Explaining the Device Tax: Part 2

October 29, 2010

By Francis Diaz, Research & Product Strategist

In an earlier blog entry, I provided a brief overview, based on a number of sources, of the proposed upcoming medical device tax. In this entry, I am going to describe a little more about who is responsible for the tax, and what (could) qualify as taxable. I have used a number of sources for this information and present my assimilated understanding here. (And please, a reminder – I am not an attorney, nor do I play one on TV. Please do not take my layperson’s analysis of the tax laws as legal advice; please always consult an attorney.) The excise tax (as outlined in Chapter 32 of the Internal Revenue Code) will be imposed on the manufacturer/producer or importer of the eligible medical device. The “manufacturer/producer” is defined as any person or entity that produces a taxable article from new or raw material or from scrap, salvage or junk material by processing or changing the form of the article or by combining or assembling two or more articles. An “importer” is any person or entity who brings a taxable item into the U.S. for sale or use in the U.S.

The manufacturer, producer or importer is liable for payment of the tax, however, there are no specific rules governing how the tax is ultimately collected. Companies are free to pass along (or not to pass along) the economic burden to their customers at their discretion (as a separate line item on the invoice, as an increased selling price, etc.) Some analysts believe this exerts the most pressure on product intermediaries who are limited by set provider reimbursement arrangements.

A “taxable event” is triggered when title passes from the manufacturer/producer/importer to the purchaser. (The IRS will refer to the legal rules of presumption within the jurisdiction where the sale occurs absent the intent of the parties as expressed in the sales contract.)

The 2.3% charge is derived from the full sales price of the taxable article. This price includes the costs of packaging and preparation of the article for shipment (although delivery costs are excluded.) Promotional expenses, rebates and discounts are similarly excluded from the taxable price.

What medical devices qualify as taxable?
The tax law refers to the Federal Food, Drug, and Cosmetic Act definition of a medical device:

“…an instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article, including any component, part or accessory which is (1) recognized in the official National Formulary, or the United States Pharmacopeia, or any supplement to them, (2) intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment or prevention of disease, in man or other animals, or (3) intended to affect the structure or any function of the body of man or other animals, and which does not achieve its primary intended purposes through chemical action within or on the body of man or other animals and which is not dependent upon being metabolized for the achievement of its primary intended purposes.”

This broad definition includes not only conventionally-conceived ideas of a medical device (X-ray machines, medical lasers, infusion pumps, catheters, diagnostic tools, etc.) but can be read as including: commodity healthcare products (i.e. bandages), products not typically associated as serving a medical function (i.e. weight scales) and subcomponents and accessories to medical devices (i.e. wheelchair armrests, medical software).

Some experts have argued that a consequence of this broad definition is the fact that many products not necessarily recognized as a “medical devices”, could potentially be subject to the FFDCA medical device definition and are potentially subject to taxation. Some examples include:

  • Dual Use Products: Products that may be considered medical devices based on their “intended use” and/or the claims of health benefits bestowed through the use of the device. Examples include treadmills and other exercise equipment, massagers, beds, hot tubs, magnets and razor blades.
  • In Vitro Diagnostics and Lab Test Kits: Devices used to help diagnose disease and are therefore “medical devices”
  • Dental Devices (unless they qualify for one of the exemptions): dentures, dental amalgam, denture cleansers and denture cushions
  • Cosmetic Medical Devices: injectable wrinkle fillers and collagen injections
  • Device Components & Accessories: any parts, subcomponents or accessories that work within or in conjunction with a medical device. This includes any raw material, substance, piece, part, soft-/firmware, label, or assembly which is intended to be included as part of the finished device. “Accessories” are any products intended to be used together with a medical device. Some examples include: monitors for imaging machines, lens cleaning brushes for scope devices, instrument cabinets, contact lens cases and cleansers

What qualifies as an exemption and how will future exemptions be determined?

At this time, the only specifically identified exemptions by the Treasury Department are eyeglasses, contact lenses and hearing aids. This is despite the fact that eyeglass frames and lenses (considered as medical device components) and contact lens cases (considered as accessories) are potentially applicable for the tax.

Going forward, medical devices that have been “determined by the Secretary [of the Treasury] to be of a type which is generally purchased by the general public at retail for individual use” will be exempt. It is important to note that the formal FDA device classification (Class I, Class II, Class III) will not have any bearing on a device’s exemption status. To qualify for an exemption under this provision requires an expressed determination by the Treasury Secretary.

There has been some indication from Congress that it expects the IRS to publish a list of medical device “classifications.” Without this determination, the tax applies to a wide range of products commonly purchased at retail, but may be regulated by the FDA as a medical device (some examples: adhesive bandages, canes and crutches, knee and ankle braces, pregnancy test kits, diabetes testing supplies, denture adhesives.)

As you can see – this could have a very wide-ranging impact. As it was originally conceived as a means to generate revenue to fund a much-needed expansion of health care coverage, it is understandable that its intention was to raise a significant amount of revenue. But the language, it seems to me, is unclear and may well wind up hurting patients and consumers in unintended ways. Device (and health-care product) makers should be forewarned.