Background: Tax on chargeback amounts versus full list price
Perrigo Sales Corporation manufactures generic prescription drugs and sells them to wholesale distributors, which then sells the products to retailers like CVS or Walmart. The distributors receive invoices reflecting a wholesale acquisition cost, or list price. However, Perrigo separately negotiates pricing agreements with retailers that typically establish a lower purchase price for the products.
When distributors sell products to participating retailers, they pay Perrigo based on the lower contracted retailer price rather than the higher invoiced list price. The difference between the list price and the retailer price is referred to as a “chargeback.” According to the court, Perrigo is contractually obligated to honor these chargebacks, and approximately 97% of its distributor sales are subject to the arrangement.
Following an audit of tax years 2016 through 2018, the Ohio Department of Taxation determined that Perrigo had underreported CAT gross receipts by excluding chargeback amounts and reporting only what it had actually received. The tax commissioner asserted that Perrigo's gross receipts should equal the full list price reflected on distributor invoices. The Board of Tax Appeals disagreed, concluding that the proper measure of gross receipts was the list price less the chargeback amount, reasoning that the CAT is a tax on receipts realized by the taxpayer.
Defining “amount realized”
On appeal, the Ohio Supreme Court noted that the CAT’s statutory definition of “gross receipts” includes “total amounts realized.” The court focused on the meaning of “amount realized” and concluded that the phrase refers to the amount actually received in exchange for property sold.
The court found that Perrigo never receives the full list price reflected on distributor invoices. Instead, distributors pay Perrigo only the lower price established under retailer pricing agreements. Because Perrigo never receives the higher invoiced amount, the court concluded that the list price cannot constitute the taxpayer's “amount realized” for CAT purposes.
In reaching its decision, the court rejected the tax commissioner's argument that Perrigo was improperly deducting a business expense from gross receipts. According to the court, the chargeback was not an expense deducted after receipt of revenue. Rather, the chargeback mechanism reflected the fact that Perrigo had never realized the invoiced list price in the first place. As a result, the taxpayer's gross receipts consisted only of the amount actually paid by distributors.
Relevance to other industries utilizing chargebacks
Although the case arose in the pharmaceutical industry, the court's reasoning may have significance beyond that sector.
Businesses that utilize contractual pricing adjustments, mandatory offsets, chargeback arrangements, or other structures that affect the amount ultimately received should consider reviewing whether their CAT reporting methodology is consistent with the court's interpretation of “amount realized.” The decision may be particularly relevant where contractual arrangements establish that certain invoiced amounts will never be collected by the taxpayer.
Taxpayers with pricing, rebate, chargeback, or similar contractual arrangements should consider evaluating the impact of this decision on current and historical CAT reporting positions. The decision may provide support for taxpayers whose receipts are reduced under preexisting contractual obligations that determine the amount ultimately received from a sale. Taxpayers with questions about this decision or the Ohio CAT generally should reach out to their Ohio tax advisor.
