IRS releases final regulations and interim guidance on medical device excise tax.

• Author: Green, David

In early December 2012, Treasury published final regulations (T.D. 9604) and additional interim guidance under Sec. 41.91 relating to the medical device excise tax that was enacted as part of the Health Care and Education Reconciliation Act of 2010; P.L. 111-152, in conjunction with the Patient Protection and Affordable Care Act, P.L. 111-148 (the health eau acts).

Effective Jan. 1, 2013, Sec. 4191 imposesa 2.3% excise tax on sales of certain medical devices by the devices' manufacturer, producer, or importer. The regulations generally adopt the guidance in the proposed regulations issued on Feb. 7, 2012 (REG-113770-10), but provide greater certainty with respect to the types of devices subject to the medical device excise tax and clarify the retail and other exemptions.

The IRS and Treasury continue to evaluate certain issues and issued Notice 2012-77 and a frequently asked questions document (available at tinyurl.com/cchfbez) with interim guidance on some of the more significant issues facing the medical device industry as it readied itself for and implemented the medical device excise tax. In particular, Notice 2012-77 provides guidance on:

1. Determining the taxable sale price for certain common supply chain scenarios under the constructive pricing rules;

2. Treatment of licensed software;

3. Donations of taxable medical devices;

4. Excise tax treatment of FDA-listed medical device kits; and

5. Interim penalty relief to taxpayers for the first three calendar quarters of 2013.

   Observation: Although the regulations and interim guidance provide clarity on the medical device excise tax, organizations will continue to face challenges in complying with this law.

   Transition Rule Provided

   The regulations provide transition relief for certain long-term contracts, including leases and installment sales. Specifically, payments made on or after Jan. 1, 2013, for contracts entered into before March 30, 2010, are not subject to the medical device excise tax unless the contract was materially modified on or after March 30, 2010, the date the health care acts were enacted.

   Taxable Medical Devices

   Under the statute, a "taxable medical device" is any device, as defined under Section 201(h) of the Federal Food, Drug, and Cosmetic Act, P.L. 75-717 (FFDCA), that is intended for humans. The regulations narrow the scope of this definition to products (with certain exemptions and exclusions) listed with the U.S, Food and Drug Administration (FDA) under Section 510(j) of the FFDCA and 21 C.F.R. Part 807, or that the FDA determines should have been so listed. They also clarify that certain biologic devices, such as those used for in vitro blood screening that are regulated under 21 C.F.R. Part 607 and not listed with the FDA under Section 510(j) of the FFDCA and 21 C.F.R. Part 807 do not meet the definition of a taxable medical device.

   Observation: Taxpayers that manufacture, produce, or import listed medical devices that may be sold either as medical devices or for other uses (e.g., a microscope) are nevertheless taxed on all sales of such devices unless another exemption or exclusion applies. This includes FDA-listed devices sold for veterinary use. Similarly, FDA-listed medical devices that are combined with branded prescription drugs are not exempt from the medical device excise tax, even if the same article is subject to the branded prescription drug fee imposed by the health care acts.

   Manufacturer, Producer, or Importer

   Existing regulations broadly define the term "manufacturer" to include "any person who produces a taxable article from scrap, salvage, or junk material, or from new or raw material, by processing, manipulating, or changing the form of an article or by combining or assembling two or more articles. The term also includes a 'producer' and an 'importer" (Regs. Sec. 4.8.0-2(a)(4)(i)). Note that definitions of "manufacturing." or "production" used by the FDA or in the Internal Revenue Code under subpart F (Secs. 951-965) or Sec. 199 do not apply to the excise tax.

   Taxable use: Taxable uses of medical devices by the manufacturer, producer, or importer (MPI) are subject to the manufacturers excise tax rules of Sec. 4218.

   Donated Medical Devices

   Donated medical devices are not specifically addressed in the regulations; however, under the interim guidance, a donation of a taxable medical device to an eligible charitable organization is not treated as a taxable use, provided the device is not intended to be sold by the donee. For this purpose, an eligible charitable organization is defined by Sec. 170(c) and generally includes U.S. federal, state, and local governments and U.S. charities organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster amateur athletic competition.

   Products Used for Demonstration, Promotion, or Testing

   The regulations' preamble indicates that FDA-listed medical devices used for demonstration purposes (e.g., displayed at a medical device trade show) are likely taxable when first used (citing Rev. Ruls. 60-290 and 72-563). The subsequent sale of the used device is not taxable, however. FDA-listed medical devices that are provided as samples likely have a similar treatment. If an FDA-listed medical device is used by its manufacturer to test another device that it also manufacturers, the first device is not subject to tax on such use; but providing devices for testing or evaluation by others likely is considered...