99-043

Response May 23, 2000

REQUEST LETTER

99‑043

July 20, 1999

Dear Ms. Rees:

This letter requests a ruling regarding the proper sales and use tax treatment of certain proficiency testing materials (PT Materials) that are transferred by the (the "College@) to pathology laboratories in Utah in connection with proficiency testing services provided by the College to such laboratories. Most of the College's proficiency testing services are subscribed to in the early fall. Hence, there is some urgency to this request. A Power of Attorney is attached as Exhibit A.

GENERAL BACKGROUND

The College is a membership organization exempt from payment of federal income tax under section 501(c)(6) of the Internal Revenue Code of 1986, as amended (the ACode@). The College is a not-for-profit corporation formed under the laws of STATE and is headquartered in STATE. It also has an office in STATE. The College has no office or other facility in Utah.

The Voluntary Disclosure

The College recently registered with Utah to collect use tax pursuant to a voluntary disclosure agreement reached through the Multistate Tax Commission's National Nexus Program or directly with your state. A copy of the executed agreement is attached as Exhibit B. One of the terms of the College's proposal was that it would treat the transfer of PT Materials as a taxable retail sale. However, the College reserved the right to file a follow-up ruling request seeking guidance as to the proper tax treatment of such testing.

At least one customer has now asserted to the College that the transfer of such materials is incident to the sale of a nontaxable service, i.e., the proficiency testing service, and is therefore not properly treated as subject to a sales tax, The purpose of this ruling request is to obtain a ruling as to (I) whether the College's transfer of PT Materials are retail sales of tangible property or transfers of property incident to nontaxable service sales, and (ii) if such transfers are

incident to nontaxable service sales, the proper tax treatment of the transfer of the PT Materials as an incident thereto. The College is filing a substantially identical ruling request in each of the states with which it entered into a voluntary disclosure agreement.

Proficiency Testing

The proficiency testing program (formally referred to as the PROGRAM) consists of the testing of pathology laboratories to determine whether the laboratories meet certain standards required by federal law and by the College. Under the Clinical Laboratory Improvement Amendments of 1988, 42 U.S.C. '263a, every pathology laboratory in the United States must be accredited periodically by the Department of Health and Human Services (AHHS@) or another organization recognized by HHS as having standards that are equivalent to or more stringent than federal accreditation standards. Id, at ' 263a (e). The only entities that HHS has recognized for these purposes are the College, other not-for-profit organizations, and agencies of a few state governments.

In order to obtain accreditation, a laboratory must, inter alia, participate in a proficiency testing program. A proficiency testing program evaluates the ability of participating laboratories accurately to perform diagnostic services for patients. Specifically, the proficiency testing program involves (I) the transfer to a participating laboratory of a specimen Qua, the PT Materials) the composition of which is unknown to the laboratory, (ii) the analysis of the PT Materials by the laboratory and transmission of the laboratory's findings to the College, and (iii) the processing and evaluation of the laboratory's findings by the College. By federal law, the furnishings of the PT Materials to the laboratory must be by a government agency or a not-for-profit entity See 42 U.S.C. ' 263a(f).

Most of the PT Materials consist of a human serum or other biologic base that is "spiked" with the analytes for which each participating laboratory must test. The College purchases the PT Materials from various manufacturers.

The manufacturer generally delivers the PT Materials by common carrier to a third party repackager retained by the College or ships the PT Materials by common carrier directly to each participating laboratory. The manufacturer invoices the College for the PT Materials at the time the manufacturer ships the PT Materials to the repackager or directly to the laboratories. The repackager breaks down the manufacturer's bulk shipment into individual packages for shipment to the laboratories, adds printed instructions supplied by the College, and then ships the materials by U.S. Mail or by common carrier to the participating laboratories.

The laboratory has no independent use for the PT materials apart from participating in the testing program. Once a participating laboratory has concluded its analysis of the PT Materials, the laboratory generally disposes of those materials. The laboratory sends a report of its analysis to the College at its headquarters in Illinois, where the College reviews the laboratory's report. The College evaluates the laboratory's analysis, and it provides its findings to the laboratory and to the accreditation organization designated by the laboratory. When the College provides the laboratory with its results for each test, the College also provides the laboratory with the mean result for that test, the standard deviation, the number of laboratories that participated in the test, the standard deviation index, the lower and upper limits of acceptability, and a plot of the relative distance of the laboratory's results from the established target as a percentage of the allowed deviation.

The College charges laboratories a single subscription amount for participating in the proficiency testing program. No separate charge is made for the PT Materials and for the testing service On average, the cost to the College of the PT Materials was historically about % of the amount it invoiced customers for providing the proficiency testing service. That percentage has been decreasing recently, and this year is expected to be approximately %. From time to time, the College also sells PT Materials to laboratories (without providing testing services) as replacements of samples that were lost or broken prior to or during a test The total sales of PT Materials apart from the testing program are equal to approximately % of the College's total receipts from the proficiency testing program.

The specific proficiency testing modules in which a laboratory will enroll depends on the scope of the work done at the laboratory Thus, a laboratory performing a wide range of analysis will participate in a larger number of modules than a laboratory doing only basic testing. Each specific proficiency testing module is priced separately.

Rulings Requested

I. The Atrue object" of the College's proficiency testing program is the administration of a proficiency testing service rather than the provision of the PT Materials; therefore, the College's charges for participation in the proficiency testing program are not subject to sales or use tax, and the College is deemed to be the consumer of the PT Materials.

II. The College is not subject to use tax on specimens shipped to Utah laboratories by common carrier from outside Utah.

III. If the College's subject to use tax on specimens shipped to Utah laboratories by common carriers from outside Utah, the College is entitled to a credit for tax properly paid to the state from which such materials were shipped.

DISCUSSION

I. The Atrue Object" of the Transaction is the Provision of Proficiency Testing Services and the Transfer of the PT Materials is a Mere Incident to that Service.

At issue is the proper taxation of the College's proficiency testing program. The testing itself is a service and is therefore exempt from sales tax (unless your state taxes testing services). The College does, however, transfer tangible personal property-i.e., the PT Materials-to a participating laboratory as an incident to providing the testing service. In those instances in which the service provider also transfers tangible personal property to the customer the taxability of the transaction is generally determined under the Atrue object" or Aessence of the sale" test. See! e.g., Bullock n Statistical Tabulating Corp., 549 S.W.2d 166 (Tex. 1977) (transactions in which taxpayer encoded raw data on punch cards and gave the cards to its customers was not a sale of tangible personal property because the "true object" of the transaction was not the card but the purchase of coded data). See also MCI Airsignal, Inc. n State Board of Equalization, 1 CA4th 1527,2 Cal. Rptr. 2d 476 (Cal. App. 1991) (taxpayer in business of providing telephone paging services did not owe sales or use tax on transfers of paging devices to its customers because the true object of the contracts was the provision of paging services).

In the present case, the "true object" of the College's proficiency testing program is the provision of a service, i.e., assessment of a laboratory's proficiency in analyzing unknown analytes. A participating laboratory has no use for the PT Materials apart from the proficiency testing service. Indeed, the laboratory generally disposes of such materials upon completing the testing. Accordingly, the College's furnishing of the PT Materials is merely an incident to the sale of the nontaxable proficiency testing service and thus there is no sale of tangible personal property.

II. The College Is Not Subject to Use Tax on Specimens Shipped to Utah Laboratories by Common Carrier from outside Utah

The PT Materials shipped to laboratories in Utah by common carrier from manufacturers or repackagers located outside Utah are not subject to use tax in Utah, Those materials are purchased by the College outside the state. The College does not own the PT Materials after they are delivered to laboratories in Utah, nor does the College exercise any right or power over those materials in Utah. More importantly, the College performs its proficiency testing services entirely outside Utah. Therefore, the College cannot be deemed to use the PT Materials in Utah. Because the College neither uses nor owns the PT Materials after they are delivered to the laboratories, and because the College performs the entire proficiency testing service outside Utah, the College is not subject to use tax on the PT Materials.

III. If the College Is Subject to Use Tax on Specimens Shipped to Utah Laboratories by Common Carriers from outside Utah, the College Is Entitled to a Credit for Tax Properly Paid to the State from which Such Materials Were Shipped

If the State Tax Commission determines that the College is subject to use tax on the specimens shipped to Utah laboratories (whether directly by the manufacturer or via a repackager), then the College should be entitled to a credit for any sales or use tax the College properly pays the state in which the PT Materials are manufactured or repackaged. The College respectfully submits that such a credit is required in order for the Utah use tax to satisfy constitutional requirements. See, e.g., Goldberg V. Sweet, 488 U.S. 252, 261-262, 109 S. Ct. 582

(1989).

PROCEDURAL STATEMENTS

Pending Audit or litigation

The taxpayer has no audit, litigation, protest or refund claim pending with the State Tax Commission with respect to the subject of this ruling request or any other matter.

The State Tax Commission Has Not Previously Ruled

To the best of the knowledge of the taxpayer and of the undersigned, the State Tax Commission has not previously ruled on the same or a similar issue for the taxpayer or a predecessor, nor has the taxpayer or any representative of the taxpayer previously submitted the same or a similar issue to the State Tax Commission but withdrawn it before the letter ruling was issued.

Power of Attorney

A Power of Attorney authorizing the undersigned to represent the Taxpayer in this matter is attached.

Deletions Statement

A deletions statement (Including a redlined version) is attached as Exhibit C

REQUEST FOR A CONFERENCE

In the event of a tentative decision to issue an adverse ruling with respect to any of the above items, the College respectfully requests a conference with the State Tax Commission. Thank you for your consideration of this request Please call me if you have any questions or would like any additional information

Sincerely,

RESPONSE LETTER

May 23, 2000

Advisory Opinion: Application of sales tax on sales of accreditation testing materials

Dear NAME,

The Utah State Tax Commission has received your request for information pertaining to the application of sales and use tax on charges by the College to laboratory facilities in Utah. On the basis of the facts summarized below, we offer the following tax guidance:

Summary of facts presented:

The (ACollege@) is authorized under federal law to provide accreditation testing to pathology laboratories in Utah. The college is recognized as a 501 8 (6) organization by the Internal Revenue Service. The College is organized and headquartered in Illinois, and it has an office in Washington, D.C. It has no physical facility in Utah.

Pathology labs in Utah are required by federal law to meet ongoing accreditation standards by successfully completing periodic proficiency testing. For laboratories using the College=s accreditation testing services, the transactions are as follows:

1. The laboratory acquires test materials from the College. The materials supplied by the College are purchased by the College from various manufacturers outside of Utah. The College arranges with the manufacturers to ship the materials to a third party Arepackager,@ who assembles the test materials for shipping. The Arepackager@ ships the materials to the laboratories in accordance with the College=s instructions. The manufacturers bill the College for the products ordered.

2. A laboratory receives the testing materials, conducts an analysis of the materials, then disposes of the materials. The laboratory reports its analysis to the College. The College evaluates the laboratory=s analysis, then reports the results along with a statistical analysis to the laboratory and to the accreditation authority. A laboratory contracts with the College for its testing service through a Asubscription@ fee. The fee apparently covers the cost of the testing materials as well as the cost of the evaluation and reporting provided by the College. If necessary, the laboratory may purchase additional kits from the College to replace lost or broken test kits.

3. The College transfers ownership of the testing materials to the laboratories. Accordingly, the college does not Aexercise any right or power@ over the materials. Presumably, a laboratory may use the materials obtained from the College for its test analysis, but contract with a different entity to confirm its results and to process its accreditation. In other words, a laboratory is not required to purchase both the test materials and accreditation services from the College.

4. The College has entered a voluntary disclosure agreement with the Mutistate Tax Commission and the Utah State Tax Commission under which the College agreed to collect all applicable sales and use taxes for its transactions in Utah. The issue of nexus has not been raised, and it is presumed, for purposes of this opinion, that the College has sales tax nexus in Utah.

Applicable law:

Use tax is a tax on the storage, use or consumption of tangible personal property in Utah. When tangible personal property is sold in interstate commerce for use or consumption in Utah, the sale is subject to Utah use tax. Although use tax is the liability of the purchaser, the retail vendor is responsible for collecting and remitting the tax to the State of Utah if the vendor has sales tax nexus in Utah. As stated above, we presume that the College has sales tax nexus.

Analysis:

If the College sells tangible personal property for delivery into Utah, the sale is subject to use tax unless otherwise exempt. You have characterized the sale of test materials as merely Aincidental@ to the sale of a nontaxable service. We disagree. First, you state that the purchase of the test materials accounts for about 35% to 45% of the total amount invoiced to the laboratory. The cost of the test materials is substantial, not incidental. Second, you have made a particular point of stating that ownership of the test materials passes to the laboratories. If the College retained ownership of the materials, perhaps you could argue that the College consumes the materials in the course of providing nontaxable proficiency testing. If that were so, the College arguably would be subject to Utah use tax with a credit for sales tax paid in another state. However, the College does not retain ownership of the materials. It sells the materials outright to the laboratories and that transaction is distinct from the sale of accreditation services.

We agree that the test analysis and accreditation reporting is a nontaxable service. However, when a charge for a nontaxable service is bundled with the charge for a taxable sale, the full amount is subject to tax. The College can avoid this result by separately itemizing the

charge for nontaxable services on its invoices to the Utah laboratories.

You mentioned that you may wish to meet with the Commission to discuss this matter further. You may make an appointment by contacting our secretary,

For the Commission,