Many medical device companies are concerned about the upcoming new MEDICAL DEVICE EXCISE TAX to be leveled against REVENUES, not profits, for most all medical devices sold in or into the USA.  What companies may not realize is that this could have a major impact on CONTRACT MANUFACTURERS both inside and outside of the USA.  Few folks have probably taken the time to read how IRS is planning to assess this new tax—as it may apply to contract manufacturers. You should obtain a copy of the IRS proposal, but here are a few of the most alarming provisions!  We’ve attached a version current to this article but you must stay current!  IRS Device Tax proposal-113770-10

I’ve opposed the tax since I first heard of it, but like many, I had mistakenly believed that this tax would be imposed when the “user” bought the device.  IRS has a very different idea.  The IRS is viewing the point of sale transaction as when it is passed to a distributor!  So many contract companies are “drop shipping” (not shipping back to their client-customer but rather shipping directly to the next entity in the distribution chain). In this circumstance, IRS considers this the point of sale.

If you work for a contract manufacturer, or have a contract manufacturing agreement which entails shipping the product directly forward into distribution, you need to work fast to make provisions for how this tax will affect you.  The clock is ticking and unless it is repealed, it takes effect January 1, 2013.  Folks may have been hoping the Supreme Court would make this problem disappear, but it didn’t work that way.  Because so-called “OBAMA CARE” is likely to prevail, it is highly unlikely that repeal of the tax will happen, because this money was to pay for many otherwise unfunded provisions (although I’ve not been able to find any publication of exactly where the money would go.)

IRS SAYS:  The FDA generally requires owners or operators of places of business (also called establishments) that are located in the United States, or in foreign countries that export devices to the United States, and that manufacture, prepare, propagate, compound, assemble, process, repackage, or relabel medical devices intended for human use to register their establishments and list their devices upon first entering into operation, and to update this information on an annual basis with the FDA. See sections 510(a)–(d), (i), and (j) of the FFDCA, 21 CFR 807.20, and 21 CFR 807.21.  Various commentators observed that the statutory definition of “taxable medical device” leaves uncertainty as to which devices are included in the definition. The proposed regulations address this concern by providing that for purposes of the medical device excise tax, a device defined in section 201(h) of the FFDCA that is intended for humans means a device that is listed as a device with the FDA under section 510(j) of the FFDCA and 21 CFR Part 807, pursuant to FDA requirements. The FDA listing requirements are longstanding. Further, device manufacturers must comply with these requirements as part of the FDA’s device regulation process. Therefore, device manufacturers can be expected to know which devices fall within the definition.

That is easy for the IRS to say.  New rules for registration and listing were just released August 2, 2012 which could impact listing requirements in a big way!  FDA has issued New rules registration and listing.  A contract manufacturer must now register and list, regardless of whether the contract manufacturer puts the device into commercial distribution or returns the device to their client-customer.

IRS SAYS:  If more than one person is involved in the manufacture or importation of an item, such as a contract manufacturing arrangement, the determination of which person is the manufacturer or the importer is based on the facts and circumstances of the arrangement. The substance rather than the form of the transaction is determinative. See Rev. Rul. 58-134 (1958-1 CB 395), Rev. Rul. 60-42 (1960-1 CB 474), and Polaroid v. U.S., 235 F2d. 276 (1st Cir. 1956), for rules regarding the determination of which party is the manufacturer for chapter 32 purposes. See Rev. Rul. 68-197 (1968-1 CB 455) and Rev. Rul. 82-40 (1982-1 CB 175) for rules regarding the determination of which party is the importer for chapter 32 purposes.

This clearly means that no matter what you do or don’t do, you could be pulled into the argument of who pays the tax.  According to this, even if your contract agreements are clear on who is responsible for actually paying this tax to the IRS, they might not agree. And, the total amount of the tax could be different (retail versus wholesale).  We don’t need fights between the contract-client and the contract manufacturer.  Just reading the above paragraph shows that only the lawyers will win with this one.  And read this!

IRS SAYS: The proposed regulations also provide that if a device is not listed with the FDA but the FDA later determines that the device should have been listed as a device, the device will be deemed to have been listed as a device with the FDA as of the date the FDA notifies the manufacturer or importer in writing that corrective action with respect to listing is required.

We have already been told that registration and listing decisions are being affected by this law, with some companies deliberately altering their listings and registration type so that they will not show up on the IRS/FDA radar.  We caution against any activity of this sort.  We don’t know if there will be an “incentive” for FDA to increase this scrutiny and potentially “over-reach” the definitions for required “listing”, but we will be monitoring this situation closely.  You can EXPECT then that FDA inspectors are going to be turned into tax collectors!!!  What we don’t know is if this means a company would be under additional penalties if FDA found the company to be “avoiding” listing, such as the same penalties when someone fails to pay enough income tax.  But, remember, there are CIVIL PENALTIES the FDA can impose for failing to properly register and list and those are imposed “per act”.  We can expect an entirely new level of scrutiny about device listing.

Regardless of presidential politics and party loyalties, the Medical Device Excise Tax must be repealed. In the event it is not (or is not soon enough to prevent its initiation) I hope you will make provisions in your contract agreements concerning responsibilities for registration, listing and payment of the excise tax and consult an attorney on how to best handle these IRS interpretations for responsibility.  The working relationship between contract-clients and contract-manufacturers in the USA is far too valuable to leave this to someone else’s interpretation!

Also read:  Medical Device Tax 101