On January 1, 2013, the new 2.3% excise tax on many medical devices goes into effect. It was imposed as a part of the Affordable Care Act (ACA), and will pose some significant challenges to this industry. The tax itself applies to manufacturers and importers of medical devices and the impact will have far-reaching effects on the market and device affordability for consumers.
It is important that manufacturers and importers understand which devices will be affected. They will need to understand exactly how much they will owe. It is also important to comprehend what the compliance requirements are when meeting with these new tax standards.
New Pricing for Devices
Since new prices will be required for devices that are subject to the new tax, companies are well served by not only assuming most of the devices they manufacture and import will be affected, so that planning and over-site can prepare for the event that will certainly have a major effect on costs throughout the company-- from salaries to the ultimate bottom line.
Which devices will be subject to this tax has been defined primarily by the definitions set forth by the Federal Food, Drug and Cosmetics Act section 201 (h). The tax will effect devices designed for human use such as:
- Dental instruments
- Research-use only devices
- Dental equipment
Medical device manufacturing markets will change. This is a certainty.
There are three primary categories for exemptions:
- Devices destined to be exported out of the US
- Devices destined to be funneled into the US retail market
- Devices that will require further manufacturing
New Exemption Considerations
The IRS has provided specific examples of what will be exempt. Some of these items include eyeglasses and hearing aides. Items that qualify for the retail exemption fall under the FDA Class I, Class II and Class III listings. Some of these items include:
- Certain bandages (Class I)
- Pregnancy test kits (Class II)
- Denture adhesives (Class III)
Medical device manufacturing companies are bound to the duty of re-establishing pricing models and establishing the amounts the taxes will be based on. Medical device manufacturing company administrators will need to reorganize their pricing models based on the tax that will be paid by the distributor when it is sold by the manufacturer.
This means if a medical device manufacturer creates a device for, say, $1000, he will then sell it to a distributor for lets say $1335. The manufacturer can realize a profit of about $335. With the tax, there is now an added $30.71 attached to the production of this item.
Who Will Bear the Cost Hikes?
Under this plan, the manufacturer needs to determine if they can pass the tax cost on to the distributor. The tax applies to the point of sale that happens between the manufacturer and the distributor. The distributor will then re-sell the item, deciding how much of the cost to pass along to the retailer. How the medical device manufacturing company handles this new pricing model will have a major impact on markets.
What's even more difficult is the fact that the tax will have to be paid on inventory kept on hand from December 31, 2012 through January 1, 2013. This tax on inventory will follow the medical device manufacturer during the sale of the company. When the company is sold, the tax will be applied to all inventory involved in the sale.
Shifting Valuations and the IRS
Medical device manufacturers are very concerned about the effect this will have on the merger-acquisitions process. Company valuations will shift dramatically. Many companies are also concerned the tax costs will not be easily negotiated with current buyers. The tax fails to leave much room for rebates and sales pricing. Even when a sale drops the price of a device from $1335 to $1235, the tax is still assessed on the full amount of $1335.
The costs of warranties, packaging and shipping are all rolled into the sales pricing. The IRS will be assuming this is all done at arm's length, and documentation between the buying and selling parties will need to be re-evaluated in order to show clarity and comprehension about who is bearing the cost of the tax itself.
Penalties for failing to register the company with the IRS is $10,000 with $1000 additionally charged per day for non-compliance once the time-line has passed. Companies who have registered with the FDA will be identified by the IRS using comparative listings.
Documentation processes will increase. Documentation of sales prices between manufacturer, distributor and retailer will be required so the IRS can determine if the new tax laws are being followed. Companies with qualifying exemptions will be providing registration numbers, proof of export, and a letter verifying the exemption provided to the purchaser.
This new excise tax will create challenges and changes for the medical device industry therefore medical device manufactures should be preparing for this rapidly approaching medical device tax now.