No. 2012-29                                 21 November 2012Technical Line                                                ...
Ernst & Young AccountingLink                                                                                 www.ey.com/us...
Ernst & Young AccountingLink                                                                                              ...
Ernst & Young AccountingLink                                                                                              ...
Ernst & Young AccountingLink                                                                                              ...
Ernst & Young AccountingLink                                                                                 www.ey.com/us...
Ernst & Young AccountingLink                                                                                 www.ey.com/us...
Ernst & Young AccountingLink                                                                                              ...
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Medical Device Tax Insights from E and Y

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An excise tax of 2.3% on the sale, lease, rental or use of certain medical devices was mandated by the 2010 health care reform legislation and goes into effect 1 January 2013. The tax applies to manufacturers, producers and importers of taxable medical devices. In some situations, a health care organization such as a hospital or other provider may also be liable for the tax. This Technical Line addresses who is affected by the tax and how it should be calculated. The publication also addresses accounting considerations under US GAAP and IFRS.

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Transcript of "Medical Device Tax Insights from E and Y"

  1. 1. No. 2012-29 21 November 2012Technical Line Implementing the medical device excise taxIn this issue: What you need to knowOverview ........................................... 1 • A 2.3% excise tax on the sale or use of certain medical devices by aKey considerations ............................ 2 manufacturer, producer or importer goes into effect 1 January 2013. Who is affected by the excise tax? ... 2 • Entities will need to assess whether the products they manufacture, produce How is the excise tax calculated or import are subject to the excise tax. and collected? ............................ 3 • Entities with taxable devices will need to determine where in their supply chains Exemptions from the excise tax ....... 5 the excise tax should be assessed. This will have accounting implications.Accounting considerations ................ 6 • Health care organizations that bundle or assemble medical devices could be Recognition .................................... 6 subject to the excise tax. Classification .................................. 6 • As manufacturers, producers and importers adjust to the excise tax, they may IFRS considerations ........................ 7 attempt to raise prices they charge hospitals, health care providers and insurers. Overview An excise tax1 of 2.3% on the sale, lease, rental or use of certain medical devices was mandated by the 2010 health care reform legislation and goes into effect 1 January 2013. The excise tax applies to manufacturers, producers and importers of taxable medical devices. In some situations, a health care organization such as a hospital or other provider may be liable for the excise tax. Medical device manufacturers, producers, importers and health care organizations need to begin evaluating whether they will be liable now and planning how they will calculate this tax. This publication addresses the implications of the excise tax for manufacturers, producers, importers and health care organizations.
  2. 2. Ernst & Young AccountingLink www.ey.com/us/accountinglink The accounting conclusions for the excise tax may change if the US Treasury Department issues final regulations or interpretive guidance that differs from our understanding of the intent of the excise tax. Standard setters may address the accounting implications arising from the implementation of the excise tax. Congress could also change the law. Key considerations The excise tax generally is based on the medical device’s wholesale price and is imposed on the manufacturer or importer when the taxable device is first sold, leased, rented or used by the manufacturer or importer. A taxable device generally is considered sold, for purposes of the excise tax, when title passes from the manufacturer to the purchaser. This may include intercompany sales between affiliated companies. Taxable medical devices that customers rent from a manufacturer may also be subject to the excise tax. If the manufacturer of a taxable device uses the device, the excise tax applies to its first use (e.g., a taxable device used in demonstrations at a trade show). Entities subject to the excise tax may try to recover the tax from their suppliers, increase prices to customers including hospitals, health care providers and insurers or implement measures to reduce their operating costs. It is unlikely that Medicare, Medicaid, the Veterans Administration and the Department of Defense — the government programs that pay for a significant portion of medical devices in the US — would increase their reimbursement rates in response to price increases initiated by manufacturers. Who is affected by the excise tax? For purposes of the excise tax, a “manufacturer” produces a taxable medical device from new, used or raw material by processing, manipulating or changing the form of an article, or by combining or assembling two or more articles. An “importer” brings a taxable medical device into the US from outside the country. (In this publication, we refer to both manufacturers and importers as manufacturers.) The US Food and Drug Administration (FDA) requires the listing of medical devices by manufacturers. Under regulations the Internal Revenue Service (IRS) has proposed for implementing the excise tax, a device is subject to the excise tax if it is intended for humans and meets the definition of a device in section 201(h) of the Federal Food, Drug and Cosmetic Act (the FFDCA),2 which generally says devices don’t achieve their primary purpose through chemical action. Certain software and medical information technology may be considered medical devices if they are listed with the FDA. An entity may perform other activities that make a device taxable under the proposed regulations. For example, a “convenience kit” is defined as two or more medical devices, or a combination of devices and other items, that are packaged together for the convenience of the user. Certain health care organizations and distributors assemble kits for their own use or for sale to others. When a health care organization or distributor sells or uses a kit it assembled, it will need to determine whether it owes the excise tax. A key factor to consider in making this determination is whether the assembled kit is on the FDA list of medical devices.2 21 November 2012 Technical Line Implementing the medical device excise tax
  3. 3. Ernst & Young AccountingLink www.ey.com/us/accountinglink A health care organization or distributor may also import a kit from a foreign manufacturer. These activities could trigger a liability for the excise tax. How we see it It is not clear from the proposed IRS regulations whether the assembly of kits or other activities such as sterilization by a health care organization would trigger the excise tax. Some health care organizations have taken the view that, because they are exempt from the FDA’s registration requirements and they use kits internally, they would not be subject to the excise tax. We believe each health care organization will need to consider its facts and circumstances when evaluating whether its activities are subject to the excise tax. Rental and leasing transactions may also trigger an obligation to pay the excise tax. The excise tax is generally due when the rental payments are collected from customers. Using a taxable medical device also may constitute a taxable sale or use, depending on the facts and circumstances of the arrangement. A manufacturer’s use of a taxable device for any purpose other than manufacturing or testing another taxable device causes the manufacturer to be obligated to pay for the excise tax on theRental and leasing device. That means that providing a device “free of charge” to another party for promotional or demonstration purposes may be a taxable event. Manufacturerstransactions may should carefully consider accounting for demonstration equipment, samples and other promotional products used by a manufacturer or provided to customers at aalso trigger an excise discount or free of charge.tax obligation. The proposed IRS regulations note that the excise tax is triggered if title of a taxable medical device passes from the manufacturer to a transferee. As a result, if a product has not been previously subject to the excise tax, the tax may be triggered in a business combination. How we see it Entities that have not assessed whether their business models, products or supply chains make them subject to the excise tax should do so now. Certain activities that entities may not have considered subject to the excise tax, such as using medical devices in demonstrations or promotions, may result in excise tax obligations. How is the excise tax calculated and collected? Measurement Because the excise tax is a manufacturer’s excise tax, it is designed to be levied on the wholesale price of the device. Current excise tax pricing rules assume that a manufacturer sells a taxable device in an arm’s-length transaction (that is, in a transaction between two unrelated parties) to a wholesale distributor that sells it to a retailer that sells it to consumers. Rebates, discounts, rights of return and refunds offered by manufacturers should be considered when determining the wholesale price.3 21 November 2012 Technical Line Implementing the medical device excise tax
  4. 4. Ernst & Young AccountingLink www.ey.com/us/accountinglink Because liability for the medical device excise tax is triggered by the first US sale by a manufacturer, regardless of whether the sale is within an entity’s consolidated group, an entity may owe the excise tax before it has sold its product to an end user. Entities that do not have a vertically integrated distribution model and sell directly to third parties will generally calculate the excise tax by using the actual sales price. Because not all manufacturers sell finished medical devices in this manner, the rules provide that the excise taxable sales price may be a “constructive” sales price rather than the device’s intercompany sales price. Entities that sell or provide medical devices to affiliated companies will likely determine the taxable price of their devices based on a constructive sales price. Manufacturers should carefully consider the selling price used to determine how much excise tax to record. The excise tax will not be imposed on medical devices that manufacturers in the US export. Rebates paid to customers also will be considered in determining the taxable sales price but, in general, can be claimed only after they are paid. Depending on their terms, there are several situations in which rebates would reduce an entity’s excise tax liability. Rebates paid to a customer may reduce an entity’s excise tax obligation only if the rebates are related to sales of taxable medical devices.Depending on their terms, For leasing or rental transactions, the excise tax will be imposed on the element of the lease or rental payment that relates to the use of the taxable device. If therebates could reduce an manufacturer sells the same type of devices that it leases in arm’s-lengthentity’s excise tax liability. transactions, the excise tax will be triggered by and calculated on each lease payment until the cumulative total of the excise tax payments equals the total excise tax that would be due if the taxable device had been sold. If the manufacturer doesn’t sell the same type of device in arm’s-length transactions, the excise tax will be triggered by and calculated on each lease payment without limitation. Providing a free medical device to a customer or providing one at a significant discount, when the manufacturer also enters into an agreement with the same customer to sell consumables to be used with the device (known as a reagent rental model), will be considered to be a taxable use of that device. Consumables sold under such an arrangement would be taxed separately as sold. If the retail price of the consumable is considered to be the taxable sales price and the rental value of the device is embedded in the price of the consumable, determining the proper taxable sales price for both the device and the consumable may prove challenging. Existing excise tax regulations do not provide a way to separate the value of the device from the consumable. Collection Estimated excise tax payments will be due semi-monthly, and excise tax returns should be filed quarterly in the month following the end of a calendar quarter. The proposed regulations would require that each legal entity deemed to be a manufacturer in a controlled group must individually report and make estimated excise tax payments. The manufacturer is prohibited from transferring liability for the excise tax to another party. A manufacturer may attempt to recoup part or all of the excise tax by increasing the price it charges customers. However, this may prove challenging, as4 21 November 2012 Technical Line Implementing the medical device excise tax
  5. 5. Ernst & Young AccountingLink www.ey.com/us/accountinglink health care organizations may be reluctant to accept price increases and surcharges when Medicare, Medicaid, the Veterans Administration or the Department of Defense is ultimately responsible for payment. How we see it Entities will need to develop, design and test compliance procedures and controls for properly capturing taxable transactions and paying the excise tax. More specifically, entities should consider: • Whether current billing systems can allow for appropriate pricing, proper calculation of the excise tax base and tracking excise taxes on domestic sales • Whether current inventory systems can monitor and track taxable and nontaxable uses of medical devices • Whether current accounting systems can allow for proper accounting and application of debit memos, credit memos, discounts, volume rebates, chargebacks and partial payments when calculating and paying the excise tax Entities will also have to develop processes and procedures to track devices sold for remanufacturing or export.The excise tax is Exemptions from the excise taxaccounted for under Certain items, such as eyeglasses, contact lenses and hearing aids, are excluded from the definition of a taxable medical device. Various medical devices and uses ofASC 450. medical devices may also be exempt: • Retail exemption — Medical devices determined by the IRS to be generally purchased by the public for individual use are not subject to the excise tax. Under the proposed regulations, to qualify for this exception, a device must be regularly available for purchase and use by individual consumers and not intended primarily for use in a medical institution or office or by a medical professional. • Research exemption — While the proposed IRS regulations discuss a research exemption, medical devices used in research that have an FDA product code and do not qualify for any other exemption are taxable devices. • Investigational device exemption — A medical device that is not required to be listed with the FDA because the FDA has not approved it for marketing is exempt from excise tax. • Remanufacturing exemption — A manufacturer is exempt from the excise tax on the sale of an FDA-listed medical device that the purchaser will use in further manufacturing of a listed medical device. However, after the purchaser remanufactures the device, if the remanufactured device is listed as an FDA medical device, the excise tax will apply to the sale, rental or first use of the remanufactured device by the purchaser. Therapeutic and diagnostic products that combine drugs, devices and/or biological products (e.g., a prefilled syringe, an inhaler), also known as “combination products,” may be considered taxable medical devices if the combination is a listed medical device.5 21 November 2012 Technical Line Implementing the medical device excise tax
  6. 6. Ernst & Young AccountingLink www.ey.com/us/accountinglink Accounting considerations Entities will need to apply judgment when determining whether the products they manufacture, produce, import or use are subject to the excise tax. Entities that determine their products are subject to the excise tax must determine when to recognize the excise tax and where to present the excise tax in the income statement. Recognition Recognition of the excise tax liability falls under ASC 450, Contingencies, not ASC 740, Income Taxes. This is because the medical device excise tax is assessed on revenues and ASC 740 applies to taxes that are based on income. If a manufacturer, producer or importer determines its products are subject to the excise tax, it should recognize the excise tax when the first sale of the eligible product occurs or when a lease or rental payment is due. The excise tax also should be recognized for demonstration and promotional products, or other products that are subject to the excise tax based on use and not sale, when the first use occurs. Entities that are subject to the excise tax should evaluate their operations and legal structures to determine where in their supply chain the excise tax is incurred and when it becomes due. If the excise tax is incurred because of an intercompany sale between legal entities that are part of a consolidated group, entities should determine whether the excise tax represents an inventoriable cost. Generally, inventoriable costs are incurred directly or indirectly in bringing a product to its existing condition and location for sale. Determining whether the excise tax is an inventoriable cost will depend on the facts and circumstances of a company’s operations. Entities should consider whether similar costs are considered inventoriable costs and ensure the excise tax is accounted for consistently. This may result in the excise tax being inventoriable for some sales and not for others within the same reporting entity. If the excise tax is determined to be an inventoriable cost, it is recorded in inventory at the time the intercompany sale is recorded and the excise tax liability is incurred. If the excise tax is included as an inventoriable cost, it may result in an income taxable temporary difference. That is, while the book basis of the inventory includes the capitalized excise tax, the income tax basis of the inventory does not include the capitalized excise tax, giving rise to a taxable temporary difference. Classification Presentation in the income statement will depend on facts and circumstances. If the excise tax is incurred because of a sale to a third party, we believe the guidance in ASC 605-45-50-3 and 50-4 (formerly EITF 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement) should be applied to determine the appropriate classification for this excise tax. This guidance states that presenting these excise taxes on either a gross basis (included in revenue and expense) or net basis (excluded from revenue) is an accounting policy election. If an entity elects gross presentation, it should disclose the amount of the excise taxes collected in both interim and annual financial statements, if material.6 21 November 2012 Technical Line Implementing the medical device excise tax
  7. 7. Ernst & Young AccountingLink www.ey.com/us/accountinglink Entities that present on a gross basis should determine whether the excise tax represents a cost of sales or an operating expense. Entities should look to how they treat similar excise taxes and other costs and ensure the tax is classified consistently. Even though the excise tax is implemented by and remitted to the IRS, the excise tax is not an income tax and should not be presented as a component of income tax. Public companies that elect to classify the excise tax on a gross basis should consider Rule 5-03 of SEC Regulation S-X, which requires the amount of excise taxes to be shown on the face of the income statement (parenthetically or otherwise) if excise taxes equal 1% or more of total revenues. If the excise tax is incurred in connection with an intercompany transaction, we do not believe the guidance in ASC 605-45-50-3 and 50-4 applies because the excise tax is incurred as a result of moving through the supply chain, not because of a revenue-producing transaction between seller and customer. Entities will need to apply the principal agent considerations of ASC 605-45 to determine whether the tax should be accounted for on a gross or a net basis. Additionally, if an entity accounts for the excise tax gross, it will need to determine whether the excise tax represents an inventoriable cost, which should be recorded as a cost of sales. If the tax is determined to not represent an inventoriable cost, is should be recorded as an operating expense. Like entities electing gross presentation, entities should look at how they treat similar costs and ensure the excise tax is presented consistently. IFRS considerations Recognition Under IFRS, taxes other than income taxes are accounted for under IAS 37 Provisions, Contingent Liabilities and Contingent Assets. To recognize a provision, an entity must have a present obligation (either legal or constructive) from a past event. It also must be probable that an outflow of resources will be needed to settle the obligation and the amount should be reliably estimated. This treatment is similar to US GAAP. However, under US GAAP, the term probable is defined as likely, while IFRS defines the term probable as more likely than not, which is a lower threshold than under US GAAP. As a result, a provision may be recognized earlier under IFRS than under US GAAP. Provisions should be measured based on the best estimate of the expenditure required to settle the obligation at the end of the reporting period. Similar to US GAAP, if the excise tax is incurred because of an intercompany sale between legal entities that are part of a consolidated group, the excise tax may be eligible for capitalization. Entities should apply the considerations under IAS 16 Property, Plant and Equipment or IAS 2 Inventories when determining whether costs are eligible for capitalization. Classification IAS 1 Presentation of Financial Statements does not specify where in the income statement excise tax expenses should be presented. Classification would depend, in part, on whether an entity presents its analysis of expenses based on the nature of the expense or based on the function to which it relates. Regardless of which approach is used, if the excise tax is material to the financial statements it will need to be presented separately, either on the face of the income statement or in the footnotes.7 21 November 2012 Technical Line Implementing the medical device excise tax
  8. 8. Ernst & Young AccountingLink www.ey.com/us/accountinglink If the excise tax can be passed on to a customer in a revenue-generating transaction, it is recognized and measured in accordance with IAS 18 Revenue, at the fair value of the consideration received or receivable. Similar to US GAAP, a key consideration is whether a manufacturer is acting as an agent (collecting and remitting excise tax on behalf of customers) or a principal. This will affect what the entity recognizes and presents in the financial statements. If the entity acts as a principal, the excise tax should be recorded gross in revenue and expense. If the entity acts as an agent, the excise tax should be recorded net. IAS 18 includes indicators on principal/agent. IFRS does not provide a policy election to present the excise tax on a gross or net basis similar to US GAAP (ASC 605-45-50-3 and 50-4) instead, further analysis is necessary. Next steps An entity that believes it may be subject to the excise tax should consider the following to evaluate the effect the excise tax may have: • Determine which products it manufactures or imports qualify as medical devices, as defined under the proposed regulations • Determine whether any of the various exemptions apply • Evaluate the entity’s infrastructure for compliance, including identifying the entities that will bear the excise tax liability and whether the structure is the most appropriate • Determine at what point the excise tax becomes due and where in the income statement the excise tax will be presented Endnotes: 1 The medical device excise tax is not an income tax. 2 The FFDCA generally defines a device as an instrument, machine, implant or other device intended to diagnose, cure, mitigate, treat or prevent disease, or intended to affect the structure or any function of the body, that does not achieve its primary intended purposes through chemical action.Ernst & Young About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, ourAssurance | Tax | Transactions | Advisory 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential.© 2012 Ernst & Young LLP. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each ofAll Rights Reserved. which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com.SCORE No. BB2439 This publication has been carefully prepared but it necessarily contains information in summary form and is therefore intended for general guidance only; it is not intended to be a substitute for detailed research or the exercise of professional judgment. The information presented in this publication should not be construed as legal, tax, accounting, or any other professional advice or service. Ernst & Young LLP can accept no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. You should consult with Ernst & Young LLP or other professional advisors familiar with your particular factual situation for advice concerning specific audit, tax or other matters before making any decision.8 21 November 2012 Technical Line Implementing the medical device excise tax

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