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
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
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
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
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
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
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
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
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
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.