The Michigan legislature recently passed H.B. 4831. Effective March 14, 2014, the bill exempts from sales tax over-the-counter (OTC) drugs purchased pursuant to a prescription. Although true for sales tax, H.B. 4831 does not equally exempt the purchase of OTC drugs from use tax. While this might seem like an innocuous distinction, this lack of unity between an exemption for sales tax and full taxability for use tax could have serious consequences for entities doing business and serving customers in Michigan. In order to understand the issues presented, a brief explanation of how use tax operates is required. The most common understanding of use tax is that it is simply due when sales tax has not been paid. A prime example of this would be purchasing an item in a state that does not collect sales tax (such as New Hampshire) and bringing the item into a state which does collect sales tax (such as Massachusetts). When this occurs, the purchaser must remit sales tax to Massachusetts since they will be making “use” of the item that state. Use tax becomes more complicated than this example when you look at the two separate types; consumer’s use tax and seller’s use tax. Consumer’s use tax is a tax on the purchaser and requires self-assessment and remittance by the purchaser. Tax needs to be paid on the consumption, or use of the item. Conversely, seller’s use tax applies to sales made by a vendor to a customer located outside the vendor’s state, or for sales in interstate commerce if the vendor is registered in the jurisdiction where delivery will be made. These concepts are fairly straightforward, where use tax is due by either the seller or consumer depending on the factors surrounding the transaction. Turning back to Michigan’s recent law change, only use tax is currently due on OTC drugs purchased pursuant to a prescription. This means that consumers who purchase these types of products in Michigan would theoretically only be required to remit consumer’s use tax. Consumer’s use tax presents a bit of a problem for taxing jurisdictions, as it requires self-remittance. Most consumers are not exactly knowledgeable about use taxes, which could mean they may not be apt to pay them. In theory, this means that sellers which conduct interstate commerce into Michigan would be required to remit seller’s use tax, whereas businesses located within Michigan do not. This not only seems unfair, but presents a constitutional law issue. While the Supreme Court of the United States has rarely handled sales tax cases, it did establish a long line of jurisprudence. A number of cases, beginning with National Bellas Hess v. Department of Revenue, have established a variety of important rules with regard to sales and use taxes, namely one of non-discrimination for interstate commerce. The Supreme Court has held that states cannot put into place sales and use taxes which discriminate against interstate commerce. This means, for instance, that a state cannot force out-of-state sellers to pay one type of tax, and in-state sellers a different use tax. Unfortunately, this is exactly what is set to happen in Michigan. Without an exemption for use tax, out-of-state sellers will be forced to remit seller’s use tax, whereas instate sellers can instead pass the burden of consumer’s use tax on to their customers. This is, by default, the type of discrimination on interstate commerce that the court’s decision in National Bellas Hess was trying to prevent. As a result, it appears that the implementation of H.B. 4831 is unconstitutional. This discrepancy is not simply due to Michigan suddenly wanting to brazenly ignore constitutional law over OTC drugs, but rather due to how Michigan’s tax statutes are arranged. Michigan has two separate sections of its governing statutes for its tax law; one for sales tax, and the other for use tax. Any time the Michigan legislature wishes to create an exemption for a taxable transaction, an amendment must be made to both of these code sections. With the current state of political affairs across the country, passing two pieces of legislation, let alone one, is extremely difficult. This is, of course, not the first time Michigan has run into an issue where their use tax and sales tax exemptions were out of sync. For instance, Michigan recently passed an exemption for vehicle trade-ins; however, the legislation for the sales tax exemption was passed and enacted well before the use tax component, leading to a similar scenario to the one which exists now.
In response to this issue, the Michigan Legislature has introduced HB 5342, which eliminates use tax on sales of OTC drugs pursuant to a prescription. HB 5342 was introduced on February 19, 2014, and, as of
March 13, 2014, is currently awaiting a vote in the Michigan Senate’s Committee on Finance. HB 4831 has been on the books for over a month, and while no use tax issues have yet to be raised, the constitutional problems surrounding this law still exist. Hopefully, Michigan will be able to rectify this issue shortly, or otherwise the passage of HB 4831 is a prescription for tax trouble.