The Internal Revenue Service (IRS) issued final regulations to implement the medical device excise tax that takes effect Jan. 1, 2013. As part of the funding for the Affordable Care Act, Congress included a 2.3 percent excise tax on the sale of medical devices by the manufacturer, producer or importer of a medical device. The tax is calculated based on gross sales. It is anticipated that the tax will raise $29 billion over 10 years. The statute included explicit exemptions for eyeglasses, contact lenses and hearing aids and also exempts devices purchased by the general public at retail for individual use. Proposed regulations were issued by the IRS concerning how the excise tax would be applied in February (REG-113770-10). The IRS also held a hearing on May 16, 2012, after the comment period had closed. The final rule does request further comment on several issues.
The final rule is similar to much of the proposed rule, while adding additional clarifications. The IRS and the Treasury Department, after consultation with the Food and Drug Administration (FDA) determined that the overwhelming majority of devices fall within the FDA regulatory categories and do not fit the sole exemption in the statute related to being a device generally purchased by the general public at retail for individual use. The rule retains the proposed rule’s facts and circumstances test to determine if a product falls within the retail exemption but provides seven additional examples to assist in determinations.
Medical Device Definition : The final rule retains the definition of a taxable medical device as a device under Section 201(h) of the Federal Food, Drug and Cosmetic Act (FFDCA) that is intended for humans. In general, the final rule tracks the FDA requirement as a device that is listed as a device with the FDA under Section 510(j) of the FFDCA.
Commenters requested clarification about a number of issues and how they relate to the tax. The final rule provides some guidance:
- Biological Devices: The FDA Center for Biologics Evaluation and Research (CBER) regulates devices that are listed with the FDA under Section 510(j) of the FFDCA as taxable medical devices. Devices the CBER regulates that are not listed with the FDA under Section 510(j) are not taxable medical devices.
- Veterinary Devices: Devices intended for use exclusively in veterinary medicine are not listed as devices under Section 510 (j) and therefore are not taxable medical devices within the meaning of the medical device excise tax.
- Dual Use Devices: Devices that have medical and nonmedical applications are not exempt because the statute does not provide an exemption based on what the end user intends to do with the device.
- Humanitarian Use Devices (HUD): Within the meaning of the FFDCA, a HUD is intended to benefit patients by treating or diagnosing a disease or condition that affects fewer than 4,000 individuals in the United States per year. Manufacturers must meet certain requirements to market such a device but are not exempt from the FDA’s listing requirements. The final regulations do not exclude HUDs from the tax unless the device falls under one of the statutory exemptions in the law such as the retail exemption.
- Software Upgrades: The IRS clarified that software and software updates that are not required to be separately listed with the FDA do not fall within the definition of a taxable medical device.
The Retail Exemption : The final rule retains the proposed rule’s safe harbor for some products as well as the facts and circumstances approach to evaluate whether a medical device is “of a type” that is generally purchased by the general public at retail for individual use. These safe harbor devices include IVD home-use lab test, over-the-counter devices and certain devices that qualify as DMEPOS for which payment is available on a purchase basis under Medicare Part B. In applying the facts and circumstances approach no one factor is determinative. A device may qualify for the retail exemption without meeting all the positive factors listed and may also qualify even if it meets one or more negative factors. The final regulations also state that there may be additional facts and circumstances, than those described in the regulation, that are relevant in the evaluation of whether a device is exempt from the tax based on the retail sales exemption. The IRS also notes that the mere fact that an individual device is sold for use in a professional setting is not determinative of whether that type of device falls within the retail exemption
The final regulations state that devices may fall into the retail exemption if consumers who are not medical professionals can purchase the device in person, over the telephone or over the Internet through retail businesses such as drugstores, supermarkets or medical supply stores and retailers that primarily sell medical devices.
The regulation also provided responses to issues raised in comments concerning how the safe harbor and the retail exemption might be applied.
- Capped Rental Devices : The IRS determined that in most instances the rental period of a capped rental device terminates before the transfer of title. In addition, information on the capped rental devices for which title has transferred to the individual user does not suggest a pattern of title transfer. Therefore, capped rental devices cannot be categorically said to quality as devices that fit the retail exemption.
- Prosthetic and Orthotics Furnished by a Home Health Agency as part of Home Health Services: Products such as catheters, catheter supplies, ostomy bags and ostomy care supplies furnished by home health agencies are payable as home health services, and the language related to home health agencies does not exclude any type of device from the definition of prosthetic and orthotic devices and therefore has no impact on the retail exemption safe harbor.
- Components of Exempt Devices : The safe harbor provision includes some components of prosthetic and orthotic devices. The IRS requests additional comments to help identify listed components of devices that are exempt and are not included in the safe harbor or that do not otherwise fall with the retail exemption through a facts and circumstances test.
- Dental Devices: The final regulations do not create a special rule for dental devices and instead suggest that whether or not these products are exempt should be the result of applying a facts and circumstances approach to the retail exemption.
- Combination Products: Combination products are therapeutic and diagnostic and combine drugs, devices or biological products. The proposed regulation ties the definition of taxable medical device to the FDA’s listing requirements for devices. These products are listed according to FDA requirements. Therefore, combination products do not fall under the retail exemption and therefore are subject to the tax. In addition, some commenters had pointed to the fact that drugs would be subject to other fees in the Affordable Care Act. The IRS responded that because the statute did not provide for coordination between the excise tax and the drug fee, a device with a drug component could not be exempt or somehow discounted because of the requirement to pay another fee.
- Replacement Parts: Replacements made and not under warranty, but listed with the FDA, are taxable medical devices and may be subject to the tax.
Additional Issues: As the final regulations do not address certain issues that the IRS and the Treasury Department continue to study, the Internal Revenue Service issued Notice 2012-77 to provide interim guidance to taxpayers. Specifically, the interim guidance addresses the determination of price under § 4216(b) and the tax treatment of (i) sales to a hospital or doctor’s office; (ii) medical software licenses; (iii) donated medical devices; and (iv) medical convenience kits. In addition, the Notice provides transitional relief to medical device manufacturers from the failure to deposit penalties relating to the medical excise tax.
A. Constructive Sales Price
The excise tax is imposed based upon the price for which the item is sold. The determination of the price when a manufacturer sells a taxable article to an independent wholesale distributor is subject to certain adjustments. When a manufacturer sells a taxable article to a purchaser other than an independent wholesale distributor, the rules provide a method for constructing a sales price that approximates the price an independent wholesale distributor would pay to the manufacturer for an identical article. In such situations, tax is imposed on the constructive sales price.
Taxpayers may apply the constructive sales price rules to certain model distribution chains listed below. Using the constructive sales price rules does not require any additional or special filing, or notation on any filing. If a taxpayer does not apply the rules provided in this notice, and does not use the actual sale price of the article to calculate its medical device excise tax liability, then the taxpayer bears the burden of demonstrating that it used the fair market price of the article to calculate its tax liability. This approach is consistent with the general rule under which a manufacturer may rebut the constructive sale price if the manufacturer demonstrates that it sold the article at a fair market price.
1. Sales at Retail Directly to Unrelated End Users
The constructive sale price for sales at retail directly to unrelated end users is 75 percent of the actual selling price after taking into account adjustments. The adjustments require the inclusion of any charge for coverings and containers and any charge incident to placing the article in condition packed ready for shipment. However, the adjustments allow a reduction for any excise tax imposed, whether or not stated as a separate charge. Also, any transportation, delivery, insurance, installation or other charge, which is not required to be included based on the adjustments above, shall be excluded from the price. No further adjustments under § 4216 are allowed.
2. Sales to Unrelated Retailers
The constructive sale price for sales to unrelated retailers is 90 percent of the lowest price for which the articles are sold to unrelated retailers. This computation is made without adjustment for any exclusion (except for the tax imposed on such article) or readjustment under § 6416(b)(1)(a) and (e).
3. Sales to Related Retailer Who Sells the Articles at Retail to Unrelated End Users
T he constructive sale price for sales to a related retailer who resells the article to unrelated end users is 75 percent of the product of 95 percent and the actual selling price (that is, the price at which the article is sold to a person who is not a member of the group of companies that are related to the manufacturer). The 5 percent discount is an allowance for the exclusions from the selling price otherwise allowed under § 4216(a). The additional 25 percent discount adjusts the selling price to approximate the selling price to an independent wholesale distributor. No further adjustments under § 4216 are allowed.
4. Sales to Related Reseller Who Leases and Sells at Retail
The constructive sale price for sales to a related reseller that leases and sells items at retail is 75 percent of the product of 95 percent and the actual selling price (that is, the price at which the article is sold to a person who is not a member of the group of companies that are related to the manufacturer). The 5 percent discount is an allowance for the exclusions from the selling price otherwise allowed under § 4216(a). The additional 25 percent discount adjusts the selling price to approximate the selling price to an independent wholesale distributor.
5. Sales to Related Reseller That Only Leases at Retail
The price for sales to a related reseller that only leases at retail is the actual selling price to the related reseller, provided that the selling price to the related reseller reasonably approximates the fair market price of the article within the meaning of § 4216.
B. Tax Treatment of Specific Items
1. Sale to Hospital or Doctor’s Office Treated as Sale at Retail for Purposes of Determining Price
Medical institutions and offices, such as hospitals and doctor’s offices, purchase taxable articles that are used to treat patients. Sometimes an article is completely consumed on the premises of a medical institution or office and other times the articles leave the medical institution or office with the patient. The IRS will treat the sale of a taxable article to a medical institution or office as a “sale at retail.” Therefore, these sales are exempted from the definition of taxable medical device and not taxable.
2. Licensing of Medical Devices
The IRS will treat a license of a taxable medical device as a lease of that taxable medical device as of the date both parties entered into the license agreement. The lease of a taxable article by a manufacturer is considered a sale and is subject to tax.
3. Excise Tax Treatment of Donations of Taxable Medical Devices to Organizations Described in § 170(c)
The donation of a taxable medical device by the manufacturer of the device to an eligible donee will not constitute a taxable use. However, if at the time of donation, the manufacturer has reason to believe that the donation is not being made to an eligible donee or that the article donated will be resold by the eligible donee, the manufacturer is not relieved from the liability for the tax. For purposes of this safe harbor, an eligible donee is an entity described in §170(c) of the Code.
4. Taxation of Medical Convenience Kits
A “convenience kit” is a set of two or more devices within the meaning of Section 201(h) of the FFDCA that is enclosed in a single package, such as a bag, tray or box, for the convenience of a healthcare professional or the end user. The kits are sometimes packaged for the convenience of a healthcare provider in the performance of a medical procedure. Convenience kits that are listed with the FDA under Section 510(j) of the FFDCA and 21 CFR Part 807 are “taxable medical devices” under the regulations unless they fall within one of the exemptions.
Until the IRS and the Treasury Department issue further guidance, no tax will be imposed upon the sale of a domestically produced convenience kit. During this interim period, the sale of a taxable medical device that goes into a domestically produced convenience kit will be subject to tax upon its sale by the manufacturer or importer; however, the sale of the convenience kit by the kit producer will not be subject to tax.
However, tax will be imposed on the sale by an importer of a convenience kit on that portion of the importer’s sale price of the convenience kit that is properly allocable to the individual taxable medical devices included in the convenience kit. When an importer sells a convenience kit that is a taxable medical device, and also sells all the individual taxable medical devices and nontaxable articles that are included in the convenience kit, the taxable portion of the sale price of such convenience kit may be determined by applying to the importer’s sale price of the convenience kit the ratio that the importer’s separate sale price of the taxable medical devices in the convenience kit bears to the sum of the sale prices of both the taxable medical devices and nontaxable articles in the convenience kit.
When an importer sells a convenience kit that is a taxable medical device, but does not sell all the individual taxable medical devices and nontaxable articles that are included in the convenience kit, the taxable portion of the sale price of such convenience kit may be determined by applying to the importer’s sale price of the convenience kit the ratio that the cost to the importer of the taxable medical devices in the convenience kit bears to the sum of the cost to the importer of both the taxable medical devices and nontaxable articles in the convenience kit. The importer may determine the cost of the taxable medical devices and the nontaxable articles in the convenience kit by any reasonable method. Thus, if the cost of the taxable medical devices represents half the total cost to the importer of the convenience kit, the tax applies to half the price charged by the importer upon the sale of the convenience kit.
In lieu of allocation, the importer of a convenience kit that is a taxable medical device may pay tax on the entire price for which the importer sells the convenience kit.
C. Excise Tax Deposit Penalty Relief
Manufacturers that are liable for the medical excise taxes are required to make semimonthly deposits of the tax with the IRS during the period in which taxable sales occur. The first deposit of the medical device excise tax, covering the first 15 days of January, is due by Jan. 29, 2013. To avoid the imposition of any penalties, the manufacturer must deposit at least 95 percent of the amount of net tax liability incurred during the semimonthly period unless the safe harbor applies. Recognizing the difficulty that manufacturers face in implementing internal procedures to determine the tax liability and then make deposits in a short period of time, the IRS and the Treasury Department have provided temporary relief. During the first three quarters of 2013, the IRS will not impose the penalty for failure to make timely deposits of the medical device excise tax provided that the taxpayer demonstrates a good faith attempt to comply with requirements and that the failure was not due to willful neglect. Also, beginning in the third quarter of 2013, medical device manufacturers may use the safe harbor rules for semimonthly deposits due during that quarter. For purposes of the safe harbor, the first calendar quarter of 2013 is the look back quarter for deposits due during the third calendar quarter.
Under the safe harbor, any person who filed a Form 720, Quarterly Federal Excise Tax Return, reporting a tax imposed for the second preceding calendar quarter is considered to have met the semimonthly deposit requirement for the current quarter if: (i) the deposit for each semimonthly period in the current calendar quarter is not less than one-sixth of the net tax liability reported for the look back quarter; (ii) each deposit is made on time; (iii) the amount of any underpayment is paid by the due date of the return; and (iv) the person’s liability does not include any tax that was not imposed during the look back quarter. Additionally, if a person fails to make deposits as required, the IRS may withdraw the person’s right to use the safe harbor rules.
Starting with the fourth quarter of 2013, the normal penalty rules will apply. If a manufacturer fails to make timely deposits under the general rules or the safe harbor, it will be subject to penalties unless the taxpayer makes an affirmative showing that such failure is due to reasonable cause and not due to willful neglect.