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How to Find Savings in the Excise Tax Era

Who Is Liable for the Tax?
When the law first went into effect, contract manufacturers were not certain whether they or their customers would be liable for the tax. Generally, the manufacturer or importer of a taxable medical device is liable for the MDET.                                                      

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According to the IRS, for purposes of the MDET, the manufacturer is the person who produces a taxable medical device from scrap, salvage, or junk material – or from new or raw material – by processing, manipulating, or changing the form of a device or by combining or assembling two or more devices.

It is not uncommon for a manufacturer to contract with another manufacturer to perform some aspect of making the device. In some instances patent owners outsource their entire manufacturing process. In such cases, the IRS has explicitly directed taxpayers to Revenue Ruling 58-134, Revenue Ruling 60-42, and Polaroid v. U.S. for rules regarding the determination of which party is the manufacturer for purposes of the tax.

These examples dictate that the substance rather than the form of the transaction is determinative. These bodies of tax authority indicate three factors that must be weighed in order to determine who the manufacturer is for purposes of the MDET:

  1. Ownership of raw materials
  2. Control over production and sale
  3. Ownership of patent rights

The most important of these factors appears to be the ownership of patent rights, as parties who hold patent rights can be ultimately liable for the tax even if they take no part in the manufacturing process. The factor weighted least is ownership of the raw materials. Critics have argued that this position is inherently counterintuitive, questioning how the party who manufactures the device isn’t the manufacturer liable for the MDET.

Surgical Kits and Procedure Trays
Surgical kits and procedure trays are a common method of delivery to end users, and, as such, determining the taxable manufacturer of the items assembled into a kit is an important issue. Under the proposed regulations, assembling and packaging devices into a kit was considered manufacturing, so companies selling individual kit components would not be liable for the tax. In the final regulations, however, the opposite rule was adopted, and assembling devices in a kit is not considered manufacturing. As a result, companies selling individual devices that will be assembled into a kit must pay the MDET. However, if a manufacturer assembles a kit that includes a nontaxable device, then only the proportional value of the taxable devices should be taxed.

Further Manufacture, Export, and Resale Exemptions
Unlike a sales tax, there is no resale exemption with respect to the MDET. Section 4191 of the IRC does, however, provide several other exemptions for the MDET, including the further manufacture and export exemptions. Devices subject to the MDET are exempt from the tax when purchased for further manufacture or for resale to a second purchaser for further manufacture. A device is considered sold for further manufacture if it is sold as a material in the manufacture or production or as a component part of another taxable device to be manufactured by the purchaser.

To document a tax-free sale of a medical device that will be used for further manufacture, the customer’s purchase order must state:

  • The exempt purpose for which the devices are being purchased
  • The purchaser’s registration number

It is important to note that purchasers and manufacturers who intend to remanufacture need to register using Form 637, “Application for Registration (For Certain Excise Tax Activities).”

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