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“A Concession For ACA Medical Device Tax Opponents”

Law 360 By Jennifer J. Hennessy

The United States Congress passed the $1.15 trillion appropriations bill unveiled on Dec. 16, 2015, last week, providing medical device manufacturers and importers a tax reprieve for the next two-year period.[1] The appropriations bill aimed, among other things, at suspending the medical device excise tax under the Affordable Care Act was signed by President Barack Obama.[2] Due to the appropriations bill’s passage, the tax will be suspended until January 2017.[3] The medical device industry is likely to view this recent legislative concession as a win, as such action eliminates the risk of an administrative veto related to repeal and results in a legislative “punt” to be dealt with by the next, new administration.[4]

The Excise Tax, Origins and Impact on Industry

Since Jan. 1, 2013, the ACA imposed a 2.3 percent tax on the sale of medical devices by manufacturers.[5] The tax applies broadly to a range of products, including pacemakers, CT scanners, artificial joints and surgical gloves.[6] Certain devices are exempted, including eyeglasses, contact lenses, hearing aids or any other device that the public generally buys for individual use.[7] Further, the tax is applied equally to imported and domestically produced devices, and devices produced in the U.S. for export are tax-exempt.[8]

According to the Joint Committee on Taxation, the tax was estimated to generate $29 billion dollars over a 10-year span.[9] It was a provision designed to offset the cost of providing health care coverage to more than 25 million Americans under the ACA.[10] The original objective of the tax was believed to arise out of the Senate’s 2009 proposal to raise revenue from the medical device industry by taxing gross receipts to be consistent with fees imposed on drug manufacturers.[11] The House proposed a flat excise tax across all device manufacturers, which was ultimately adopted, and any limitation to tax profits did not appear in the final tax.[12]

Since its passage in 2010, the medical device excise tax has garnered much attention. Proponents of this tax pointed to the benefit that device manufacturers would receive from increased revenue related to the needs of the newly insured Americans under the ACA, which was believed to increase medical device demand.[13] The tax, criticized for its assessment on gross device sales rather than net profits, results in device firms being taxed even if the company is losing money.[14] In the current regulatory environment, market clearance and approvals of medical devices are criticized as being unpredictable both in terms of time and money.[15] The time period of research and development prior to commercialization of a device is critical and the prospect of a device firm generating profits during that time can be uncertain and costly.[16] Opponents’ strongest argument against the tax appears to be that it suffocates innovation by reducing profits used to grow research and workforces.

In January 2015, AdvaMed, the largest of the medical device industry groups, issued results of a survey of device industry members that confirmed a reduction in both research and development dollars and employee workforce as well as an increase in the relocation of or diversion to manufacturing operations outside the U.S.[17]Other reports have refuted the purported impact on medical device company revenue and stifling of innovation. The U.S. Government Accountability Office released a report in June 2015 that discussed preliminary finding on the impact of the medical device tax on publicly traded device companies, which suggested the largest 30 publicly traded companies’ profits grew over the 10-year span while medium- to smaller-sized companies declined in profits.[18] Furthermore, the report’s findings indicate that larger publicly traded companies may have felt less impact than the smaller privately held firms, which are theoretically and reportedly the most severely impacted by the medical device excise tax.

Commentators have noted that the real threat to innovation is this impact on the smaller privately held innovative device companies, which are attempting to enter the market.[19] Such medical device firms are having a harder time becoming profitable with the additional cost of this excise tax.[20] The ultimate effect is that the larger, more established device firms (particularly those that are publicly traded) have even a stronger hold on the market thereby reducing the competition.[21] In the end, if fewer innovations make it to market, it is patients who are impacted.[22] Clearly a suspension of this excise tax for these smaller device firms will provide a more inviting environment for continued innovation.

Repeal Efforts

Medical device industry groups have been very active in raising awareness regarding the impact of the tax on manufacturers, the economy and individual patients.[23] Members of Congress have made the repeal of the tax a priority since the 2013 negotiations over ending the federal government shutdown and increases in federal debt ceiling.[24] The bill that has had the most momentum is the M.R. 160, the Protect Medical Innovation Act, which would repeal the excise tax retrospectively to 2013.[25] Republican and Democratic legislators in support of the bill cited their concern in a letter of support to Congress:

... the U.S. device industry is subject to one of the highest corporate tax rates in the world. And many smaller early-stage companies must pay the tax even though they are years from becoming profitable. As companies look to make cuts to offset the tax, one of the first items to go is research and development ...[26]

Nonetheless commentators reported concern that an outright repeal of the tax could not pass Congress, and that any measures to cut back on the tax would have to be part of a larger effort with significant bipartisan support.[27] Accordingly, the recent passage of the appropriations bill may have been the best outcome for device excise tax opponents.

What’s at Risk with Passage of the Appropriations Bill?

The elephant in the room is how will the suspension on the medical device excise tax be offset to fund the deficit. Will other taxes be imposed or other budgetary cuts be made? Will other negative impacts of the device tax be thwarted, such as increasing device prices to offset the tax? These are some of the questions that will need to be examined in the new year.