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The Supreme Court of Ohio recently issued a decision that provides important and long-awaited guidance for taxpayers on what constitutes a “gross receipt” for purposes of calculating the commercial activity tax (“CAT”) base.
The Court held that a drug manufacturer’s “gross receipts” from selling generic prescription drugs to a distributor were the payment the taxpayer actually received, not the higher list price that the taxpayer put on an invoice and recorded as a placeholder in its accounting records. The full decision is available here.
The taxpayer in this case was Perrigo Sales Corporation (“Perrigo”). Perrigo sold prescription drugs to distributors, who in turn sold the drugs to retailers. Perrigo had pricing agreements with both the distributors and the retailers. Perrigo invoiced the distributors a list price, but the actual payment that the distributors made was dependent on Perrigo’s pricing agreements with the retailers. Perrigo’s agreements with retailers normally had a price that was less than the list price with the distributor. The difference between the list price and the retailer’s price was labeled a “chargeback.” The distributor would pay Perrigo the list price less the chargeback. Stated differently, Perrigo did not receive payment of the list price.
The Court focused its analysis on the statutory definition of gross receipts, “the total amount realized by a person, without deduction for the cost of goods sold or other expenses incurred, that contributes to the production of gross income of the person.” The decision turned on the meaning of “amount realized.” Since Ohio laws do not define this phrase, the Court relied on the plain meaning of the words, as well as the Internal Revenue Code. I.R.C. 1001(b) provides that the amount realized from the sale or disposition of property is the “sum of any money received” plus the fair market value of any other property received. Perrigo received the list price less the chargeback, so the Court concluded that the list price less the chargeback was the “amount realized” that was subject to CAT.
The Court rejected the Tax Commissioner’s various arguments in support of taxing the list price, and a few of those are worth noting. The Court rejected the contention that the chargeback was a nondeductible expense, finding that the chargeback amounts were simply an accounting entry to reflect the amount Perrigo actually realized on the transaction. The Court also rejected the contention that Perrigo had “received” the list price by recording the list price in its internal accounting records at the time it shipped the drugs. The Court instead relied on substantial evidence that Perrigo never received the full list price amount.
While few taxpayers will have the same facts as Perrigo, this decision is significant because it limits the CAT to amounts actually received (rather than accounting placeholders), and because it affirms the use of federal tax authorities to determine the meaning of undefined terms like “amount realized.”
To discuss how this decision may impact your business, contact your GBQ advisor or a member of GBQ’s State and Local Tax team.
