BDO Indirect Tax News

United States - Navigating sales tax in the life science industry: Challenges and solutions

The U.S. stands at the forefront of the life science industry, a sector that spans biotechnology, pharmaceuticals, biomedical technologies, life systems technologies, nutraceuticals, cosmeceuticals and food processing. According to 2022 government data, foreign direct investment in the life science sector in the U.S. reached USD 656 billion and supported over 348,000 jobs. Pharmaceutical manufacturing is nearing an all-time high, driven by an expanding drug pipeline and the onshoring of operations in response to supply chain disruptions caused by the COVID-19 pandemic. This industry is synonymous with innovation and technological breakthroughs. However, navigating the complexities of regulatory frameworks is crucial, particularly in understanding and complying with U.S. taxes, such as state and local taxes.

Sales tax could be the largest spend for inbound companies due to the need to purchase goods for facility build-out, equipment and testing inventory. It is also the highest risk area for noncompliance due to broad nexus rules and multistate operations, challenges with correct product classifications for determining taxability, the introduction and use of technology to connect with customers and deliver products, and timely collection of exemption certificates documenting exempt sales. Navigating sales tax compliance in the life science industry requires a strategic approach, leveraging technology, expertise and best practices. In this article, we delve into the sales tax challenges faced by inbound life science companies and explore potential solutions to streamline compliance processes.

Nexus considerations

Inbound life science companies can establish nexus in a state through various means. A physical presence, such as employees, independent contractors performing services on a company’s behalf, location of labs, offices and inventory, can create nexus. For instance, utilizing third-party clinical research organisations (CROs) for drug trials or to find new uses for marketed drugs can establish nexus for a pharmaceutical company, especially if it retains ownership of the drugs being tested. Many states may consider retained ownership as creating nexus in the state where the CRO operates. Travel by employees or representatives in states can create nexus even if no sales are generated.

Sales tax nexus can also be established by eliciting sales that exceed economic thresholds (e.g., USD 100,000 of gross sales or 200 separate transactions in the past or current year). All states that impose sales tax have economic nexus standards.

It is important to note that for state income tax purposes, economic presence, exemplified by activities like the licensing of trademarks and patents, or having sales over a bright-line nexus, can also establish nexus. In addition, some states assert corporate income tax nexus when a corporation has a “substantial economic presence” or “significant economic presence” and others assert nexus to the “fullest extent of the U.S. Constitution.”


A majority of states provide for an exemption from sales tax on purchases of various equipment and other assets related to manufacturing and research and development (R&D) activities. Inbound companies looking to utilise such exemptions need to understand their breadth and application, which varies by state, and document them in the event of future audits.  

For example, North Carolina offers a sales and use tax exemption for purchases of equipment, attachments or repair parts that meet the following criteria:
  • The item is sold to a company mainly involved in R&D in the physical, engineering and life science industries, as classified under NAICS industry group 54171;
  • The company capitalises the item for tax purposes according to the Internal Revenue Code; and
  • The item is utilized by the company in researching and developing tangible personal property.

More restrictive states, such as California, provide only a partial exemption from state tax—excluding local tax—on the purchase or lease of qualified machinery and equipment primarily used in manufacturing and R&D. Wisconsin requires purchases to be directly and exclusively used in the manufacturing process. Conversely, other states, like Pennsylvania, grant a more generous exemption, i.e., a tax exemption on purchases of tangible personal property intended for predominant use—defined as more than 50% of the time—in manufacturing.

By appropriately issuing an exemption certificate to the vendor before acquiring the equipment, companies can achieve immediate tax savings. Moreover, if the equipment is purchased and then used in a manner that qualifies for exemption, previously paid sales tax can be reclaimed through a refund claim, provided the claim is filed within the applicable statute of limitations.

Exemptions similar to those for equipment can also apply to purchases of utilities (e.g., electricity, water, gas, etc.) used in qualifying manufacturing and R&D activities. To qualify for such exemptions, states may mandate that the company conduct a utility study to determine the percentage of exempt usage. Following this, the company can issue an exemption certificate to the utility provider, delineating taxable and nontaxable usage based on a reasonable method.

Companies should be cautious with purchases not used in manufacturing or R&D activities, or in cases where the company is considered the end-user. Items such as tangible property used for testing, cleaning supplies and assets employed outside the manufacturing area typically incur sales tax. If sales tax was not collected at the time of purchase, the company is responsible for self-assessing and remitting the corresponding use tax to the state in a timely manner.

Sales and taxability

Upon reaching commercialisation stage, a life sciences company should be concerned about the taxability of its products and services. In general, prescription medicines developed for human consumption are exempt from tax in most states, except for Illinois, which imposes tax at a reduced rate. Over the counter medicines, however, are subject to tax in most states. State taxability rules in this area can be intricate and should be examined regularly and thoroughly.

Drugs developed for pet consumption are subject to tax in most states, with some exceptions for food-producing livestock. If sold directly to veterinary practices, companies should be aware that most states view them as end users of their products, rather than resellers. However, if sold to distributors that then resell the product to veterinary practices, the initial sale may be exempt as a sale for resale. Thus, life science companies should be aware of their customers and collect exemption certificates where required to document exempt sales.

With the life science industry's growing shift towards digitisation, transactions involving software, digital products and online subscriptions are on the rise. However, navigating the tax landscape for these intangible assets can be complex, given the evolving regulations. It should be noted that around 35 states levy sales tax on software delivered electronically, while more than 30 states tax various digital products. Additionally, about half of the U.S. states apply sales tax to Software as a Service (SaaS), and 12 states tax data processing or information access services. Life science companies should be consistently thinking about their products and delivery models and ensure they charge and collect sales tax where appropriate.

Solutions and other state tax considerations

Inbound life science companies should consider consulting with sales tax experts to understand their nexus profile and filing obligations, and address intricate taxability concerns, product classification nuances and potential exemption qualifications. Inbound companies frequently face costly exposures or unintended expenditures when they do not engage experienced U.S. tax professionals and advisors or when they lack robust internal controls for overseeing sales and use tax obligations.

Leveraging indirect tax compliance software or outsourcing this function can streamline the compliance process and mitigate the burden on the company. Using compliance software can assist with automating sales tax calculations, provide real-time updates on rate and taxability changes, flag new states where activity may reach nexus thresholds, help collect exemption certificates and track their expirations, and generate reports for internal review and external audits.

Periodic reviews and analyses of taxability, either on sales or the purchase side, can pinpoint opportunities for optimisation and reduce potential risks. Significant savings can be realized before purchasing specific equipment and machinery by determining whether their use qualifies for sales tax exemptions under manufacturing or R&D categories.

Expenditure on utilities should also be considered and reviewed. If sales tax was mistakenly paid, it is possible to recover it, provided the refund claim is submitted within the statute of limitations period specific to the state. With respect to products that are consumed in trials, taken out of inventory for use or not covered by an exemption, it is important to monitor that purchases were subject to tax or that the company is self-accruing and reporting use taxes.

From an income tax perspective, a life science company should consider filing tax returns in jurisdictions where it has established nexus to record and document losses. These documented losses can be invaluable in the future, offsetting taxable income once the company becomes profitable. It is important to note that the company may lose the opportunity to carry forward net operating losses from previous years in states where it established nexus but failed to file a return. During the pre-commercialisation and commercialisation phases, it is crucial to review state-specific income tax sourcing methodologies. This ensures that various revenue streams, such as licensing payments and drug sales, are correctly attributed to the appropriate state.

Companies should also be aware of local tax obligations. The largest life science markets include San Francisco, Los Angeles, Philadelphia and New York City, all of which impose taxes based on income and/or gross receipts. 

Lastly, inbound life science companies need to be aware of potential credits and incentives they may receive for creation of new jobs, training, building new or upgrading existing facilities, or locating within special tax opportunity zones.

Angela Acosta
Ilya Lipin
BDO in the United States
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