Retailers have won a victory in the realm of California taxation in McClain v. Sav-on Drugs (March 13, 2017) __ Cal.App.5th __ (Nos. B265011 & B265029).

In McClain, pharmacy customers brought a class action to require retail pharmacies to file an administrative claim with the Board of Equalization to seek a refund of sales tax paid for certain products used by diabetics. The retailers won because California's tax code does not provide for this remedy and although the courts have the power to fashion a new remedy, the prerequisites for doing so did not exist in this case.

California law requires retail pharmacies to pay sales tax for certain products used by diabetics. To cover the cost of that sales tax, pharmacies charge customers a "sales tax reimbursement." But what happens if the customer wants to argue that no tax was actually owed? The customer cannot seek a refund directly from the Board of Equalization, because the customer is not the taxpayer. In theory, the pharmacies could file an administrative claim for a refund, of course, but in reality the stores have no incentive to do so, since they would then have to pass any recovery along back to their customers. So, can customers go to court to require pharmacies to file an administrative claim to recover the wrongfully paid tax? The Court of Appeal held that the answer to that legal question is "yes" if three "unique circumstances" exist: (1) the customers seeking the tax refund have no other remedy available; (2) allowing the suit would not be inconsistent with existing tax refund remedies; and (3) the Board must have already determined that refunds are actually owed, such that not allowing the customer to force the store to get the refund will unjustly enrich the store or the Board.

In this case, the retailers prevailed, because the court found that none of the three prerequisites for allowing the remedy were present. First, the customers have other remedies—they can urge the Board to initiate an audit or they could petition the Board to repeal the regulation requiring collection of the sales tax. Second, allowing suit when the Board has not yet determined any refund is due is inconsistent with other provisions of the Revenue and Taxation Code. Third, the Board has not yet decided whether the retail pharmacies, and thus the customers, are entitled to a refund.

Why it matters: This is a solid win for retailers—in this case. The three-part test seems like it would be difficult for most customer groups to satisfy. But in the right case, the "unique circumstances" could arise. Thus, retailers who charge customers for taxes that retailers must pay should be aware of this law and how it might be applied to their specific situation.

Moreover, the court itself concluded that the result "is not an entirely satisfying one" because the pharmacies lack any financial incentive to seek tax refunds, and the statutory remedies available to the customers are merely "the practical equivalent of allowing them to tug (albeit persistently) at the Board's sleeve." The court directs the Legislature's attention to this topic. Whether Sacramento responds will remain to be seen.