Many U.S. subsidiaries of Japanese companies are importing "medical devices" into the U.S. and should be aware that a new federal excise tax will be imposed on the sale of "taxable medical devices" starting January 1, 2013. With the effective date approaching, manufacturers and importers of medical devices must act quickly to determine whether their products are taxable and prepare for compliance with the new rules. This article provides an overview of the new medical device excise tax regime and specific action steps to comply with the administrative rules set forth in the proposed regulations.
IRC Section 4191, which imposes an excise tax at the rate of 2.3 percent on the sale of "taxable medical devices" by their manufacturer or importer, was signed into law in March, 2010 as a part of the Patient Protection and Affordable Care Act as modified by the Health Care and Education Reconciliation Act to fund President Obama’s health care reform. In December, 2010, the IRS requested public comments on issues to be addressed in preparing for the new medical device excise tax. The IRS issued proposed regulations on February 3, 2012, to provide proposed guidance on the implementation and administration of the new medical device excise tax. If finalized, the proposed regulations would establish rules that explain which medical devices are taxable and how the existing excise tax rules apply to the new tax.
IRC Sec. 4191 is part of Chapter 32 of IRC, which relates to taxes imposed upon the sales of taxable articles by manufacturers, producers, and importers (commonly referred to as "manufacturers excise taxes"). Therefore, as discussed in the preamble to the proposed regulations, the existing rules governing the manufacturers excise taxes apply to the medical device excise tax.
Under the present manufacturers excise tax rules, the manufacturer or importer of a taxable article is liable for the tax upon the sale of the article. Entities disregarded for federal income tax purposes are regarded and there is no consolidated return concept for manufacturers excise tax purposes.
Under the existing rules of the manufacturers excise taxes, the excise tax doesn’t apply if an article is sold for use by the purchaser for "further manufacture" or "export." To make a tax-free sale for "further manufacture" or "export," the manufacturer and purchaser must be registered by the IRS, except for foreign purchasers. Therefore, it is important for the manufacturers and purchasers of taxable medical devices to be registered by the IRS if the "further manufacture" or "export" exception is to be claimed.
Under the existing rules of the manufacturers excise taxes, the excise tax, in general, is triggered by the sale of a taxable article by the manufacturer or importer to a purchaser. The use or lease of a taxable article by the manufacturer or importer is treated as a sale under the existing rules. For leases, the excise tax generally attaches to each lease payment. In the case of a sale on credit, the tax attaches whether or not the purchase price is actually paid. In the case of conditional or installment sales, the tax attaches to each partial payment.
"Taxable medical device" is broadly defined in IRC Sec. 4191 as any device intended for humans that meets the definition of "device" in Section 201(h) of the Federal Food, Drug, and Cosmetic Act ("FFDCA"). This statutory definition of "taxable medical device" leaves uncertainty as to which devices are included in the definition. The proposed regulations address this concern by referring to Food and Drug Administration ("FDA") rules. Under the proposed regulations, "device defined in section 201(h) of the FFDCA that is intended for humans" means a device that is listed as a device with the FDA under FFDC Act section 510(j) and 21 CFR part 807, pursuant to FDA requirements.
Guidance is provided in the preamble to the proposed regulations that discusses application of the proposed rules to various medical devices below. The key to determining whether a medical device is taxable or not is whether or not a device is listed as a device under FDA requirements and whether a device falls within the so-called "retail exemption" (discussed later).
- Devices intended for use exclusively in veterinary medicine that are labeled as such with the FDA would not be a taxable medical device. However, devices that are intended for humans, but are also intended for use or used in veterinary medicine and that are listed as a device with the FDA would be taxable medical devices unless the devices fall within the "retail exemption."
Dual Use Devices
- Devices that have both medical and non-medical uses, such as latex gloves, that are listed with the FDA would be taxable medical devices unless the devices fall within the "retail exemption."
- Research-use-only devices that are not listed because the devices are exempt from the FDA’s registration and listing requirements would not be taxable medical devices. In contrast, devices that are sold for use in research that are listed with the FDA pursuant to FDA requirements, such as devices not solely used in research or ones that are introduced into commercial distribution, are "taxable medical device" unless the devices fall within the "retail exemption."
- Devices subject to the FDA Investigational Device Exemption are exempt from the FDA’s listing requirements and thus would not be taxable medical devices.
Dental Instruments and Equipment
- Dental instruments and equipment that are listed as devices with the FDA would be taxable medical devices unless the dental instruments and equipment fall within the retail exemption.
- A kit is defined by the proposed regulations as a set of two or more articles in a single package, such as a bag, tray, or box, for the convenience of the end user. A kit is a taxable medical device if the kit is listed as a device with the FDA pursuant to FDA requirements unless it falls within the retail exemption. If a kit is a taxable medical device, the entire sale price of the kit would be subject to the medical device tax: the taxable and nontaxable articles used in the kit’s production or assembly would lose their identity as separate articles.
Associated Devices and Components of Devices
- Associated devices (such as a monitor sold with an x-ray system) and components that are listed as devices with the FDA would be taxable medical devices unless the associated devices fall within the "retail exemption."
IRC Sec. 4191(b)(2) provides a retail exemption for certain medical devices that are determined by the Secretary to be of a type that is generally purchased by the general public at retail for individual use (the "retail exemption"). Under the proposed regulations, a medical device would meet the retail exemption if it satisfies the following two-part test:
- The medical device is regularly available for purchase and use by individual consumers who are not medical professionals, and
- 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.
Whether a device satisfies the two-part test above and therefore qualifies for the retail exemption would be evaluated based on all the relevant facts and circumstances. As guidance, the proposed regulations provide a set of non-exclusive factors to be considered for each part of the retail exemption test, as outlined below.
Regularly available for purchase and use by individual consumers
- Whether consumers who are not medical professionals can purchase the device through retail businesses that also sell items other than medical devices, such as drug stores and supermarkets
- Whether consumers who are not medical professionals can safely and effectively use the device for its intended medical purpose with minimal or no training by a medical professional
- Whether the device is classified by the FDA as a "physical medical device" (this includes devices such as canes, crutches, and walkers)
Primarily intended for use in a medical institution or office or by a medical professional
- Whether the device generally must be implanted, inserted, operated, or otherwise administered by a medical professional
- Whether the cost to acquire, maintain, and use the device requires a large initial investment and ongoing expenditure that is not affordable for the average consumer
- Whether the device is a Class III device under the FDA system of classification (Class III devices require pre-market approval by the FDA)
- Whether the device is classified under specified FDA classification regulations
- Whether the device qualifies as durable medical equipment, prosthetics, orthotics, or supplies for which payment is available exclusively on a rental basis under the Medicare Part B payment rules and is an "item requiring frequent and substantial servicing"
To provide greater certainty, the proposed regulations also include a safe harbor provision that identifies categories of devices that would fall within the retail exemption. Exempt devices would be devices that:
- Are included in the FDA’s online "IVD Home Use Lab Test (Over-the-Counter Tests)" database
- Are described as over-the-counter devices in the relevant FDA classification regulation heading
- Are described as over-the-counter devices in the FDA’s product code name, the FDA’s device classification name, or the "classification name" field in the FDA’s device registration and listing database
- Qualify as durable medical equipment, prosthetics, orthotics, and supplies identified in the proposed regulations for which payment is available on a purchase basis under Medicare Part B payment rules
As discussed above, this excise tax on medical devices goes into effect on January 1, 2013. US Subsidiaries of Japanese companies importing medical devices into the U.S. (and those that are manufacturing in the U.S.) should start analyzing their products and preparing for compliance with the new requirements as soon as possible. Specifically, they should at least start considering relevant issues including:
- Whether the products fall within the general definition of "taxable medical devices."
- Whether the products qualify for the "retail exemption."
- Whether the transactions qualify for use in "further manufacture" or "export" (if so, ensure that the manufacturer and purchaser have been registered by the IRS in order to engage in a tax-free sale).
- Whether the internal system has been set up to correctly report and pay the tax to the IRS.
- Whether proper documentation has been prepared in anticipation of the examination by the IRS.
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