We in Minnesota are keenly aware of the importance of the medical device industry to our state and economic health. Since the passage of the Affordable Care Act, better known as ObamaCare or the bill that “you have to pass before knowing what is in it," there has been great concern across the medical device industry about the medical device tax, which takes effect in 4 months on Jan. 1, 2013. This tax is supposed to take $20 billion (yes, with a "b") from medical device manufacturers. To add insult to injury, this tax is levied against revenues, rather than profits as is typical with taxes, for most all medical devices sold in the U.S.
Twenty billion dollars in new taxes on medical devices is a staggering penalty to apply to an industry credited with reducing pain and improving the quality of human life world-wide. What’s worse is that given pricing pressures, the industry is unlikely to be able to pass those costs along to consumers. Customer rebates and group pricing plans are not considered in the tax levy thus removing any incentive of manufacturers to offer discount pricing programs. This tax will simultaneously reduce profit margins on each device and ultimately increase the price to consumers. With lower profits, medical device companies in turn will find it harder to raise capital, fund research and development, and invest to create the next generation of medical technology.
But it gets worse.
Few companies realize this tax could have a major negative impact on contract manufacturers both inside and outside the United States and their critical role in both developing new products and providing low cost, high-quality manufacturing support for existing medical devices. Few have probably taken the time to read how the IRS is planning to assess this new tax and how the IRS may levy the tax on the contract manufacturers. What follows is a few of the most alarming provisions from the medical device tax proposal-113770-10:
The fundamental problem is that the IRS considers the point of sale transaction as the point when the product moves from a manufacturer to the distribution chain, rather than when the finished product is sold to the ultimate customer (hospital or physician). The IRS is not making a distinction between the manufacturer of record and a contract manufacturer.
1. The FDA has had longstanding regulations requiring annual registration of devices and facilities for manufacturing devices for human use by the company responsible for its sale. The FDA has changed the listing requirements effective October 1, 2012 to require all contract manufacturers to register medical devices it processes, regardless of whether that contract manufacturer puts the device into commercial distribution, or passes that device to another contractor in a product development chain, or returns the device to their client-customer. This is significant because the IRS has defined a medical product as any device “listed” with the FDA.
2. If more than one company is involved in the manufacture or importation of a medical device, such as in a contract manufacturing arrangement, the determination of which company is the manufacturer or the importer may be determined by the IRS rather than the contractual relationship. This clearly means that no matter what a manufacturer does or doesn’t do, the company could be pulled into the argument of who pays the tax. According to this, even if the contractual agreements are clear as to who is responsible for actually paying this tax, the IRS might not agree. Many existing contracts are long-term and established before the IRS published this proposal. Therefore few if any would have anticipated how a tax of this sort would be passed back to the manufacturer of record (commonly considered to be the PMA or 510(k) holder.) Because the IRS intends to levy the tax on the final sale price (market value) of the device, it is conceivable the IRS would attempt to collect the tax on the contract manufacturer who has contracted to place the device directly into distribution. Conflicts between the contract-client and the contract manufacturer could totally disrupt the medical device supply chain and create a health care catastrophe.
3. FDA inspectors could become surrogate tax collectors because under the IRS proposal, whether or not a device should be “listed” could fall to the inspector to decide. We see that with the new interpretation of when devices must be listed, the FDA has already increased the potential pool of taxable entities.
If an FDA inspector determined a company failed to list a particular device, could that company incur penalties (fines or even liens) similar to when an individual fails to pay enough income tax? Plus the FDA can already impose Civil Penalties for failing to properly register and list. We can expect an entirely new level of scrutiny for device listing. Medical device listing records are published on the FDA’s public website (although FDA intends to provide a check box on the computer form to withhold the trade names of the devices that are produced as “private label”.) Contract manufacturing sources are a closely-held, proprietary, trade-secrets which are now at risk for public disclosure.
Regardless of presidential politics and party loyalties, the medical device excise tax must be repealed for the sake of our nation’s and state’s economy, if not our personal health. In the event it is not (or is not soon enough to prevent its initiation) we hope contract manufacturers will make provisions in their 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 is far too valuable to leave the decision on who must pay the IRS to someone else (the IRS or FDA) to interpret.
John J. Alexander is President of Business Development Advisors, Founder and Chair of the Twin Cities Angels, and business author of the Angel Investment Tax Credit. Email him at: John@BusDevAdvisors.com
Elaine Duncan is Elaine Duncan, M.S.M.E., RAC, is President and founder of Paladin Medical and a recognized leader in regulatory and clinical strategies for new medical technology development. ?Email her at: firstname.lastname@example.org