The IRS has finalized its regulations on the medical device excise tax and released interim guidance that provides safe harbor rules for determining constructive sales price. Beginning on Jan. 1, 2013, manufacturers, producers and importers are required to remit a 2.3% manufacturers excise tax levied on the sale of medical devices. There are exceptions for devices sold for further manufacture or export, and devices that are generally purchased by the public at retail for individual use.
The final regulations (TD 9604) and interim guidance (Notice 2012-77) make very few changes to the facts-and-circumstances test and safe harbor for the retail exception, but do clarify several important points, including:
- there is a significant new safe harbor under the constructive pricing rules that will allow percentage reductions in the sales price;
- semi-monthly deposits of the tax are generally required, but the IRS is offering penalty relief for good faith efforts through the first three quarters of 2013;
- convenience kits made up of more than one taxable medical device will not themselves be taxable medical devices under interim guidance;
- installment sales of medical devices entered into before March 30, 2010, are exempt from tax, regardless of when payments are made;
- taxpayers may not file Form 637 or Form 720 on a consolidated basis; and
- the IRS rejected requests for carve-outs on many types of devices, including for nonhuman, nonmedical, dental or humanitarian uses.
Definition of device
The IRS defines a taxable medical device as any device listed with the FDA under section 510(j) of the FFDCA and 21 CFR part 807, and fully relies on this FDA designation without exception. The IRS rejected many requests for exceptions, including requests to carve out biologic devices that are also subject to a pharmaceutical industry fee, dual-use devices sold as "not intended for humans," dual-use devices sold for nonmedical applications, devices for humanitarian use and dental devices. The IRS ruled that any item listed by the FDA under the applicable definition is a taxable medical device, unless it meets an exemption.
The IRS did acknowledge, however, that many components of nontaxable prosthetic or orthotic devices are themselves listed as taxable devices (this situation also applies to taxable components of nontaxable dental devices). The IRS did not provide an exemption for these components but asked for comments on the issue.
The original proposed regulations provided that when taxable medical devices are sold and placed in a convenience kit that is itself a taxable device, the sale of the components would be exempt as sales for further manufacture, while the sale of the kit itself would be taxable. The IRS has reversed this position with interim guidance. Notice 2012-77 provides that the sale of a domestic convenience kit comprising other taxable devices will not be taxable even if it is a listed device, and the sale of the components will be taxable instead. The sale of an imported convenience kit will be taxable only to the extent of the price that can be allocated to the taxable devices in the kit.
Items exempt from the tax include eyeglasses, contact lenses, hearing aids and other medical devices determined by the IRS to be generally purchased by the public at retail for individual use. The IRS did not change its safe harbor lists of devices that are automatically exempt from tax, which includes:
- devices identified in the FDA's IVD Home Use Lab Tests (Over-the-Counter Tests) database;
- devices described as "OTC" or "over the counter" devices in the relevant FDA classification regulation heading;
- devices described as "OTC" or "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; and
- certain devices that qualify as durable medical equipment, prosthetics, orthotics and supplies (DMEPOS) for which payment is available on a purchase basis under Medicare Part B payment rules (list is in the regulations).
Devices that are not covered by this safe harbor will be subject to a facts-and-circumstances test to determine if they meet the retail exception. The device must generally satisfy two requirements:
- The device is regularly available for purchase and use by individual consumers who are not medical professionals.
- The device's design demonstrates that it is not primarily intended for use in a medical institution or office, or by medical professionals.
Each of these requirements includes a set of nonexclusive factors that the IRS will use to make the determination. The IRS accepted a recommendation to expand the factor that looks at whether consumers who are not medical professionals can purchase the device at retail businesses. This factor will now look at whether consumers can buy the device in person, over the phone, over the Internet or in retail establishments such as drugstores, supermarkets or medical device stores. The IRS also provided seven new examples for applying the retail exception.
The manufacturers excise tax regulations prescribe various constructive price rules for determining price when manufacturers and importers do not sell to independent wholesalers, but instead sell directly at retail, directly to retailers or to related parties. The regulations generally set a constructive price based on the highest price for which such devices are sold by others to independent wholesalers.
The IRS acknowledges that the medical device industry faces difficult implementation issues regarding these rules and has provided interim guidance with the following safe harbors when there are no sales to independent wholesalers:
- Sales at retail: 75% of price after exclusions for transportation, delivery, installation and insurance
- Sales to retailers: 90% of price without exclusions for transportation, delivery, installation and insurance
- Sales to related retailer: 75% of 95% of the selling price (or 71.25%) without exclusions for transportation, delivery, installation and insurance
The interim guidance provides that sales to medical institutions and offices such as hospitals and doctors are considered sales "at retail."
Taxpayers who do not apply the rules in the interim guidance or use the actual selling price bear the burden of demonstrating that they used the fair market price to calculate liability. The IRS rejected a request to apply transfer pricing under Section 482 to arrive at a constructive price, although it said that certain facts and circumstances relevant to Section 482 transfer pricing may also be relevant for constructive price.
Uses and rebates
The IRS rejected requests to exempt from tax certain uses by the manufacturer for demonstration, evaluation, testing and development. The regulations generally consider use to be a taxable sale. The use of a taxable device as a demonstration product may be taxable depending on the facts and circumstances (Rev. Rul. 60-290 and Rev. Rul. 72-563). If a device is used in the testing of another taxable article, the use is not taxable.
The IRS regulations provide that rebates may be taken into account for determining the sales price only to the extent the rebate is made prior to the close of the quarter when the sale is made. After that, the manufacturer may make a credit or refund claim.
Deposits and filing
The medical device excise tax is reported on the quarterly Form 720, but deposits are due twice a month unless tax liability does not exceed $2,500 for the quarter. Generally, the deposit must equal at least 95% of net liability for the semi-monthly period, but the IRS interim guidance provides penalty relief as long as the taxpayer makes a good faith effort to comply and the failure was not caused by willful neglect.
Taxpayers must register on Form 637 to qualify for the exceptions from tax for further manufacture or export. Neither Form 720 nor Form 637 may be filed on a consolidated basis.
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