IRS Issues Device Tax Regulations; Industry Braces for 2013 Implementation

by Morgan Lewis
Contact

[authors: Roderick K. Donnelly, Frances Emmeline Babb, M. Elizabeth Bierman, and Michele L. Buenafe]

Pending the January 1 effective date, final regulations and interim guidance on the medical device excise tax provide some clarity but leave many questions unanswered.

On December 7, the Internal Revenue Service (IRS) issued final regulations[1] providing guidance on the implementation of the "medical device excise tax," which was imposed in section 4191 of the Internal Revenue Code (Code), as enacted under the Health Care and Education Reconciliation Act of 2010, Pub. L. No. 111-152, in conjunction with the Patient Protection and Affordable Care Act, Pub. L. No. 111-148 (together, the ACA). Device companies should review the devices they market in the United States to assess their potential tax liability and consider whether there are strategies to potentially reduce this tax liability. Significantly, tax payments must be made semimonthly, and the first payment will be due January 29, 2013.

Overview of the Regulations

Subsection 4191(a), which becomes effective January 1, 2013, imposes on the sale of any taxable medical device by the manufacturer, producer, or importer an excise tax of 2.3% of the price for which the device was sold. Subsection 4191(b) defines a "taxable medical device" as any "device" (as defined in section 201(h) of the Federal Food, Drug, and Cosmetic Act) intended for humans; there are, however, carve-outs for eyeglasses, contact lenses, heading aids, and "any other medical device" determined by the IRS to be "of a type" that is "generally purchased by the general public at retail for individual use" (the retail exemption).

The ACA added section 4191 to an existing framework of "manufacturers excise taxes" in chapter 32 of the Code. The medical device excise tax thus depends on existing statutes, regulations, case law, and IRS pronouncements (as modified by the ACA) that define "manufacturer," "importer," "sale," and "price" and provide working rules for applying all manufacturers excise taxes. Critically, for taxable medical devices made under a contract manufacturing arrangement, a facts-and-circumstances dependent legal conclusion must be made as to whether the principal or the contract manufacturer is the "manufacturer" (thus bearing the medical device excise tax). Manufacturers excise taxes are also imposed on leases or uses of articles by a manufacturer, producer, or importer.

The final regulations were issued after a two-year comment period, during which industry stakeholders made tremendous efforts to seek repeal of the medical device excise tax. While these efforts continue, many believe that if a repeal occurs, it will not take place until after the medical device excise tax becomes effective in 2013.

The regulations also recast the statutory definition of a "taxable medical device" as a device listed with the U.S. Food and Drug Administration (FDA) under section 510(j) of the Federal Food, Drug, and Cosmetic Act and 21 C.F.R. part 807. This definition sparked a number of comments from stakeholders regarding the applicability of the tax to certain products. The final regulations respond to these comments, but it is clear that many questions will remain unresolved until after the tax becomes effective. In conjunction with the final regulations, the IRS issued Notice 2012-77 (the Notice),[2] which provides separate interim guidance on four areas of concern mentioned in the preamble to the final regulations.

Issues Addressed in the Final Regulations

  • Application of the definition of "taxable medical device" to biologic devices, veterinary devices, devices with medical and nonmedical applications, humanitarian use devices, and devices that are required to be, but are not, listed with the FDA
  • Scope of the retail exemption
    • The final regulations mirror the proposed regulations by rephrasing the retail exemption, stating that the exemption applies to a device if (i) it is regularly available for purchase and use by individual consumers who are not medical professionals, and (ii) 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.
    • The final regulations also mirror the proposed regulations by using a facts-and-circumstances approach to determine if a device meets requirements (i) and (ii), providing lists of nonexclusive factors relevant for making determinations under these requirements.
    • The final regulations helpfully augment eight examples from the proposed regulations with seven new examples illustrating the determination of whether a device falls within the retail exemption.
  • Application of the tax to combination products (i.e., products that combine drugs, devices, and/or biological products)
  • Application of the tax to installment sales, leases, and long-term contracts

Issues Addressed in the Notice

  • Application of the constructive sale price rules to the medical device industry
    • The Notice provides interim rules for how to apply the constructive sale price rules of chapter 32 of the Code to certain representative model distribution chains used by some manufacturers in the medical device industry.
    • The Notice also provides, as an interim rule, that the IRS will treat the sale of a taxable article to a medical institution or office as a "sale at retail" for purposes of the manufacturers excise tax.
  • Treatment of a donation of a taxable medical device by a device manufacturer to an "eligible donee" (an entity defined in section170(c) of the Code) as a nontaxable use
  • Application of the tax to software sold together with services, licensing of software, refurbished and remanufactured medical devices, replacement parts, and convenience kits
    • For purposes of the manufacturers excise tax, the IRS will treat a license of a taxable medical device as a lease of that device.
    • For "convenience kits"—sets of two or more devices (perhaps with other articles) enclosed in a single bag, tray, box, or other package for the convenience of a healthcare professional or end user—the IRS (i) will not impose the medical device excise tax on the sale of a domestically produced convenience kit by a manufacturer or importer[3] but (ii) will impose the medical device excise tax on the sale by an importer of a convenience kit that is a taxable medical device.[4]
  • Deposit penalty relief
    • During the first three calendar quarters of 2013, the IRS will not impose the penalty under section 6656 of the Code for failure to make the semimonthly deposits of excise taxes under section 6032 of the Code, provided the taxpayer demonstrates a good-faith attempt to comply with regulatory requirements and that the failure was not due to willful neglect.

Implications

Effective January 1, 2013, device companies will be subject to a 2.3% excise tax on all devices listed with the FDA and will need to make payments semimonthly, with the first payment due January 29, 2013. Device manufacturers, therefore, should review the devices they have listed with the FDA to assess their potential tax liability and consider whether there are strategies to reduce this liability.

The Notice is only interim guidance, and the IRS is requesting comments for the issues addressed in the Notice before the guidance is finalized. Thus, device companies still have the opportunity to provide insight to the IRS on these particular issues and should submit comments by March 29, 2013.


[1]. Taxable Medical Devices, 77 Fed. Reg. 72,924 (Dec. 7, 2012) (to be codified at 26 C.F.R. pt. 48), available here.

[2]. View the Notice here.

[3]. The sale of a taxable medical device going into such a convenience kit will be subject to the excise tax.

[4]. The medical device excise tax is only imposed on that portion of the importer's sale price of the convenience kit that is "properly allocable" to separate taxable medical devices included in such kit.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morgan Lewis | Attorney Advertising

Written by:

Morgan Lewis
Contact
more
less

Morgan Lewis on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.