11 September 2015

Medical device excise tax — technical overview and congressional efforts to repeal

The US Health Care and Education Reconciliation Act of 2010 created a new medical device excise tax under section 4191 of the US Internal Revenue Code. Final regulations interpreting the new rules were released in 2012, along with Notice 2012-77, which provides interim guidance on certain issues that remain unresolved in the final regulations. Manufacturers, producers, importers and end-users of the medical devices subject to these rules should pay close attention to legislation recently introduced in the House and the Senate to repeal these rules, although the Obama administration has threatened to veto the repeal absent sufficient revenue offset provisions.

Section 4191 imposes a 2.3% excise tax (the “MDET”) on the actual sales price (and in related party situations, the deemed sales price) of any 'taxable medical device' sold by its manufacturer, producer or importer. The MDET must be reported and paid in full quarterly on Internal Revenue Service Form 720. However, profitable taxpayers may ultimately pay a lower effective rate of MDET because the MDET is deductible from gross income as an ordinary cost of doing business. While price increases generally will not eliminate the MDET's cost because of corresponding increases in revenue and likely reductions in demand, careful planning may allow taxpayers to approximate pre-MDET profits.

A 'taxable medical device' is any 'medical device' under the Federal Food, Drug, and Cosmetic Act that is intended for human use. Statutorily exempt items include eyeglasses, contact lenses, hearing aids and 'any other medical device determined by the US Department of Treasury to be of a type which is generally purchased by the general public at retail for individual use.' This exemption generally requires the device to be regularly available for purchase and use by individual consumers and not primarily intended for use by a medical professional.

Although courts historically have interpreted the Federal Food, Drug and Cosmetic Act's definition of 'medical device' broadly, the final MDET regulations generally limit the scope of 'taxable medical device' to those that currently must be registered and listed as medical devices with the Food and Drug Administration. Notably, registered and listed devices (and, therefore, 'taxable medical devices') could include those with non-human or non-medical uses, even if they are intended solely for human or medical use.

The final MDET regulations still contain areas of uncertainty. For example, it is unclear under the regulations whether the MDET applies to licenses of medical software, although medical software itself is generally a taxable medical device for MDET purposes. However, under Notice 2012-77, the IRS will treat licenses of taxable medical devices, whether software or otherwise, as leases (and not as sales subject to the MDET) until further guidance is issued.

While the MDET has remained unchanged since its passage, it has been a target for repeal for nearly as long. The latest repeal attempt passed the House on June 18, 2015 in a 280-140 vote (with 46 Democrats voting in favor but not all House members voting), just one vote shy of a veto-proof majority.

The legislation was received by the Senate and has been read twice but no further action has been taken. It is unclear that the repeal legislation will have sufficient support to gain a veto-proof majority in the Senate, with the primary concern being the absence of a revenue provision that would offset the MDET's projected revenue of $30 billion over the next 10 years. Further, the Obama administration has threatened to veto any legislation that repeals the MDET without satisfactory offsetting revenue provisions.

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