2.3% Medical Device Tax Hits Clinical Labs in 2013

Newly-enacted health reform bill requires medical device companies to pay excise tax

CEO SUMMARY: One aspect of the massive new health bill is that medical device companies will pay a 2.3% tax, effective January 1, 2013. Students of economics know that it is customers who invariably end up paying such direct taxes. Thus, clinical laboratories in the United States should prepare to see this 2.3% tax show up as a line item on sales contracts and in the form of higher prices for in vitro diagnostics analyzers, lab equipment, reagents, consumables, and even medical software.

BY SIGNING THE HEALTHCARE REFORM bill into law last week, President Obama started the clock on a 2.3% tax on medical devices that will go into effect on January 1, 2013. On that date, sales that close on any product classified as an FDA-approved medical device, including laboratory analyzers, laboratory equipment, reagents, and consumables, will be taxed at the 2.3% rate.

As currently structured, in vitro diagnostics (IVD) manufacturers, along with all medical device companies, will be required to pay this new 2.3% excise tax on almost all the products they sell to clinical laboratories and pathology groups. This makes it likely that clinical labs will pay this tax in one of two ways: either as an excise tax item of 2.3% that appears on the sales invoice from the manufacturer or in the form of higher prices, as medical device manufacturers use that method to recover the 2.3% they must pay to the federal government starting in 2013.

“It’s a straightforward tax on the universe of medical device products and services as regulated by the FDA—regardless of class but with some exceptions,” stated Brett Loper, Senior Executive Vice President and Director, Government Affairs, for the Advanced Medical Technology Association (AdvaMed), in Washington, D.C., in an interview with THE DARK REPORT. AdvaMed member companies produce about 90% of the medical devices, diagnostic products, and health information technology systems sold in the United States each year.

With passage of this bill, the clinic laboratory industry dodged the bullet of the proposed $750 million per year tax that was in an early draft of the Senate bill. In that sense, lab industry efforts to educate Congress about the negative impact of such a direct tax on the revenues of clinical laboratories were successful. Now the laboratory industry needs to assess the financial impact of the 2.3% tax that will soon be paid by medical device companies.

Far-Reaching Effects

According to Loper, as currently written in the law, the tax would affect just about every purchase a laboratory would make. This includes analyzers, lab automation systems, lab equipment, information systems (including software), reagents, and consumable products. While the tax would apply to products and equipment a lab would purchase, it is not yet clear how the 2.3% tax would be administered for equipment a lab would lease or acquire on a reagent-rental basis, he added.

On questions regarding lease and reagent-rental arrangements that are commonly used by IVD companies and their clinical laboratory customers, Loper said that, “as with many of the details regarding this new legislation, we must wait for the U.S. Treasury Department to issue regulations that provide answers to these questions. There are rules that relate to rental payments and leasing payments. It could be some time before we learn how the 2.3% tax will be assessed on these types of medical device sales.”

Questions Await An Answer

“As to whether the tax will be collected on consulting fees or equipment service contracts provided by IVD manufacturers, I think they would not be taxed under this new law,” Loper added. “Consulting fees and service contracts are not FDA-approved products. Rather, these contracts ride alongside certain products. It may be that the answer to this question depends on how individual contracts for consulting and services are spelled out.

“If a medical device service contract is currently listed as being part of the price of the equipment, I would expect the buyer would see manufacturers wanting to unwind that connection in some way so that consulting fees and service fees would not be subject to the tax,” explained Loper.

“At this point, it is impossible to accurately predict who will bear the economic imposition of the tax,” he said. “I suspect that—depending on the company and the product involved—there will be varying degrees of absorption by the manufacturer versus the purchaser, and ultimately the consumer through Medicare or their insurance plan.

“Certainly manufacturers are responsible for remitting the tax,” he added. “But economists generally agree that excise taxes are passed along—to be paid ulti- mately by the consumer.

Not Good Public Policy

“Medical device manufacturers certainly are not supportive of this tax,” Loper noted. “We didn’t want it and we don’t think it is good public policy. There is some resignation that it will be in place in 2013. But if there is an opportunity to press for its repeal, I’m sure the industry would pursue that outcome. We have not yet developed a strategy related to repeal because these are all new developments.

“As it was, we worked very hard to get the device tax down to the rate that it is now,” Loper continued. “There were suggestions that it should be much higher. In fact, the Senate bill had the tax structured differently and in such a way that it would have raised twice as much revenue. Also, in earlier versions of the health reform bill, the tax was going to become effective this year.

“As mentioned, there are exceptions in the bill that include eyeglasses, hearing aids, contact lenses, and a list to be determined by the Secretary of the Department of Treasury at a later date,” Loper explained. “These exceptions cover prod- ucts that are used by individuals and generally purchased in retail settings. The exemptions cover simple products found, for example, at pharmacies, but not clinical laboratory equipment or supplies.”

A Dampening of Innovation

Officials at the Medical Device Manufacturers Association (MDMA) believe the 2.3% federal tax will dampen innovation among companies that develop medical equipment. “MDMA is concerned that this $20 billion medical device tax will have a negative impact on patient care, innovation, and small business,” said Mark Leahey, MDMA’s President and CEO. “If eliminating the 2.3% tax is not possible, structuring it to provide relief for smaller companies is critical.”

“Under the current structure, many companies will owe more in taxes than they generate in profits,” predicted Leahy, “These companies will lay off employees, slash research and development budgets, and slow the development of new therapies that would have improved the quality of care for all Americans. Moving forward, these issues must be addressed before the tax takes effect.”

Work To Repeal Tax

Because the effective date for this new tax is almost three years into the future, medical device manufacturers hope to eliminate or reduce the tax before then. In the meantime, the effect of the tax on pathologists and lab directors is likely to cause an increase the cost of all the equipment, reagents, consumables, and software that laboratories purchase as manufacturers take steps to offset that 2.3% tax.

THE DARK REPORT recommends that clinical laboratories and pathology groups assess the impact that the 2.3% federal tax on medical devices w ill have on their laboratories’ finances. Although the effective date is not until January 1, 2013, lab industry suppliers will be looking for ways to recover that tax to minimize its negative impact on their own profits.

Moreover, pathologists and laboratory administrators should keep a watchful eye as the Obama administration begins to implement the actions defined in the new legislation. With 2,700+ pages, the bill is a smorgasbord of action items. It includes the creation of almost 200 new health boards, review committees, and similar government departments.

As authorized by the new health law, many of these newly-formed departments will operate under the radar—until they issue directives and regulations that significantly alter existing aspects of the healthcare system. Because laboratory testing underpins a significant proportion of clinical activity, it is inevitable that a large number of these directives will have a direct and radical impact on how clinical laboratories provide testing services.

Two Senators Recognize Corrosive Effect of Tax

LAST WEDNESDAY, U.S. Senators Scott Brown (R-Massachusetts) and Pat Roberts (R-Kansas) co-sponsored an amendment to repeal the 2.3% medical device tax immediately.

“In Massachusetts, more than 200 medical device manufacturers—who employ tens of thousands of workers— would be impacted by this jobs-killing tax,” predicted Brown. “Furthermore, this tax would ultimately be passed onto consumers, who will all pay more for their necessary medical equipment.

“With unemployment in my state near 10%, placing a tax on medical devices is the absolute last thing we should be doing right now,” he stated. “This [2.3% medical device] tax will burden employers and cost jobs at a time we cannot afford one more job being lost.”

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