Phillip Brown05.14.13
On Jan. 1, 2013, the medical device excise tax (MDET) became effective for many manufacturers of medical devices as prescribed by Section 4191 of the Internal Revenue Code. Recent guidance suggests that the view of the U.S. Department of Treasury is that it doesn’t care when the devices were manufactured—even prior to Dec. 31, 2012. As far as the tax goes, the date of sale determines when the application of the tax is in effect. The significance to manufacturers is that prior inventories and production builds on the books as of December 2012 are not exempt from the tax. If you sold it after Dec. 31, 2012, it is taxable.
Vote to Repeal the Tax
The U.S. Senate voted on a nonbinding resolution to eliminate the MDET. But the bottom line is the tax still is in effect, and if you determined you qualify to pay it, you still need to file and remit payment. The real effect of the largely symbolic vote (an amendment to the Democrats’ Senate budget proposal) is that it reflects bipartisan support for repeal of the tax due to Democrats from states with significant medical device manufacturing concerns joining Republicans. The ultimate repeal is an uphill battle due to lawmakers having to replace the projected $27 billion in revenue generated by the MDET to continue to fund the 2010 Affordable Care Act.
Permission to Pay Late
Additional guidance provided by the Internal Revenue Service (IRS) in late December concluded that firms required to pay the MDET may do so late for three quarters (nine months) without penalty. The qualifier to be able to take advantage of the late filing and/or remittance is that a company must be able to prove that it was attempting to implement the tax into its system during the period prior to the late filing.
Conundrum of the MDET
Traditionally, excise taxes have been imposed on products and services perceived to be luxury items and commodity items that the public has alternatives to purchasing. This includes gas-guzzling automobiles, sport fishing equipment, tanning salon services, and certain types of specialty fuels. Medical devices now have been added to the updated forms of the IRS referencing those same luxury and commodity items. Notwithstanding the argument that medical devices are not luxury items or commodities for which alternatives exist, the impact of the tax is further exacerbated by the functional definition of excise—which means to “cut out surgically,” “carve out,” or “remove from the whole.” In the case of excise-taxed products, the item is taxed on the whole sales price to the purchaser (or amount of business done), not the portion of profit derived from the sale.
In the case of medical devices, especially in the early phases of startup or product life cycle, the realization of profitability from a medical device may be years off (if ever) in the future of the manufacturer based on the investment, cost of development, and potential for increase in sales volume or units sold. The potential impact on mid-level to startup medical device manufacturers with business model profitability that is not fully realized can be an especially significant impact to the developing financials.
Trends in Funding
Device manufacturers are not seeing the offsetting gains (in the form of additional healthcare recipients using more devices) promised by the sponsors of the Affordable Care Act.
Device manufacturers have fallen into two distinct camps regarding funding the 2.3 percent excise tax:
MDET Determination and Compliance Revisited
Acknowledging that the medical device excise tax is law, it is still in effect and ultimately will be required to be remitted without penalty (fourth-quarter filing 2013). There are fundamentals that deserve consideration and tasks that require compliance. They include:
– Devices with “over the counter” specified in their FDA listing; and
– Parenteral and enteral nutrition and DME and orthotic equipment that is purchased through Medicare Part B.
5. Compliance. Important figures to keep in mind are 108,695 and April 30, 2013. The first is the revenue (in dollars equivalent to $2,500 of excise tax due) a medical device manufacturer must realize in one quarter that would qualify or be subject to the MDET to be required to file a Quarterly Federal
Excise Tax Return. The second was the filing date of the first quarterly filing. The quarterly filing is accomplished by completing IRS Form 720 as revised in January 2013 referencing line 136 for Taxable Medical Device Sales Price.
If the threshold of $2,500 of MDET is not met in the quarter, the filing and remittance can be deferred until met in a subsequent quarter. Remittance of MDET due is expected to be through semimonthly deposits to the IRS, once again using the $108,695 in medical device taxable revenue as the threshold. If you determine that your firm exceeded $108,695 in taxable medical device sales in the first quarter and you haven’t yet performed any or all semimonthly deposits; the IRS has provided you a reprieve. The tax still will be due.
However, you will not be assessed a penalty for late payment through the end of the third quarter. You will, however, need to provide evidence of intent to meet the requirements of determining, collecting and remitting the MDET. Documenting the steps your manufacturing firm has taken toward meeting the requirements of the MDET—even in the management review—is a strong recommendation.
Phillip Brown is the medical device practice leader in Plante Moran’s management consulting group, with more than 20 years of manufacturing operations and engineering experience in the medical device industry. Brown has performed product and process transfers through a variety of business relationships including OEM consolidation, OEM outsourcing domestically and internationally through contract and toll manufacturing, OEM insourcing, shelter, and the establishment of offshore principal/subsidiary manufacturing. Consulting firm Plante Moran is based in Southfield, Mich.
Vote to Repeal the Tax
The U.S. Senate voted on a nonbinding resolution to eliminate the MDET. But the bottom line is the tax still is in effect, and if you determined you qualify to pay it, you still need to file and remit payment. The real effect of the largely symbolic vote (an amendment to the Democrats’ Senate budget proposal) is that it reflects bipartisan support for repeal of the tax due to Democrats from states with significant medical device manufacturing concerns joining Republicans. The ultimate repeal is an uphill battle due to lawmakers having to replace the projected $27 billion in revenue generated by the MDET to continue to fund the 2010 Affordable Care Act.
Permission to Pay Late
Additional guidance provided by the Internal Revenue Service (IRS) in late December concluded that firms required to pay the MDET may do so late for three quarters (nine months) without penalty. The qualifier to be able to take advantage of the late filing and/or remittance is that a company must be able to prove that it was attempting to implement the tax into its system during the period prior to the late filing.
Conundrum of the MDET
Traditionally, excise taxes have been imposed on products and services perceived to be luxury items and commodity items that the public has alternatives to purchasing. This includes gas-guzzling automobiles, sport fishing equipment, tanning salon services, and certain types of specialty fuels. Medical devices now have been added to the updated forms of the IRS referencing those same luxury and commodity items. Notwithstanding the argument that medical devices are not luxury items or commodities for which alternatives exist, the impact of the tax is further exacerbated by the functional definition of excise—which means to “cut out surgically,” “carve out,” or “remove from the whole.” In the case of excise-taxed products, the item is taxed on the whole sales price to the purchaser (or amount of business done), not the portion of profit derived from the sale.
In the case of medical devices, especially in the early phases of startup or product life cycle, the realization of profitability from a medical device may be years off (if ever) in the future of the manufacturer based on the investment, cost of development, and potential for increase in sales volume or units sold. The potential impact on mid-level to startup medical device manufacturers with business model profitability that is not fully realized can be an especially significant impact to the developing financials.
Trends in Funding
Device manufacturers are not seeing the offsetting gains (in the form of additional healthcare recipients using more devices) promised by the sponsors of the Affordable Care Act.
Device manufacturers have fallen into two distinct camps regarding funding the 2.3 percent excise tax:
- Large OEMs with profitable business units (lines) that absorb the cost of tax in the device’s sales price and maintain the margin of the medical device through reduction of the cost of goods (i.e., consolidation of overhead functions—layoffs and/or reduction of labor costs through offshoring and transfer of manufacturing to lower labor-cost countries); and
- Mid-level to startup companies with low to unprofitable business units (lines) that 1) increase the sales price of the product to “collect” the incremental cost of the MDET or 2) pass along the MDET as a separate “line item” charge when invoicing the customer.
MDET Determination and Compliance Revisited
Acknowledging that the medical device excise tax is law, it is still in effect and ultimately will be required to be remitted without penalty (fourth-quarter filing 2013). There are fundamentals that deserve consideration and tasks that require compliance. They include:
- Exemptions. There are significant exemptions to the MDET that may have been overlooked in these early days of implementation, even if the manufacturer has determined its medical device meets most of the criteria to qualify for paying the tax. Let’s take a look at the most significant ones:
- Sales on devices exported or sold OUTSIDE the United States. Even if the device is determined to qualify for paying the tax if sold domestically to some degree in percentage of sales in the United States, the portion of revenue derived from sales outside the United States will be exempt from the MDET after the manufacturer has completed IRS form F637 (the Application for Registration for Certain Excise Tax Activities). The F637 completion, if approved, will yield a registration number to the manufacturer to use in commercial invoicing and export documentation.
- Sales on devices manufactured on behalf of another manufacturer (specification developer) or contract manufacturing. Once again, even if the device is determined to qualify for the tax if sold domestically, if the device is manufactured on behalf of another manufacturer (or entity) who provided the specification, formula, recipe, etc., to manufacture the product, sales derived from that revenue will be exempt from the MDET after the manufacturer has completed IRS form F637. Conversely, the customer who purchases these devices will become the responsible party qualifying to pay the MDET (F737 will require identifying the specification developer).
- Retail exemption facts and circumstances rationale. So your medical device is listed; it may even require a prescription. It may still qualify for exemption from the MDET based on certain facts and circumstances that, when fully evaluated, make for an argument that your medical device is exempt.
- The ability to purchase an equivalent device at a retail vendor, including “e-commerce” sites;
- Use of the device does not require professional medical training;
- The device falls into the FDA classification “Physical Medicine Device”;
- The device must be used in a medical facility;
- The cost of the device is significant for the average citizen;
- The device is classified as U.S. Food and Drug Administration (FDA) Class III—the highest compliance level;
- The device does not fall into 21 CFR statutory classifications parts; and
- The device qualifies as durable medical equipment (DME) per Medicare Part B rental reimbursement basis. “Safe Harbor” requirements are:
– Devices with “over the counter” specified in their FDA listing; and
– Parenteral and enteral nutrition and DME and orthotic equipment that is purchased through Medicare Part B.
5. Compliance. Important figures to keep in mind are 108,695 and April 30, 2013. The first is the revenue (in dollars equivalent to $2,500 of excise tax due) a medical device manufacturer must realize in one quarter that would qualify or be subject to the MDET to be required to file a Quarterly Federal
Excise Tax Return. The second was the filing date of the first quarterly filing. The quarterly filing is accomplished by completing IRS Form 720 as revised in January 2013 referencing line 136 for Taxable Medical Device Sales Price.
If the threshold of $2,500 of MDET is not met in the quarter, the filing and remittance can be deferred until met in a subsequent quarter. Remittance of MDET due is expected to be through semimonthly deposits to the IRS, once again using the $108,695 in medical device taxable revenue as the threshold. If you determine that your firm exceeded $108,695 in taxable medical device sales in the first quarter and you haven’t yet performed any or all semimonthly deposits; the IRS has provided you a reprieve. The tax still will be due.
However, you will not be assessed a penalty for late payment through the end of the third quarter. You will, however, need to provide evidence of intent to meet the requirements of determining, collecting and remitting the MDET. Documenting the steps your manufacturing firm has taken toward meeting the requirements of the MDET—even in the management review—is a strong recommendation.
Phillip Brown is the medical device practice leader in Plante Moran’s management consulting group, with more than 20 years of manufacturing operations and engineering experience in the medical device industry. Brown has performed product and process transfers through a variety of business relationships including OEM consolidation, OEM outsourcing domestically and internationally through contract and toll manufacturing, OEM insourcing, shelter, and the establishment of offshore principal/subsidiary manufacturing. Consulting firm Plante Moran is based in Southfield, Mich.