Medical Device Tax: Tax Minimization and Rise of the Distributor
*Legal Disclaimer: All thoughts on this site are mine and do not represent any organization I am involved with in any way
Recently I read through the healthcare bill (H.R. 4872, Public Law 111-152, Health Care and Education Reconciliation Act of 2010) to learn more about the tax that will be imposed upon medical device companies. While I am not an accountant or a lawyer, as I read the extremely slim text regarding the tax it appeared that there may be a simple way for domestic medical device companies to minimize the tax.
IN GENERAL.—There is hereby imposed on the sale of any taxable medical device by the manufacturer, producer, or importer a tax equal to 2.3 percent of the price for which so sold.
This text, along with some minor content regarding definitions and exemptions, is all that currently defines the excise tax.
I take this to mean that the manufacturer, even if they do not sell the finished device to the end user, will be responsible for the tax. In the case of OEM or contract manufacturers this will likely be a boon as the tax will be taken prior to the final sales price, as opposed to adding the tax at the final sale. Distributors will experience a similar relative benefit as the tax will also be added prior to the final sale. Perhaps most interesting will be the response by companies that both manufacture and sell their devices. Theoretically a company could form a new subsidiary that engages exclusively in manufacturing and subsequently sells the finished product to the parent company for final distribution.
What does this mean in terms of real dollars? Let’s take the case of ablation antennas, a high margin product. Radio frequency ablation device manufacturers, such as Boston Scientific, Celon, Integra Lifesciences, and AngioDynamics amongst others, sell their products at a range of price points around $2,000 per unit; for this example I will assume they all sell at exactly $2,000. Similarly the standard cost likely varies from $100 to over $400 per unit; I will assume a constant standard cost of $250.
Undoubtedly the healthcare bill was intended to tax the devices at the $2,000 final sales price, resulting in an approximate $46 price increase due to the excise tax (assuming the seller passes the tax on to the buyer as intended). However a company that manufacturers the device in the United States, such as Boston Scientific, could form a new subsidiary (which I will call it Boston Sci Mfg). Boston Scientific could then act as the distributor for Boston Sci Mfg and the tax, now paid by Boston Sci Mfg, would be an approximately $6 on the standard cost of the $250, reducing the net tax to 0.3%. If Celon wanted to compete in the US market, as an importer the tax would have to be on the $2,000 final price, resulting in a $40+ larger tax than the domestic competitor.
While an approximately $40 difference on such a device is seemingly small, the effect is similar to implementing a 2% import tariff on the foreign manufactured device. And in the $95 billion US medical device market that is a lot of cash. Certainly, for example in the young microwave ablation market American startups such as NeuWave against the UK's Acculis, domestic companies will enjoy the advantage over foreign competitors.
Of course many devices have lower margins, resulting in a lower difference in effective tax rates. Further, the difference will be slightly diminished as the tax can be considered as a cost of the device sold, though this will have a minimal affect. But what will be the long-term effects of the medical device tax? A new version of transfer pricing? Last minute changes to the legislation? A slowing of manufacturing moving to low-cost countries? What are your thoughts?