Managing the Medical Device Tax

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CFO Studio Magazine, 4th Quarter 2012
By Emmalee MacDonald, Senior Tax Manager at EisnerAmper LLP & Michael Hadjiloucas, Partner at EisnerAmper LLP

How to prepare for the new sales tax, effective January 1, 2013

One of the provisions of the Affordable Care Act is an excise tax on sales of medical devices. This tax becomes effective January 1, 2013, and will be imposed upon the manufacturer, producer, or importer of the medical devices.

The tax will be charged at a rate of 2.3 percent of the sales price, and the IRS has issued proposed regulations (IRC 4191) to identify which medical devices will be subject to tax and which are exempt.

Definitions

Per the announced regulations, a medical device includes any device defined in the Federal Food, Drug & Cosmetic Act that is intended for humans. This section explains that the term “device” means an instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article used for health-care purposes.

The trigger for the tax is the passage of title from the manufacturer to the purchaser. The sales price subject to tax includes charges for packaging as well as charges incident to plac­ing the device in a condition to be packed and ready for shipment.

Specifically excluded from the sales price are:

  • Manufacturer’s excise tax.
  • Cost of transportation, delivery, insurance, installation.
  • Discounts, rebates, and similar allowances actually granted to the purchaser.
  • Local advertising charges.
  • Charges for warranty paid at the purchaser’s option.

If a rebate is offered, the tax must be levied on the original sales price, unless the rebate has been made prior to the close of the pe­riod for which the return is due. If a rebate is subsequently allowed for a device on which tax has already been paid, the manufacturer is entitled to a credit or refund.

Exemptions

Tax-free sales include sales for use in further manufacture, export, or by purchaser for export by a second purchaser. In order to qualify for the exemption, registration must first be completed with the IRS on Form 637.

In addition, IRC Section 4191 specifically exempts eyeglasses, contact lenses, hearing aids, and any other medical devices that are generally purchased by the general public at retail for individual use.

In order to qualify for the retail exemption the device must be regularly available for purchase and use by individual consumers who are not medical professionals, which is determined by reviewing whether:

  • Consumers who are not medical profes­sionals can purchase the device through retail businesses that also sell items other than medical devices, including drug stores, supermarkets, and similar vendors;
  • Consumers who are not medical profession­als can safely and effectively use the device for its intended medical purposes with minimal or no training from a medical professional; and
  • The device is classified by the FDA under Subpart D of 21 CFR Part 890 (Physical Medicine Devices).
  • It also must have a design that demon­strates that it is not primarily intended for use in a medical institution or office, or by medi­cal professionals. This can be determined by reviewing whether:
  • The device generally must be implanted, in­serted, operated, or otherwise administered by a medical professional;
  • The cost to acquire, maintain, and/or use the device requires a large initial investment and/or ongoing expenditure that is not affordable for the average consumer;
  • The device is a Class III device under the FDA system of classification;
  • The device is classified by the FDA under certain parts or subparts of 21 CFR; or
  • The device qualifies as durable medical equipment, prosthetics, orthotics, and sup­plies for which payment is available exclu­sively on a rental basis.

The regulations provide a safe-harbor provision for qualification under the retail exemption, for medical devices listed on the FDA’s IVD Home Use Lab Tests (over-the-counter tests) database at http://www. accessdata.fda.gov/scripts/cdrh/cfdocs/ cf IVD/Search.cfm. This also includes those described as “OTC” or over-the-counter de­vices in the relevant FDA classification regu­lation heading, or in the FDA’s product code name, the FDA’s device classification name, or the “classification name” field in the FDA’s device registration and listing database.

Devices that qualify as durable medical equipment, prosthetics, orthotics, and supplies, for which payment is available on a purchase basis under Medicare Part B payment rules, are also included under this provision.

The regulations provide that veterinary devices are specifically exempted. “Research Use Only” devices are exempt to the extent that they are not listed with the FDA pursuant to FDA requirements. A device would be listed if it had other purposes than research and/or had been introduced into commercial distribution.

In addition, devices subject to “Investigational Device Exemptions” are not subject to the tax.

Observations and Recommendations

The principal area on which commentators have sought additional guidance is with respect to the retail exemption. Unfortunate­ly, the proposed regulations did not provide the clarity that many interested parties had been seeking.

While the safe harbor is fairly straight-forward and exempts most over-the-counter items, more scrutiny is required in order to determine whether or not other types of medical devices qualify for the exemp­tion. Therefore, it is advisable that taxpayers review their product lists prior to year-end in order to ensure they have identified which of their devices are subject to the tax and which may qualify for an exemption.

If any products qualify for an exemption, it is important that the correct forms be com­pleted to ensure the exemption is properly claimed and supportable.

For those products on which the tax must be charged, manufacturers should evaluate their pricing structures to determine whether it is appropriate to adjust prices to compensate for the tax. Observers, however, have noted that it is unlikely that most companies will be able to pass the cost of the tax on to their customers.

Some companies have already forecasted a large charge to their expected earnings due to the fact that they anticipate the need to absorb the cost, which is what many critics of the tax had feared. There has been concern that if companies are forced to absorb the cost of the tax it will eventually hinder inno­vation as there will be less reinvestment into research and development. Job loss within the industry has also been a primary criticism of those who oppose the tax.

Companies with taxable devices should also familiarize themselves or contact their tax advisors regarding IRS Form 720, which is the form on which the excise tax is reported. Lastly, if the company is not already registered to electronically remit tax to the IRS, it may be required to register.

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