Summary of the Medical Device Excise Tax
As of January 1, 2013, transactions in medical devices within the U.S. have been burdened by an excise tax equal to 2.3% of the price obtained for each device. IRC section 4191. On December 7, 2012, the Treasury Department and Internal Revenue Service issued final regulations setting forth their rules interpreting many but not all issues arising under the 2.3% medical device excise tax (MDET). 77 Fed. Reg. 72,924. Safe harbor guidance intended to address some areas under continued study was also released in December 2012. Notice 2012-77.
The novelty of the tax to this industry, the cumbersome nature of existing excise tax rules now made applicable here, and the very nature of medical device delivery in the US healthcare system are posing significant challenges to the device industry. This tax hits all medical device industry members, whether emerging or mature, large or small.
On the “buy” side, importers of “taxable medical devices” from sources outside of the U.S. (directly from the manufacturer or from a non-U.S. reseller) for use or consumption in the U.S. are subject to the excise tax on the sales price paid for the device. Further, the “tax-exempt” status of a charitable organization, such as a hospital, does not avoid the MDET liability.
For example, if Hospital A purchases specialized surgical kits for use by physicians in its operating theatres from Company B, an entity organized and operating in Ireland, MDET applies to Hospital A, whether or not it is a charitable institution. Hospital A must put in place procedures to track these types of purchases, report its MEDT liability to the IRS and remit tax payments.
Taxable Medical Devices
A taxable medical device is any device intended for humans and required to be listed as a device with the FDA under section 510(j) of the Federal Food, Drug, and Cosmetic Act (Act).
Absent an applicable exemption, when the tested item meets the above criteria, it is a taxable medical device. This includes:
- software and software upgrades if required to be separately listed with the FDA under Act section 510(j);
- devices not used in the direct treatment, diagnosis or monitoring of a patient; and
- devices used in veterinary medicine if also intended for human use.
Two principal categories of exemptions for taxable medical devices exist as follows:
- “per se” exemptions for eyeglasses, contact lens and hearing aids; and
- any other item of a type designated by Treasury/IRS as generally purchased by the public at retail for individual use.
The “Retail” Exemption
The second category – the so-called “retail” exemption – requires subjective determinations of (i) the nature of the item and its use by a typical purchaser, (ii) the manner of the purchase, and (iii) the volume of transactions. If on balance more factors point to the device falling within the retail exception, then it should qualify thereunder. Further, items qualifying within this second category will not necessarily be determined solely by reference to FDA Class I, Class II, or Class III listings.
Positive factors – regularly available for purchase and use by individual consumers:
- Consumers can purchase the device through retail businesses such as drug stores, supermarkets or medical supply or specialty stores or suppliers, via physical location or over the internet
- Consumers can use the device safely and effectively for its intended medical purpose with minimal or no training from a medical professional
Negative factors – primarily for use in a medical institution or office by a medical professional:
- Must the device generally be implanted, inserted, operated or otherwise administered by a medical professional?
- Do the costs to acquire, maintain and use the device require a large initial investment or ongoing expenditure that is not affordable to the average consumer?
- Does the FDA regard the item as a Class III device?
The final regulations set forth both safe harbors and examples as additional guidance to taxpayers for purposes of the retail exemption. Also under continued review are the treatment of listed devices combined to a device with non-listed devices, other than certain prosthetic and orthotic devices (see the details of safe harbor in the final regulations).
Administratively, advance relief from ambiguities on the scope of the exemptions to a specific device is presently unavailable. See section 3.01(76) of Rev. Proc. 2013-3 (section 4191(b)(2) is a new “no-rule” area).
The transfer of beneficial ownership of a taxable MD for its consumption in the U.S. is the principal targeted activity of the MDET. Thus, the tax applies to transfers by the device manufacturer for direct use or resale in the US.
By inclusion of section 4191 into the broader manufacturer excise tax rules, MDET also applies to:
- Importation of MDs into the U.S. for consumption (e.g., hospital supplies from offshore suppliers) is a taxable event to the importer.
- Other U.S.-based beneficial uses of MDs – demonstrators, surgical tool loans, as an example – may also subject the manufacturer to the excise tax.
Types of transactions not subject to the excise tax are:
- Transfers of MDs to be further manufactured by the purchaser into a taxable medical device, or for export outside the U.S.
- Use of device in testing or evaluating other items produced by the manufacturer.
Remanufacturing or refurbishment of a medical device will also recycle MDET if the process results in a new and different taxable item.
Bundled device and software. For this form of transaction, the MDET would be applicable only to the device and software if each was listed with the FDA under Act section 510(j).
For more information on the new medical device excise tax, please contact Padric Kelly O'Brien.