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Living with the Medical Device Excise Tax

ABA Health eSource; Volume 10, Number 7

March 2014

It has been over one year since the Internal Revenue Service (“IRS”) issued its final regulations explaining the scope and application of the medical device excise tax.1 The IRS issued the final regulations merely one month prior to the excise tax’s January 1, 2013 effective date. Since that time, health law and tax attorneys, and the medical device industry, have been busy putting the IRS guidance into practice and, more often than not, finding plenty of challenges along the way.

This article begins with a brief primer on the medical device excise tax, surveys a few of the more common challenges faced by medical device companies and their counsel in complying with it, and discusses the tax’s uncertain future.

I. The Medical Device Excise Tax
The medical device excise tax was created by the Health Care and Education Reconciliation Act of 2010, which modified the Patient Protection and Affordable Care Act of 2010 (collectively, “PPACA”).2 As part of its healthcare reform efforts, Congress imposed a 2.3 percent excise tax on the sale of certain medical devices by manufacturers, producers or importers of such devices. The application of the excise tax is broad and a “taxable medical device” is any medical device intended, at least in part, for use on humans that has been registered with the Food and Drug Administration (“FDA”) pursuant to the FDA’s existing registration scheme.3 Despite this broad scope, Congress included an exception for certain medical devices sold to consumers at retail. PPACA specifically excluded eyeglasses, contact lenses and hearing aids from the excise tax and also empowered the Secretary of the Treasury to exempt “any other medical device” which it determines to be of a “type which is generally purchased by the general public at retail for individual use” from the excise tax.4

II. Challenges
As with many new regulatory schemes, application of the regulations to the “real world” often raises new questions and brings challenges not previously anticipated. In other cases, industry may simply have a more difficult time operationalizing the regulations than the federal government may have expected. While a full review of such challenges is beyond the scope of this article, the following paragraphs highlight a few of the challenges faced by medical device companies.

Treatment of Biological Products. The medical device excise tax applies to the sale of some, but not all, “biological products.” A “biological product” is a medical product, often made from natural sources, which is intended to treat diseases and medical conditions or is used to prevent or diagnose diseases. Examples of biological products include vaccines, blood products, and human cells and tissues used for transplantation (e.g. ligaments). The application of the medical device excise tax to biological products has been a concern for certain manufacturers who have not traditionally viewed themselves as manufacturers of “medical devices” and did not anticipate being subject to the medical device excise tax.

Biological products generally must receive a “biologics license” from the FDA prior to being made available for sale. Products for which the FDA requires a biologics license are generally not listed under Section 510(j) of the federal Food, Drug and Cosmetic Act (“FDCA”) and, thus, are generally not subject to the medical device excise tax. However, this is not a bright line rule and, for various reasons, some biological products are in fact required to be listed with the FDA as a medical device, even if the manufacturer has not traditionally viewed its product as a medical device. In light of this, a manufacturer’s finance staff tasked with excise tax compliance may be unaware that certain of the manufacturer’s biological products are considered medical devices for purposes of the tax. Thus, it is important for manufacturers of biological products to determine (i) if their biological products are in fact listed under Section 510(j) of the FDCA, and (ii) whether any new biological products being brought to market will be subject to the tax.

FDA Listing Determinations. At times, when bringing a new product to market, it may be unclear whether a product would be considered a “medical device,” a “biological product” or if another FDA product category would apply. Thus, it is often unclear whether a particular product would need to be listed under Section 510(j) of the FDCA and thus be subject to the medical device excise tax. A product’s category and listing may be discussed at length by the manufacturer and the FDA, and initial determinations regarding category and listing may change even after the product has entered the market.5 Faced with this uncertainty, manufacturers often ask when they would need to begin collecting the medical device excise tax should listing be required as a result of negotiations with the FDA or a change in product category.

If there is uncertainty or a dispute regarding product listing, a manufacturer should expect to begin collecting the excise tax on the date the FDA first notifies the manufacturer that a product must be “listed” under Section 510(j) of the FDCA. The notice from the FDA does not need to be final for the tax to apply. If the FDA’s decision is later overturned or changed, a manufacturer can apply for a refund from the IRS for any tax paid.

Determining a Sale Price. When paying any tax to the IRS, it is important to know on what value the tax is to be applied. In the context of the medical device excise tax, it is important for manufacturers to understand what is meant by 2.3 percent of the “sale price” of a medical device. As many medical device manufacturers define “sale price” differently, particularly with respect to what costs are included in a sale price, calculating the excise tax owed is not always as simple as 2.3 percent times the sale price listed on a manufacturer’s price sheet.6

For purposes of the medical device excise tax, the sale price is the “total consideration” paid for the device, including: (i) the device itself; (ii) any “coverings or containers;” and (iii) "any charge incident to placing the [device] in a condition to be packed and ready for shipment."7 The sale price excludes: (i) the 2.3 percent excise tax; (ii) the cost of transportation, delivery, insurance, installation and other expenses incurred by the manufacturer in placing the device in the hands of a purchaser after the sale of the device (note that transportation of a device to a warehouse prior to its sale is not excluded); (iii) discounts, rebates and similar allowances granted to the purchaser; and (iv) charges for warranties paid at the purchaser's option.8 Manufacturers should take note of what constitutes the sale price of their devices and determine an appropriate sale price figure upon which to apply the tax.

Future Changes. Manufacturers should also be aware of the potential for future guidance from the IRS and be prepared to modify their collection and compliance activities as necessary. The medical device excise tax final regulations acknowledge the potential need for future guidance on particularly challenging issues, including the treatment of software licensing and “kit” products.9 Thus, medical device manufacturers and their counsel should expect the scope and application of the medical device excise tax to be subject to continuing modification and rulemaking.

III. The Demise of the Medical Device Excise Tax?
Since its inception, the medical device excise tax has not been popular on Capitol Hill and has been the subject of a bipartisan drive to repeal the tax since shortly after its passage in the spring of 2010. Led by the medical device industry and a mix of Republicans and Democrats (the latter primarily being from districts reliant on the medical device industry), various attempts have been made to repeal the tax.10 Opponents of the tax claim that the tax will lead to job losses in the medical device sector and will deter innovation and research.11 On the other hand, the tax retains support among many legislators, particularly Democrats. The tax’s advocates view it as an essential funding mechanism for PPACA and maintain that the tax will not adversely affect employment or research expenditures in the medical device industry.12

IV. Conclusion
While those opposing the tax have been unsuccessful to date, the tax’s fate is far from secure and it and its regulations remain in flux. Medical device manufacturers should continue to monitor developments with the tax and adjust their practices accordingly.

***

1

See 77 Fed. Reg. 72924 (2012)

2

Health Care and Education Reconciliation Act of 2010, P.L. 111-152, Title I, Subtitle E, § 1405(a)(1), 124 Stat. 1029 (2010) amended the Patient Protection and Affordable Care Act of 2010, P.L. 111-148.

3

Pursuant to Section 510(j) of the federal Food, Drug and Cosmetic Act ("FDCA"), medical devices intended for human use must be registered with the FDA. Note that certain devices, such as “Research Use Only” devices and devices subject to an Investigation Device Exemption (“IDE”) are not required to be registered with the FDA and are thus not subject to the tax. Additional information about the registration scheme is found at 21 C.F.R. Part 807.

4

Internal Revenue Code § 4191b)(2)(D).

5

For example, the FDA and a manufacturer often engage in lengthy discussions with respect to the categorization of medical products containing or constructed with human-derived components. Such products may be categorized as a human cellular and tissue-based product, a biological product or a medical device. Because such products often fall into a ‘gray area’ among these three product categories, the FDA and manufacturers often undertake lengthy discussions regarding the appropriate category. In addition, a product’s category may be changed due to modifications to the product, additional information provided to the FDA or other circumstances.

6

For example, a list price for a product may or may not include charges for insurance, delivery, support or other costs.

7

77 Fed. Reg. 6028 (2012)

8

Id.

9

In general, a “kit” is two or more different medical devices, or a combination of medical devices and other items, packaged together for the convenience of the user. See also 77 Fed. Reg. 72932-33 (2012).

10

For example, on June 7, 2012, the House of Representatives voted 270 to 146 to repeal the tax. Further, on March 21, 2013, the Senate voted 79-20 to repeal the tax as part of a nonbinding budget resolution.

11

For example, see information prepared by the Advanced Medical Technology Association (“AdvaMed”) available at http://advamed.org/issues/19/medical-device-tax.

12

For example, see the October 2, 2013 report published by the Center for Budget and Policy Priorities available at http://www.cbpp.org/cms/?fa=view&id=3684.

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