21st annual health sciences tax fconference

Medical device excise tax: background and implications

6 December 2011

Disclaimer

► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may , , p p g p ybe imposed under the Internal Revenue Code or applicable state or local tax law provisions

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Disclaimer

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► This presentation is © 2011 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced transmitted or otherwise distributed in any form or bydocument may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited andtransmission or distribution of this form or any of the material herein is prohibited, and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party.

► Views expressed in this presentation are not necessarily those of Ernst & Young LLP.

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Presenters

► Ed TarleVice President Tax

► Michael UdellErnst & Young LLPVice President, Tax

Edwards Life SciencesErnst & Young LLPWashington, D.C.+1 202 327 5752

► Chris OhmesErnst & Young LLPWashington D C

michael.udell@ey.com

Washington, D.C.+1 202 327 8753chris.ohmes@ey.com

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Agenda

► Legislative history► Key considerations► Tax base

Wh th t► Who pays the tax► Leasing and renting► Price determinations► Price determinations► What should you do► Contacts

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Legislative history

► On 30 March 2010, President Obama signed into law the Health Care and Education Reconciliation Act of 2010 (H R 4872)Care and Education Reconciliation Act of 2010 (H.R. 4872), enacting in Act Section 1405 a new excise tax on medical device sales.

► The new excise tax incorporated into Code section 4191 as a► The new excise tax — incorporated into Code section 4191 as a manufacturer’s excise tax — is imposed at a rate of 2.3% on sales of medical devices after 31 December 2012.

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Key considerations

► Because it is not an income tax, it will likely be reported as an increase in cost of goods sold for tax purposesan increase in cost of goods sold for tax purposes pursuant to Code section 164.

► The tax will be a material item on the financial statements for many medical device manufacturers.

► While there are several bills in Congress to repeal the medical device excise tax none have been passed bymedical device excise tax, none have been passed by either the House or the Senate.

► It is unlikely that President Obama would sign a bill ► s u e y a es de Oba a ou d s g a brepealing the excise tax.

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Tax base

► Taxable medical devices are defined with reference to section 201(h) of the Federal Food, Drug and Cosmetic ActAct.► A device is:

► an instrument, apparatus, contrivance or in vitro reagent, recognized in the National Formulary or the U.S. Pharmacopoeia,

► intended for use in diagnosis of disease or other conditions, or in the cure, mitigation, treatment or prevention of disease,

i t d d t ff t th t t f ti f th b d f th► intended to affect the structure or any function of the body, of man or other animals, in a non-chemical manner

► The medical device excise tax only applies to medical d i i t d d f hdevices intended for use on humans.

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Tax base

► The device class number refers to the level of regulation by the FDA with► Class 1 devices subject to general controlsj g

► Class 2 devices subject to general and special controls

► Class 3 devices subject to general and special controls and premarket clearance

► Not all devices have a class number

► However, all devices have a three-letter product code

► All devices are subject to the excise tax unless exempt► If a product does not have a three-letter product code assigning it as a medical device by► If a product does not have a three letter product code assigning it as a medical device by

the FDA, it is exempt

► Eyeglasses, hearing aids, and contact lenses are exempt

► Exports are exempt

► Medical devices sold for “further manufacturing” can be exempt

► Once Treasury provides guidance, there will be an exemption for medical devices sold at retail

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Tax base

► The exemption for medical devices sold at retail contains five factors on which Treasury will provide guidance this f ll T b t d i t bfall. To be exempt a device must be:

► of a type

► generally purchased

► by the general public

► at retail

► for individual use

► Notice 2010-89 solicited comments on how Treasury should administer the exemption. Numerous comments have been providedhave been provided.

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Tax base

► The tax applies to► Government and non-profit sales► Charitable donations of medical devices► Medical devices that may not be sold for a profit such as:

► Humanitarian Device Exemptions – HDE► Humanitarian Device Exemptions HDE

► Research Use Only Exemptions – RUO

► Investigational Device Exemptions – IDE

U t t d l f i t► Uses: uses are treated as a sale for excise tax purposes

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What triggers the tax

► First sale after completion of manufacturing► Importation► First sale in the United States

► Government and non-profit sales► Charitable donations of medical devices► Medical devices that may not be sold for a profit such as

► Humanitarian Device Exemptions – HDEp

► Investigational Device Exemptions – IDE

► Uses: uses are treated as a sale for excise tax purposes► Lent tools► Lent tools

► Rentals

► Samples and demonstration uses

► Quality control testing

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Q y g

► Research Use Only Exemptions – RUO

Who pays the tax

► The tax applies to a manufacturer, producer or importer of a medical device► The FDA definition of a manufacturer, producer or importer is broader

than the tax definition, because the FDA definition is intended to identify and locate issues of risk to the patient throughout the manufacturing processprocess.

► Who is an importer?► The beneficial owner of the property, i.e., not the freight forwarder.► FDA registration may be used to define an importer.

► Tax liability arises upon first transfer of title of the finished productproduct.

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Who pays the tax

► Limited related party rules► Chapter 32 rules contains related party rules, but these rules pertain only

to the determination of price

► Contract manufacturing rules► Chapter 32 rules focus on title► Chapter 32 rules focus on title► Other tax rules look to benefits and burdens, with reference to

► Control of the details of the manufacturing process

► Title passage

► Exclusivity

► Risk of loss

► Product liability risk

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Leasing and rental considerations

► Code section 4217 lease rules ► Manufacturers, producers or importers

who lease medical devices can spread thewho lease medical devices can spread the excise tax over the lease term.

► Does a manufacturer need to separately track the income from each and everytrack the income from each and every rented medical device to be covered under Code section 4217?

► Current rental rules► Current rental rules► Each rental payment is treated as a use► Will the existing rental agreements be

grandfathered?grandfathered?

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Determining the sales price

► The price concept is that of a manufacturer’s wholesale price of a finished product ready for market.► A single price will be used in determining the tax on each product

in each quarter.

► When is the sales price for an item determined?► What triggers a sale for excise tax purposes?► How many times can a product be taxed?

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Determining the sales price

► Which prices will qualify as fair market value of the manufacturers wholesale price?► Can a retail price be used?► Can a wholesale price be used?► Can a transfer price be used?► Can a transfer price be used?► Why related party rules are important

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Determining the sales price – potential complicationsp► Bundling

► A company that “bundles” or “kits” finished medical devices is treated as a f t f FDAmanufacturer for FDA purposes.

► Bundling may not rise to the level of manufacturing under tax code definitions:► Sterilization is not manufacturing for tax purposes, but is for FDA purposes.

► How should a maquiladora be treated for excise tax purposes?

► Bundling may rise to the level of manufacturing if it is a condition of sale.

► What constitutes further manufacturing?

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Determining the sales price after taxable sale

► Can prices can be adjusted for rebates, claw-backs, volume discounts and incentive payments?

► Are replacement parts subject to tax if provided under a warranty?warranty?

► Are service contracts subject to the excise tax?► Are service contracts subject to the excise tax?

► Can reconditioning or refurbishing give rise to a second► Can reconditioning or refurbishing give rise to a second tax?

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What should you do?

DetermineDetermine system and

process changes

Consider how these issues may affect your ability to

Determine the impact of the

new tax on other

Determine timing and resources

needed to make changes to theg

required for compliance.

comply with the tax. taxes.changes to the

system and processes.

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Contacts

Ernst & Young LLP National TaxChris Ohmes B siness Ta Ser ices R&D +1 202 327 8753Chris Ohmes Business Tax Services — R&D +1 202 327 8753

Michael Udell Quantitative Economics and Statistics (QUEST)

+1 202 327 5752

Steve Meadows International Tax Services +1 202 327 6020

Bob Everitt Business Tax Services +1 613 371 6796

Faranak Naghavi Indirect Tax +1 202 327 8033

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