By Katherine Jett Hayes

Background

Section 1405 of the Health Care and Education Reconciliation Act of 2010 (HCERA) requires the Secretary of Treasury to implement an excise tax on the sale of certain medical devices.^[1] The HCERA included a series of amendments to the Affordable Care Act (ACA). The medical device excise tax, along with a similar tax on pharmaceuticals and health insurance, is seen by authors of the law as a means of raising federal revenue to help offset the cost of certain provisions of the ACA that increased federal spending. The device tax was set at 2.3 percent. The most recent estimate of federal revenues raised under the tax is $29.1 billion over the 10 year period beginning October 1, 2012.^[2] This estimate was prepared to evaluate the estimated loss of federal revenue associated with legislation to repeal the tax on medical devices. Although the legislation passed the House of Representatives during the 112th Congress, it failed to pass the Senate.

Recent Activity

The Internal Revenue Service (IRS) and Department of Treasury released the final Medical Device Tax rule on December 11, 2012. The rule imposes a tax on the sale of any “taxable medical device” by the manufacturer, producer or importer of a device. The amount of the tax is 2.3 percent of the price of the device, with an effective date of January 1, 2013.

Defining Taxable Medical Devices

Under the rule, the agencies define a “taxable medical device” as any device defined in section 201(h) of the Federal Food, Drug and Cosmetic Act (FFDCA) that is intended for humans. A device is intended for humans if it is listed as a device with the Food and Drug Administration (FDA) under section 510(j) of the FFDCA and 21 CFR part 807, pursuant to FDA requirements. The rule also provides for a process for the inclusion of devices that are not listed with the FDA, if the FDA determines that a device should have been listed. Exemptions from the definition of taxable devices include eyeglasses, contact lenses and hearing aids, any device of a type generally purchased by the general public at retail, and is not primarily used by consumers who are not medical professionals and the device was not primarily intended for use in a medical institution or office by a medical professional. The rule lays out a series of factors — a “facts and circumstances test” — used for making a determination as to whether a device is generally purchased by the public at retail for individual use. The two-step test asks whether i) the device is regularly available for purchase and use by individual consumers who are not medical professionals, and ii) the device’s design demonstrates that it is not primarily intended for use in a medical institution or office, or by medical professionals. The final rule includes a series of examples to assist in this determination.

 Safe Harbors

The final rule establishes a “safe harbor” for devices that are described as “over the counter” (OTC) devices in the relevant FDA classification regulation heading, the FDA’s product code name, device classification name or “classification name” field in the FDA’s device registration and listing database.^[3] The rule also establishes a safe harbor for devices that qualify for durable medical equipment (DME), prosthetics, orthotics and supplies under Medicare (Subpart C of 42 CFR part 414), which are reimbursed under Medicare part B payment rules. The rule includes a series of examples to assist in determining whether a Medicare covered item fits into this safe harbor.^[4]

Explanations of Decisions relating to Defining Taxable Devices (Preamble)

In the preamble to the rule, the agencies clarify decisions made in a number of areas raised in comments to the proposed rule. The agencies note that the rule excludes devices reviewed by the FDA Center for Biologics Evaluation and Research (CBER).^[5] IRS and Treasury rejected a clarification that certain devices such as sterilization process indicators, software and containers used to transport medical products or specimens should be exempt from the tax, as they are not “intended for humans,” and further, they are not used in the direct treatment, diagnosis or monitoring of a patient. The agencies indicated that there is no statutory support in the legislative history or in the Joint Committee on Taxation’s general explanation of the legislation that would support the proposition that Congress intended to distinguish between devices used directly on patients from those “otherwise used in human medicine.”

The agencies declined to exclude from the tax those devices which are approved for use in both human and veterinary medicine. Specifically, a commenter requested that the agencies exempt devices labeled “not for human use” or “veterinary use only.” While noting that the final rule limits the definition of a taxable medical device to devices described in section 201(h) of the FFDCA that are intended in use for humans, it does not provide that the device must be intended exclusively for humans. Noting that under existing FDA regulations a device intended for use in human medicine must be listed as a device with the FDA even if the device may also be used in veterinary medicine, the agencies state that the decision to include taxation of devices used in human and veterinary medicine is consistent with existing FDA regulation.^[6] The agencies also declined to exempt from taxation a medical device that is used for non-medical purposes, and Humanitarian Use Devices (those that are intended to benefit patients by treating or diagnosing a disease that affects or is manifested in fewer than 4,000 patients in the U.S. per year). In the latter case, the agencies indicated that there is no statutory authority for the exemption. The preamble also noted that a number of requests for exemption were by definition not subject to taxation, such as software upgrades, to the extent that the upgrades are not required to be separately listed with the FDA, and also noted that a manufacturer that lists a product as a device in instances that the FDA does not require listing, may be eligible for a credit or refund once the device has been de-listed. The agencies also clarify that a combination product — products that combine drugs, devices and/or biological products — are subject to the tax if they are listed as a device with the FDA under section 510(j) of the FFDCA and 21 CFR part 807, to the extent that they do not fall under a statutory exemption. The Preamble also rejected requests to make exceptions in a number of other areas including a removal from the facts and circumstances test, whether the device can be used safely and effectively by those with no training, the elimination of cost from the test, and that the final rule exclude Class III devices from the definition of taxable devices, among others.

The Preamble also includes discussion of a number of comments received relating to filing requirements, semimonthly deposits and penalties for failure to file and pay device taxes pursuant to other sections of the tax code. Generally, the agencies declined to make exceptions to these requirements for the excise tax on devices. They did, however, indicate that the agencies will issue separate interim guidance on the applicability of the excise tax under existing chapter 32 rules, with respect to whether the excise tax generally attaches upon the sale or use of a taxable article by the manufacturer, when it applies to the licensing of software.^[7] The agencies also made clear that under chapter 32 rules, remanufacturing or refurbishing constitutes manufacture if the process produces a new and different taxable article, and the tax will be applied to the sale or use of the remanufactured or refurbished article.^[8]

Computation of tax on leases and installment sales

The rule applies the tax to payments made on or after January 1, 2013 pursuant to a contract for the lease, installment sale, or sale on credit of a taxable device that was entered into on or after March 30, 2010. The rule also clarifies that payments made after January 1, 2012 pursuant to written binding contracts in effect prior to March 30, 2010, are not subject to the medical device tax.

Tax-free sales and exportations, uses sales and resales

Under the final rule, device taxes apply to products that would otherwise be exempt under section 4221(a)(3) through (a)(6) of the Internal Revenue Code.