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The Device Tax Beat Goes On: IRS Releases Proposed Regs

As far as the federal government is concerned, the beat goes on for the planned 2.3 percent medical device excise tax—as does the beat-down by the industry in voicing its continued opposition to that tax.

On Feb. 3, the U.S. Department of the Treasury released proposed regulations on how the device tax will be applied. While those proposals do set out some exemptions for early stage devices and also somewhat mollify those who had worried about a potential double tax for contract manufacturers, their release has spurred the medtech industry and its congressional allies to accelerate their drive for repeal of the tax.

Part of the Patient Protection & Affordable Care Act that is scheduled to take effect next January, the medical device tax is a top-line tax that is to be applied to sales, which opponents say is particularly difficult on the smaller companies that make up the vast majority of the device industry.

The new guidelines, titled Section 4191 of Internal Revenue Code, outlined that “all devices that are listed under a single product code listing in conjunction with the U.S. Food and Drug Administration’s (FDA) device listing requirement are ‘taxable medical devices’ unless they fall within an exemption.”

In general, a “taxable medical device” is one described by law as “any device defined under the Federal Food, Drug & Cosmetic Act as an instrument, apparatus, machine, contrivance, implant, in vitro reagent, or other similar or related article, including any component, part, or accessory that is recognized in the official National Formulary, or the United States Pharmacopeia, or any supplement to them; intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment, or prevention of disease; or intended to affect the structure or any function of the body, and that does not achieve its primary intended purposes through chemical action within or on the body and that is not dependent upon being metabolized for the achievement of its primary intended purposes.”

Among the exemptions carved out by the Internal Revenue Service (IRS) are a specific retail exemption for eyeglasses, contact lenses, hearing aids, and any other medical devices purchased by the general public at retail for individual use.

Also exempted from the tax are instruments that fall under FDA investigational device exemptions and devices labeled for “research purposes only,” as well as devices used in veterinary medicine.

The industry has worried for months about potential double taxation of contract manufacturers and OEMs, but the IRS clarified that issue only somewhat by saying that if more than one entity is involved in the manufacture or importation of an item, the determination of which entity is, in fact, regarded as the manufacturer would be based on the “facts and circumstances of the arrangement.”

Addressing additional concerns that medical products organized into “convenience kits” would be double-taxed, the IRS guidelines say the tax applies only to the “entire sale price of the kit,” not once forthe components and again for the finalcompleted kit.

Especially outspoken about the device-tax issue were officials of the largest industry trade association, AdvaMed, along with Rep. Erik Paulsen (R-Minn.), who has been leading the congressional charge against the device tax. He said the report from the Treasury Department “further highlights the fierce urgency of repealing this job-crushing tax on innovation before it is too late. [This] move by the Obama Administration is further proof that the medical innovation tax will increase healthcare costs while putting thousands of jobs on the line.”

Paulsen said he plans to work with leadership of the House of Representatives to schedule a vote on his Protect Medical Innovation Act before the tax takes effect. Joining in the fight this recently were 75 freshmen congressional Republicans, who wrote a letter to House GOP leadership asking them to bring to the floor H.R. 436, the aforementioned Protect Medical Innovation Act of 2011. A little over a year since its initial introduction by Paulsen, the bill has just under 230 co-sponsors, and is plodding its way through committee.

Todd Rokita, a first-term Indiana Republican who is spearheading the freshmen’s push, said, “We must act now to repeal this onerous and irresponsible tax. With so many jobs hanging in the balance, this should not be a political issue.”Their letter cited the impact of the planned tax on smaller companies, which the politicos termed the “engine” of the U.S. economy.

The 75 lawmakers brandished theirpolitical bona fides by adding: “We believe this is exactly the kind of bill we were elected to pass.”

AdvaMed President and CEO Stephen Ubl said in a statement that the proposed regulations highlight the need for “prompt action” by Congress and the Obama Administration to repeal what he termed “this anti-competitive, job-killing tax.” He said the continued failure to repeal the device tax “flies in the face of the president’s comments during the State of the Union about the need to reform our tax system to make our nation more competitive in the world market, a view shared by members of Congress from both parties. I’d like to keep the focus on the need to repeal the tax,” Ubl said.

As for the IRS guidelines themselves, he said AdvaMed will be “carefully examining the proposed regulation. Obviously, the rule is not going to do anything to simplify our tax code or make our tax burden more rational.” Ubl said that implementation will create “a number of complex administrative and technical burdens that must be addressed.”

Four days after release of the IRS guidelines, Ubl and AdvaMed Chairman James Mazzo outlined the organization’s plans to unhook the “no device tax” effort from the health care reform debate and instead rebrand it as part of a tax reform push. “Let me make one thing very clear. This isn’t about health care reform,” he said. “Repealing the device tax is the first down payment on much-needed tax reform. The device tax had little to do with the Accountable Care Act, except that it was added to obtain $20 billion to help pay for the bill.”

In a statement issued the day the IRS guidelines were released, Mark Leahey, president and CEO of the Medical Device Manufacturers Association, also turned his group’s release into an opportunity to rail against the device tax. Citing what he termed the “complexities and unanswered questions” in the proposed regulations, he said they “show just how important it is to repeal the onerous medical device tax.”

Saying that the device tax threatens America’s leadership position in medicalinnovation, Leahey added a final broadside: “It’s time to repeal this job-killing tax.”

A Vocal Hearing

During a recent hearing on the White House’s proposed budget for 2013 held on Feb. 15 by the House Committee on Ways and Means, Republican members of the committee took time out to grill Treasury Secretary Tim Geithner about the device tax.

“My district is outside of Philadelphia. We have a very significant medical device industry. And we’re very concerned that the 2.3 percent tax imposed as part of the Obamacare legislation actually will have the opposite effect,” said Rep. Jim Gerlach from Pennsylvania’s 6th District. “In fact, there was a study by AdvaMed that there would be about a 48,000 job loss in the industry if this $20 billion tax over 10 years is implemented. So, based upon your testimony today that you intend to, as part of the administration, put forward a comprehensive corporate tax reform plan of action—although it won’t be in a legislative form. Will the repeal of the medical device tax be part of that? And if not, why not?

Geithner said it would not be part of that, but that he shared Gerlach’s concerns, and would be happy to discuss it more detail with lawmakers and industry.

“Let me give you our general sense,” Geithner explained. “The Affordable Care Act will dramatically expand insurance coverage, as you know, for tens of millions of Americans. And therefore, we’re pretty confident that the net impact on businesses that are in the business of providing healthcare devices or otherwise will be very positive—substantially positive—even with the measures we propose to make sure we’re doing that in a fiscally responsible way.”

Gerlach was quick to respond.

“Well, given the nature of the tax, if you’re familiar with it, it’s a 2.3 percent tax on gross receipts right off the top. Whereas, many of the companies in our area—and Rep. Paulsen has been working very hard on this issue—many of these companies only have a net profit at the end of the day of only about 1 or 2 percent. So if you’re taking 2.3 percent off their gross revenues, you’re putting many of those companies at risk, and, in fact, allowing them to consider moving to other parts of the world to undertake their R&D and their manufacturing. So again, what is it about the medical device tax you think somehow is going to create jobs, rather than what you agree is the purpose of corporate tax reform, which is to incentivize the growing of jobs here in the United States?”

Geithner reiterated that while he’d “be happy” to spend more time trying to understand lawmakers’ concerns, he believes that “on balance a mix of reforms that again will expand healthcare dramatically … will be very positive for American businesses that are in [medical technology].”

Rep. Paulsen added to the chorus of critics peppering the Treasury chief with device tax questions—a topic that certainly hadn’t been at the forefront of the day’s agenda.

“I want to follow up on this because I know in Massachusetts, which has some similar provisions that are in the president’s new healthcare law, there’s been no increased utilization of medical device sales. And [U.S. Department of Health and Human Services] Secretary [Kathleen] Sebelius has been here to talk about this as well. And my understanding is that 75 percent of the folks that are uninsured are 45 years of age or less. And you know a lot of these medical devices that are life-improving, life-saving go to folks that are above age 45. And so I don’t think there’s data. If there’s data out there I’d like to see the data of what’s supporting it.”

Paulsen said the companies he represents in Minnesota are “very concerned” about the impact to R&D jobs.

“It’s about innovation—and the president has talked about that,” Paulsen said. “You mentioned it today, and I just really think this is an American success story as much as it is a Minnesota success story. This is a tax that’s about $20 billion over a 10-year period. It’s more than the amount of money that’s invested in this industry actually each and every year. So I really want to follow up with you if there’s actual data that’s going to support this down the road. In fact, Stryker—which is based in Michigan where the chairman and the ranking member [of the Ways and Means Committee] are from—is laying off 5 percent of their workforce this year because of the tax in anticipation. It’s a time bomb out there.
This is a real issue.”

Paulsen has said that his bill to repeal the tax will head for a vote on the House floor soon. But while members of the House seem to be “fired up” about this issue, the subject of medical device taxes doesn’t seem to have nearly as much cache in the Senate. The upper house also has two pending device tax-repealing bills that have been referred to the Finance Committee, but there hasn’t been a lot of movement lately and given the Democratic control of the Senate, it’s likely that such legislation wouldn’t pass, particularly in an election year.

A public hearing on the final IRS regulations is scheduled for May 16.

—This report was compiled by Jim Stommen, contributing writer, and Christopher Delporte, editorial director.

Senator Uses Diplomacy to Dampen China’s Price Control Threat

There certainly is no shortage of headwinds that potentially could impact America’s medical device industry over the nextfew years, whether it be the sputteringeconomic recovery, increased scrutiny from U.S. regulators or the 2.3 percent excise tax set to take effect in 2013.

Now there’s another obstacle that possibly could thwart growth, particularly overseas: proposed price controls from China. The top Republican on the U.S. Senate Foreign Affairs Committee is warning that China’s proposed price controls on medical products could adversely affect both American companies and Chinese patients. Many U.S. medical device companies have made significant investments in research and manufacturing facilities in the Middle Kingdom, hoping to capitalize on the anticipated meteoric growth of that country’s middle class and demand for healthcare goods and services. Price controls, however, potentially could cut into profits and make American products less competitive in China. Such controls also could exacerbate tensionsbetween the two countries. China already has rubbed U.S. lawmakers the wrong way for allegedly manipulating its currency to boost exports. Using price controls to squeeze out American medical products from its market—which could become the world’s largest—only would add fuel to the proverbial fire.

Sen. Richard G. Lugar (R-Ind.), though, is hoping to dampen the flames of impending controversy with a diplomatic approach to the issue. He has urged Chinese Ambassador Zhang Yesui to consider the concerns of American device makers when debating the merits of a price control proposal unveiled last summer by the National Development and Reform Commission (NDRC).

“Representatives of the industry have expressed serious concerns about medical device price controls proposed by the NDRC,” Luger wrote to Yesui. “I am hopeful that you will convey these concerns to appropriate agencies in your government and encourage them to engage further dialogue that could explore alternatives to price controls.

“This approach would be consistent with our mutual support for transparency and consultation as we work together to find mutually beneficial ways to further harmonize our commercial relations. Both the United States and China would stand to benefit from a solution that achieves China’s healthcare objectives without harming this important industry,” Luger concluded.

Globus and FDA Reach aMillion-Dollar Resolution

The U.S. Food and Drug Administration (FDA) has reached a $1 million civil money penalty settlement with Globus Medical Inc., of Audubon, Pa., for the distribution of unapproved medical devices.

The settlement requires Globus to pay a $550,000 penalty and David C. Paul, the firm’s CEO, to pay a $450,000 penalty, for a total of $1 million.

During an inspection of Globus Medical in September 2010, FDA investigators learned that the company had marketed its NuBone Osteoinductive Bone Graft product without proper premarket approval or clearance, as required by law.

“The device-clearance process assures the quality and safety of devices before they reach the market. Firms can’t simply choose to sell devices that FDA has found are not safe and effective,” Steve Silverman, director of the Office of Compliance in the FDA’s Center for Devices and Radiological Health, said in a news release. “We took action against Globus Medical to protect patients and we are pleased with the outcome.”

Globus had sought clearance ofNuBone in January 2009, but the FDA declined to clear the product after determining that it was not substantially equivalent (NSE) to legally marketed products. The FDA advised Globus Medical that it could not distribute the product, but the firm continued to do so, even after receiving the NSE letter in December 2009, the agency claims.

The FDA then filed a complaint for civil money penalties against Globus Medical and the company’s CEO for distributing the NuBone product without properFDA approval or clearance. The agency

informed Globus Medical and Paul of this action in November 2011, and laterparticipated in settlement discussions which ultimately lead to the $1 million penalty agreement.

“This company ignored previous warnings by the FDA and continued to produce and distribute unapproved medical devices,” said Dara A. Corrigan, associate commissioner for regulatory affairs.

“By taking this enforcement action, the FDA is demonstrating its commitment to protecting the public from the dangers of unapproved devices.”

No patient safety issues were reported regarding NuBone, according to Globus. Company officials also stressed that the settlement does not allege any intentional wrongdoing by Globus Medical or by Paul.

The company’s side of the story is that it had considered NuBone to be minimally manipulated tissue exempt from premarket notification, but in March 2008 the FDA’s Tissue Reference Group determined that NuBone required 510(k) clearance. Globus and FDA maintained an ongoing dialogue regarding NuBone’s regulatory statusincluding two 510(k) submissions withsubstantial animal data. During that time, Globus executives claim they communicated regularly with the agency regarding NuBone and throughout the product’s lifecycle, and that they were acting in a manner that was acceptable to the FDA.

Despite what company officials said was history of safe use, Globus decided todiscontinue NuBone in 2010.

“Globus strives to conduct our business in a manner that is consistent with the highest legal standards in our industry. In this particular situation, there was an unfortunate miscommunication between Globus and FDA such that we believed we were acting in a manner that was acceptable to FDA,” Paul said in a prepared statement. “We accept full responsibility and are pleased to have resolved this matter without further legal action, and look forward to a continuation of our long standingrelationship with FDA, based on cooperation and mutual respect.”

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