Tax alert

Tennessee drug distributor’s sales qualify for wholesaler exemption

Mar 03, 2023
Health care Life sciences Business tax State & local tax

This article has been revised to reflect that the state did not further appeal. You can find the updated language in the Takeaways section. The article was updated as of May 25, 2023 and originally published March 3, 2023.

Executive summary: Wholesaler exemption applies when drugs sold to medical professionals

On Feb. 24, 2023, the Tennessee Court of Appeals ruled that a pharmaceutical company’s sales were exempt from the state’s business tax in Eisai, Inc. v. Gerregano, Tenn. Ct. App., M2021-01408-COA-R3-CV (Feb. 24, 2023). The taxpayer, a Japanese pharmaceutical company with its U.S. operations headquartered in New Jersey, used warehouses in Tennessee to store and ship prescription pharmaceuticals that it manufactured. The inventory was subsequently sold and shipped to specialty pharmaceutical distributors (specialty distributors) and then sold to licensed physicians, clinics and hospitals to treat patients.

Tennessee drug distributor’s sales qualify for wholesaler exemption 

The Tennessee Business Tax is a tax based on gross sales of tangible personal property and services to customers within the state. The tax applies to both retail sales to end-users and wholesale sales to retailers. The tax allows for a small number of exemptions, including wholesaler-to-wholesaler sales and human use drugs used to treat patients (pharmaceuticals). In the pharmaceutical arena, however, the state has long taken the position that hospitals and physicians groups are the end users of medications sold or administered to patients. Accordingly, the Tennessee Department of Revenue considered the retail tax to apply when distributors sell pharmaceuticals to hospitals and physicians’ groups and the wholesale tax to apply to manufacturers when they sell to distributors. Both the Tennessee Chancery Court and the Tennessee Court of Appeals have now rejected this position.

Background and appeal 

The department originally assessed business tax liabilities against the taxpayer asserting that the specialty distributors were retailers, and therefore the taxpayer’s sales did not qualify for any exemption. The taxpayer set forth two primary arguments on appeal. First, the taxpayer argued that the business tax code excludes from the definition of ‘tangible personal property’ substances or other items of any nature inserted of affixed to the human body by licensed physicians or otherwise dispensed by them in the treatment of patients (pharmaceutical exemption). The taxpayer noted that the pharmaceuticals were ultimately used for the treatment of patients by licensed physicians. Second, and alternatively, the taxpayer argued that if the pharmaceutical exemption only applied to a physician’s sale of pharmaceuticals and not the taxpayer’s sale to the specialty distributor, then the sales should qualify for exemption as non-taxable wholesaler-to-wholesaler sales. In this case, the first sale was to the specialty distributor, a wholesaler, and then to medical facilities, the retailer, that then sold the medications to patients. 

A trial court granted the taxpayer’s motion for summary judgment finding that its pharmaceutical sales were exempted from the business tax because they did not qualify as taxable tangible personal property under state law as pharmaceuticals to treat patients. The trial court made that determination without regard to whether the sales were wholesale or retail sales. 

On appeal, the appellate court agreed, but primarily under taxpayer’s alternative argument, that the sales were wholesaler-to-wholesaler sales. The court took the position that the patients were ultimately the end-users under statute, not the medical professionals purchasing the pharmaceuticals. Accordingly, the specialty distributors were not retailers, but wholesalers selling pharmaceuticals to retailers that ultimately sold them to the end-using patients. The taxpayer’s original sales to the specialty distributor qualified for exemption under the ‘wholesaler-to-wholesaler’ exemption. The appellate court also concluded that if the pharmaceutical sales to the specialty distributor were excluded from the wholesaler-to-wholesaler exemption, the sales were still outside the scope of taxable tangible personal property as pharmaceuticals used to treat patients. 


The trial and appellate courts addressed very specific facts and circumstances. Still, this expansive approach to interpreting the exemption would extend to many pharmaceutical companies and distributors potentially creating significant broad-based refund opportunities for open years. The healthcare industry has thrived in Tennessee with pharmaceutical manufacturing and distributing popular activities among many of the middle and large healthcare businesses. The availability of the wholesaler-to-wholesaler exemption when distributing pharmaceutical as in this case may provide both planning and structuring opportunities for eligible pharmaceutical manufacturers. 

Affected taxpayers should also note that the Tennessee Department of Revenue did not further appeal the appellate court’s decision. Accordingly, refunds may be available as well as reductions to audits that include similar facts as the Eisai decision.

The Tennessee business tax is broadly imposed and often missed by businesses first beginning activity in the state. Taxpayers with business operations, payroll or inventory should consider a compliance review for potential business tax mitigation or refund opportunities. 

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