March 1, 2012

IRS Issues Proposed Regulations for New Medical Device Excise Tax

On February 3, the IRS issued proposed regulations that provide guidance on the 2.3% excise tax that will be imposed on the sale of certain medical devices by a manufacturer, producer or importer. The excise tax was added to the U.S. Internal Revenue Code as part of the Health Care and Education Reconciliation Act of 2010, in conjunction with the Patient Protection and Affordable Care Act. The IRS and Treasury Department have requested comments on the proposed regulations by May 7, 2012.

The excise tax will apply to sales of taxable medical devices made after December 31, 2012 and will attach when a medical device is sold by a manufacturer, producer or importer. The proposed regulations reference existing authority under chapter 32 for purposes of determining whether medical device contract manufacturers are to be treated as a manufacturer or producer for purposes of the excise tax. The term “sale” means an agreement whereby the seller transfers the title to the property or substantial incidents of ownership to the buyer for consideration (which may consist of money, services or other items). As such, the manufacturer will be liable for the tax at the time of the sale, and the tax will apply to each partial payment in the event of an installment sale. The sale price upon which the tax will be assessed will include the total consideration, in any form, paid for the device, and includes packaging costs. However, the sale price excludes shipping costs and any warranties or rebates offered to the purchaser.

A “taxable medical device” is defined as any device that is intended for humans under the definition provided in the Federal Food, Drug & Cosmetic Act of 2006. Under that definition, a “device” is broadly defined to include any instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent or other similar article intended for use in diagnosing, treating, mitigating or preventing disease that does not achieve its primary purposes through a chemical reaction in the body and is not dependent on being metabolized in order to achieve its intended purposes.

Certain medical devices will be exempted from the excise tax. Such exempted devices include eyeglasses, contact lenses, hearing aids and other medial devices determined to be of a type that is generally purchased by the general pubic at retail for individual use (the so-called “retail” exemption). The proposed regulations clarify that a device will qualify for the retail exemption if the device is regularly available for purchase and use by customers who are not medical professionals, and the device’s design indicates that it is not primarily intended for use in a medical environment. The proposed regulations set forth non-exclusive factors to be evaluated in determining whether the retail exemption applies under the facts and circumstances involved. Factors that suggest that a device is of a type regularly available for purchase and use by customers who are not medical professionals include (i) whether the device is available for purchase through retail businesses that also sell items that are not medical devices, such as drug stores or supermarkets, (ii) consumers who are not medical professionals can use the device safely and effectively for its intended medical purpose with minimal or no training from a medical professional and (iii) the device is classified as a Physical Medicine Device by the FDA (see 21 CFR §890).

By contrast, factors that suggest that the device is primarily intended for use in a medical environment or by medical professionals include (i) the device must be implanted, inserted, operated or otherwise administered by a medical professional, (ii) the cost to acquire or use the device requires a large expenditure that is not affordable to the average consumer, (iii) the device is classified by the FDA under parts or subparts of 21 CFR and (iv) the device qualifies as durable medical equipment, prosthetics, orthotics, and supplies for which payment is available exclusively on a rental basis under Medicare Part B rules and requires frequent and substantial services.

The proposed regulations clarify that whether a medical device requires a prescription is not relevant to whether the device will qualify for the exemption. A safe harbor is included for certain over-the-counter devices such as pregnancy tests, blood glucose monitors, test strips and lancets.

An exemption also exists for devices that are used by the purchaser for further manufacture or export, or are used solely for research or teaching purposes and are not introduced into commercial distribution. Likewise, there is an exemption for devices that are intended for use exclusively in veterinary medicine. However, the proposed regulations clarify that a device that is used both for humans and in veterinary medicine would constitute a taxable medical device that is subject to the excise tax.