Finance chiefs of medical-device manufacturers required to file their next quarterly excise-tax returns by July 31 should be breathing a tad easier at the moment because of a tax-friendly interim guidance by the Internal Revenue Service that had become effective in January.
While manufacturers and importers of medical devices still must report on the products to the IRS and pay taxes on them, the new interim guidance concerning Section 4191 of the federal tax, which imposes an excise tax on the sale of certain devices, adds more clarity about which products are tax and which are exempt.
The 2.3 percent tax under the code applies to the sale, use and lease of medical devices after December 31, 2012. But retail products consumed by the general public such as eyeglasses, contact lenses and hearing aids are exempt.
The new guidance is more advantageous for manufacturers. That’s because consumers who use the Internet or telephone to buy a firm’s medical equipment would fall under the retail category, thereby making their purchases exempt. In such a case, firms would not have to pass on any extra tax cost to consumers.
The IRS has also more clearly defined what constitutes wholesaler, distributor and retailer in its new guidance. What’s more, the service has distinguished between distribution channels that manufacturers use today and outdated ones, said Taylor Cortright, senior manager in the excise-tax practice at KPMG’s Washington National Tax group on a webcast earlier this month. The guidance, she says, now provides more “certainty” to manufacturers.
Cortright noted that if a firm calls a customer a wholesale distributor, the customer must meet the definition of wholesale distributor under the excise tax rules and not in fact be a retailer at the time. The guidance defines wholesale distributor as a firm involved in the business of selling products to people or firms who resell such products. Retailers are considered to be those who sell to end users.
“There’s been a lot of confusion about that when people in the industry think they are selling to wholesalers, but really the excise tax world would consider that person a retailer under these definitions that are provided for in the regulations,” added Deborah Gordon, senior manager in the excise tax practice at KPMG’s Washington National Tax group on the webcast.
Information on charitable donations is also now included in the interim guidance — which, Cortright noted, is a “welcome piece of guidance for the industry.” Firms previously did not have much clarity about how the tax code would apply or if the donation would be tax-exempt.
In another favorable move towards manufacturers, the new guidance also grandfathered certain lease contracts for medical devices. Payments made under written binding contracts for lease or installment sale entered into before March 30, 2010 are not subject the medical device tax, according to KPMG. Also, the IRS equated licensing medical devices to be the same as leasing the device.
But some areas of guidance remain unclear, such as how to gauge the value of the sale of a medical device to a related company, according to Gordon. “It’s still an open issue. If a firm is not selling at the fair-market price, how do you treat that?” she asked on the webcast, referring to the different pricing regime that might occur in transactions between related companies. Typically, the selling price reasonably approximates the fair-market price of the device, but she noted that the IRS code does not define what fair-market price is and make clear how the definition would apply in related-party transactions.
In the case of a related-company sale, she said a firm needs to ask, “Is that a price that it would have sold something at in an unrelated company sale?” Manufacturers, she noted, also need to show a “burden of proof,” to establish that the product was sold at a fair-market price backed up by data or testimony.
Similarly, manufacturers can often face challenges determining the estimated sale price of a device when the actual sale, for example, has not yet occurred. Matching up the two prices in time to file quarterly tax returns can often be difficult.