NOTICE: IC § 6-8.1-3-3.5 and IC § 4-22-7-7 require the publication of this document in the Indiana Register. This document provides the general public with information about the Department's official position concerning a specific set of facts and issues. This document is effective on its date of publication and remains in effect until the date it is superseded or deleted by the publication of another document in the Indiana Register. The "Holding" section of this document is provided for the convenience of the reader and is not part of the analysis contained in this Letter of Findings.

Pharmacy Benefit Management Provider was unable to establish that it did not earn Indiana source income by arranging for the purchase and subsequent sale of pharmaceutical drugs in transactions with Indiana customers; therefore, Provider had an apparent right, title, and interest in the pharmaceuticals; as a result, Provider was required to include receipts earned from the Indiana transactions in both the sales factor numerator and denominator and to pay Indiana income tax on income sourced to Indiana.

I. Corporate Income Tax - Prescription Drug Sales.

Authority: IC § 6-3-2-2(e); IC § 6-3-2-2(f); IC § 6-3-2-2(l); IC § 6-3-6-10(a); IC § 6-3-6-11; IC § 6-8.1-5-1(b); IC § 6-8.1-5-1(c); Dept. of State Revenue v. Caterpillar, Inc., 15 N.E.3d 579 (Ind. 2014); Indiana Dep't of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463 (Ind. 2012); Wendt LLP v. Indiana Dep't of State Revenue, 977 N.E.2d 480 (Ind. Tax Ct. 2012); Scopelite v. Indiana Dep't of Local Gov't Fin., 939 N.E.2d 1138 (Ind. Tax Ct. 2010); Lafayette Square Amoco, Inc. v. Indiana Dep't of State Revenue, 867 N.E.2d 289 (Ind. Tax Ct. 2007); Treas. Reg. § 1.471-1; 45 IAC 2.2-5-8(c); 45 IAC 3.1-1-50; 45 IAC 3.1-1-51; 45 IAC 3.1-1-52.

Taxpayer argues that the Department erred when it concluded that Taxpayer earned Indiana source income by selling Indiana customers prescription medicine.

Taxpayer is an out-of-state "pharmacy benefit management provider" for various health insurers, union-sponsored health benefit plans, workers' compensation plans, and government health programs.

Taxpayer contracts with insurance companies to provide the plans' beneficiaries access to discounted prescription medicine. Taxpayer contracts with retail pharmacies to allow the policy beneficiaries to obtain the medicine from the retail pharmacies. Taxpayer also has contractual relationships with the drug manufacturers.

The Indiana Department of Revenue ("Department") conducted an audit review of Taxpayer's business records and income tax returns for the 2011, 2012 and 2013 tax years. The Department's audit concluded that Taxpayer earned income by selling prescription medicine to Indiana customers and that this income was subject to Indiana's corporate income tax. As a result, the audit assessed additional corporate income tax.

Taxpayer disagreed on the ground that it was not selling prescription medicine to Indiana customers and that its income was entirely attributable to services performed outside the state. Taxpayer submitted a protest to that effect. An administrative hearing was conducted during which Taxpayer's representative explained the basis for the protest. This Letter of Findings results.

I. Corporate Income Tax - Prescription Drug Sales.

The issue is whether Taxpayer is able to establish that it did not earn income includable in the numerator of the Indiana sales factor for Indiana income tax apportionment purposes when facilitated the sale of prescription drugs to Indiana customers.

The audit found that Taxpayer earned money from the "delivery of the prescription drugs . . ." to Indiana customers. Quoting Taxpayer's SEC filings, Taxpayer earned money "primarily from the delivery of the prescription drugs, through contracted network of retail pharmacies, home delivery, and specialty services and [Emerging Market] services." Taxpayer argues that it does not sell prescription medicine but that it is a "service provider" for which the costs of performing those services are incurred "outside of Indiana."

For the years at issue, Taxpayer filed Indiana corporate income tax returns, reported zero sales in the numerator of the apportionment factor, reported its total gross receipts in the denominator of the sales, and reported "zero" income attributable to Indiana. As a result, Taxpayer claimed a full refund of Indiana "Economic Development for a Growing Economy" (EDGE) credits.

The audit described Taxpayer as a "pharmacy benefit management provider" in the business of providing "access to medicines at lower costs . . . ." The audit found that Taxpayer did so by entering into contracts with health insurance providers and - separately - by entering into contracts with retail pharmacies as well as prescription drug manufacturers.

The audit found that Taxpayer's primary "revenue stream" was attributable to buying, selling, and delivering prescription drugs in transactions which occurred within the state. According to the audit, Taxpayer bought drugs at one price and then resold those drugs at a higher price to Indiana customers. As described in the audit report in part:

The audit concluded that Taxpayer was not simply being reimbursed for its costs but was earning money by buying drugs at one price and then reselling those same drugs at a higher price. The audit found that approximately 99 percent of Taxpayer's revenue was derived from, buying, selling, and delivering drugs. As explained in the audit report:

After reviewing the parties' agreements, the audit found that Taxpayer:

The audit determined that Taxpayer should have included money received from the sale of drugs at Indiana pharmacies in both the numerator and denominator of the Taxpayer's "sales factor" for two reasons:

The audit found that, under IC § 6-3-2-2(e), money from sales of the pharmaceuticals "in this state" was properly sourced to Indiana and was properly included in both the numerator and denominator of the sales factor. The statute provides:

(Emphasis added).

As authority for requiring Taxpayer to include receipts from drug sales "to this state" in the sales factor numerator, the audit report also cited to 45 IAC 3.1-1-52 which provides in relevant part:

As authority for requiring to include receipts from drug sales in the sales factor denominator, the audit report also cited to 45 IAC 3.1-1-51 which states in relevant part:

Although finding that Taxpayer did not have its own Indiana retail location from which it sold pharmaceuticals, Taxpayer entered into contracts with both insurance companies and retail pharmacies for purchases and sales of drugs which took place in Indiana. As explained in the audit report:

After arriving at this conclusion, the audit proposed an adjustment to account for retail sales of drugs to Indiana customers. In order to properly calculate this adjustment, the Department requested that Taxpayer provide information detailing the retail and mail order sales along with information on sales rebates. Taxpayer refused the request on the ground that it had no Indiana retail sales, all of its income was attributable to services performed outside Indiana, and that the requested information was irrelevant and of no concern to the Department. However, Taxpayer did not provide a "cost of performance" analysis nor did it explain how and where it was reporting those costs.

In the face of Taxpayer's refusal to provide the Department's audit the requested financial information, the audit calculated an assessment "on the assumption that 2[percent] of [Taxpayer's] prescription drug sales [were] located in Indiana" and on the assumption that Taxpayer had sales in all fifty states. As authority for doing so, the audit cited to IC § 6-8.1-5-1(b) which provides in relevant part:

(Emphasis added).

In addition, the audit cited to IC § 6-3-2-2(l) as further justification for its decision that Taxpayer was required to include sales resulting from the Indiana sale of prescription drugs in order to more "fairly represents the [T]axpayer's" Indiana income. In part, that statute provides:

In effect, the audit concluded that including money received from its Indiana prescription sales in both the numerator and denominator of the sales factor was necessary in order to "effectuate an equitable allocation and apportionment of [T]axpayer's [Indiana] income."

Taxpayer disagrees with the decision in which the Department concluded that Taxpayer was earning money from Indiana sales of "tangible personal property" (prescription drugs).

Taxpayer cites to IC § 6-3-2-2(f) as authority for its position that the sales income at issue should have been sourced to a location outside Indiana. The statute provides:

Taxpayer explains its position:

(Emphasis added).

However, it is appropriate to repeat here that Taxpayer did not document or explain the manner in which it calculated its "cost of performance" not did it establish how and where those costs were reported.

Taxpayer makes a secondary argument. According to Taxpayer, the Department's assessment "violates both the Commerce Clause and the Due Process Clause of the United States Constitution" by assessing tax on transactions and activities which are unrelated to any Indiana activity.

Taxpayer contends that the Department's "adjustments violate both the Equal Protection Clause and the Due Process Clause of the United States Constitution and the Indiana Constitution" on the ground that the Department is "discriminating" against Taxpayer. Taxpayer asserts that the Department is discriminating against Taxpayer "by treating it differently than other similarly-situated Indiana taxpayers" and thereby depriving Taxpayer "of property without equal protection and due process of law."

Taxpayer argues that the assessment of tax was wrong because the income at issue was attributable wholly to the provision of services, that the services were performed by its employees located outside Indiana, and that based on the "cost-of-performance" rule, the income is properly attributed to locations other than Indiana.

As a threshold issue, it is the Taxpayer's responsibility to establish that the existing tax assessment is incorrect. As stated in IC § 6-8.1-5-1(c), "The notice of proposed assessment is prima facie evidence that the department's claim for the unpaid tax is valid. The burden of proving that the proposed assessment is wrong rests with the person against whom the proposed assessment is made." Indiana Dep't of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463, 466 (Ind. 2012); Lafayette Square Amoco, Inc. v. Indiana Dep't of State Revenue, 867 N.E.2d 289, 292 (Ind. Tax Ct. 2007). Thus, a taxpayer is required to provide documentation explaining and supporting his or her challenge that the Department's position is wrong. Poorly developed and non-cogent arguments are subject to waiver. Scopelite v. Indiana Dep't of Local Gov't Fin., 939 N.E.2d 1138, 1145 (Ind. Tax Ct. 2010); Wendt LLP v. Indiana Dep't of State Revenue, 977 N.E.2d 480, 486 n.9 (Ind. Tax Ct. 2012). Consequently, a taxpayer is required to provide documentation explaining and supporting his or her challenge that the Department's position is wrong. Further, "[W]hen [courts] examine a statute that an agency is 'charged with enforcing . . . [courts] defer to the agency's reasonable interpretation of [the] statute even over an equally reasonable interpretation by another party.'" Dept. of State Revenue v. Caterpillar, Inc., 15 N.E.3d 579, 583 (Ind. 2014). Thus, interpretations of Indiana tax law contained within this decision, as well as the original audit, are entitled to deference.

Taxpayer argues that its involvement in the "retail sales" consists solely of the provision of services, that the services are performed outside Indiana, and that it has no ownership interest in the products provided to the insurance company customers.

Taxpayer further asserts that these receipts–in which it has no interest because it has no interest in the goods–are exclusively service receipts and are included in only the sales factor denominator because the services are performed outside of Indiana pursuant to IC § 6-3-2-2(f).

Taxpayer details its business activity in its 2012 SEC 10-K form. Taxpayer explains in the "Company Overview" that its business consists in part in the provision of the following services:

• Distribution of pharmaceuticals and medical supplies to providers and clinics.

• Healthcare account administration and implementation of consumer-directed healthcare solutions.

Taxpayer SEC report explains:

Taxpayer also described its business model in a 2016 prospectus 424B5 disclosure form. In that prospectus Taxpayer stated:

Taxpayer is mistaken in its reliance on IC § 6-3-2-2(f) on the ground that Taxpayer's income is wholly attributable to providing services. For the receipts to be receipts wholly attributable to providing a service, Taxpayer would be a simple conduit collecting from the insurance company the same amount that it pays the retail pharmacy stores for the drugs provided to the insurance company customers. That is not the case here. In this instance, Taxpayer's documents demonstrate that it has an apparent right to sell the prescription drugs at a mark-up and it reports a federal cost of goods sold on its tax returns. Moreover, if a taxpayer were a service provider with receipts and costs of goods for which it had no interest, that taxpayer would neither include such receipts as part of the taxpayer's business receipts nor use the receipts to calculate the apportionment factor–i.e., the receipts would be included in neither the numerator or denominator of the sales factor. In effect, Taxpayer wants to operate in the "best of both worlds." In that world, Taxpayer collects receipts for which it has no purported interest, but simultaneously claims that the sales receipts are business income reported in the denominator of the sales factor.

The Department's audit found that Taxpayer's "retail sales" result from two categories of contractual arrangements. Taxpayer contracts with various insurance companies to "procure" products for the insurance company's customers. Then, the insurance company pays Taxpayer a specified contract rate for each drug provided to the insurance company customers. Taxpayer also contracts with a network of retail pharmacy stores to provide the drugs to the insurance company customers. Under the agreement, Taxpayer pays the retail pharmacy stores a specific amount for each of the drugs provided to the insurance company customers. The contractually agreed amount Taxpayer pays to the retail pharmacy stores for drugs provided to the insurance company customers are not the same contractually agreed amounts that Taxpayer receives from the insurance company for the drugs provided to the insurance company's customers. Therefore, these contractual arrangements do not result in a simple dollar-for-dollar reimbursement in which Taxpayer has no interest in the amounts received from the retail pharmacy stores.

For illustrative purposes, Taxpayer contracts with a retail drug store and agrees that Taxpayer will pay the retail store $50 for a prescription medicine provided to the insurance company customers. Taxpayer simultaneously contracts with the insurance company and agrees that the insurance company will pay Taxpayer $60 for the prescription medicine provided to the insurance company customer. Therefore, Taxpayer's contractual arrangements result in prescription medicine being transferred to the customers and Taxpayer receiving a $10 profit for each drug transaction.

Accordingly, these transactions result in Taxpayer earning a profit on the acquisition and transfer of the drugs. Taxpayer has an interest in the resulting receipts and, therefore, an interest in the drugs being transferred in retail transactions occurring in Indiana. Moreover, since these transactions are an "income-producing factor" in Taxpayer's business, the Internal Revenue Service requires Taxpayer to report these purchases as purchases of goods recorded as inventory when the transactions are an "income-producing factor." See Treas. Reg. § 1.471-1. Taxpayer, in compliance with this regulation, recorded its purchases of the drugs from the retail stores as inventory on its federal income tax returns. Since these receipts were received by Taxpayer for an interest in tangible personal property transferred in Indiana, the receipts from these transactions would be sourced to Indiana for purposes of the sales factor numerator as provided in 45 IAC 3.1-1-50. The Department's adjustments to the sales factor followed this provision.

Although Taxpayer provided a certain amount of redacted and unredacted documentation during the course of the audit and administrative hearing, Taxpayer declined to provide documentation directly related to the drug pricing issue, its cost of performance study, or documentation establishing the methodology by which Taxpayer reported its income to the sourcing state. Therefore, this Letter of Findings takes note of Taxpayer's refusal to provide the Department with documents and information requested during the course of the audit and during the course of the administrative protest. IC § 6-3-6-10(a) provides:

IC § 6-3-6-11 in part provides:

The Department also takes note of Taxpayer's refusal to provide documentation requested pursuant to the administrative protest process. The Department issued an administrative subpoena requesting income tax returns, its sales apportionment, unredacted vendor contracts, and a documented explanation of the basis on which it claimed a deductions for "cost of goods sold." Taxpayer declined to provide the information based on its "company policy" and its own determination that the requested documents were not relevant to the issues at hand. In this case, Taxpayer's recalcitrance in providing the requested documentation has made it difficult to conclude that Taxpayer has met its burden of establishing that the assessment was "wrong."

Taxpayer has failed to explain why it was justified in refusing to provide records requested during the audit or why it should not now be subject to the penalties provided under IC § 6-3-6-10(a) and or IC § 6-3-6-11.

Nonetheless, some two years after the audit was completed and in response to an administrative subpoena, Taxpayer provided a limited number of documents in response to the audit's original documentation request. The records - as explained above - are relevant as to the amount of money Taxpayer earned from purportedly buying and selling drugs and not to the question of whether Taxpayer's sales activities resulted in income taxable in this state.

In addition to unresolved issues stemming from Taxpayer's refusal to provide the documents at first requested and afterwards subpoenaed, Taxpayer has in an unrelated protest argued that it is entitled to a refund of sales tax on equipment it uses to sort, weigh, inspect packages and label prescription drugs. In support of its argument, Taxpayer cited to 45 IAC 2.2-5-8(c) arguing that the property for which it sought the refund was "machinery, tools, and equipment . . . directly used in the production process." In its sales tax refund protest, Taxpayer argued that it acquired and distributed "bulk drugs" and that it operates an Indiana facility which constitutes "the last integral, essential step to transform [drugs] into a marketable product." Taxpayer's argument in that protest - that it operates "an [Indiana] automated pharmaceutical processing facility" - would seem to be at odds with its argument here that it is simply a service provider which incurs expenses entirely outside Indiana.

The Department acknowledges but declines to address in any fashion the multiple constitutional objections raised in Taxpayer's protest. An administrative hearing is not the appropriate venue in which to address such objections but must note that there is nothing on the face of the Department's decision to assess income tax which appears to rise to the level of a fundamental, constitutional concern.

Taxpayer asks that the Department conclude that the assessment should be entirely set aside on the ground that it has met its statutory burden of establishing that the assessment was wrong. Taxpayer asks that the Department set aside the detailed and thoughtful audit report, ignore the fact that Taxpayer has refused to provide all the subpoenaed documentation, and issue an administrative decision based upon what the Taxpayer has determined is relevant and what is irrelevant.

Given the complexity of Taxpayer's business and contractual relationships with its many suppliers and vendors, the absence of documentation - requested and subpoenaed - which the Department deemed necessary to make its determination, and Taxpayer's baseless determination that it - and it alone - will decide what information is "relevant" and what is not "relevant" to these questions, the Department is unable to conclude that Taxpayer's position is correct. In addition, as noted above, Taxpayer has taken apparently inconsistent positions in a protest also filed with the Department. While Taxpayer here states that it has no possessory interest in the drugs and no financial stake in the sale of the drugs other than to recoup its distribution expenses, Taxpayer has elsewhere argues that it is entitled to sales tax refunds on equipment it uses to transform drugs into its "marketable product."

Given the elusiveness of the circumstances under which Taxpayer conducts its business, Taxpayer's protest of the Department's adjustments to the sales factor for the "retail sale" of drugs cannot be sustained. Taxpayer has not met its statutory burden of establishing that the Department's assessment was "wrong." IC § 6-8.1-5-1(b).

Taxpayer's protest is respectfully denied.

December 28, 2018