Final regulations implementing the new medical device excise tax appeared on the Internal Revenue Service (IRS) website on December 5, 2012, and in the December 7, 2012 Federal Register.1 Manufacturers and importers must begin paying the 2.3% tax on the sale of taxable medical devices beginning on January 29, 2013, when the tax deposit covering sales of taxable medical devices from January 1-15, 2013 is due.2 The IRS proposed rule was published for comment in a February 7, 2012 Federal Register Notice, as discussed in detail in an earlier newsletter article.3
To accompany the final regulation, the IRS also issued Interim Guidance clarifying its intended implementation of the regulations in certain areas.4
IRS Request for Comments
Due to the complexity of the issues, the IRS has asked for comments in both the final regulations and Interim Guidance. Comments on the regulations may be made at any time and the IRS, in particular, is seeking the identity of additional listed components of devices that are not included in a safe harbor or that do not otherwise fall within the retail exemption by an application of the facts and circumstances test.
Comments on the Interim Guidance may be made until March 29, 2013. The IRS asks for information on distribution chains not described in the guidance that are commonly employed in the medical device industry, as well as how the constructive sale price addresses the various determination of prices across the different segments in the industry. The IRS also solicits comments on alternative methods for determining price for sales to resellers that the manufacturer does not control and that lease, but do not sell, taxable medical devices.
The final regulations and IRS Interim Guidance include changes to the original proposals related to taxable device status, the taxable event definition, and advice for tax payments.
Summary of the Chief Changes to the Regulations
- CBER Listed Devices and Humanitarian Use Devices are Taxed but Some Device Software is Excluded
In response to industry inquiries, the IRS clarifies that devices governed by the Center for Biologics Evaluation and Research (CBER), Humanitarian Use Devices (HUD), and combination products are taxable medical devices if they are listed with the Food and Drug Administration (FDA), unless another exemption applies.
However, software not required to be separately listed with the FDA is not a "taxable medical device," even if the software is sold with a service and/or maintenance contract, as long as the entire bundle is not a "taxable medical device."
Devices that are erroneously or voluntarily listed with FDA may claim credit or refund for any taxes paid, but only after the device has been delisted.
- Retail Exemption Factors are Clarified
The final regulations reconfirm that the IRS will decide whether a device meets the retail exemption criteria based upon the "facts and circumstances" surrounding a device sale and design. However, the IRS emphasizes that "no one factor is determinative," which seems to allow for some flexibility. For example, a device may qualify for the retail exemption even if some training is required to permit consumers to use the device safely and effectively or a device may qualify for the exemption even if it sells for a relatively high price.
In addition, the IRS will take into account consumer purchases made by telephone or over the Internet, and purchases from "retailers that primarily sell medical devices (for example, specialty medical stores, DMEPOS suppliers, and similar vendors)" in deciding whether consumers who are not medical professionals can purchase the device at retail.
The retail exemption for devices also now includes orthotic or prosthetic devices or dental devices for initial and periodic fittings or adjustments are administered by a medical professional.
However, the IRS refused the addition of the following factors to the analysis of whether a device is intended for individual use:
- whether a device’s packaging and labeling is easy for someone who is not a medical professional to understand, because manufacturers may package and label a device in a consumer-friendly manner, even if the device is of a type that is primarily intended for use in a medical institution.
- whether premarket clearance and approval documents submitted by a company to FDA characterize the device as "OTC."
- Transition Relief for Installment Sales, Leases, and Long-term Contracts is Included
Unlike the proposed regulations, the final regulations provide that payments made on or after January 1, 2013, pursuant to a written binding contract for the lease, installment sale, or sale on credit of a taxable medical device that was in effect prior to March 30, 2010, are not subject to the tax. However, the contract must not have been "materially modified" on or after March 30, 2010, in a way that materially affects the property, terms of payment, or the amount payable under the contract. A material modification excludes modifications required by Federal, State, or local law.
- Consolidated Filings are Prohibited
Unlike income tax returns, each business entity that has or is required to have a separate employer identification number is separately liable. Thus, even if an entity is a member of an affiliated group for income tax purposes or engages in intra-group sales within a group, each entity must file a separate Quarterly Federal Excise Tax Return (Form 720) and Application for Registration For Certain Excise Tax Activities (Form 637).
Summary of the Chief Points in the Interim Guidance
The IRS published a notice with the final regulations to provide interim guidance on issues the regulations do not address. The Interim Guidance is in effect until the IRS issues further guidance on these matters.
The final regulations eliminated the proposed provision that the use of other taxable medical devices in the assembly of a kit constitutes "further manufacture" by the producer of the kit.
The Interim Guidance clarifies that no tax will be imposed on the sale of a domestically produced convenience kit, which it defines as a set of two or more devices enclosed in a single package for the convenience of a health care professional or end user. However, the sale of any taxable medical devices used within the kits will be subject to tax upon their sale to the kit producer.
On the other hand, a convenience kit produced outside the United States is considered a taxable medical device subject to the excise tax. The kit importer may pay tax on the entire kit sale price, but if the kit contains non-device items, the importer is only required to pay tax on the portion of the kit sale price that is properly allocable to the individual taxable medical devices included in the convenience kit. The taxable portion is calculated according to formulas explained in the Interim Guidance.
The Interim Guidance concludes that the IRS is still studying the taxability of convenience kits and intends to issue additional guidance in the future.
- Constructive Sales Price Rules Apply to Certain Model Distribution Chains
The Interim Guidance explains that generally, if a manufacturer sells a taxable article to a purchaser other than an independent wholesale distributor, the tax is imposed based on a constructive sale price as determined under IRS Code § 4216(b). The constructive sales price approximates the price an independent wholesale distributor would pay to the manufacturer for an identical article.
The Interim Guidance also designates constructive sales prices for manufacturers that do not regularly sell their taxable articles to independent wholesale distributors and the price depends upon the nature of the relationship between the manufacturer and the party to whom the manufacturer sells and the subsequent actions of that party. For example, the constructive sales price calculation differs if the manufacturer controls the end-user or retailer, or if the controlled reseller in turn leases the devices to end-users that the reseller does not control, or if the controlled retailer sells the articles to end-users that the retailer does not control but which does not regularly sell the articles to independent wholesale distributors.
- Sale to Hospital or Doctor’s Office Treated as Sale at Retail for Purposes of Determining Price
The Interim Guidance states that the IRS considers the sale of a taxable article to a medical institution or office as a "sale at retail."
Under the Interim Guidance, the IRS will treat licensing of a taxable medical device, such as software, as a lease as of the date both parties entered into the license agreement.
- Donation of Taxable Medical Devices
If a manufacturer donates its taxable medical device to an eligible donee organization, the donation will not constitute a "taxable use" as long as the manufacturer does not have reasonable belief that the donee is not eligible or that the donee organization will resell the device. If the donee subsequently sells the taxable medical device, it must comply with the tax provisions.
- Deposit Penalty Relief
Manufacturers that are liable for excise taxes must make semi-monthly deposits of tax during the period in which the tax liability is incurred.5 Normally, IRS may impose a penalty if the taxpayer fails to pay unless the taxpayer affirmatively shows the failure is due to reasonable cause and not due to willful neglect.6 In response to proposed regulations comments requesting transition relief, the IRS will waive penalties during the first three 2013 calendar quarters if the taxpayer fails to make timely deposits on the tax, provided that the taxpayer demonstrates a good faith attempt to comply and that the failure was not due to willful neglect. In other words, the IRS will waive the normal "reasonable cause" requirement for the first three quarters.
In addition, during the third and fourth 2013 calendar quarters, the IRS will not exercise its authority to withdraw the taxpayer’s right to use the deposit safe harbor rules of § 40.6302(c)-1(b)(2)(ii).7 Under this provision, any person that filed a Form 720, Quarterly Federal Excise Tax Return, reporting a tax imposed by chapter 32 for the second preceding calendar quarter is considered to have met the semi-monthly deposit requirement for the current quarter if certain conditions are met. Normally, if a person fails to make deposits as required, the IRS may withdraw the person’s right to use the safe harbor rules, but the Interim Guidance also waives this IRS authority.8