Revenue Administrative Bulletin 2024-21

Sales and Use Tax: The Prescription Drug and Over-the-Counter Drug Exemptions

(Replaces Revenue Administrative Bulletin 1993-3)

Approved: November 26, 2024

Note: A taxpayer may rely on this Revenue Administrative Bulletin (RAB) until it is revoked by Treasury or until a law on which this RAB is based is altered by legislation or by binding judicial precedent. See MCL 205.6a and RAB 2016-20.

RAB 2024-21. This RAB replaces RAB 1993-3 and discusses the statutory exemptions from sales and use taxes for prescription drugs and certain over-the-counter drugs in Michigan. This RAB refers to the exemption applicable to drugs that can only be legally dispensed by prescription as the “Prescription Drug Exemption.” The term “Over-the-Counter (OTC) Drug Exemption” refers to the exemption applicable to OTC drugs dispensed by prescription.

I. Background

The imposition of sales and use taxes on prescription drugs is expressly prohibited by the Michigan Constitution which provides, in pertinent part, that “[n]o sales tax or use tax shall be charged or collected from and after January 1, 1975 on the sale or use of prescription drugs for human use.” Const 1963, art IX, § 8. In Syntex v Dep’t of Treasury, the Michigan Court of Appeals interpreted “prescription drugs” to mean drugs that can be bought only as prescribed by a physician. Syntex Laboratories, Inc v Dep’t of Treasury, 188 Mich App 383 (1991). The interpretation of Article IX was later enshrined in the General Sales Tax Act (GSTA), MCL 205.51 et seq., and Use Tax Act (UTA), MCL 205.91 et seq., in the form of a statutory exemption. Because OTC drugs were not included within Article IX, Section 8 and would otherwise have been subject to tax, the statutory exemption was further broadened to encompass OTC drugs legally dispensed by prescription. As a result, the GSTA and UTA now exempt “drugs that can only be dispensed by prescription” and “over-the-counter drugs that are legally dispensed by prescription.” MCL 205.54g(1)(a); MCL 205.94d(1)(a).

The Prescription Drug Exemption and OTC Drug Exemption share common terms, yet important differences exist in the eligibility and scope of each exemption. This RAB discusses each statutory exemption in detail to highlight these differences.

II. The Prescription Drug Exemption

Section 4g(1)(a) of the GSTA, MCL 205.54g(1)(a), and Section 4d(1)(a) of the UTA, MCL 205.94d(1)(a), create an exemption for “sales of drugs for human use that can only be legally dispensed by prescription.” Codifying the prohibition against the taxation of prescription drugs within Article IX, Section 8 of the Michigan Constitution, the Prescription Drug Exemption requires the satisfaction of two predicate requirements – (i) the drug must be for human use; (ii) the drug “can only be legally dispensed by prescription.”

i) Identifying a “drug for human use.”

The Prescription Drug Exemption first requires a “drug for human use.” The Acts define “drug” as follows:

[A] compound, substance, or preparation, or any component of a compound, substance, or preparation, other than food or food ingredients, dietary supplements, or alcoholic beverages, intended for human use that is 1 or more of the following:

(i) Recognized in the official United States pharmacopoeia, official homeopathic pharmacopoeia of the United States, or official national formulary, or in any of their supplements.

(ii) Intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease.

(iii) Intended to affect the structure or any function of the body. MCL 205.51a(i); MCL 205.92b(i).

As defined, a “drug” must satisfy both a definitional and functional component — a “drug” must be (1) a “compound, substance, or preparation” not otherwise excluded by statute that (2) is either officially recognized or otherwise intended for a specific statutory function.

1) Satisfying the definitional component of a “drug”

Foundationally, a “drug” must be either a “compound, substance, or preparation.” These terms are understood both by their common meaning and their placement within the statutory definition. Cf. Griffith v State Farm Mut Automobile Ins Co, 472 Mich 521, 533 (2005) (holding that “words grouped in a list should be given related meaning”). The term “compound” is commonly understood as “a distinct substance formed by chemical union of two or more ingredients in definite proportion by weight.” Merriam-Webster Dictionary, https://www.merriam-webster.com/dictionary/compound (accessed June 20, 2024). Likewise, a “substance” is defined as “matter of particular or definite chemical constitution.” Merriam-Webster Dictionary, https://www.merriam-webster.com/dictionary/substance (accessed June 20, 2024). A “preparation” refers to “a medicinal substance made ready for use.” Merriam-Webster Dictionary, https://www.merriam-webster.com/dictionary/preparation (accessed June 20, 2024). Collectively, these terms generally limit a “drug” to specific chemicals or combinations made ready for use. These terms exclude property regulated as a medical device.

Example 1: A specialized machine is used in the mitigation and treatment of respiratory ailments of patients. The machine may only be dispensed to patients by prescription based on governing FDA regulations. The machine does not qualify as a “drug” because it is not a “compound, substance, or preparation;” it is a medical device. Note that, as a medical device, other tax exemptions may apply (e.g., prosthetic device, durable medical equipment).

Certain products are statutorily excluded from being considered a “drug.” This includes “food or food ingredients,” which is understood in this context to refer to “substances, whether in liquid, concentrated, solid, frozen, dried, or dehydrated form, that are sold for ingestion or chewing by humans and are consumed for their taste or nutritional value.” Cf. MCL 205.54g(3)(c); MCL 205.94d(3)(c). This also includes “dietary supplements,” which are commonly identified based on the presence of a “Supplement Facts” box printed on the product’s label. MCL 205.51a(g); see also 21 CFR 101.36 (specifying the labeling requirements of any “dietary supplement” regulated by the FDA).

A “drug” is further limited to medications “intended for human use.” While drugs intended for use in animals are regulated by the FDA (see 21 USC 360b), they are not “drugs” under the Prescription Drug Exemption. In practice, prescription drugs either purchased or dispensed by veterinary professionals are not eligible for the Prescription Drug Exemption.

2) Satisfying the functional component of a “drug”

A “drug” must be intended for use as a drug. This requirement is typically satisfied through a drug’s recognition within any one of the official drug compendiums recognized by the FDA under the Federal Food, Drug, and Cosmetic Act (FFDCA). 21 USC 321(j). This includes the following official compendiums — the United States Pharmacopoeia (USP), the United States National Formulary, the Homeopathic Pharmacopeia of the United States (HPUS), and any of their supplements. Cf. MCL 205.51a(i); MCL 205.92b(i). Alternatively, this requirement may be satisfied if it is established that the drug is (1) intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease, or (2) intended to affect the structure or a function of the body. If a drug is not specifically recognized in any one of the official drug compendiums, then establishing a product as a “drug” will depend on the facts and circumstances regarding the use of that drug.

Example 2: A company manufactures a pharmaceutical product that is designed to prevent wrinkles and other signs of aging in the skin of patients. The product, which is administered through an injection into the skin by a licensed physician, contains a mixture of three separate ingredients – microspheres, purified bovine collagen gel, and lidocaine hydrochloride. Because the product is a substance made ready for use that is intended to affect the structure of the body, the product qualifies as a “drug.”

ii) Identifying a drug that “can only be legally dispensed by prescription”

A “drug” qualifies for the exemption only if it “can only be legally dispensed by prescription.” MCL 205.54g(1)(a); MCL 205.94d(1)(a). This phrase describes the nature of an exempt prescription drug – it is a drug which, by law, can only be obtained by prescription from a licensed health professional. By describing the nature of the drug rather than the circumstances of the underlying transaction, this phrase creates a categorical exemption of all prescription drugs in Michigan.

The Prescription Drug Exemption applies when a “drug” can be identified as a “prescription drug.” The identification of a “prescription drug” is typically done by reference to the applicable state or federal laws limiting the distribution or use of that drug. Generally, drugs sold within the United States are subject to regulation by the FDA in accordance with the FFDCA, 21 USC 301 et seq. The FDA reviews and approves drugs for either prescription or nonprescription use. If designated for prescription use, then the FFDCA not only prohibits that drug from being dispensed without a valid prescription (21 USC 353(b)(1)(B)), but also requires the drug packaging to contain special branding demarcating its use as for prescription use only (21 USC 353(4)(A)). A drug designated by the FDA as a prescription drug and limited under federal law to prescription use will automatically qualify as a prescription drug eligible for the Prescription Drug Exemption.

Example 3: A drug was issued an Emergency Use Authorization (EUA) from the FDA for the treatment of symptoms caused by COVID-19. The EUA specifies that the drug must be prescribed to patients by physicians or state-licensed pharmacists. The drug is an exempt prescription drug because the EUA limits the drug to prescription use only.

If a “drug” is a prescription drug, then the categorical exemption will apply to all sales of that drug. The sale of a prescription drug will therefore be exempt even without a prescription having been issued as part of the underlying transaction. Likewise, the sale of a prescription drug will be exempt even in a transaction in which the drug is not being “dispensed” (see Section III.B) to the end user of that drug. Cf. Syntex, 188 Mich App at 389 (noting the definition of a prescription drug “focus[es] on the nature of the drug, instead of on whether the drug has actually been dispensed pursuant to a prescription”). Thus, all sales of prescription drugs in Michigan will be exempt, including sales by manufacturers or wholesalers to retailers, suppliers, physicians, and other intermediaries.

Example 4: A drug manufacturer manufactures a drug that is required by law to be dispensed by prescription. As part of a marketing campaign for that drug, the manufacturer provides complementary samples to Michigan physicians. The drug manufacturer is exempt from use tax for the use of those drugs in its marketing campaign. Even though a prescription was not issued in providing the samples, the drugs are prescription drugs that can only be legally dispensed to patients by prescription. Cf. Syntex, 188 Mich App at 391.

Example 5: A drug manufacturer sells to a medical care facility a drug that is regulated by the FDA as “For Prescription Use Only”. The facility does not resell the drug to its patients, but instead uses and consumes the drug in rendering medical services to those patients. Even though the drug is not actually dispensed in the sale between the drug manufacturer and the doctor’s office, the sale is nonetheless exempt under the Prescription Drug Exemption because the drug is designated as “For Prescription Use Only” and therefore “can only be legally dispensed by prescription.”

III. The Over-the-Counter (OTC) Drug Exemption

Section 4g(1)(a) of the GSTA, MCL 205.54g(1)(a), and Section 4d(1)(a) of the UTA, MCL 205.94d(1)(a), exempt “over-the-counter drugs for human use that are legally dispensed by prescription.” The OTC Drug Exemption requires the following elements to be established —(i) there must be an OTC drug for human use; (ii) that OTC drug must be legally dispensed by prescription.

i) Identifying an “over-the-counter drug for human use”

An “over-the-counter drug” is defined as “a drug that is labeled in accordance with the format and content requirements for OTC drug product labeling under 21 CFR 201.66.” MCL 205.54g(1)(a); MCL 205.94d(1)(a). As referenced, 21 CFR 201.66 establishes certain format and content requirements of labels for any product regulated as an OTC drug by the FDA. Products subject to the above labeling requirement — which requires the packaging to contain certain information about usage, dosage, warnings, and other information pertinent to users — include all drugs not otherwise designated by the FDA as a prescription drug. Drugs whose retail packaging conforms to the OTC drug labeling requirement satisfy the requirements of an OTC drug. Further, any drug regulated by the FDA as an OTC drug, regardless of packaging, will be presumed eligible for the OTC Drug Exemption when dispensed by a licensed physician or other licensed health care professional.

Example 6: A patient receives a script for a drug to be filled at their local pharmacy. The drug is regulated by the FDA as an OTC drug. The pharmacy fills the order and sells that drug to the patient. The drug is not sold to the patient in the original retail packaging that would otherwise meet the labeling requirements under 21 CFR 201.66. Because the drug is regulated by the FDA as an OTC drug and sold by a pharmacist to the patient, it is presumed that the drug is an “over-the-counter drug” for purposes of the OTC Drug Exemption.

Example 7: In vitro diagnostic reagents are a specific type of diagnostic reagent that are used in laboratory tests to test blood or tissue samples to detect diseases or other conditions within the human body. In vitro diagnostic reagents are not regulated as an OTC drug and are instead regulated as a medical device. 21 CFR 809.3. In vitro diagnostic reagents are therefore not subject to the format and content requirements of 21 CFR 201.66 and, consequently, are not “over-the-counter drugs” for purposes of applying the OTC Drug Exemption.

The OTC Drug Exemption is limited to OTC drugs “for human use.” OTC drugs specifically regulated for animal use by the FDA (21 USC 360b) will not qualify for the exemption. OTC medications prescribed by veterinary professionals for use in the treatment of animals, such as household pets or livestock, will therefore not be eligible for the exemption.

ii) Establishing that the OTC drug is “legally dispensed by prescription”

The OTC Drug Exemption is applicable only for OTC drugs “that are legally dispensed by prescription.” MCL 205.54g(1)(a); MCL 205.94d(1)(a). This phrase describes two essential characteristics of an exempt transaction – the OTC drug must not only be “legally dispensed” in that transaction, but it must also have been dispensed “by prescription” in that transaction. By describing the facts about the underlying transaction, such characteristics limit the scope of the OTC Drug Exemption. The result is that the OTC Drug Exemption is not a categorical exemption applicable to all sales of OTC drugs, but rather a transactional exemption limited only to specific sales. An exempt sale of an OTC drug must therefore accord with the following:

1) Identifying the transaction in which OTC drugs are “legally dispensed"

The statutory requirement that an OTC drug be “legally dispensed” limits the scope of the OTC Drug Exemption to certain sales. The term “dispensed” is commonly understood to mean “to divide and share out according to a plan; to deal out in portions; administer; to prepare and distribute (medication).” Merriam-Webster Dictionary, https://www.merriam-webster.com/dictionary/dispense (accessed June 20, 2024). In the context of drug administration, the term “dispensed” refers to the act of administering or distributing the drug to the end user. By referencing the transaction in which the OTC drugs “legally dispensed,” the OTC Drug Exemption applies only to the specific transaction in which the OTC drug is administered to the end user. Cf. LR 2019-2 (concluding implantable medical devices are only “dispensed” when sold to a patient). In other words, an OTC drug is “dispensed” only when sold or administered to an individual patient.

Example 8: A pharmacy sells an OTC drug to an individual based on a doctor’s written prescription. The sale to the individual is an exempt sale because the OTC drug is being legally dispensed by prescription to that individual. The transaction involving the original purchase of that OTC drug by the pharmacy from a drug wholesaler would not be eligible for the same exemption, as in that case the pharmacy is not the end user of the drug.

An OTC drug is not “dispensed” when sold to a wholesaler, retailer, or other intermediary. The OTC Drug Exemption will therefore not apply to most sales by manufacturers or wholesalers. In these cases, alternative exemptions may apply to that sale, and purchasers should consider all exemptions available under their respective circumstances. The most common exemption in this context is the sale for resale exemption. MCL 205.51(1)(b); MCL 205.94(1)(c)(i). To apply, the resale exemption requires that the purchaser will eventually resell the drug. Establishing the resale of an OTC drug will be based on the facts related to the purchaser’s intended use of that drug, although typically the resale exemption will apply to the purchase of OTC drugs that will be sold by the purchaser in standalone retail transactions.

Example 9: Assume the same facts as in the preceding example. Although the original purchase of the OTC drug by the pharmacy is not eligible for the OTC Drug Exemption, the purchase of those drugs may be treated as an exempt sale for resale. Indeed, the pharmacy will subsequently resell the drugs in standalone retail transactions. The pharmacy may therefore claim a resale exemption when purchasing the OTC drugs from the drug manufacturer.

In some cases, an OTC drug may be used by a purchaser as part of rendering professional medical services to a patient. Where an OTC drug and a professional medical service are provided as part of a single mixed transaction, the “incidental to service” test from Catalina Marketing Sales Corp v Dep’t of Treasury (see Section IV) must be applied to determine whether the OTC drugs are merely incidental to the professional medical services rendered. Cf. LR 2019-2. If an OTC drug is “incidental” to the professional medical services, then the OTC drug is not resold to the patient; rather, it is used by the purchaser to provide a medical service. In such a case the resale exemption is inapplicable, and the drug may be subject to tax.

Example 10: A for-profit medical care provider purchases a drug from a drug manufacturer. The OTC drug is used by the medical care provider to mitigate certain side effects caused by a local anesthetic used in a medical procedure performed by a physician employed by that provider. The cost of the OTC drug is de minimis relative to the total cost of the procedure. The medical care provider does not itemize the costs of the procedure and instead charges a lump sum price which includes all costs associated with the procedure, including the cost of the OTC drug. Applying the “incidental to service” test, the OTC drug is incidental to the professional medical service rendered to the patient. As a result, the OTC drug is not being sold, but rather used by the medical care provider to render a nontaxable service. The for-profit medical care provider is therefore not able to claim the resale exemption at the time of purchase.

Thus, because the OTC Drug Exemption only applies to transactions in which the drug is administered to the end user, some purchasers of OTC drugs may need to consider alternative exemptions, such as the resale exemption or the exemption for sales to qualified nonprofit entities (see RAB 2020-25). See RAB 2024-11 for additional information on the procedures and format for claiming an exemption.

2) Identifying when OTC drugs are dispensed “by prescription”

The OTC drug must also be legally dispensed to the end user “by prescription.” A “prescription” is defined by statute as:

[A]n order, formula, or recipe, issued in any form of oral, written, electronic, or other means of transmission by a licensed physician or other health professional as defined in section 3501 of the insurance code of 1956, 1956 PA 218, MCL 500.3501. MCL 205.51a(o); MCL 205.92b(o).

Because a prescription refers to an “order, formula, or recipe,” a prescription requires an affirmative directive that a specific drug be sold or otherwise prepared for a patient. A prescription does not include sales that are made without such directive, or sales that are based merely on the presentation of an identification card that indicates an individual has been certified to suffer from a particular medical condition.

Example 11: An individual purchases an OTC drug while shopping at a retail store. The purchase is not made based on a specific “order, formula, or recipe” issued by a licensed physician or other health professional; therefore, the OTC drug is not dispensed “by prescription” in that transaction. The sale of the OTC drug is subject to tax.

Example 12: The Medical Marihuana Facilities Licensing Act, MCL 333.27101 et seq., authorizes the sale of marijuana to qualified patients in possession of a registry identification card. The registry identification card indicates the holder has been certified by a physician to suffer from a debilitating medical condition. At the time of sale to the cardholder, the marihuana is not being dispensed to the patient by prescription, therefore, the exemption does not apply. See RAB 2018-2 for additional information.

This prescription must be issued by a “licensed physician or other health professional as defined in section 3501 of the insurance code of 1956.” As incorporated, Section 3501 of the Insurance Code of 1956 defines a “health professional” as any “individual licensed, certified, or authorized in accordance with state law to practice a health profession in his or her respective state.” MCL 500.3501(f). A prescription may therefore be provided by many types of licensed health care professionals, including, most commonly, physicians, dentists, optometrists, and pharmacists. A “health professional” is not limited to health professionals licensed in the State of Michigan. Prescriptions issued by health professionals licensed in any state therefore constitute valid “prescriptions” for purposes of the exemption.

Example 13: A patient calls a telehealth provider and describes the symptoms of an illness to a licensed pharmacist that is located outside of Michigan. Based on the symptoms represented by the patient, the pharmacist makes a recommendation for an OTC drug. A local pharmacy receives the pharmacist’s recommendation and thereafter dispenses those drugs by completing a retail sale to that patient. That retail sale is exempt because the order of the licensed pharmacist represents an order by which an OTC drug has been dispensed to the patient.

A prescription is valid if provided in “any form of oral, written, electronic, or other means of transmission.” The means in which a prescription may be issued by a licensed health care professional is broad; there is no specific form or format required for the issuance of a valid prescription.

Example 14: A pharmaceutical company makes sales of drugs to individual patients. Prior to a sale, the patient must undergo a physical consultation with a licensed physician. Based on that consultation, the physician may transmit an electronic order for the purchase of a specific drug to the pharmaceutical company. The patient will then be able to purchase the drugs as ordered by the physician. The patient has no authority to modify the contents of the physician’s order. Each sale is completed based on the electronic order of a drug by a licensed physician. If the sale is for an OTC drug, that sale qualifies for the exemption because the OTC drug is “legally dispensed by prescription.”

Example 15: A patient visits a doctor for an annual physical. The doctor prescribes an OTC drug to the patient and calls ahead to a pharmacy for the order to be prepared. The resulting sale of the drug by the pharmacy to the patient is exempt under the OTC exemption because the drug is being dispensed to the patient based on an oral order made by a licensed physician.

A prescription may be identified based on the facts and circumstances of the underlying transaction between the health care provider and the patient. While the circumstances for issuing a prescription are broad, sufficient documentation must still be retained to substantiate that a prescription was, in fact, issued in the transaction.

IV. Single Mixed Transactions Involving Prescription and OTC Drugs

Drugs may often be sold as a single component of a kit that includes various types of tangible personal property used to administer that drug. In these types of cases, the sales and use tax consequences may depend on how the kit is sold. If the invoice related to the sale of each kit separately lists the price for each item of tangible personal property included within the kit, then tax is due only on the taxable items of tangible personal property included therein. In such cases, the separately itemized charges for exempt prescription drugs or OTC drugs will not be subject to sales or use tax.

Example 16: A testing kit used to diagnose diseases includes both a prescription drug and other tangible personal property. The kit is sold for a price of $150, with a separately itemized invoice presented to the consumer detailing the itemized cost of the prescription drug ($100) and other tangible personal property ($50). Because the respective charges are separately itemized, sales tax is only due on the itemized charges for the taxable tangible personal property ($50).

In other cases, the kit may be sold for a single lump sum price. When taxable and exempt tangible personal property are sold as one inseparable unit (i.e., a single mixed transaction), a multi-factor test will be applied to determine if the entire transaction is taxable or exempt. Cf. Catalina Marketing Sales Corp v Dep’t of Treasury, 470 Mich 13 (2004). This test considers all of the following to determine the taxable status of the transaction:

i. what the buyer sought as the object of the transaction,

ii. what the seller or service provider is in the business of doing,

iii. whether the goods were provided as a retail enterprise with a profit-making motive,

iv. whether the taxable tangible goods were available for sale without the non-taxable goods,

v. the extent to which intangible services have contributed to the value of the taxable item(s) transferred, and

vi. any other factors relevant to the particular transaction.

If the taxable tangible personal property is deemed to be incidental to the exempt prescription or OTC drugs included within the kit, then the entire kit may be exempt. But, if the tangible personal property is not incidental to the exempt prescription or OTC drugs, then the entire kit will instead be taxable.

Example 17: An infectious disease kit is designed for the diagnosis and prevention of an infectious disease. The kit includes a diagnostic reagent that allows the user to perform an at-home test that identifies the presence of a rare infectious disease. The kit is specifically regulated by the FDA as for prescription use only, as the diagnostic reagent included within the kit is considered a “prescription drug.” The other tangible personal property included in the kit is ancillary to the reagent, which includes swabs, pipettes, and other de minimis tangible personal property used only to collect a sample for use with the reagent. Under these facts, the tangible personal property included in the kit is likely incidental to the diagnostic reagent included within the kit. As such, the entire kit will constitute a single mixed transaction that is exempt under the Prescription Drug Exemption.

Example 18: A prescription drug is sold in a pre-filled syringe capable of only a single use. The syringe is sold for a single lump sum price. Because the syringe is considered de minimis tangible personal property incidental to the sale of the prescription drug, the sale is exempt under the Prescription Drug Exemption.

The potential tax treatment of kits that include both prescription and OTC drugs is a fact-specific inquiry whose outcome will depend on the specific facts underlying each transaction.