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CRS Examines Regulations for Medical Device Excise Tax

FEB. 26, 2013

R42971

DATED FEB. 26, 2013
DOCUMENT ATTRIBUTES
Citations: R42971

 

Andrew Nolan

 

Legislative Attorney

 

 

February 26, 2013

 

 

Congressional Research Service

 

7-5700

 

www.crs.gov

 

R42971

 

 

Summary

On December 7, 2012, the Department of the Treasury and the Internal Revenue Service issued final regulations explaining the scope of the medical device excise tax created by the Health Care and Education Reconciliation Act of 2010 (HCERA), which modified the Patient Protection and Affordable Care Act of 2010. The new regulations were issued less than a month before the 2.3% excise tax took effect on January 1, 2013. This report provides a brief overview of the recently enacted Treasury regulations and the legal implications of the regulations.

The Treasury regulations on the medical device excise tax explain both who is subject to the excise tax and the scope of the statutory exemptions provided for the tax. Specifically, the regulations incorporate by reference the general definitions for a "manufacturer, producer, or importer" outlined in the Internal Revenue Code, meaning that the excise tax will be directly paid by manufacturers, as opposed to consumers or others that use a given medical device.

Furthermore, the regulations attempt to clarify the limits to the medical device excise tax. Beyond the statutory exemptions created for eyeglasses, contact lenses, and hearing aids, the law created a "retail exemption" to the excise tax, excluding from the tax medical devices that are "generally purchased by the general public at retail for individual use." The Treasury regulations attempt to simultaneously provide certainty to potential taxpayers as to which devices are subject to the retail exemption, while allowing the government the flexibility to properly apply the retail exemption to the variety of devices that could be exposed to the excise tax. The regulations provide a flexible two-prong test to determine whether a device should fall within the retail exemption, applying the exemption when the device is (1) regularly available for purchase by non-professional consumers and (2) not primarily intended for use by medical professionals. The regulations provide several factors to consider when applying the two-prong test. To provide some certainty to the scope of the retail exemption, the regulations also included several "safe harbor" provisions, explicitly acknowledging that certain devices, such as "over-the-counter" devices, fall within the retail exemption.

The new Treasury regulations on the medical device excise tax, while providing some certainty with respect to what devices will be exempt from the tax, generally favor a more flexible approach to defining the scope of the central exemption to the tax. As a consequence, uncertainty remains as to which medical devices will be subject to the tax. Indeed, Treasury, in releasing the medical device excise tax regulations, notes that further clarification on various issues implicated by the tax is still needed. As such, the regulations constitute only the first step in defining the limits of the medical device excise tax.

 Contents

 

 

 Introduction

 

 

 On Whom Is the Medical Device Excise Tax Imposed?

 

 

 What Is a "Taxable Medical Device"?

 

 

 Medical Devices Exempted from the Excise Tax

 

 

      The Retail Exemption

 

 

      The Retail Exemption's Safe Harbor Provisions

 

 

      Examples of How the Retail Exemption Is Applied

 

 

 Issues that Remain for the Medical Device Tax

 

 

 Contacts

 

 

 Author Contact Information

 

 

Introduction

As part of recent health care reform efforts, Congress, in the Affordable Care Act,1 imposed a 2.3% excise tax on the sale of certain medical devices by device manufacturers, producers, or importers.2 The excise tax is effective on sales of devices made after December 31, 2012.3 The implementation of the medical device tax has prompted some Members of Congress to seek a delay of the enforcement of the tax out of a concern that the "uncertainty and confusion" regarding compliance with the medical device excise tax will harm the medical technology industry.4 Others in Congress have sought an outright repeal of the tax.5 While December 31, 2012, passed without Congress changing or repealing the medical device excise tax, congressional interest remains.6 On December 7, 2012, the Department of the Treasury (Treasury) issued its final regulations that provide guidance on both who must pay the excise tax and the scope of products encompassed by the excise tax.7 This report provides a brief overview of the regulations and discusses the extent to which the rules have clarified the excise tax imposed on the sale of medical devices.8

On Whom Is the Medical Device Excise Tax Imposed?

Pursuant to § 4191(a) of the Internal Revenue Code (IRC), a "manufacturer, producer, or importer" making the sale of a taxable medical device is liable for a tax of 2.3% of the price9 for which the device was sold.10 Treasury, in the newly released regulations on the medical device excise tax, states that the "existing chapter 32 rules," including the definitions for "manufacturer," "producer," and "importer," apply with respect to the medical device excise tax.11 In turn, the general chapter 32 rules define the term "manufacturer" as "any 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."12 Moreover, the general definition for a manufacturer necessarily includes the terms "producer" and "importer."13 While courts have interpreted the term "manufacturer" within the general chapter 32 rules to encompass a range of activities where a person physically changes a taxable article,14 the medical device excise tax, by definition, is not directly levied upon a consumer of a medical device.

What Is a "Taxable Medical Device"?

The medical device excise tax created by the ACA is imposed on the sale of "taxable medical device[s]."15 The statute defines that term by incorporating the definition of "medical device" from the Federal Food, Drug and Cosmetic Act (FFDCA), as that term pertains to a device "intended for humans."16 Courts have recognized that Congress defined the term "medical device" in the FFDCA "very broadly,"17 as the FDA regulates a range of devices from tongue depressors18 to artificial hearts.19 As such, the Health Care and Education Reconciliation Act of 2010 (HCERA) casts a wide net with the term "taxable medical device."20 In line with the broad scope of the term "taxable medical device," the December 7, 2012, Treasury Regulations explain that a "taxable medical device" is a device that has been registered with the Food and Drug Administration pursuant to Section 510(j) of the FFDCA21 and 21 C.F.R. part 807.22 Importantly, Treasury resisted efforts by commenters to narrow the scope of the general term "taxable medical device," by limiting, for example, the term to devices that could exclusively be used by humans or could only be used for a medical purpose, preferring instead to maintain a broad reading of what devices are subject to the excise tax.23 As a result, devices like infusion pumps, which can be used on both humans and animals,24 and latex gloves,25 which can be used for both medical and non-medical purposes, fall within the broad definition of a "taxable medical device."

Medical Devices Exempted from the Excise Tax

In an effort to limit the ambit of the excise tax imposed on medical device manufacturers, Congress explicitly excluded three types of devices from the term "taxable medical device" in IRC § 4191(a).26 Specifically, Congress exempted eyeglasses, contact lenses, and hearing aids from the excise tax.27 Moreover, the statute empowers the Secretary of the Treasury under the "retail exemption" to exempt "any other medical device" which is determined to be of a "type which is generally purchased by the general public at retail for individual use" from the 2.3% excise tax.28

The Retail Exemption

The regulations issued by Treasury on December 7, 2012, provide a broad framework as to which medical devices fall within the "retail exemption" to the excise tax under IRC § 4191(b)(2)(d). Specifically, the new Treasury regulations provide a two-prong test to resolve whether a device should fall within the residual exception to the excise tax.29 First, the device in question should be "regularly available for purchase and use by individual consumers who are not medical professionals." Second, the device's design should "demonstrate[] that it is not primarily intended for use" in a medical institution, office, or by a medical professional.30 Neither prong is dispositive to the determination, as the regulations caution that an analysis of whether a device fits within the retail exemption is dependent on "all" "relevant facts and circumstances."31

To guide the analysis of whether a particular device meets the relevant requirements for the retail exemption, the new Treasury regulations provide a host of factors to examine.32 Factors implicating the question of whether a device is regularly available for purchase by individual consumers include (1) the ability of end consumers to purchase the device in person through a drug store or other retailer that primarily sells a particular device; (2) the need of a consumer to seek help from a medical professional to use the device safely and effectively; and (3) whether the device has been classified by the Food and Drug Administration as a "physical medicine device" for human use.33 To illustrate, with respect to adhesive bandages,34 an application of the multi-factor test would conclude that the device is regularly available for purchase by individual consumers. Specifically, while adhesive bandages are not a "physical medicine device," the product can be readily purchased at various retail stores and can be properly used without formal training from a medical professional.35

Treasury also issued a list of factors to aid the determination of whether a device is designed primarily for use in a medical institution or office or by a medical professional.36 Relevant factors include (1) whether the device must be implanted, inserted, operated, or administered by a medical professional; (2) the cost of obtaining and using the device; (3) how the device has been classified by the FDA;37 and (4) whether the device is one for which payment is available "exclusively on a rental basis" and is an item requiring "frequent and substantial servicing" as those terms are defined under Medicare Part B payment rules.38 Returning to the example of adhesive bandages, the multi-factor test counsels that the product is not primarily intended for use in a medical institution, office, or by a medical professional. Specifically, using adhesive bandages does not require the aid of a medical professional, and bandages are inexpensive to obtain and use.39 Moreover, adhesive bandages are not classified as a complex medical device or a device needing frequent and substantial servicing.40 Coupled with the earlier conclusion that adhesive bandages are regularly available for purchase by individual consumers, the totality of the circumstances indicates that "adhesive bandages are devices that are of a type that" should fall within the retail exemption to the medical device excise tax.41

Notably, Treasury explained in issuing the medical device excise tax regulations that two potential factors -- the packaging or labeling of a medical device and the nature of documents submitted to the FDA in obtaining approval of a device -- are irrelevant in assessing whether a device should fall within the retail exemption to the excise tax.42 As a consequence, a medical device manufacturer cannot hope to escape the excise tax, for example, by labeling that its product is "intended for retail use only."

The Retail Exemption's Safe Harbor Provisions

In contrast to the malleable multi-factor test that outlines the limits to the retail exemption, the December 7, 2012, Treasury regulations also include a list of "safe harbor" devices that necessarily fall within the retail exemption.43 The purpose of the safe harbor provisions is to "provide greater certainty" with respect to which devices are subject to the retail exemption.44 The safe harbor includes medical devices, like pregnancy test kits, that are described as "over-the-counter" (OTC) devices in the FDA's online database for in vitro diagnostic tests, the FDA's classification regulations, or the FDA's device registration and listing database.45 In addition, the safe harbor includes certain devices that qualify as "durable medical equipment, prosthetics, orthotics, and supplies" for which payment is available on a purchase basis under Medicare part B payment rules,46 such as therapeutic shoes.47

Examples of How the Retail Exemption Is Applied

The Treasury regulations conclude by providing 15 different examples of how the retail exemption to the medical device excise tax would be applied in practice.48 The examples range from the aforementioned "adhesive bandages"49 to "blood glucose monitors"50 to "magnetic resonance systems."51 Examples of devices that Treasury concludes "based on the totality of the facts and circumstances" fall within the retail exemption include "absorbent tipped applicators,"52 "adhesive bandages,"53 "snake bite suction kits,"54 "denture adhesives,"55 "mechanical and powered wheelchairs,"56 "portable oxygen concentrators,"57 and "therapeutic AC powered adjustable home use beds."58 Treasury also concludes that "pregnancy test kits,"59 "blood glucose monitors, test strips, and lancets,"60 "prosthetic legs and certain prosthetic leg components,"61 and "urinary ileostomy bags"62 fall within the regulations' safe harbor provisions. In contrast, Treasury, in its examples, finds that the following devices, based on the totality of the circumstances, are not exempt from the medical device excise tax: "mobile x-ray systems,"63 "nonabsorbable silk sutures,"64 "nuclear magnetic resonance imaging systems,"65 and "powered floatation therapy beds."66

Issues that Remain for the Medical Device Tax

Whether the new Treasury regulations provide the needed clarity to alleviate the "uncertainty and confusion" that some Members of Congress have feared that the new tax would engender within the medical technology industry remains to be seen.67 To be sure, the medical device tax regulations, with their safe harbor provisions, clarify that generally devices recognized as over-the-counter devices will not be the subject of the tax, providing an easy to understand exemption to manufacturers, importers, and producers of such products.68 However, the safe harbor provisions are narrow, and the regulations open-ended two-part test defining the limits of the retail exemption, while providing flexibility as to the scope of the exemption, naturally creates ambiguity with respect to which products are exposed to the excise tax, save those specifically exempted under the regulations. Moreover, the limits of the retail exemption, which are based, in part, on regulations that were not crafted with the retail exemption in mind, could prove to be either over or under inclusive of Congress's original intent in enacting the medical device excise tax.69 Treasury, in the release of the final regulations, identified several issues raised by the medical device tax regulations that warranted the agency issuing separate clarifying guidance, including the treatment, for purposes of the medical device excise tax, of licensing software70 and "kits."71 Given the wide variety of items that are categorized as medical devices,72 some may see a need for further clarification with respect to other medical devices, including potentially expanding the safe harbor provisions. As a result, the December 7, 2012, regulations could be only the first step in clarifying the application of a tax that the Treasury Department acknowledges "may present certain implementation challenges."73

Author Contact Information

 

Andrew Nolan

 

Legislative Attorney

 

anolan@crs.loc.gov, 7-0602

 

FOOTNOTES

 

 

1 The medical device excise tax was included in an amended version of the Affordable Care Act. See Health Care and Education Reconciliation Act of 2010, P.L. 111-152, Title I, Subtitle E, § 1405(a)(1), 124 Stat. 1029, (2010) (amending the Patient Protection and Affordable Care Act of 2010, P.L. 111-148).

2See I.R.C. § 4191(a). The medical device excise tax is only one of several provisions created under the HCERA or Patient Protection and Affordable Care Act to raise revenues to pay for expanded health insurance coverage. See CRS Report R41128, Health-Related Revenue Provisions in the Patient Protection and Affordable Care Act (ACA), by Janemarie Mulvey.

3See supra footnote 1, § 1405(c). For medical devices financed through an installment sale or a long-term lease, the regulations do not provide any relief for payments made for a device after December 31, 2012, unless that agreement was entered into prior to March 30, 2010, the date the ACA was enacted. See Treas. Reg. § 48.4191-1(f) (citing Treas. Reg. § 48.4216(c)-1(e)).

4See Letter to the Honorable Harry Reid from 18 Current and Future Members of the Senate, (Dec. 4, 2012) http://www.franken.senate.gov/?p=hot_topic&id=2248.

5 A bill repealing the medical device excise tax passed the House of Representatives in the 112th Congress. See Health Care Cost Reduction Act of 2012, H.R. 436 (2012).

6See, e.g., Melissa Attias and Emily Ethridge, Medicare Board, Device Tax Lead House GOP Target List, Roll Call, Jan. 22, 2013, http://www.cq.com/doc/news-4208077?wr=eFF6UlQqRXM3azJhbDBGWEpQWjBIUQ.

7See "Taxable Medical Devices," 77 Fed. Reg. 72,924 (Dec. 7, 2012).

8 This report does not discuss the general Treasury regulations for manufacturer excise taxes unless those regulations uniquely impact the medical device excise tax.

9 For explanation of the definition of the "price" of an article taxed under Chapter 32 of the Internal Revenue Code, see I.R.C. § 4216(a).

10See I.R.C. § 4191(a).

11See 77 Fed. Reg. at 72930. Notably, the general exemptions for excise taxes provided to manufacturers who sell an article to a state or local government or to a nonprofit educational organization do not apply to the medical device excise tax. See I.R.C. § 4221(a).

12See Treas. Reg. § 48.0-2(4)(i). The general definitions for a manufacturer, producer, and importer are incorporated by reference into the regulations clarifying the medical device excise tax. See Treas. Reg. § 48.4191-1(c). The Internal Revenue Code does not subject a manufacturer to an excise tax if the sale of the article is for use by the purchaser for further manufacturing. See I.R.C. § 4221(a)(1).

13Id. Treasury regulations also explain that the term "importer," while typically entailing the person who brings an "article into the United States from a source outside the United States," can also include the beneficial owner of an item if, for example, a customs broker is engaged by an entity to bring a particular item into the country. Id. In contrast, the Internal Revenue Code exempts a manufacturer from being subject to an excise tax when the sale of the article is for export. See I.R.C. § 4221(a)(2).

14See Ruan Financial Corp. v. United States, 765 F. Supp. 987-88 (S.D. Iowa 1990), aff'd 976 F.2d 452 (8th Cir. 1992).

15 I.R.C. § 4191(a).

16Id. at (b)(1) (citing 21 U.S.C. § 321(h)).

17See Committee of Dental Amalgam Mfrs. & Distribs. v. Stratton, 92 F.3d 807, 810 (9th Cir. 1996); see also United States v. McGuff, 781 F. Supp. 654, 655 (C.D. Cal. 1991).

18 21 C.F.R. § 880.6230.

19 21 C.F.R. part 870, subpart D.

20 Specifically, the Food, Drug, and Cosmetics Act defines a medical device as an "instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article including any component, parts or accessory which is" either (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, 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." See 21 U.S.C. § 321(h).

21 21 U.S.C. § 360(j).

22 For a general explanation of the medical device regulatory framework, see CRS Report R42130, FDA Regulation of Medical Devices, by Judith A. Johnson. Devices used exclusively in veterinary medicine are not listed under Section 510(j) of the FFDCA and 21 CFR part 807, and, therefore, Treasury's regulations are exclusive to devices that are intended, at least in part, for use on humans.

23 77 Fed. Reg. at 72,925-26. However, medical kits created by a hospital or medical institution are exempt from the excise tax, as the creations of such kits are necessarily excluded from the FDA's registration and listing requirements. See 21 C.F.R. § 807.65(f).

24See Food and Drug Administration, How FDA Regulates Veterinary Devices, (Jan. 20, 2012), http://www.fda.gov/AnimalVeterinary/ResourcesforYou/ucm047117.htm.

25 21 C.F.R. § 880.6250.

26 I.R.C. § 4191(b)(2).

27Id. § 4191(b)(2)(A)-(C).

28Id. § 4191(b)(2)(D); see also Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 111th Congress, committee print, prepared by Staff of the Joint Committee on Taxation, 111th Cong., March 2011, JCS-2-11, p. 366 ("The Secretary may determine that a specific medical device is exempt under the provision if the device is generally sold at retail establishments (including over the internet) to individuals for their personal use.")

29 Treas. Reg. § 48.4191-2(b)(2).

30Id.

31Id .

32Id.

33 For more detail on the factors implicating whether a device can be considered regularly available for purchase and use by individual consumers, see Treas. Reg. § 48.4191-2(b)(2)(i)(A)-(C). With respect to devices classified by the FDA as a "physical medicine device," such devices are listed under subpart D of 21 CFR part 890, and include devices such as canes, see 21 C.F.R. § 890.3075, crutches, id. § 890.3150, and wheelchairs, id. §§ 890.3850 - 890.3860.

34See Treas. Reg. § 48.4191-2(b)(2)(iv) (Example 2).

35Id.

36See Treas. Reg. § 48.4191-2(b)(2)(ii)(A)-(E).

37 The regulations specifically cite as a factor a devices' classification as a Class III device, the medical devices subject to the most intensive pre-market screening by the FDA, see CRS Report R42130, FDA Regulation of Medical Devices, by Judith A. Johnson, to be relevant in determining whether a device should be subject to the retail exemption. See Treas. Reg. § 48.4191-2(b)(2)(ii)(C). In addition, the new Treasury regulations explain that the FDA's classification of a device under one of fifteen various categories of medical devices in the Code of Federal Regulations is an additional factor to examine when determining whether to apply the retail exemption. Id. § 48.4191-2(b)(2)(ii)(D).

38See Treas. Reg. § 48.4191-2(b)(2)(ii)(D) (citing 42 C.F.R. part 210).

39See Treas. Reg. § 48.4191-2(b)(2)(iv) (Example 2).

40Id.

41Id.

42 77 Fed. Reg. at 72,929.

43See Treas. Reg. § 48.4191-2(b)(iii).

44Id. at 72927.

45See Treas. Reg. § 48.4191-2(b)(2)(iii)(A)-(C).

46Id. § 48.4191-2(b)(2)(iii)(D).

47Id. § 48.4191-2(b)(2)(iii)(D)(4).

48Id. § 48.4191-2(b)(2)(iv).

49Id. (Example 2).

50Id. (Example 7).

51Id. (Example 13).

52Id. (Example 1).

53Id. (Example 2).

54Id. (Example 3).

55Id. (Example 4).

56Id. (Example 9).

57Id. (Example 10).

58Id. (Example 14).

59Id. (Example 6).

60Id. (Example 7).

61Id. (Example 8).

62Id. (Example 11).

63Id. (Example 5).

64Id. (Example 12).

65Id. (Example 13).

66Id. (Example 15).

67See supra footnote 4.

68See Treas. Reg. § 48.4191-2(b)(2)(iii)(A)-(C).

69 Several of the factors used to determine the scope of the retail exemption are FDA regulations relating to safety controls on the release of medical devices or Medicare Part B payment rules. See, e.g., Treas. Reg. §§ 48.4191-2(i)(C), (ii)(C)-(E).

70 77 Fed. Reg. at 72931.

71Id. at 72932.

72See supra note footnote 22.

73 77 Fed. Reg. at 72933.

 

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