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August 30, 2012


Medical Device Excise Tax Could Have a Profound Impact on Southern California Medical Device Manufacturers
One important provision of President Obamas healthcare legislation that did not receive its deserved attention, but could have a profound impact on southern California medical device manufacturers, is the new tax on medical device manufacturers. Many businesses in the medical device industry had adopted a wait-and-see approach to the 2.3 percent excise tax on sales of medical devices that was enacted as part of the Patient Protection and Affordable Care Act (PPACA) to help finance the healthcare laws expansion of insurance coverage. Now that the Supreme Courts ruling on the PPACA has left the medical device excise tax intact, businesses in the medical device industry can no longer afford to put off preparing for the new tax and grappling with the effects it will have on their businesses. The potential cost of the new tax on businesses in the medical device industry will be enormous. Estimates suggest that the 2.3 percent excise tax will raise $20 billion by 2019. Although the House passed a bill to repeal the tax, the White House has promised to veto it. Even without the White Houses promise, the Democrat-controlled Senate is unlikely to approve the measure. Barring a change in control of the Senate and White House and the successful repeal of the medical device excise tax with retroactive effect, unless businesses in the medical device industry prepare for the new tax, which applies to sales beginning on January 1, 2013, they will face significant difficulties catching up and have missed important planning opportunities. To prepare, businesses should: Estimate the likely tax obligation; Evaluate the availability of any exemptions or expected changes in their business that may impact their tax obligation; Make sure that their financial and accounting systems are set up to enable accurate and timely compliance with the tax; and Make any necessary changes in the operational structure of their business to minimize the impact of the tax.

Shahzad A. Malik Chair, Tax Practice (949) 725-4067

Ryan C. Gaglio (949) 725-4042


The 2.3 percent medical device excise tax is imposed upon a manufacturer, producer or importer of a taxable medical device. In general, a taxable medical device is any device, as defined in section 201(h) of the Federal Food, Drug & Cosmetic Act (FFDCA), that is intended for humans. The definition of device in the FFDCA is very broad and includes among other items, instruments, machines, implants and in vitro reagents, among others. The definition also includes associated parts and accessories, which are: Recognized in the official National Formulary, the United States Pharmacopeia or any supplement to them; Intended for use in the diagnosis, cure, treatment or prevention of disease or other conditions; or Intended to affect the structure or any function of the body, excluding products relying on a chemical reaction within or on the body or being metabolized to achieve their primary intended purposes.

The Proposed Treasury Regulations addressing the medical device excise tax generally defer to the Food and Drug Administration's registration rules for the definition of taxable medical devices by reference to the products listed under Section 510(j) of the FFDCA.

Under what is commonly referred to as the retail exemption, taxable medical devices do not include eyeglasses, contact lenses, hearing aids and any other medical device determined by the U.S. Department of Treasury to be of a type that is commonly purchased by the general public at retail for individual use. Congress intended that the U.S. Department of Treasury would treat a medical device as falling within the retail exemption if the device generally is sold at retail establishments (including over the Internet) to individuals for their personal use. The Proposed Treasury Regulations set forth a list of nonexclusive factors to be examined in determining whether any medical device meets a two-prong, facts-and-circumstances test, as well as a safe harbor, for purposes of the retail exemption.

The Internal Revenue Code includes a number of general rules that apply to the medical device excise tax, including rules related to: The computation of the sales price on which the excise tax is imposed, including price adjustments, credits and refunds; The treatment of leases as sales; The treatment of certain uses by manufacturers or importers as sales; Tax-free sales for further manufacture or export; and Reporting requirements and exemptions.

Other federal excise tax exemptions, including for use as supplies for vessels or aircraft and for sales to state or local governments, nonprofit educational organizations and qualified blood collector organizations do not apply to the medical device excise tax.

The Proposed Treasury Regulations generally address the definition of taxable medical devices, the scope of the retail exemption and related matters concerning the treatment of veterinary devices, devices that have both medical and non-medical uses, research and investigational devices, kits and products combining more than one device or combining drugs or biological products with devices and secondary devices and components sold with primary devices. Notwithstanding the breadth of the Proposed Regulations, there are many uncertainties and questions that remain unanswered. For example: Because the medical device excise tax is generally intended to be levied on the price of a sale by a manufacturer to a third party wholesaler, other types of sales in different supply-chain settings, including related party sales, generally require the computation of a constructive sales price. Currently, the Proposed Regulations do not include a clear way to rebut the computed constructive sales price, for example by providing appropriate evidence of an arms length transfer price. There are significant tax planning opportunities related to the establishment of a constructive sales price, although some of these may require some operational restructuring of businesses. Well advised businesses should start discussing these opportunities with counsel. There is uncertainty about the application of the price adjustment rules for rebates, discounts and bonuses in the computation of a constructive sales price. The facts and circumstances test for the retail exemption and the applicable safe harbor set forth in the Proposed Regulations leave many questions unanswered about which products are exempt and the documentation that will be necessary to substantiate the exemption. The approach on kits could lead to double taxation on medical devices sold to distributors that are further assembled into kits that include taxable medical devices and non-taxable medical devices.

We expect that many of these questions will be resolved when the regulations are finalized or in other guidance. Given the complexity of the medical device excise tax and the potential magnitude of the tax, businesses should waste no time in preparing for the new tax in advance of January 1, 2013.

Messrs. Gaglio and Malik are tax attorneys at Stradling, where Mr. Malik chairs the tax department. The authors have significant expertise in advising businesses in the medical device and related technology industries on all aspects of tax planning, including mergers and acquisitions, venture investment and international taxation, as well as in tax controversies. This publication is provided for your convenience and does not constitute legal advice. It is prepared for the general information of our clients and other interested persons. This publication should not be acted upon in any specific situation without appropriate legal advice.

IRS CIRCULAR 230 DISCLOSURE: Any federal tax advice contained in this communication is not intended or written to be used, and it cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code of 1986, as amended, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.


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