The U.S. Department of the Treasury and the Internal Revenue Service (IRS) recently issued much-anticipated final regulations under Section 4191 of the Internal Revenue Code (Code), which imposes a 2.3% tax on sales of any “taxable medical device” by a manufacturer, producer or importer (collectively referred to as “manufacturers”). The IRS simultaneously issued Notice 2012-77, providing interim guidance to manufacturers while it continues to study certain issues that are not addressed by the final regulations. Medical device manufacturers should become familiar with the 2.3% tax in order to comply with the new requirements beginning on January 1, 2013.
What is a “taxable medical device?”
The Code defines a “taxable medical device” as any “device” under the Federal Food Drug and Cosmetics Act (FFDCA) that is intended for humans. Attempting to provide greater certainty, the final regulations provide that if a product is required to be registered and listed with the Food and Drug Administration pursuant to Section 510(i) of the FFDCA and 21 C.F.R. part 807, it is a taxable medical device. Except for the “retail exemption” described below, classification as a taxable medical device does not take into account actual use of a product or any policy considerations. For example, dual-use devices are taxable medical devices whether or not they are used for a medical purpose, and Humanitarian Use Devices (as defined in Section 201(h) of the FFDCA) are not exempt. Additionally, manufacturers of combination products with both device and drug components may be subject to multiple taxes on sales of a single product—the 2.3% tax on the device component and the branded prescription drug fee on the drug component.
What is the scope of the retail exemption?
Code Section 4191 exempts medical devices that are of a type that is generally purchased by the general public at retail for individual use. Purchase at retail for individual use includes purchases by consumers who are not medical professionals from general retail businesses (including both physical locations and Internet sites) such as drug stores or supermarkets. Under a safe harbor provision, prosthetic and orthotic devices that do not require implantation or insertion by a medical professional are considered to be of a type generally purchased by the public at retail for individual use, even if they may require fitting or adjustment from time to time. The final regulations list nonexclusive factors to be considered but emphasize that whether or not a device falls within the retail exemption is determined based on all relevant facts and circumstances.
What is a “sale” triggering the medical device excise tax?
Generally, a manufacturer using a taxable article in any way other than in the manufacture of another taxable medical device is liable for the 2.3% tax. In particular, the explanation of the final regulations highlights that provision or use of a taxable medical device as a demonstration product may constitute a use triggering the tax, depending on the facts and circumstances of the arrangement. In addition, a transaction in which a manufacturer furnishes a taxable medical device and receives any promotional or advertising services or other value for the transfer is considered a “sale” subject to the 2.3% tax.
Notice 2012-77 provides that, until further guidance is issued, two types of transactions will not be treated as taxable uses. First, licensing of software that is a taxable medical device will be treated as a lease of the software rather than as a taxable sale. Second, if a manufacturer of a taxable medical device donates the device in a transaction for which the manufacturer is permitted to take a charitable contribution deduction, the donation will not be treated as a sale.
What does the medical excise tax require manufacturers to do?
Manufacturers must file Forms 720 on a quarterly basis, reporting sales of taxable medical devices and paying excise tax due on the sales, and must generally make semimonthly deposits of excise tax by electronic funds transfer. Manufacturers of taxable medical devices may be eligible to sell devices tax free for further manufacture or export if certain requirements are met and to qualify for exemption. These manufacturers must file a Form 637 registration for certain excise tax activities. Importantly, the final regulations make clear that there is no consolidated reporting and registration available with respect to federal excise taxes, even where a wholly owned entity is regarded as separate from its owner for federal income tax purposes. Instead, each entity with a separate employer identification number must separately file Forms 720 and 637.
Manufacturers who fail to comply with filing and payment requirements may be subject to penalties and interest. While the final regulations do not provide manufacturers with time to prepare their systems to comply, Notice 2012-77 provides temporary relief during the first three quarters of calendar year 2013 from penalties for failure to deposit, provided a manufacturer demonstrates a good faith effort to make required deposits in a timely manner.
This update provides only a general summary of the new medical device excise tax. Read the full text of the final regulations or read Notice 2012-77. Please contact counsel for more detailed information regarding the 2.3% tax and its potential application to your particular circumstances.