New Indiana Ruling Puts a Spotlight on the Sourcing of Product Sales vs. Services

June 29, 2021

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By: Aspen Fairchild, SALT Associate

At a glance:

  • The main takeaway: We revisit a recently reversed Indiana case that highlights the importance of product sales versus services for state income tax purposes.
  • Impact on your business: The ruling underscores the complexities surrounding the application of correct apportionment sourcing rules for taxpayers that provide services closely related to the sale of tangible personal property.
  • Next steps: Partner with a tax advisor experienced in income apportionment issues, one that can help you minimize state income tax liability and the risk of penalties for noncompliance.

Contact Aprio’s State and Local Tax (SALT) team to learn more.

The full story:

In the April 2019 edition of Aprio’s SALT Newsletter, we wrote an article on an Indiana ruling that concluded an out-of-state pharmacy benefit management company was selling prescription medication as opposed to providing services, and thus had to apportion revenues to the state under the sales of tangible personal property rules.[1]

The taxpayer appealed the Indiana Department of Revenue’s (Department) assessments, and on May 14, 2021, the Indiana Tax Court (Court) issued a decision reversing the Department’s determination and ruling in favor of the taxpayer.[2]

Distinguishing services vs. sales of tangible personal property

Whether income is derived from services or from sales of tangible personal property determines how the taxpayer must calculate its sales factor for income tax apportionment purposes. While many states follow the market-based sourcing method — which sources sales of services to the state where the customer receives the service benefit — about a third of states follow the cost-of-performance sourcing method, which sources sales of service revenue to the state where the service is performed. For the years assessed, Indiana followed the cost-of-performance sourcing method and the taxpayer, self-identifying as a service provider, sourced its revenue to where it performed its income-producing activities (i.e., outside Indiana).[3]

The taxpayer administers and manages prescription drug and pharmacy benefits for various health insurers nationwide by providing access to a network of third-party retail pharmacies, as well as drug reviews, claims processing and other plan benefits. The taxpayer contracts with local retail pharmacies to provide plan beneficiaries with widespread access to discounted prescription drugs.

Under these contracts, the taxpayer agrees to pay the pharmacy prenegotiated rates and a dispensing fee for all prescription drugs filled. These costs paid to pharmacies are included, at a mark-up, in the service charges billed to customers, along with the taxpayer’s administrative fees for managing the plans. The taxpayer’s revenue is primarily derived from these service charges and from rebates received from pharmaceutical manufacturers.

The Court’s ruling

The Court ruled that the taxpayer has consistently identified and represented itself as a service provider. In its U.S. Securities and Exchange Commission (SEC) filings, the taxpayer states that its revenues are from the “delivery of prescription drugs” and that it “contracts with retail pharmacies to provide prescription drugs to members of the pharmacy benefit plans [it] manage[s].”

The Court noted that none of the emphasized words described a sale of goods — only services. However, the Department argued in its assessment that the taxpayer has admitted in the past that it sold prescription drugs, referring to a previously issued Washington Court of Appeals decision concerning the same taxpayer. The Court dismissed this remark as a misinterpretation of the case, highlighting that the Washington Court even stated that the taxpayer “does not contend that it sells prescription drugs” in its decision.[1]

The Department also claimed, without any explanation, that reporting costs of goods sold (COGS) on its federal tax returns automatically meant that the taxpayer is a retailer.  However, this claim was rejected by the Court, noting that apportionment is unique to state taxation and that the calculation of federal income tax liability, and thus COGS, does not reference apportionment in any capacity. Therefore, without any explanation from the Department, the inference that reporting COGS on a federal tax return dictates how the taxpayer should apportion for state income tax purposes is unreasonable.

The bottom line

The Court’s denial of the Department’s previous assessment illustrates how distinguishing between service providers and those selling tangible personal property can be difficult when a taxpayer provides services closely related to the sale of tangible personal property. However, that distinction can cause significant impacts on how a business apportions its income.

Aprio’s SALT team has experience with apportionment issues and the nuances associated with varied state rules and interpretations. We can assist your business with these issues to both minimize state income tax liability and the risk of penalties for noncompliance.

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 Aspen Fairchild, SLAT Associate, at or Jeff Glickman, partner-in-charge of Aprio’s SALT practice at for more information.

[1] For our article on Washington’s decision in Express Scripts, Inc. v. Washington, Docket No. 50348-4, Wash. Ct of App. Div. II (March 26, 2019) on how pass-through revenue is defined and treated for B&O taxes, see our May 2019 SALT Newsletter.

[1] For our article on Indiana’s Letter of Findings No. 02-20160351 (December 28, 2018) and its impact on revenue apportionment for service providers, see our April 2019 SALT Newsletter.

[2] See Express Scripts, Inc. v. Indiana, Docket No. 19T-TA-00018, Tax Court of Indiana (May 14, 2021).

[3] As of January 1, 2019, Indiana follows the market-based sourcing rules and sources receipts from services if and to the extent the benefit of the service is received in the state. See Ind. Code §6-3-2-2(f)(3)(C).


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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