Woodward, Hobson & Fulton v. Revenue Cabinet,
No. 2000-CA-002784-MR (Ky. Ct. App. Feb. 22, 2002)

Kentucky's Revenue Cabinet audited a law firm's financial records and determined that the firm owed over $2,500 in use tax, plus penalty, for the purchase of copies of medical records from out-of-state health care providers. The Board of Tax Appeals upheld the tax, finding the essence of the transaction between the firm and the health care organizations to be a sale of tangible property (i.e., the paper copies of the medical records) rather than a service, which is excepted from use tax. The Board did not uphold the penalty. Both parties appealed.

The Kentucky Court of Appeals held that the sale of copies of medical records from a health care organization to a law firm, for the purpose of supporting litigation, is not subject to use taxation. According to the court, the provision of copies was merely incidental to the service rendered by the health care organization, since the records existed only as a result of the medical services provided and for the purpose of documenting the diagnosis and treatment of the patients and skills of the providers.

The court supported its holding by noting that the purpose of the use tax law was to ensure that out-of-state retailers compete with in-state retailers equally. Thus, purchases made from out-of-state retailers are subject to a use tax that is equal to the sales tax that would be imposed on an in-state purchase. The court noted that the law firm probably would not have had to pay sales tax on copies of medical records it obtained from in-state health care providers. Accordingly, there was no justification for applying a use tax to records obtained from out-of-state providers.