Minnesota Supreme Court rules on PBM receipt sourcing

In its second significant state tax decision in recent weeks, the Minnesota Supreme Court addressed the sourcing of receipts from a pharmacy benefit management (PBM) agreement. In finding for the Minnesota Commissioner of Revenue, the Court determined that PBM receipts should be sourced for sales factor apportionment purposes to the state in which the benefit of the transaction was received by plan members, rather than the location of the PBM service provider’s direct customer.¹

Facts and procedural history

The taxpayer, a group of entities owned by Humana, included two subsidiaries, Humana Insurance Company (HIC) and Humana Pharmacy Solutions, Inc. (HPS), that entered into a PBM agreement. Humana, HIC and HPS were incorporated and based outside Minnesota. HIC is an insurer that provides or services medical and drug insurance programs for its plan member customers within and outside Minnesota (consisting of individuals and employer groups). HPS is a PBM company that contracts with an established network of participating pharmacies to process prescription drug orders for HIC’s plan members. HPS did not contract directly with HIC plan members or sell or take possession of any pharmaceutical drugs.

Under the PBM agreement, HPS provided a wide range of services to HIC, including the administration of retail, mail order, and specialty drug pharmacy benefits for members, as well as point-of-care, physician office communications, cost-containment services, and other services developed and implemented by HPS. The PBM agreement required HIC to pay HPS covered drug reimbursements and base service provider fees.

The taxpayer initially filed a 2016 Minnesota corporate franchise tax return in which HPS’s receipts from services provided under the PBM agreement were sourced to Minnesota to the extent the plan member resided in the state when purchasing a drug plan from HIC. However, in April 2021, the taxpayer amended its 2016 tax return and recomputed the numerator of HPS’s sales factor by sourcing all of HPS’s receipts from PBM services to Wisconsin, HIC’s headquarters, rather than to the location of the plan members. The numerator of HPS’s Minnesota sales factor for 2016 was reduced from approximately 1% to zero, and the taxpayer requested a refund. The Department, through its Commissioner, rejected the refund claim, and the taxpayer appealed the denial to the Minnesota Tax Court.

At the Tax Court,² the dispute hinged on interpretation of the Minnesota sourcing statute for sales of services.³ Specifically, at issue was whether the law limited the recipients of the services to “direct” recipients or customers, and whether HIC, or its individual plan members, was the recipient of HPS’s services under the PBM agreement. The taxpayer argued that it was entitled to summary judgment because the Commissioner could not source receipts based on the location of an indirect beneficiary of the service, like HIC’s plan member customers. The Commissioner argued that there was no requirement in the sourcing statute that the recipient of the service had to be the same person who contracted or paid for the service, and that the taxpayer’s interpretation would read in a “direct” requirement that was not in the statute itself.

Agreeing with the Commissioner, the Tax Court noted that the service sourcing statute at issue in Minnesota did not limit the receipt of services to the location of the service provider’s direct customers. None of the language in the sourcing statute made references to a “direct” requirement, and the Tax Court could not add that language to the statute. As a result, the taxpayer’s interpretation was deemed to be unreasonable, and the statute required a fact-specific determination of who received the services, and where the party receiving the services was located.

The Tax Court then applied the statute, confirming the Commissioner’s argument that HIC’s plan members received the services generating these receipts, and that HPS’s receipts must be sourced to the location of the plan members. As a result, HPS’s receipts were included in the numerator of the Minnesota sales factor to the extent plan members were located in Minnesota. This was the case despite the fact that PBM services were provided to HIC under the PBM agreement, because many of the services provided by HPS also served plan members. The Tax Court affirmed the Commissioner’s summary judgment motion, and the taxpayer appealed the decision to the Minnesota Supreme Court.

Minnesota Tax Court decision

The Court began its analysis by confirming that while its review of the Tax Court’s analysis was limited and deferential, it was allowed to review the legal conclusions reached on a de novo basis. After providing an overview of the Minnesota apportionment regime, the Court concentrated on the services sourcing statute. The first sentence of the statute, “[r]eceipts from the performance of services must be attributed to the state where the services are received,” was in dispute. The taxpayer claimed that the sentence must be interpreted so that the term “received” actually meant “directly received,” so a sale could only be sourced to a direct customer, rather than a customer’s customer. The Department argued for a broader interpretation so that the sale could be sourced to the customer’s customer in certain cases.

To resolve this interpretive issue, the Court first found that the definition of “received” in the Minnesota tax code was not dispositive. The Court then applied a definition of the term derived from several dictionaries, along with case law, to determine that the plain meaning of “received” for purposes of the sourcing statute was “to come into possession of or get from some outside source.” This meaning did not specifically exclude receipts by indirect versus direct recipients of the service.

The Court then looked to the cascading steps of the sourcing statute,⁴ and in doing so, posited that this structure implicitly allowed for situations where services provided by a business may not be received by a direct customer, and instead could be received by a customer’s customer. Even though the sourcing statute contains some rules that would require sourcing to “the office of the customer,” these rules were lower in the cascade than the general rule, which did not provide similar specificity and was the favored sourcing rule to use.

The taxpayer analogized that the sourcing rule for receipts from the performance of services for a mutual fund to the location of the shareholder (the customer’s customer) was an exception to the general rule that the direct customer location was required to be used for other sales of services. The Court ultimately rejected this argument on the basis that the language in the mutual fund sourcing provision had little bearing on the sourcing statute at issue in this matter.

Having decided this issue in favor of the Department, the Court then looked to determine who actually came into possession of or received, HPS’s PBM services during the tax year in question, and in which state such recipient was located. The Court concluded that HPS’s services were received by both HIC in its domiciliary location of Wisconsin, and HIC plan members within and outside Minnesota. However, both parties had stipulated that all of the receipts at issue from HPS’s services should be sourced together, resulting in an “all-or-nothing” stipulation that these receipts would be sourced either to Wisconsin or to Minnesota. With that stipulation in place, the taxpayer was unable to overcome the burden of showing that none of the services at issue were received in Minnesota under the Court’s interpretation of the sourcing statute, the Court concluded that the Tax Court did not err by granting the Commissioner’s summary-judgment motion.