Washington Rules That Pharmacy Benefit Service Provider’s Revenues are Subject to B&O Tax
May 31, 2019
A Washington Court of Appeals opinion explains how the status of a third party as an agent or independent contractor can play a significant role in determining whether certain amounts received by such party are taxable revenues or non-taxable pass-through receipts.
By Jeff Glickman, SALT Partner
In the April 2019 edition of Aprio’s SALT Newsletter, we wrote an article addressing an Indiana ruling that concluded that a pharmacy benefit service provider was selling prescription medication as opposed to providing services, and thus had to apportion revenues under the rules for sales of tangible personal property instead of the rules for sourcing service revenue. The ruling focused on the fact that the taxpayer’s contracts allowed it to sell prescription drugs at a mark-up and reasoned that if the taxpayer was really just a service provide it would merely be a conduit for collecting from the insurance company the same amount that it pays the retail pharmacy stores for the drugs provided to the insurance company customers.
Whether or not a taxpayer can treat certain amounts it receives as “pass-through” funds (i.e., not recognized as revenue) is often dependent on how the transactions are structured and documented, and can affect how a taxpayer is treated for a variety of state tax purposes, including nexus, sales tax liability and income tax apportionment.
In Washington, which imposes a Business & Occupation (“B&O”) tax on the gross receipts of taxpayers engaged in certain business activities, the issue of pass-through revenue is significant since those amounts would be excluded from the B&O tax base. Interestingly, this issue was the subject of a recent Washington Court of Appeals opinion involving another pharmacy benefit service provider.
Similar to the facts of the Indiana ruling, the taxpayer is a pharmacy benefit management provider for various health plans. It contracts with insurance companies to provide the plans’ beneficiaries access to discounted prescription medicine and it separately contracts with retail pharmacies to allow the policy beneficiaries to obtain the medicine from the retail pharmacies.
The taxpayer argued that it was not subject to B&O tax on the amounts received from its clients that represent that value for the prescription drugs since those amounts were just passed-through to the pharmacies. However, the Court ruled that these amounts are not pass-through revenues, noting that the state’s rule excludes only those amounts treated as advances or reimbursements for which the taxpayer assumes solely agent liability. For example:
[W]here a taxpayer engaging in the business of selling automobiles at retail collects from a customer, in addition to the purchase price, an amount sufficient to pay the fees for automobile license, tax and registration of title, the amount so collected is not properly a part of the gross sales of the taxpayer but is merely an advance and should be excluded from gross proceeds of sales.
In this case, there is no agency relationship established by the taxpayer in its contracts with either its clients or the pharmacies, as the Court explains:
Pursuant to its contracts with retail pharmacies, [Taxpayer] is solely responsible for payment to the pharmacies for the drugs dispensed to plan members and assumes the credit risk of [Taxpayer’s] clients’ ability to pay for the drugs. [Taxpayer] negotiates the payment it receives from its clients for the value of the prescription drugs and separately negotiates how much it will pay retail pharmacies to settle its obligation to them. As such, [Taxpayer] does not act as a mere pass-through agent for its clients. Rather, the compensation [Taxpayer] receives from its clients for the value of the prescription drugs is an integral part of [Taxpayer’s] business model for its [pharmacy benefit management] services.
Based on that determination, the taxpayer argued that if the value of the prescription drugs is subject to B&O tax, then it should be taxed as a retailer or wholesaler as opposed to a service provider. However, the Court disagreed and explained that the taxpayer is just being assessed on the full amount of revenue it receives from its clients for providing pharmacy benefit management services. This service includes managing the drug benefit program for which the taxpayer receives amounts from its clients representing the value of the prescription drugs sold by retail pharmacies. At all times, the taxpayer is being treated as engaged in providing a service and not in the business of buying and selling prescription drugs.
These types of issues can be very frustrating for taxpayers, particularly where, under seemingly identical facts, two states take inconsistent positions which creates an unfavorable result for the taxpayer in both cases. However, sometimes this happens because the states are imposing different types of taxes (e.g., income vs. gross receipts) or apply different rules to a transaction (e.g., cost-of-performance vs. market-based sourcing of service revenue or business vs. non-business income).
Aprio’s SALT team has multi-state expertise which allows us to provide clients a complete picture of how their operations and transactions are likely to be taxed in each of the jurisdictions in which they do business. In addition, we can make recommendations to minimize those multi-state liabilities and make sure that the 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.
This article was featured in the May 2019 SALT Newsletter.
 Express Scripts, Inc. v. Washington, Docket No. 50348-4, Wash. Ct. of App. Div. II (March 26, 2019).
 See Wash. Admin. Code 458-20-111 (Rule 111).
 Under the B&O tax, a retailer’s revenue is taxed a .471%, a wholesaler’s revenue is taxed at .484%, and a service provider’s revenue is taxed at 1.5%.
 For those that read our Indiana article, you will note that Indiana came to a different conclusion on this point, ruling that the taxpayer was selling prescription drugs for purposes of applying its income tax apportionment revenue sourcing rules. In both cases, the inconsistent treatment is for each state’s benefit.
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.
About the Author
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.