IRS guidance regarding the medical device excise tax: Part 2
TAX ALERT |
This article represents the second in a three-part series of articles focused on the medical device excise tax (MDET), a 2.3 percent tax imposed on the sale of taxable medical devices. Part 1 in the series summarizes the final regulations, which detail the parameters under which the tax will be imposed. Part 2 addresses interim guidance published in Notice 2012-77 dealing with constructive sale price, convenience kits and other matters. Part 3 addresses exemptions for export sales and sales for use in further manufacture and also addresses registration and filing requirements.
The IRS issued an advance copy of Notice 2012-77 on Dec. 5, 2012, the same day it issued final regulations to provide taxpayers with further guidance regarding the new 2.3 percent MDET established as part of the Health Care and Education Reconciliation Act of 2010 in conjunction with the Patient Protection and Affordable Care Act (collectively known as the Affordable Care Act (ACA)). The notice provides interim guidance regarding several issues the final regulations did not address, including determining constructive sale price under section 4216(b). The notice addresses interim guidance relating to donated taxable medical devices, the licensing of taxable medical devices, and the tax treatment of medical convenience kits. The notice also provides medical device manufacturers with transition relief from the failure to deposit penalties imposed by section 6656.
Constructive sale price
The MDET equals 2.3 percent of the price of the taxable medical device sold (also referred to as the tax base). In determining the tax base subject to the MDET, the constructive sale price rules contained in section 4216(b) apply.
- Section 4216(b)(1) - Sales at retail, sales on consignment and sales not at arm’s length
Sales at retail
For arm’s length retail sales, the constructive sale price is the highest price for which the articles are sold to wholesale distributors by manufacturers. If the constructive price is less than the actual sale price, the constructive price should be used as the tax base. If the constructive sale price is not less than the actual sale price, the actual sale price is considered to be not less than fair market value and should be used as the tax base. In determining the highest price for which articles are sold by manufacturers to wholesale distributors, normal industry practices should be considered. However, once a constructive sale price has been determined, the price should not be adjusted further.
Sales on consignment
The constructive sale price for sales on consignment is the price for which the articles are ordinarily sold by manufacturers. An article is considered sold at consignment if it is sold while on consignment to a person who had the right to sell, and does sell, the article in its own name but never receives title to the article from the manufacturer. Ordinarily, the constructive sale price of an article sold on consignment is the net price received by the manufacturer from the consignee.
Sales not at arm’s length
A sale is considered made not at arm’s length if (1) one of the parties is controlled by the other, or there is common control, whether or not such control is actually exercised to influence the sale price, or (2) the sale is made pursuant to special arrangements between a manufacturer and a purchaser.
In the case of an article sold at other than arm’s length and at less than fair market value, the constructive sale price is the price at which manufacturers ordinarily sell the articles. Once a constructive price has been determined, the price should not be adjusted further.
- Section 4216(b)(2) - Arm’s-length sales at retail and to wholesale distributors
This special rule applies if all of the following are met:
- The manufacturer regularly sells articles at retail or to retailers
- The manufacturer also regularly sells articles to one or more wholesale distributors in arm’s length transactions and establishes that its prices are determined without regard to any tax benefit
- The transactions are at arm’s length
The constructive sale price for a manufacturer meeting these requirements is the lower of its actual sale price or the highest price for which it sells the same articles to wholesale distributors.
- Section 4216(b)(3) - Sales to an affiliated distributor that regularly sells to independent retailers but does not regularly sell to wholesale distributors under section 4216(b)(3)
If the manufacturer of an article regularly sells articles to a distributor that is a member of the same affiliated group of corporations (as defined in section 1504(a)) and the affiliated distributor regularly sells the article to one or more independent retailers, but not to wholesale distributors, the constructive sale price of the article is 90 percent of the lowest price at which the distributor regularly sells the article to independent retailers in arm’s-length transactions.
- Section 4216(b)(4) - Sales to an affiliated distributor that regularly sells to independent retailers where the industry practice is to sell at arm’s length to distributors
- The manufacturer of an article regularly sells (except for tax-free sales) to only a distributor that is an affiliated corporation (as defined in section 1504(a));
- The distributor regularly sells (except for tax-free sales) the article only to retailers; and
- The normal method of sales for such articles within the industry by manufacturers is to sell the articles in arm’s-length transactions to distributors,
the constructive sale price for the article is determined based on a series of complex formulas contained in section 4216(b)(4). Under various rulings, the constructive sale price more often than not works out to be 95 percent of the lowest price of sales to independent wholesale distributors.
In addition to the constructive sale price rules contained in section 4216(b), there have been several rulings pre-dating the MDET that address other distribution chains, leading to uncertainty as to how these may or may not apply to medical devices. Further, these rulings do not translate well in the medical device industry, as manufacturers sell products to a diverse customer base that ranges from wholesalers to individual users. To remedy this, Notice 2012-77 identified several model distribution chains commonly employed by manufacturers in the medical device industry. For purposes of these rules, a “related” entity means that one entity is controlled by another entity or that two entities are controlled by the same entity. Under the interim guidance, the taxpayer calculates price based on the rules contained in the notice, and the price calculation depends on the model distribution chain utilized. For taxpayers not utilizing a methodology contained in the notice, the taxpayer bears the burden of demonstrating that it used the fair market price of the article to calculate its tax liability.
- Sales at retail; no regular sales to independent wholesale distributors
In this distribution chain, the manufacturer sells taxable medical devices directly to end users and does not regularly sell to independent wholesale distributors. For these taxpayers, the constructive sale price equals 75 percent of the actual sale price. The actual sales price does not include any amounts related to manufacturers excise taxes, transportation, delivery, insurance, or installation charges.
- Sales to unrelated retailers; no regular sales to independent wholesale distributors
In this distribution chain, the manufacturer sells taxable medical devices to unrelated retailers and does not regularly sell to independent wholesale distributors. For these taxpayers, the constructive sale price is 90 percent of the lowest price for which the articles are sold to unrelated retailers. No adjustment is made for any exclusion (except for the excise tax imposed on such articles).
- Sales to related retailer; no regular sales to independent wholesale distributors
In this distribution chain, the manufacturer sells taxable medical devices to related retailers that in turn sell the devices at retail to unrelated end users. The manufacturer and related retailer do not regularly sell their articles to independent wholesale distributors. For these taxpayers, the constructive sale price is 75 percent of the product of 95 percent and the actual selling price for which the article would be sold to an unrelated party.
- Sales to related reseller that leases and sells at retail
In this distribution chain, the manufacturer sells taxable medical devices to a related reseller that sells the articles at retail to unrelated end users and also leases articles to unrelated end users. For these taxpayers, the constructive sale price is 75 percent of the product of 95 percent and the actual selling price for which the article would be sold to an unrelated party.
- Sales to related reseller that only leases at retail; no regular sales to independent wholesale distributors
In this distribution chain, the manufacturer sells taxable medical devices to a related reseller that leases the articles to unrelated end users but does not sell articles at retail. Neither the manufacturer nor related reseller regularly sells the articles to independent wholesale distributors. For these taxpayers, the constructive sale price is the actual selling price to the related reseller, provided the selling price to the related reseller reasonably approximates the fair market price of the article.
Sale to hospital or doctor’s office treated as sale at retail for purposes of determining price
To resolve uncertainty regarding whether a sale of a taxable medical device to a medical institution or doctor’s office is a sale at retail or a sale to a retailer, section 4 of Notice 2012-77 provides that, until further guidance is issued, the IRS will treat the sale of a taxable medical device to a medical institution or office as a sale at retail.
The notice provides that the IRS will treat a license of a taxable medical device as a lease of that device as of the date the parties enter into a license agreement. Under existing excise tax rules, a lease of a taxable article by the manufacturer is treated as a taxable sale.
Donations of taxable medical devices to charitable organizations
The notice provides that taxable medical devices donated to eligible charitable organizations are not subject to excise taxes. However, if a manufacturer had reason to believe that the charitable organization was not an eligible donee or that the article would be resold by the donee, the manufacturer will be liable for the excise tax. An eligible donee is any donee described in section 170(c).
Finished taxable medical devices are sometimes packaged together into kits for the convenience of health care providers. Unless an exemption applies, convenience kits that are required to be listed with the Food and Drug Administration are considered taxable medical devices for purposes of the MDET. A convenience kit is defined as a set of two or more FDA-registered devices enclosed in a single package, such as a bag, tray or box, for the convenience of a health care professional or the end user.
The notice provides interim guidance that no MDET is imposed upon the sale of a domestically produced convenience kit that is considered a taxable medical device under the Internal Revenue Code and related regulations. However, the sale of the underlying medical device included in the kit is subject to the MDET upon its sale by the manufacturer or importer. For importers selling convenience kits, the notice provides that an importer can calculate the amount of MDET by performing an allocation of the percentage of items in the kit that are subject to the MDET. In lieu of an allocation, the importer will be required to pay the MDET on the entire price for which it sells the convenience kit.
Deposit penalty relief
Manufacturers liable for excise taxes are required to make semi-monthly deposits of tax during the period in which the tax liability is incurred. The amount of the deposit must be at least 95 percent of the amount of net tax liability incurred during the period unless the safe harbor applies. The safe harbor provides that any person filing a quarterly excise tax return is protected from deposit penalties as long as several conditions are met.
Because many manufacturers indicate they are still preparing their systems to comply with the new MDET, the IRS and Treasury Department are granting temporary relief from deposit penalties for the first three quarters of 2013, provided a taxpayer makes a good faith attempt to comply with the deposit requirements and any failure is not due to willful neglect. The normal deposit penalty rules will apply with respect to deposits due during the fourth calendar quarter of 2013 and thereafter.