On January 1, 2013 an excise tax of 2.3 percent on total revenues from manufacturers of medical devices in the U.S. took effect, impacting not just device makers—small and large—but also impacting the medical institutions and professionals that interact with device makers. The IRS released the final rule on December 5, 2012 with an accompanying guidance document, leaving little time for the industry to fully grasp and correctly implement the burdensome requirements.

The applicability of this excise tax, added to the Internal Revenue Code as part of the Affordable Care Act (ACA) in 2010, has raised a number of questions for medical device companies. Luckily, the IRS has indicated that it would not penalize companies for incorrect tax payments for the first three calendar quarters of 2013, a clear acknowledgment that it will take the industry some time to transition into compliance. A number of issues remain unresolved even at this point. But perhaps the most challenging question to be addressed is the threshold question of which entity in the chain of production of the taxable device is required to collect the tax

Specification Developer or Contract Manufacturer to Collect the Tax?

The device excise tax is imposed “on the sale of any taxable medical device by the manufacturer, producer, or importer of the device.” The preamble to the IRS final rule responded to a request by a commenter that the IRS specifically link the “manufacturer” definition to the FDA’s listing requirements by stating “whether a person is considered a manufacturer or importer for FDA purposes is not relevant.” The IRS has decided to apply existing manufacturer excise tax rules to the medical device industry despite the complexity of the current medical device distribution channels and the additional layer of FDA regulation.

The existing IRS rules define the term manufacturer to include “any person who produces a taxable article from scrap, salvage, or junk material, or from new or raw material, by processing, manipulating, or changing the form of an article or by combining or assembling two or more articles.” Those familiar with the device industry will see immediately that in most instances this definition describes the entity who is contract manufacturing the product based on a customer’s specifications and under the customer’s quality requirements. The existing IRS rules do contemplate a scenario where one party provides the materials to another under an agreement for manufacturing where the person providing the materials retains title, and states that “the person for whom the taxable article is manufactured or produced, and not the person who actually manufactures or produces it, will be considered the manufacturer.” Unfortunately, the majority of the contract manufacturing or supply agreements we have seen do not have the specifications developer providing the materials or retaining title to materials for manufacturing.

The IRS has not yet addressed the role of contract manufacturers in the medical device industry and as manufacturers for purposes of this new tax. Medical device companies, whether specification developers or contract manufacturers, should consult with their legal counsel to obtain a facts-and-circumstances dependent legal conclusion as to whether the principal or the contract manufacturer is the “manufacturer” and thus responsible for the tax.

Additional Twists to the New Tax

A couple of little know provisions within the IRS final rule that are also worth highlighting are:

  1. Retroactive Tax on Lease, Installment and Long-Term Sales Contracts: The new medical device tax will apply to lease payments, installments and long-term contract payments after Jan. 1, 2013 even if the lease or contract was signed before Jan. 1, 2013. Only those agreements that were in place before the ACA was enacted in March 2010 will be allowed to continue without a tax.
  2. “Taxable Medical Device” Applicability to Software: Under existing FDA rules, certain software will be considered a medical device as defined in section 201(h) of the Federal Food, Drug, and Cosmetic Act and thus will be a “taxable medical device” under the new IRS rules. According to the IRS’ interim rule, it will treat a license of a taxable medical device, including software, as a lease of that taxable medical device as of the date both parties entered into the license agreement. Finally, software service and/or maintenance contracts are not themselves a “taxable medical device” and therefore the tax only attaches to that portion of the manufacturer’s sale price of the unit that is properly allocable to the taxable article. Thus, software and service bundles that are not listed with the FDA as a bundle require additional assessment to properly allocate the tax.


Although the IRS has proved reasonable in granting some penalty relief as this new tax rolls out in 2013, medical device companies should be proactive in evaluating its applicability to their products and business during the first quarter of 2013.