Indiana DOR: Out-of-State Pharmacy Benefit Management Company’s Revenue is Sourced to Indiana

April 24, 2019

Whether a taxpayer is a service provider or a seller of goods has significant state tax consequences, and taxpayers that want their state tax position upheld should make sure that their documentation and transaction reporting methods are consistent with that position.

By Jeff Glickman, SALT Partner

One of the well-documented trends in the state income tax area over the last 15 years has been the move from cost-of-performance to market-based sourcing of service revenues for purposes of the income tax apportionment sales factor.  Despite this trend, nearly a third of the states still use the cost-of-performance sourcing rule for service revenue.  What this means is that a taxpayer will have a very different result depending on whether it is selling tangible property or services, since the rules for sourcing revenue from the sale of property look to the state to which the property was delivered, whereas the cost-of-performance rule for sourcing service revenues generally look to the state where most of the services were performed.

Whether a taxpayer is selling goods or providing services is not always clear, and this can lead to utilizing the wrong state income tax apportionment rules.  On Feb. 27, 2019, the Indiana Department of Revenue (“Department”) published a Letter of Findings (“LOF”) in which it determined that a Pharmacy Benefit Management Company (“Taxpayer”) was selling prescription medication as opposed to providing services, and thus was unable to use the cost-of-performance method for sourcing its revenues.[1]

Taxpayer is a pharmacy benefit management provider for various health plans, and is located outside of Indiana.  It contracts with insurance companies to provide the plans’ beneficiaries access to discounted prescription medicine and it contracts with retail pharmacies to allow the policy beneficiaries to obtain the medicine from the retail pharmacies.  Almost all of the Taxpayer revenue is derived in the following manner:

  1. A customer will present an ID card to the pharmacist when ordering prescription drug in Indiana.
  2. The pharmacist will contact Taxpayer using a computer in the retail pharmacy.
  3. Taxpayer will pay the pharmacy the prearranged price for the drug dispensed per the contracts negotiated with the member pharmacy.
  4. Taxpayer will seek payment from the insurance company for the drug at the prearranged price for the drug per the contracts negotiated with the insurance company.
  5. Taxpayer will receive an administration fee at the prearranged contract price for the services per the contracts negotiated with the insurance company, approximately 2 percent, for every prescription they process. This administrative fee is in addition to the amount received for the drug from the insurance company discussed in item 4 above.

On audit, the Department determined that the Taxpayer derived revenues from selling prescription medication (i.e., property) and included in the numerator of the Indiana sales factor all revenue derived from sales at Indiana pharmacies (i.e., delivery location).  The Taxpayer’s position is that it is a service company that should be allowed to use the cost-of-performance method for sourcing revenues, and that since all of its services are performed outside Indiana, the number of the Indiana sales factor should be zero.

Ultimately, the Department ruled that the Taxpayer is not a service provider, relying mainly on the fact that “Taxpayer’s documents demonstrate that it has an apparent right to sell the prescription drugs at a mark-up and it reports a federal cost of goods sold on its tax returns.”  Since the Taxpayer earns a profit on the acquisition and transfer of the drugs, it has “an interest in the drugs being transferred in retail transactions occurring in Indiana.”

The Department explains that for the Taxpayer to be viewed as a service provider:

“[It] would be a simple conduit collecting from the insurance company the same amount that it pays the retail pharmacy stores for the drugs provided to the insurance company customers. . . .  Moreover, if a taxpayer were a service provider with receipts and costs of goods for which it had no interest, that taxpayer would neither include such receipts as part of the taxpayer’s business receipts nor use the receipts to calculate the apportionment factor . . . .”

In other words, if Taxpayer was really a service provider, it’s only “revenue” would be the 2 percent administrative fee it receives for managing the pharmacy plan and processing the claim, and the prescription drug cost would just be a reimbursed pass-through expense.  Thus, the Taxpayer’s own reporting of these transactions was inconsistent with its state income tax position.

This ruling is instructive because these issues impact more than just income tax apportionment.  For example, if the taxpayer in this ruling took the same position for sales tax purposes (i.e., that it was just a service provider), it is likely that a state would be successful in arguing that the taxpayer is a retail seller of goods and is required to collect and remit sales tax.  It just happens to be the case that the sales under the facts of this particular ruling are exempt,[2] but if the sales were taxable, then the taxpayer may also find itself with nexus and sales tax exposure.

Aprio’s SALT team understands all of the factors that can impact a state tax position and will assist businesses to make sure that its documentation and reporting of transactions are consistent with the desired state tax position.  This will increase the likelihood that the state tax position is sustained in the case of an audit and does not result in unexpected exposure.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at for more information.

This article was featured in the April 2019 SALT Newsletter.

[1] Letter of Findings No. 02-20160351, Ind. Dept. of Rev. (12/28/18).

[2] There are likely two bases for sales tax exemption under the facts of this ruling.  First, prescription medication for humans is generally exempt in the states, and second, the Taxpayer sold to pharmacies which then sold to the plan member, so the sale to the pharmacy should be exempt as a sale for resale.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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About the Author

Jeff Glickman

Jeff Glickman is the partner-in-charge of Aprio, LLP’s State and Local Tax (SALT) practice. He has over 18 years of SALT consulting experience, advising domestic and international companies in all industries on minimizing their multistate liabilities and risks. He puts cash back into his clients’ businesses by identifying their eligibility for and assisting them in claiming various tax credits, including jobs/investment, retraining, and film/entertainment tax credits. Jeff also maintains a multistate administrative tax dispute and negotiations practice, including obtaining private letter rulings, preparing and negotiating voluntary disclosure agreements, pursuing refund claims, and assisting clients during audits.