Second in Series: Medical Device Tax
This article is second in a series from McGuireWoods on the proposed Medical Device Tax. For our previous installment, click here.
On Feb. 3, 2012, the Internal Revenue Service (IRS) issued long-awaited proposed regulations that provide guidance on the excise tax imposed on the sale of medical devices under Internal Revenue Code Section 4191. Section 4191 was added to the Internal Revenue Code by Section 1405 of the Health Care and Education Reconciliation Act of 2010, in conjunction with the Patient Protection and Affordable Care Act (jointly, the ACA).
The tax applies to the sale of certain medical devices by a manufacturer, producer or importer of the device. The tax is in the amount of 2.3 percent of the sale price and will apply to all devices that are sold after Dec. 31, 2012. The Treasury will be holding a public hearing on May 16, 2012, at the Internal Revenue Service in Washington, D.C., and comments on the proposed regulations and outlines of the topics to be discussed at the public hearing are due by May 7, 2012.
The ACA specifically exempts eyeglasses, contact lenses and hearing aids.
The proposed regulations provide clarification to the provisions of Section 1405 of the ACA, particularly on what type of devices may be excluded from the tax under the retail sales exemption. In large part, the current regulations describe broadly applicable tests for the retail exemption. Additionally, the proposed regulations state that existing excise tax provisions of the Internal Revenue Code will apply to the interpretation of the medical device tax. The following are ten key issues for medical device manufacturers to consider with respect to the proposed regulations.
1. To What Devices Does The Tax Apply?
Currently, “taxable medical device” is vaguely defined as any device that is intended for humans. The proposed regulations clarify which medical devices are taxable. Under the proposed regulations, the medical device tax would apply to any device that is or should be listed with the Food and Drug Administration (FDA) under Section 510(j) of the Food, Drug and Cosmetic Act or 21 CFR Part 807. This approach by the IRS makes the tax applicable to nearly all medical devices that are sold in the United States.
Moreover, the IRS noted that if a device is not listed with the FDA currently, but the FDA later determines that the device should have been listed as a device, the device will be deemed to have been listed as a device with the FDA as of the date the FDA notifies the manufacturer or importer in writing that corrective action with respect to listing is required.
2. The Retail Exemption.
Section 4191(b)(2) currently provides an exemption that precludes certain retail medical devices from being taxed. Section 405 of the ACA provides that the term “Taxable Medical Device” does not include eyeglasses, contact lenses, hearing aids and any other medical device determined by the Secretary to be of a type that is generally purchased by the general public at retail for individual use (the “Retail Exemption”). The proposed regulations adopt an expansive approach to determining what devices qualify for the Retail Exemption. The proposed regulations would provide as follows:
A device is considered to be of a type generally purchased by the general public at retail for individual use if it is regularly available for purchase and used by individual consumers who are not medical professionals, and if the design of the device demonstrates that it is not primarily intended for use in a medical institution or office or by medical professionals. Whether a device is of a type described in the preceding sentence is evaluated based on all the relevant facts and circumstances.
The proposed regulations provide a set of nonexclusive factors for use in evaluating whether a taxable medical device is of a type that is generally purchased by the general public at retail for individual use. These factors include (i) whether consumers can purchase the device through retail businesses; (ii) whether consumers can effectively and safely use the device for its intended medical purpose with minimal or no training from a medical professional; and (iii) whether the device is classified by the FDA as a Physical Medicine Prosthetic Device under 21 CFR Part 890 Subpart D.
Additionally the proposed regulations also provide a nonexclusive list of factors that can be considered as to whether a device is primarily intended for use in a medical institution or office or by medical professionals, including (i) whether the device must be implanted, inserted, operated or otherwise administered by a medical professional; (ii) whether the cost to acquire or maintain the device requires an investment that is not affordable for the average consumer; and (iii) whether the device qualifies as durable medical equipment, prosthetics, orthotics or other supplies (DMEPOS) that can be paid for only on a rental basis under Medicare payment regulations.
In addition to these nonexclusive lists of factors, the proposed regulations include a “Safe Harbor Provision” that identifies certain categories of taxable medical devices that the IRS have determined fall within the retail exemption. These Safe Harbor devices include IVD home-use lab tests, over-the-counter devices and certain devices that qualify as DMEPOS for which payment is available on a purchase basis under Medicare Part B payment regulations.
The Treasury is specifically seeking comments on how to provide greater clarity with respect to the Retail Exemption. Comments are requested on whether the following factors should be part of the determination of whether the retail exemption applies: (i) whether devices are sold primarily through specialty medical retailers and (ii) whether devices are sold over the Internet.
3. Other Exemptions.
Under the proposed regulations, the Treasury would provide a number of other exemptions to the applicability of the medical device tax, including an exemption for devices that are labeled as “Research Use Only” if they are not listed with the FDA. For example, laboratory tools and bench test devices may fall within the Research Use Only exemption. Additionally, devices that are in circulation only under Investigational Device Exemption also are not subject to the medical device tax.
4. To Whom Does The Tax Apply?
In the proposed regulations, the Treasury clarifies that Chapter 32 of the Internal Revenue Code, which incorporates regulations that are generally applicable to other excise taxes (for example, cigarette taxes), also applies to the medical device tax. These regulations contain longstanding IRS regulations and revenue rulings that determine when a manufacturer is subject to a tax. For example, contract manufacturers are commonly used for medical devices. Here, the proposed regulations provide that existing Revenue Rulings 68-197 and 82-40 will be applied to medical device contract manufacturers to determine if a person or a company is the manufacturer or importer.
5. When Is There A Taxable Event?
Under general tax regulations, a manufacturer or importer is liable for the tax when the article is sold. The proposed regulations clarify that the medical device tax attaches “when the title to the taxable article passes from the manufacturer to a purchaser.” Thus, if the device is sold on credit, the tax attaches regardless of when the purchase price is actually paid. In the case of installment sales or lease payments, the tax attaches to each partial payment that is made by the purchaser.
6. How Is The Sale Price Calculated?
The proposed regulations clarify that the price for which a taxable article is sold includes the total consideration that is paid for the device, whether the consideration is in the form of money, services or other things (i.e., trade-in). The proposed regulation commentary specifically includes any cost of packaging but excludes the cost of shipping. The sale price also excludes any warranties that may be purchased and any rebates that may be offered to the purchaser as described below.
7. How Are Rebates Accounted For?
There have been many comments to the Treasury requesting clarification on how the sale price is calculated in regard to rebates, as there is a wide use of rebate structures within the medical device industry. The proposed regulations clarify that the existing IRS excise tax regulations-related rebates will apply to the medical device tax. The tax will initially apply on the original purchase price that is paid by the purchaser. If a rebate is subsequently paid by the manufacturer to the purchaser, then the manufacturer can either offset the amount of that rebate when it makes its tax payment or if the rebate is made in a subsequent tax period it can apply for a refund of the tax that was paid.
8. Does The Tax Apply To Component Manufacturers?
The proposed regulations clarify that component manufacturers who do not manufacture a “taxable medical device” will not be subject to the excise tax. Again, the existing excise tax regulations set forth in the Internal Revenue Code will apply to determine if a component manufacturer is actually the manufacturer of a taxable medical device.
9. How Will Kits And Kit Manufacturers Be Taxed?
The proposed regulations addressed comments raised in response to IRS Notice 2010-89 concerning the taxation of “convenience kits” combining medical devices and other items that are packaged together for the user’s convenience. Specific concerns were over the potential for double taxation when one or more taxable medical devices are included in a kit. Despite these significant concerns raised on this topic, the IRS determined that sales of kits are not excluded from the application of the medical device excise tax. Thus, if a manufacturer or a distributor purchases several taxable medical devices and incorporates these into a kit that is then resold, the kit is not excluded from the tax if the kit is listed with the FDA as a medical device. This may lead to double-taxation of certain medical devices that are commonly included in kits.
10. Combination Products.
The IRS elected at this time not to make any special regulations for combination products, combining drugs, devices and/or biological product, as it determined that few combination products would be double taxed under the branded prescription drug tax and the medical device tax. The IRS, however, is seeking comments on the extent to which combination products should be subject to the medical device tax.
McGuireWoods is available to assist clients and industry members in submitting comments to the IRS on these regulations. Additionally, we will be issuing a summary of the May 16 public hearing and other developments that impact medical device manufacturers.