IRS rules on application of MDET to foreign-assembled convenience kits
TAX ALERT |
The IRS on Dec. 23, 2013, released PLR 201351002, which provides guidance regarding the applicability of the section 4191 medical device excise tax (MDET) to medical convenience kits. The ruling was requested by a domestic manufacturing corporation that is the parent of an affiliated group that includes two domestic entities and two foreign entities. Addressing convenience kits, cross-border transactions, determining which party is the manufacturer, and taxable sale price allocations, this ruling provide important insights on how to apply several MDET rules to a complex set of facts.
The taxpayer is in the business of producing taxable medical devices and also produces medical convenience kits that it sells in the United States. The convenience kits include both taxable medical devices produced by the taxpayer and taxable medical devices that the taxpayer purchases from unrelated domestic third parties. The convenience kits are assembled in both the United States and in a foreign country. For the kits assembled in a foreign country, the taxpayer gathers together all the items that will go into the kit and then ships them to one of its foreign subsidiaries, which assembles the convenience kits and ships them back to the taxpayer. Some of the kits also include taxable medical devices manufactured by the second foreign subsidiary under a contract manufacturing arrangement, where the domestic taxpayer is represented to be the manufacturer for federal excise tax purposes.
The contract between the taxpayer and the foreign subsidiary performing the assembly of the convenience kits provides that:
- While the kits are being assembled by the foreign entity, title to all devices remains with the taxpayer
- The foreign entity does not alter the devices in any way
- The foreign entity combines the devices into convenience kits and ships them back to the taxpayer
- The taxpayer pays the foreign entity for its services
- The taxpayer carries all devices on its books during the time they are in the foreign country
- The taxpayer has title to the convenience kits assembled by the foreign entity
The foreign subsidiary participates in a special program in the foreign country under which the taxable medical devices and other articles the foreign entity receives from the taxpayer are brought into the foreign country under a temporary importation regime. Under this regime, the taxable medical devices and other articles are exempt from import duties as well as value-added taxes.
The taxpayer requested guidance regarding how the MDET would apply to the convenience kits under the circumstances described above.
The MDET contained in section 4191 was enacted in 2010 as part of the Patient Protection and Affordable Care Act. The tax is imposed on manufacturers, producers and importers of taxable medical devices and is equal to 2.3 percent of the device's selling price.
While final regulations were issued in 2012, several issues were not addressed, including how the MDET applied to the assembly and sale of medical convenience kits. Subsequent guidance regarding convenience kits is contained in Notice 2012-77. The notice provides that a convenience kit is a set of two or more 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.
For domestically produced convenience kits, the notice provides that the MDET will not be imposed on the sale of the kit by the kit producer, even if it would be considered a "taxable medical device" under section 4191 and the regulations thereunder. However, any taxable medical device going into the kit will still be subject to the MDET upon its sale by the manufacturer or importer of the device.
For convenience kits produced in a foreign country and imported into the United States, the notice provides that the MDET is imposed on the sale of any convenience kit that is a taxable medical device under section 4191 and the regulations thereunder, but only on that portion of the importer's sale price of the convenience kit that is properly allocable to the individual taxable medical devices included in the convenience kit.
In applying Notice 2012-77 to the taxpayer's facts, the IRS concluded that because the taxpayer retains title to all of the devices going into the convenience kits, as well as title to the finished convenience kits themselves, the taxpayer is the "producer" of the kits. When the taxpayer ships all the articles to the foreign entity for assembly, the taxpayer is not considered to "export" the items due to the "special program" with the foreign country that ensures the devices and articles are returned in their entirety to the United States.
Likewise, the taxpayer does not "import" the articles when the foreign entity ships the finished convenience kits to the United States. As a result, the convenience kits are considered "domestically produced" for purposes of the MDET. As these are domestically produced kits, the MDET does not apply to the sale of the kits themselves, but only to the sale of the taxable medical devices going into the kits. Accordingly, to the extent the taxpayer produces taxable medical devices going into the kits, it is subject to the MDET on the sale of these devices. However, the taxpayer is not liable for the MDET for any third-party devices that it purchases for inclusion in the convenience kits. The taxable sale price of the taxable devices produced by the taxpayer must be computed in accordance with section 4216 and Reg. section 48.4216(a)-1(e), which provides a method for allocating the price of the kit between taxable and non-taxable articles based on their relative separate sale prices.
Since the IRS focused on the contractual arrangement between the taxpayer and its foreign subsidiary in determining that the items making up the convenience kits were only in the foreign country temporarily, taxpayers with a similar fact pattern should carefully review their agreements with foreign entities. To the extent possible, the contract terms between a taxpayer and foreign entity should provide that the taxpayer retains title and all incidences of ownership of any articles sent to the foreign entity. Pursuant to the PLR, any convenience kits assembled by the foreign entity and returned to the domestic taxpayer would be considered domestically produced for purposes of the MDET.
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