The Medical Device Excise Tax: ready or not?

22nd Annual Health Sciences Tax Conference Medical device excise tax: ready or not? December 5, 2012

Page 1 Medical device excise tax: ready or not?

Disclaimer

► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.


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Presenters

► Mar Haeussler Vice President Economic Analysis/Transfer Pricing Olympus Center Valley, PA

► Chris Ohmes Ernst & Young LLP Washington, DC +1 202 327 8753 [email protected]


Agenda

► Introduction to MDET ► Preparation for the medical device excise tax (MDET)

► Supply chain mapping ► Tax base ► When liability arises

► Amount of Liability ► Compliance and IT considerations

Introduction to the MDET


What is the MDET?

► The MDET is a federal, ad valorem, manufacturers excise tax.

► Enacted as part of the Patient Protection and Affordable Care Act, the MDET imposes on manufacturers, importers, and producers a tax at a rate of 2.3% of the price of the first sale or use of medical devices in the US.

► The MDET is effective for taxable sales (and uses) occurring after December 31, 2012.

► The MDET is incorporated into Chapter 32 of the Internal Revenue Code, thus a series of existing manufacturers excise tax rules apply to the MDET.

Preparation for the MDET


Where to start?

► Do we obtain ownership of taxable medical devices in a way that potentially make us liable for the tax?

► Do we make them? ► Did we import them? ► Are we treated as if we made them? ► What about:

► Kitting ► Installation and/or periodic servicing ► Repairs/refurbishing


What are we talking about?

► Taxable medical devices are defined with reference to Section 201(h) of the Federal Food, Drug and Cosmetic Act. A medical device is:

► An instrument, apparatus, contrivance, in vitro reagent, recognized in the National Formulary or the US Pharmacopoeia

► Intended for use in diagnosis of disease or other conditions or in the cure, mitigation, treatment or prevention of disease

► Intended to affect the structure or any function of the body of man or other animals, in a non-chemical manner


Who is liable for the tax?

► MDET is imposed on the manufacturer, producer or importer of a taxable medical device.

► For excise tax purposes, the term manufacturer includes a “producer” and an “importer.”

► A manufacturer is a person who produces a taxable article by processing, manipulating or changing the form of an article or, by combining or assembling two or more articles.

► The importer rule treats the importer as the manufacturer of imported goods.

► MDET applies by legal entity, thus multiple entities within a controlled group can have compliance obligations.


Which devices are exempt?

► Exemptions based on the product ► Some medical devices are MDET-exempt because they are not

listed with a three-letter Food and Drug Administration (FDA) product code.

► Eyeglasses, hearing aids and contact lenses ► Certain medical devices sold at retail, as specified in regulations

► Exemptions based on sales ► Exports (can we prove it?) ► Sold for further manufacturing (shifting of liability)


The retail exemption isn’t sales based?

► Congress delegated to Treasury the authority to exempt medical devices, which are of a type generally purchased by the general public at retail for individual.

► Internal Revenue Service (IRS) has proposed regulations indicating the retail exemption applies to medical devices ► The device satisfies a three-part test:

► It is regularly available for purchase and use by individual consumers who are not medical professionals.

► The design demonstrates that it is not primarily intended for use in in a medical institution or office or by medical professionals.

► Alternatively, the device satisfies one of the regulations’ safe harbor provisions


Triggering liability for the tax

► In general, the tax attaches to the first sale in the US after the completion of manufacturing of a taxable medical device

► Importers are subject to the same first sale rule, when a taxable medical device is imported into the US.

► Uses are also subject to the MDET ► Leases ► Rental arrangements not involving payments of rent ► Loaners ► Demonstration units


Section 4191 medical device excise tax point of attachment

No tax

No tax

Do you export medical devices?

Do you sell partially completed medical devices?

No tax

Tax due

Yes

Yes

Yes No

Yes

No

No

No

Yes

Do you manufacture, produce, or import listed FDA medical devices for use by

humans?

Do you sell, rent, lease, lend or use medical devices?

Are they eyeglasses, contact lenses,

hearing aids or exempt devices?

No tax Yes

MDET liability


Identifying the tax price

► The supply chain and distribution channels determine which prices can be used to calculate the tax.

► Existing manufacturers’ excise tax rules assume a certain supply chain and distribution-channel paradigm – pricing rules follow from that paradigm.

► Supply chain and distribution channels vary widely in the medical device industry.

► Economic versus legal responsibility for MDET


The pricing paradigm

US manufacturer or

Importer

Unrelated distributer

Unrelated retailer

End customer

Seeking a manufacturer’s wholesale price


What is a constructive sales price?

► A fair market value price that the IRS may impose by statute

► Applies only if tax is not paid on fair market value price. ► IRS has issued numerous rulings allowing a fixed

percentage of retail as a proxy for a wholesale price but these are specific to other excise taxes.

► Most MDET taxpayers will want to avoid constructive pricing

► Constructive price rules are set out in code Section 4216(b)(1) through (b)(4)


US manufacturer

or importer

At what price is the tax paid? Constructive price rules

Outside US (OUS)

manufacturer

Related wholesaler/ distributer

Unrelated wholesaler/ distributer

Unrelated retailer

Related retailer

E n d c u s t o m e r

Constructive Sales Price Taxable Sale

Taxable Transaction is always the first sale or use

Transfer Price

True wholesale


Determining pricing

► Price must reflect a return for all functions, intangibles and risks necessary to manufacture a finished device ready for the market

► Existing regulations provide for the following exclusions ► Excise tax ► Transportation ► Delivery ► Insurance ► Installation charges


Pricing hot topics

► Separately stating the tax on invoices ► Intercompany sales to related distribution company ► Rebates and sales incentives ► Treatment of marketing intangibles and marketing costs ► Services incorporated into sales price (training, repairs,

loaners, etc.) ► Application of Rev Rul 80-273 ► Vendor communications on tax-exempt sales ► Razor and razor blade sales model

MDET compliance


Compliance issues

► Tax deposits every two weeks, electronic federal tax payment system per legal entity

► Quarterly form 720 (yet to be modified for MDET) ► Form 637 exemption certificates

► Acquire ► Provide ► Maintain

► Record retention (and compliance with export and further manufacturing regulations)

► Refunds


Compliance issues

► No off the shelf software solution is available ► Integration with Enterprise Resource Planning Software

(ERP) or standalone? ► Systems

► Calculate tax and refunds ► Create audit reports ► Update financials

► Customer relationship changes ► Supplier relationship changes ► Item master changes ► Acquisitions


Questions

Economy & Finance

The Medical Device Excise Tax: ready or not?