in which you dispute the denial of a retail sales and use tax refund for the period January 2017. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer, an operator of medical diagnostic laboratories in Virginia, timely submitted a refund request for the period at issue and received a refund credit for transactions where tax was either accrued or remitted on exempt transactions. However, the auditor denied the Taxpayer a refund credit for tax accrued on reagents used in testing human blood, urine, and other bodily specimens on the basis that they did not qualify for the medicines and drugs exemption. The Taxpayer contests the disallowance of the refund credits claiming the reagents meet the definitional requirements of a drug in accordance with the Virginia Drug Control Act (Chapter 34 of Title 54.1, Virginia Code § 54.1-3400 et seq.).

DETERMINATION

Virginia Code § 58.1-609.10 9 provides exemptions related to sales and purchases of medicines and drugs. At issue in this case is the exemption for “medicines and drugs purchased for use and consumption by a licensed hospital, nursing home, clinic or similar corporation not otherwise exempt under this section.” The Taxpayer believes its business operation is a “similar corporation” and, therefore, its purchases of reagents as drugs should qualify for the exemption. In addition to the exemption statute, the Taxpayer cites Public Document (P.D.) 15-242 (12/23/2015) in support of its claims.

The reagents in question are chemical compounds that consist of drugs and other substances. The reagents are used to react with other chemical or biological substances in order to promote a reaction that can help diagnose potential diseases or medical deficiencies.

Virginia Drug Control Act

Virginia Code § 54.1-3401 defines “drug” to mean:

(i) articles or substances recognized in the official United States Pharmacopoeia National Formulary or official Homeopathic Pharmacopoeia

of the United States, or any supplement to any of them; (ii) articles or substances intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease in man or animals; (iii) articles or substances, other than food, intended to affect the structure or any function of the body of man or animals; (iv) articles or substances intended for use as a component of any article specified in clause (i), (ii), or (iii); or (v) a biological product.

This definition is consistent with the definition set forth in Title 23 of the Virginia Administrative Code 10-210-940. The Taxpayer cites (ii) to support its claim that the reagents are drugs.

In a prior determination issued as P.D. 01-52 (4/30/2001), the Tax Commissioner addressed biological and allergy products as drugs. The Tax Commissioner determined that the products at issue qualified as drugs pursuant to the Virginia Drug Control Act based on the Virginia Pharmacy Board’s classification of the products as Schedule VI controlled drugs for use by licensed physicians and prescriber practitioners. As the products in P.D. 01-52 may be similar to the reagents in this case, the Department does not dispute that the reagents may be defined as controlled drugs. However, in order for the reagents to be purchased exempt (or to qualify for a refund credit of tax), the Taxpayer’s business operation must be similar to that of the qualifying entities stated in Virginia Code § 58.1-609.10 9.

Hospitals, Clinics, Nursing Homes, and Similar Corporations

Sales and use tax exemptions are strictly construed pursuant to the decision in Commonwealth v. Community Motor Bus Co., Inc. , 214 Va. 155, 198 S.E.2d 619 (1973). The medical entities cited in Virginia Code § 58.1-609.10 9 qualify for the exemption because their purchases of medicines and drugs are consumed or administered in their perspective roles as providers of (1) medical and surgical treatment to patients, (2) nursing home care for sick or injured persons, and (3) outpatient medical treatment and patient services, respectively. The Taxpayer, however, is engaged in providing diagnostic testing and analytical services in a laboratory setting for the purpose of testing human specimens in order to obtain information for medical providers (such as the above mentioned medical service providers) to use in the diagnosis, treatment, and care of their patients. The Taxpayer does not provide direct medical treatment and care to individuals on an inpatient and outpatient basis. In addition, the reagents are not consumed by or administered to individuals by the Taxpayer. Rather, they are used by the Taxpayer to perform diagnostic and analytical services. Based on these differences, the Taxpayer is not a “similar corporation” to a licensed hospital, nursing home or clinic. This distinction has been addressed by the Department in similar cases. See P.D. 23-22 (3/1/2023), and P.D. 22-132 (8/24/2022).

Regarding P.D. 15-242, cited by the Taxpayer, the Tax Commissioner determined that a for-profit family medical practice qualified for the exemption in Virginia Code § 58.1-609.10 9 regarding purchases of medicines and drugs for use in the medical practice. This decision was made in accordance with the 2006 statutory amendment that expanded the exemption to include purchases of medicines and drugs by nursing homes, clinics, and similar corporations. In this instance, the Taxpayer is not similar to a family medical practice engaged in providing medical care and treatment to patients. Therefore, P.D. 15-242 is not applicable to this case.

CONCLUSION

In accordance with this determination, the Taxpayer is not eligible for claim the cited exemption in Virginia Code § 58.1-609.10 9. Therefore, the auditor properly denied the refund of taxes accrued by the Taxpayer on its purchases of biological and chemical reagents.

The Code of Virginia sections, regulation, and public documents cited are available online at www.tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at (804) , or via email at **@tax.virginia.gov.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/4570-C

Related Documents

01-52

15-242

22-132

23-22