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Indiana rules on apportionment question

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The Indiana Tax Court recently held that a pharmacy benefit management company received its Indiana income for apportionment purposes from the provision of services rather than the retail sale of prescription drugs.1 Accordingly, the company properly sourced its income under Indiana’s cost of performance statute for sourcing service revenue that applied to the 2011-2013 tax years at issue. Because a greater portion of its income-producing activities for the relevant tax years was incurred in a state other than Indiana, none of the taxpayer’s revenue was apportioned to Indiana.

Background The taxpayer is a Delaware corporation that is one of the largest pharmacy benefit management companies in the United States. In administering the prescription drug/pharmacy benefits for its health insurer clients, the taxpayer provides services that include: (i) access to a network of third-party retail pharmacies that offer discounted prescription drugs; (ii) concurrent drug interaction reviews; (iii) claims processing and adjudication; and (iv) call centers. The taxpayer negotiated contracts with over 60,000 local pharmacies to provide its clients’ members with access to discounted prescription drugs.2 The health insurance clients pay a service charge to the taxpayer for the administration and management of the prescription drug/pharmacy benefits.3 In addition to the service charges, the taxpayer generates revenue from rebates received from drug manufacturers.

For the 2011-2013 tax years at issue, the taxpayer filed Indiana adjusted gross income tax returns that apportioned income using the statutory provisions applicable to service providers. The taxpayer determined that none of its revenue should be sourced to Indiana because the greater portion of its income-producing activities was in a state other than Indiana. Following an audit, the Indiana Department of Revenue found that the taxpayer was not a service provider because its primary revenue stream was generated from buying and selling prescription drugs. As a result, the Department concluded that the taxpayer’s receipts from its sale of prescription drugs should be sourced to Indiana as sales of tangible personal property. The taxpayer timely protested the proposed assessments, but they were upheld by the Department. Following the Department’s letter of findings affirming the assessment, the taxpayer filed an appeal with the Indiana Tax Court. The Department filed a motion for partial summary judgment.

Indiana apportionment methodology A corporation apportions its business income between Indiana and other states by using a single sales factor.4 The numerator of the sales factor is the taxpayer’s total sales in Indiana during the tax year and the denominator is the taxpayer’s total sales everywhere during the tax year.5 Sales of tangible personal property are sourced to Indiana if “the property is delivered or shipped to a purchaser that is within Indiana, other than the United States government.”6 For tax years beginning before 2019, receipts from the sales of services were sourced via a cost of performance rule, in which such sales were sourced to Indiana if the income-producing activity was performed in the state, or if more of the income-producing activity was performed in Indiana than in any other state, based on costs of performance.7

Revenue derived from provision of services Since the sourcing rules substantially varied with respect to the character of the product being sold to a customer, the key issue in the case was whether the taxpayer’s Indiana source income was from selling tangible personal property (prescription drugs) or from providing services. In determining that the taxpayer received its revenue from the provision of services rather than the sale of prescription drugs, the Tax Court found that the taxpayer properly used the cost of performance methodology to source its revenue for the 2011-2013 tax years at issue.

Because the Department filed the partial motion for summary judgment, it had the burden of proving that there was no genuine issue of material fact that the taxpayer received its income from prescription drug sales. The Department argued that the taxpayer derived its Indiana income from selling prescription drugs to members because it did not act as a mere conduit or agent between the local pharmacies and the members. To support its argument, the Department presented three contracts for the Tax Court that had been executed by the taxpayer governing transactions with a client, a local pharmacy, and a pharmaceutical company. The Tax Court did not consider the taxpayer’s contracts with the client and the pharmaceutical company because the Department failed to indicate which provisions in the documents supported its conclusion. Also, the Department did not sufficiently explain why the taxpayer’s contract with the local pharmacy demonstrated that the taxpayer was selling prescription drugs. Similarly, the Department failed to explain how the taxpayer’s “provider manual” indicated that the taxpayer was selling prescription drugs.

The Department also failed to convince the Tax Court that the taxpayer had repeatedly admitted that it was engaged in the sale of prescription drugs in other forums. First, the Department asserted that the taxpayer admitted its income was from sales of prescription drugs on the 2011 Form 10-K that it filed with the Securities and Exchange Commission. In rejecting this assertion, the Court determined that the language in the form cited by the Department described the taxpayer’s activity as the facilitation of the delivery of drugs, which is the sale of services, rather than the direct sale of drugs, which would be the sale of goods. The Department also unsuccessfully argued that the taxpayer had taken a “stance in other jurisdictions” that constituted an admission that it sold prescription drugs. According to the Department, the taxpayer argued in a Business and Occupation Tax case before the Washington Court of Appeals that it was the seller of prescription drugs.8 After determining that the Department had misread the Washington case, the Tax Court noted that the Washington court expressly recognized that the taxpayer “does not contend that it sells prescription drugs,” in response to the taxpayer’s contention that the Washington tax authority was treating the taxpayer as if it were selling prescription drugs.9

Finally, the Department failed to convince the Tax Court that the taxpayer’s 2011-2013 federal tax returns supported an admission that the taxpayer was selling prescription drugs. The Department argued that this admission was indicated on the taxpayer’s federal income tax returns because the taxpayer calculated and recorded deductions for cost of goods sold (COGS). In rejecting the Department’s argument, the Tax Court noted that apportionment is “uniquely a state concept” that is not relevant to the federal income tax returns. The Department failed to explain why it was reasonable to infer that the taxpayer “has admitted that it sells goods for Indiana apportionment purposes simply by reporting COGS on its federal tax returns.” The Tax Court concluded that the Department failed to show that there was no genuine issue of material fact that would shift the burden to the taxpayer to demonstrate an issue that must be considered at trial. Therefore, the Department was not entitled to summary judgment as a matter of law.

While the taxpayer did not file its own motion for summary judgment, an Indiana trial rule provides when any party has moved for summary judgment, a court has the power to grant summary judgment to another party on the same issue even though a motion for summary judgment was not filed.10 Based on this rule, the taxpayer argued in response to the Department’s summary judgment motion that it had presented sufficient evidence that it was providing a service, entitling the taxpayer to summary judgment. To support its argument, the taxpayer offered testimony from its leadership and contracts with its clients to demonstrate that it generates income from providing services to its clients rather than selling prescription drugs to its members. After determining that there was no genuine issue of material fact that the taxpayer’s income was received from providing pharmacy benefit management services, the Tax Court granted summary judgment in favor of the taxpayer.

Commentary The taxpayer’s ability to convince the Tax Court that it was providing a pharmacy benefit management service to customers, instead of the prescription drugs themselves, was integral in this apportionment sourcing case. Historically, many states used the plurality cost of performance test to source sales of all items other than tangible personal property, including intangibles. The application of the “all-or-nothing” version of the cost of performance test in the case is particularly challenging in a number of ways. For taxpayers like large pharmacy benefit management service providers with revenue streams that could be considered to have mixed components, the potential implications can be especially dramatic. In addition to the question of what a prescription benefits manager may be selling, the issue of how to calculate and measure costs of performance through a transactional or operational approach can be tricky, though that issue was not specifically addressed in the case.

While there are some states like Virginia that still require a pure “all or nothing” cost of performance analysis, the cost of performance test has been largely replaced over time by market-based sourcing provisions in many states, including Indiana in 2019. Despite this sea change in the method of sales factor apportionment, the determination of whether a taxpayer is generating revenue from providing services or selling tangible personal property is still relevant under market-based sourcing regimes. This is because the market-based sourcing of services will not always result in the same sourcing answer as the pure destination sourcing method typically required for sales of tangible personal property.



1 Express Scripts Inc. v. Indiana Department of State Revenue, Indiana Tax Court, No. 19T-TA-00018, May 14, 2021.
2 Under the contracts, when filling a member’s prescription, the local pharmacies charge a negotiated rate that reflects both the cost of the drug and a dispensing fee.
3 The service charges have three components: (i) the ingredient costs of the prescription drugs dispensed by the local pharmacies; (ii) the local pharmacies’ dispensing fees; and (iii) the taxpayer’s administrative fee.
4 IND. CODE § 6-3-2-2(b)(5).
5 IND. CODE § 6-3-2-2(e).
6 IND. CODE § 6-3-2-2(e)(1).
7 Former IND. CODE § 6-3-2-2(f). For tax years beginning after 2018, Indiana has adopted market-based sourcing for sales other than sales of tangible personal property. IND. CODE § 6-3-2-2(f)(3).
8 Express Scripts, Inc. v. Department of Revenue, 437 P.3d 747 (Wash. Ct. App. 2019).
9 Id.
10 Indiana Trial Rule 56(B).



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