Update on IRS Medical Device Tax Final Rule
Section 1405(a) of the Health Care and Education Reconciliation Act (HCERA), which amended the Patient Protection and Affordable Care Act (PPACA), provides that any “manufacturer, producer, or importer” of taxable medical devices must pay a tax equal to 2.3 percent of the sales price of the device. Over the past few years since the PPACA was enacted, the medical device industry has made numerous attempts to repeal the tax, and several legislative proposals have been introduced in Congress.
In addition, dozens of reports from the medical device sector and other stakeholders have shown the significant affect this tax will have on medical device innovation and jobs. Small device companies asserted that the tax would practically put them out of business. The tax is expected to raise $29 billion in government revenues through 2022, reported Reuters.
Nevertheless, the Obama administration and the Internal Revenue Service (IRS) moved forward with the implementation of the device tax by publishing final regulations in early December 2012. Concurrently with the final regulations, the IRS also issued interim guidance (Notice 2012-77) dealing with certain pressing issues — including the determination of a manufacturer’s taxable sales price. The tax applies to sales of taxable medical devices after Dec. 31, 2012.
The government has defended the tax by noting that “medical device manufacturers and importers (who) will now have access to 30 million new customers due to the health care law,” Treasury Department spokeswoman Sabrina Siddiqui said in a statement. However, the device tax “could cost upwards of $660 million annually in implementation costs alone.”
The law firm of Arnold & Porter LLP provided an in-depth review of the final regulations and their impact on medical device manufacturers. The IRS is requesting comments on the interim guidance (Notice 2012-77). The comments are due by March 29, 2013. FierceMedicalDevices also provided a good summary of the IRS guidance.
What is a “Taxable Medical Device”?
A “taxable medical device” is any device defined under section 201(h) of the Federal Food, Drug, and Cosmetic Act (FFDCA) that is intended for humans. For purposes of the medical device excise tax, the IRS final rule has adopted a listing system in which taxable devices that are “intended for humans” are those that are listed with the Food and Drug Administration (FDA) under section 510(j) of the FFDCA. If a device is not listed with the FDA, but the FDA later determines that it should have been listed as a device, the device will be deemed listed as a device as of the date the FDA notifies the manufacturer in writing that such device should have been listed.
The final rule also addresses biologics and combination products. Biological products that are listed with the FDA under section 510(j) of the FFDCA are taxable medical devices; however, other biologics will not be considered taxable medical devices, including those listed under 21 C.F.R. part 607 (dealing with human blood products).
Combination products — combining drugs, devices, and/or biological products — that are listed as a device with the FDA under section 510(j) also will be treated as taxable medical devices without exception. Other combination products that are not listed under 510(j) as a device are not taxable under the new rules.
Medical device excise tax and branded prescription drug fee.
“Although public comments requested that manufacturers be exempt from the medical device excise tax in instances where a particular product is accounted for when computing the branded prescription drug fee enacted pursuant to PPACA, the IRS indicated that there is no statutory basis for doing so and that the health reform legislation did not provide for coordination between the two provisions,” the advisory said. The IRS believes that “few, if any, combination products will be subject to both the medical device excise tax and the [branded prescription drug] fee.”
The IRS interim guidance also addresses the determination of the taxability of “convenience kits,” which are sets of two or more medical devices enclosed in a single package for the convenience of a health care professional or other end user. For the moment, and until IRS and the Treasury Department issue further guidance, “no tax will be imposed upon the sale of a domestically produced convenience kit. The medical device tax will still apply, however, upon the sale of a taxable medical device that goes into a domestically produced convenience kit.”
Exclusions to the Tax
Statutory exemptions. There are specific statutory exemptions from the medical device excise tax for eyeglasses, contact lenses, and hearing aids.
Retail exemption. There is also an exemption for other devices that are “regularly available for purchase and use 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 a medical professional.” For purposes of this “retail exemption,” the IRS has adopted a “facts and circumstances approach” for evaluating whether a medical device is of a type that is generally purchased by the public at retail for individual use.
The determination of whether a device is of a type that qualifies for the retail exemption is made based on the overall balance of factors relevant to the particular type of device. The fact that a device is of a type that requires a prescription is not a factor in the determination of whether or not the device falls under the retail exemption. The factors for “regularly available” include:
- Whether consumers who are not medical professionals can purchase the device in person, over the telephone, or over the internet, through retail businesses such as drug stores, supermarkets, or medical supply stores and retailers that primarily sell devices (for example, specialty medical stores, durable medical equipment, prosthetics, orthotics, and supplies (DMEPOS) suppliers and similar vendors);
- Whether consumers who are not medical professionals can use the device safely and effectively for its intended medical purpose with minimal or no training from a medical professional; and
- Whether the device is classified by the FDA under Subpart D of 21 CFR part 890 (Physical Medicine Devices).
The IRS factors for determining whether a device is designed primarily for use in a medical institution or office or by a medical professional include:
- Whether the device generally must be implanted, inserted, operated, or otherwise administered by a medical professional;
- Whether 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 individual consumer;
- Whether the device is a Class III device under the FDA system of classification;
- Whether the device is classified by the FDA under certain regulations (see p. 45)
- Whether the device qualifies as durable medical equipment, prosthetics,orthotics, and supplies for which payment is available exclusively on a rental basis under the Medicare Part B payment rules, and is an “item requiring frequent and substantial servicing” as defined in 42 CFR 414.222.
The final regulations establish a safe harbor that identifies certain devices as exempt from the tax. Specifically, the following devices are in the safe harbor:
- Devices that are included in the FDA’s online IVD Home Use Lab Tests (Over-the-Counter Tests) database
- Devices that are described as “OTC” or “over the counter” devices in the relevant FDA classification regulation heading.
- Devices that are described as “OTC” or “over the counter” devices 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, as described in Subpart C of 42 CFR part 414 (Parenteral and Enteral Nutrition) and Subpart D of 42 CFR part 414 (Durable Medical Equipment and Prosthetic and Orthotic Devices), for which payment is available on a purchase basis under Medicare Part B payment rules, and are—
1) “Prosthetic and orthotic devices,” as defined in 42 CFR 414.202, that do not require implantation or insertion by a medical professional;
2) “Parenteral and enteral nutrients, equipment, and supplies” as defined in 42 CFR 411.351 and described in 42 CFR 414.102(b);
3) “Customized items,” as described in 42 CFR 414.224;
4) “Therapeutic shoes,” as described in 42 CFR 414.228(c); or
5) Supplies necessary for the effective use of durable medical equipment (DME), as described in section 110.3 of chapter 15 of the Medicare Benefit Policy Manual (Centers for Medicare and Medicaid Studies Publication 100-02).
The guidance provides fifteen (15) examples of how the rules and factors IRS enumerated will be applied.
Paying the Medical Device Excise Tax
The interim guidance published by the IRS includes guidance for determining the constructive purchase price — based upon distribution chains — upon which the tax will be based. The manufacturer or importer of a taxable medical device is responsible for filing Form 720, Quarterly Federal Excise Tax Return, and paying the tax to the IRS. Form 720 is filed with the IRS quarterly, and the first return to report the medical device excise tax will be due by April 30, 2013, for the quarterly period including January, February, and March 2013.
Manufacturers and importers must, however, make semi-monthly deposits where the tax liability exceeds US $2,500 for the quarter. Failure to file or pay the taxes due may result in penalties assessed by the IRS. Under certain circumstances, these penalties may be abated. The IRS has additional information about deadlines and payment on its website, in the form of frequently asked questions (FAQs).
FierceMedicalDevices noted that while the IRS acquiesced to expanding its over-the-counter provision to include devices bought over the Internet or by telephone, but requests to better define "affordable," elaborate on "minimal or no training" and to exempt Class III devices were all spurned by the IRS.
Mark Leahey, CEO of the Medical Device Manufacturers Association, said the final ruling does nothing to dull the blow the 2.3% tax will deliver to jobs and innovation in the industry. “There is growing bipartisan support in Congress to repeal the medical device tax, and MDMA remains committed to working with elected officials to fix a policy that was a bad idea when it passed, and is proving to be more harmful than imagined to our economy and patient care as it gets closer to implementation,” Leahey said in a statement.
Companies including Boston Scientific Corp, 3M Co and Kimberly-Clark Corp have been lobbying the U.S. Congress for a repeal of the tax. A repeal bill passed the Republican-controlled U.S. House of Representatives in June, but it has not been voted on by the Democratic-controlled Senate. Democratic Senator Kay Hagan (D-NC), however, “is looking to her state's business leaders to find a way to repeal the 2.3% medical device tax and make up for the make up for the $30 billion in revenue it's slated to raise to support healthcare reform,” reported MassDevice.com.
In one potentially problematic aspect of the tax, companies selling dual-use products to medical and non-medical customers must pay the tax on those products, potentially putting them at a competitive disadvantage, said Lew Fernandez, a director at PricewaterhouseCoopers LLP and a former IRS official. For example, it remains “an open question” when latex gloves come under the tax, he said.