Despite the recent issuance of regulations by the IRS, questions remain regarding complying with the new medical device excise tax.
Authors: Edward P. Rigby and Brian P. Collins, ParenteBeard, LLC
A new excise tax is now imposed on the sale of certain medical devices under IRC Section 4191 effective for sales occurring after December 31, 2012. The new “medical device excise tax” was enacted as part of the Health Care and Education Reconciliation Act of 2010, in conjunction with the Patient Protection and Affordable Care Act (collectively referred to as the Affordable Care Act, ACA). The tax is imposed at the rate of 2.3% of the price for which taxable medical devices are sold by the manufacturer, producer, or importer. In assisting our medical device industry clients in complying with this new tax, we have had several discussions with the IRS National Office regarding certain critical issues, such as:
- What constitutes a taxable medical device?
- What are the available exemptions from the excise tax for medical device manufacturers?
- How are sales of taxable medical devices for further manufacture or export treated?
- What are the tax filing and payment requirements for the new tax? This article highlights some of the key answers to these questions. However, since the IRS has announced that it will not issue formal rulings with respect to the Section 4191 excise tax, it is critical that medical device manufacturers discuss the new excise tax statute and corresponding Treasury Regulations with their trusted tax advisors.
What Constitutes a Taxable Medical Device?
According to Section 4191(b)(1), the definition of a “taxable medical device” is linked to the definition of a “device” under Section 201(h) of the Federal Food, Drug, and Cosmetic Act (FFDCA) that is intended for humans. This definition is also linked to the listing requirements for a “device” by the Food and Drug Administration (FDA) under Section 510(j) of the FFDCA. According to the IRS, the FDA’s listing requirements have been in existence for a long time. Since device manufacturers must already be complying with these requirements as part of the FDA’s device regulation process, from the IRS’s perspective, understanding the definition of taxable medical device for Section 4191 purposes should not create an additional burden.
What Are the Exemptions From the Excise Tax?
The section 4191 regulations provide a safe harbor provision which includes devices that are identified in the FDA’s online lVD Home Use Lab Tests; devices described as OTC or over the counter devices in the relevant FDA classification regulation heading; and devices that are described as OTC or over the counter devices in the FDA’s product code name, the FDA’s classification name, and listing database. The safe harbor also includes certain devices that qualify as durable medical equipment, prosthetics, orthotics, and supplies. To the extent a medical device manufacturer’s device is described or is one of the types listed in the safe harbor provision, there is a presumption that such device is exempt from the excise tax.
IRC Section 4191(b)(2) provides that the excise tax does not apply to sales of eyeglasses, contact lenses, hearing aids, and any other medical device determined by the IRS to be of a type which is generally purchased by the general public at retail for individual use (i.e., the “retail exemption”). Thus, if the device does not meet the safe harbor criteria, taxpayers may still meet the retail exemption based on the evaluation of these various factors.
A device is considered available for purchase by the general public for individual use if it is:
- 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 by a medical professional.
A nonexclusive list of factors indicating that the device satisfies the retail exemption criteria 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
- 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.
Still, the regulation provides various criteria a taxpayer can use to determine whether its medical device is designed primarily for use in a medical institution or office or by a medical professional. These criteria are:
- Whether the device generally must be implanted, inserted, operated, or otherwise administered by a medical professional; and
- 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. The regulations provide several examples illustrating the application of this test for purposes of determining whether the retail exemption applies to a particular medical device.
As stated above, the IRS has announced that it will not issue formal rulings on this issue. Thus, it is critical that medical device manufacturers seek guidance from its tax advisor to assist it in determining whether a particular device meets the retail exemption.
Tax-Free Sales for Further Manufacture or Export
According to the IRS, the ACA added IRC Section 4191 to the manufacturers excise tax rules (i.e., the “Chapter 32 rules”), emphasizing that such rules are longstanding. The rules relating to tax-free sales of taxable medical devices for further manufacture or export are provided under IRC Section 4221 and the associated regulations. Under Section 4221, the tax imposed by Section 4191 does not apply to the sale of taxable medical devices for use by the purchaser for further manufacture, or for resale by the purchaser to a second purchaser for use by such second purchaser in further manufacture. Regulation Section 48.4221-2 sets forth rules for tax-free sales of articles to be used or resold for further manufacture including proof of resale for use in further manufacture. According to the regulations, to make a tax-free sale for further manufacture or export, the manufacturer, the first purchaser, and in some cases - the second purchaser- must be registered by the IRS (application for registration is made by filing Form 637). Regulation Section 48.4221-2(c) provides the requirements of appropriate proof of resale that needs to be received by the manufacturer.
Tax Filing and Payment Requirements (Plus IRS Relief on Tax Deposit Penalties)
The medical device excise tax is reported on Form 720, Quarterly Federal Excise Tax Return. In general, Form 720 must be filed quarterly. Medical device manufacturers will generally be required to make semimonthly deposits of tax. According to IRS Notice 2012-77, the IRS and the Treasury Department have decided to provide temporary relief from the penalty for failure to make timely deposits (under IRC Section 6656) for the first three calendar quarters of 2013.
Not all medical devices are subject to the new excise tax, as various exemptions and exceptions are provided in the rules. Likewise, some devices a manufacturer may not otherwise consider a medical device, may be taxable for Federal excise tax purposes. Thus, it is important to understand how the rules and exemptions apply to your particular medical device, and an important part of this exercise will be to analyze and document the safe harbor and “retail exemption” provisions as they relate to a particular medical device. This upfront analysis will serve both as a comfort for any tax-related financial statement purposes (i.e., FIN 48), and mitigate the burden and costs of a potential IRS audit.
In addition to helping you understand the applicability of the new excise tax to your medical device, a tax advisor can also assist you in identifying tax-free sales for further manufacture or export as well as navigating the applicable compliance requirements.