Comments Regarding Taxable Medical Devices

May 07, 2012 Categories: Comments and Letters, Regulatory Issues


May 7, 2012

Steven T. Miller
Deputy Commissioner for Services and Enforcement
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC

Submitted electronically via (IRS REQ-i 13770-JO)

Re:       Taxable Medical  Devices;  CC:PA:I2PD:PR  (REC—113770-10). Dear Deputy Commissioner Miller:

On behalf of the American Clinical Laboratory Association (“ACLA”), I am pleased to provide these comments in connection with the Internal Revenue Service’s (“IRS”) Notice of Proposed Rulemaking (“NPRM”) relating to taxable medical devices.’ This NPRM contains proposed regulations implementing the excise tax imposed on certain medical devices  under Section 4191 of the Internal Revenue Code (the “Code”), pursuant to the Health Care and Education Reconciliation Act of 2010 and the Patient Protection and Affordable Care Act (collectively, the “ACA”). ACLA is a not-for-profit association  that  represents  the  nation’s leading providers of clinical laboratory services, including local,  regional,  and  national laboratories throughout the United States. Most laboratories, including  most  ACLA members, offer testing services that they develop “in-house” (usually referred to as “Laboratory-Developed Tests” or “LDTs”), which are the principal concern of ACLA as discussed in this letter. ACLA previously  provided comments on the device tax, including in response to Notice 201089,2

Under the proposed regulations, the new excise tax on medical devices applies to a device if it is listed as a device with the Food and Drug Administration (“FDA”) under section 510(j) of the Federal Food, Drug, and Cosmetic Act [FFDCA] and 21 CFR part 807, pursuant to FDA requirements.3 ACLA is generally supportive of this definition, as it will help to distinguish LOTs, which were not intended to be subject to the medical device tax, from medical devices that were intended to be subject to the tax. However, ACLA is also concerned about what could happen in the future if FDA changes its position on the need for LDTs to be listed.

In addition, there is considerable ambiguity regarding how the tax would be calculated on laboratory tests in the event that an LDT is subject to the tax, because LDTs are not sold in commerce and because such testing is actually a service, rather than a medical device.


ACLA’s comments on the proposed regulations are summarized as follows:

Comments Relating to the Definition of Taxable Medical Device (Prop. Rcg. § 48.4191-2):

  • ACLA supports the provision  in the proposed  regulations  that anything that is not listed as a device with the FDA is not subject to the tax.  ACLA agrees that an item or service should not be subject to the medical device excise tax if it is not “listed as a device” with the FDA.  With respect to LDTs specifically, LDTs are not now regulated by FDA. Thus, most LDTs are not listed with the FDA and excluding LDTs from the tax is consistent with Congressional intent.
  • The provision in the proposed regulations relating  to  “devices  that  should  have been listed with the FDA”  should be modified so that mere notice from the FDA that it believes that a device should have been listed does not trigger the excise tax. The final rules should reflect the fact that a notice from the FDA does not constitute a final determination that an item or service is, in fact, required to be listed with the FDA, especially if appeals of that position are still on-going. The final rule should also clarify that “listed as a device” refers to listing information (new, updates or annual review) electronically using Form FDA 3673, or if FDA grants a request for a waiver from the requirement for electronic submission, listing using Form FDA 2892.
  • To ensure consistency with Congressional intent, and to prevent inequity if FDA decides to subject LDTs to new requirements, a specific exemption from the tax should be established for any LDTs listed as medical devices. Congress clearly did not intend to subject LDTs to the medical device tax, even if they are listed with the FDA as medical devices.


Comments Relating to the Calculation of the Tax (Prop. Reg. § 48.4191-1)


  • In the event that an LDT is considered a taxable device in a particular case, constructive price rules should recognize that an LDT is primarily a service, i.e., the performance of a test using medical devices such as reagents and other supplies, rather than a device in and of itself. In those limited situations in which an LDT may be subject to the device tax, the tax will generally be imposed under Code Section 4218, and a constructive sales price will be needed, because LDTs are not sold as devices. In order to ensure that the rules are consistent and treat tests performed using devices such as kits the same as those performed using LDTs, IRS should ensure that the constructive sales price is based on the cost of components necessary to perform the EDT, and not on the reimbursement for performing the lab test.


These issues are discussed in detail below.

I. Overview of LDTs and the Potential Application of the Medical Device Tax

In order to understand whether the medical device excise tax should be applied to LDTs, and if so, how, it is important to understand how laboratory testing is developed and performed. Clinical laboratories perform testing on human specimens ordered by physicians and other health care providers as an aid in the assessment of a patient’s health and to help guide care  and treatment.  Laboratory tests can come to market under two different pathways —  as a test kit sold to clinical laboratories and others in interstate commerce or as an LDT developed by the laboratory that performs the test itself. Under the first approach, a medical device manufacturer can develop a test as a physical product and then package all of the necessary  components together in a “kit,” including the necessary reagents and other  materials, plus  a package  insert and directions for conducting the test.

Manufacturers sell these kits to clinical laboratories, hospitals, and other health care providers who then use them to perform testing services. These types of kits are classified by the FDA pursuant to its medical device authority as Class I, II or III devices, and the manufacturers are required to register their manufacturing establishments and list their device products with the FDA. These “kits,” when sold by manufacturers to customers to perform tests, will be subject to the medical device tax under the proposed regulations (unless an exception applies, e.g., certain kits may qualify for the retail exception to the tax). The actual testing service performed with these kits, however, is not a device or regulated as such, but is a process or service and therefore would not be subject to the tax. Thus, the manufacturer would pay the device tax based on the sale price of a listed testing kit, but the tax would not be imposed on the revenue earned by the laboratory when performing a test using the kit.

A second way that a test can be introduced, however, is when a laboratory develops an LDT for use by that laboratory alone. Laboratories are not regulated by the FDA, but rather are subject to a  different oversight system established by the Clinical Laboratory Improvement Amendments (“CLIA”),4 which is enforced and overseen by the Centers for Medicare & Medicaid Services (“CMS”), rather than by FDA. Unlike the commercial kits described above, LDTs are not physical products sold to other laboratories, providers,  physicians  or  patients. Rather, LDTs are services developed “in house” by a laboratory, for performance solely in the laboratory. Laboratories  create LDTs by establishing a Standard Operating Procedure  (“SOP”) for performing the tests. Laboratories, however, do not create a physical product like a test “kit.” Instead, an LDT essentially describes a process for how a particular test service will be performed in the laboratory.

Reagents and other supplies are typically purchased in bulk to perform the LDTs. Some of these reagents and supplies, purchased in bulk, are taxable medical devices under the proposed regulations and, as such, would be subject to the medical device tax. Laboratories that develop LDTs in house offer to perform the testing service to physicians and their patients. When the service is ordered, the laboratory performs the test and reports the result back to the physician. The laboratory does not use reagent and other supply components it acquires in order to develop a product that is sold, but rather uses those components to perform the service. LDTs are extremely common and are performed within stand-alone clinical reference laboratories or laboratories in facilities at other locations, such as hospitals, physician pathology practices, and university medical centers, none of which, consistent with FDA regulations, consider themselves manufacturers. Large and small laboratories all develop and perform LDTs, in addition to purchasing test kits and equipment from medical device manufacturers.

Although over the past decade the FDA has made general statements that it considers laboratories that create LDTs to be manufacturers and LDTs to be devices, the FDA does not currently regulate LDTs as medical devices. It does not require laboratories to go through registration and listing, which it requires for medical device manufacturers, nor does it require laboratories to seek approval or clearance for LDTs. While most medical devices are classified as Class I, II or III by FDA, most LDTs are not classified by the FDA under this scheme. Further, laboratories utilizing LDTs are not currently required to pay user fees under the Medical Device User Fee Amendments of 2007 (“MDUFA”).

Based on these facts, it should be clear that all LDTs are not currently treated as medical devices by the FDA and it is important that the final rules under Section 4191 maintain a distinction between medical device products and LDT services.


II. ACLA’s Specific Comments on the Proposed Regulations

With this background, we can now turn to ACLA’s specific comments on the proposed regulations. As discussed below, ACLA is generally supportive of the decision to focus on whether an item or service is “listed as a device” or not in deciding whether it should be considered a “taxable medical device;” however, the NPRM still leaves a number of unanswered questions related to how the rules should apply to LDTs, which are more properly viewed as services rather than products or devices.

A. Comments Relating to the Definition of a Taxable Medical Device

1.  ACLA supports the provision in the proposed regulations that anything that is not listed with the FDA is not a “taxable medical device.”

The proposed regulations define a taxable medical device as one that is “listed as a device with the Food and Drug Administration (FDA) under section 510(j) of the Federal Food, Drug, and Cosmetic Act and 21 C.F.R. Parts 807, pursuant to FDA requirements.” Thus, items or services that are not listed with the FDA are not taxable medical devices. ACLA supports the exclusion from the tax of items or services that are not listed with the FDA and agrees that this approach  will  serve the  goals  of certainty  and administrability.    With respect to LDTs in

particular,  this is the correct result under the statute and is supported by the legislative history. LDTs are not currently required to be listed as devices with the FDA.

As we have discussed in our prior comments on  the device tax, both the laboratory industry and the medical device manufacturing industry contributed in their respective  ways to the funding of health care reform.  The primary purpose of imposing a medical device tax was to obtain a contribution from registered device manufacturers because such manufacturers are not directly reimbursed by Medicare. Laboratories and other providers, unlike device manufacturers, are directly paid by the federal government through the Medicare  Program;  thus,  laboratories were able to contribute to health care reform through adjustments in their  Medicare reimbursement. And, in fact, laboratory organizations,  including ACLA, worked cooperatively with the key Congressional committees to identify cuts in lab reimbursement that could be used to fund a portion of health care reform. These cuts in laboratory reimbursement, which were substantial, were included in the final legislation. Thus, Congress did not intend for LDTs to be subject to the device tax, because clinical laboratories contributed to the financing of health care reform by other means. Further details of the legislative history that support exclusion of LDTs from the device tax are discussed in our earlier comments, which are attached for your reference.


2. The proposed rule regarding when an item or service becomes subject to tax based on a future FDA determination should be modified.

The proposed regulations provide that if the FDA determines that an item or  service should be listed as a device  at some point in the future, then “the device will be deemed to be listed as a device with the FDA as of the date the FDA notifies the manufacturer or importer in writing that corrective action with respect to the listing is required.”5 ACLA disagrees with this approach and is concerned that this language may create confusion in the future depending on what form of action the FDA takes. Further, this approach does not sufficiently recognize that a notice from the FDA is not a final determination that an item or service should be listed.

First, ACLA believes that it should be clear that in referencing “listing,” the regulation is referring only to electronically listing using FDA Form 3673 or, if FDA grants a request for a waiver from the requirement for electronic submission, listing using the specific FDA Form 2892, which are the FDA forms required for persons seeking to list their items or services. We emphasize that point because various forms of notification are often required or proposed for health care entities. For example, the National Institutes of Health (“NIH”) has its own registry of genetic tests, which is currently voluntary but conceivably could become mandatory at some point in the future. (It is also conceivable that the FDA would utilize the NIH registry as a proxy for FDA listing.) Many LDTs will likely be included on such a registry. Thus, for the sake of clarity, it should be specified that the only form of “listing” that is contemplated by the IRS definition is a listing with the FDA using the electronic listing pursuant to Form FDA 3673 or waived-listing using Form FDA 2892.

Further, it should not be sufficient for FDA simply to notify an entity that an item or service should  be listed. For example, an entity may  challenge  a determination  by the FDA either administratively or through court action. Therefore, and  especially  given the  unsettled status of the FDA’s regulatory authority over LDTs, we recommend that the regulations provide that the tax is required  as of the date that the FDA notifies the entity in writing with respect to listing, or when a final determination has been made by a court of competent jurisdiction that such listing is required, whichever is later.


1.                          To ensure consistency  with Congressional intent, a specc exemption from  the tax should be established for  any LDTs listed as medical devices.


As noted above, under FDA’s current regulatory approach, LDTs would not typically be captured by the current definition because they are not usually listed. ACLA is concerned, however, that even this approach will be insufficient if FDA takes additional action in the thture to regulate LDTs. As noted above, FDA has discussed this possibility, although it has yet to issue guidance defining what approach it intends to take. FDA has discussed that it may initially require laboratories to list their LDTs in some way, even without requiring them to go through other regulatory steps, such as pre-market approval or clearance or post-marketing controls. Thus, ACLA is concerned that based on the regulations’ current approach, LDTs could be made subject to the tax even though this seems inappropriate and inconsistent with Congressional intent, as discussed below. (As noted above, ACLA also believes it is important that the regulations specify what is meant by “listing,” so that LDTs do not become subject to the tax if FDA takes some other approach, such as requiring listing in the NIH Genetic Test Registry.) Therefore, ACLA believes that the regulations should simply exclude LOTs from the definition of “taxable medical device.”


As discussed above and in our earlier comments, Congress clearly did not intend to apply the medical device tax to LDTs because laboratories were already contributing to the financing of bealthcare reform through Medicare reimbursement cuts to which traditional medical device manufacturers were not subject. Therefore, to also apply the medical device tax to LDTs would unfairly require labs to fund healthcare reform through both Medicare reimbursement cuts and the medical device tax, when other stakeholders are only subject to one or the other. The legislative history also indicates that the device tax was intended to apply to “medical devices regulated by the Food and Drug Administration as a medical device and subject to premarketing and postmarketing regulatory controls.”6 This language also demonstrates that Congress did not intend for the tax to apply to LDTs, because they were not regulated by the FDA and were not subject to pre- and post-market controls.


Further, not only does FDA not currently regulate LDTs but it does not require laboratories using them to pay user fees under MDUFA, which applies to medical device manufacturers. In fact, in the latest set of MDUFA negotiations, FDA has stated that it is seeking additional authority to waive the user fee requirement in certain instances. It has also stated that it will use that authority “to ensure that no additional LDTs or laboratories would be subject to user fees” during the period covered by the reauthorization.7 In sum, the current FDA position maintains the status quo with regard to the treatment of LDTs under MDUFA. As a result, the regulations should also recognize this distinction  and ensure that LDTs are not inappropriately captured by the device tax requirements.


Finally, even if the FDA required listing of LDTs at some point in the future, that requirement alone should not be sufficient to convert LDTs into “taxable medical devices.” The FDA’s own regulations state that the mere fact that a product is listed “does not constitute an admission or agreement or determination that a product is a device within the meaning of section 201(h)” of the FFDCA.8 Thus, an FDA requirement to list LDTs should not be sufficient to make them “taxable medical devices,” especially given the questions that exist about the validity of such an argument. Moreover, the distinctions between medical devices and LDTs would be even clearer, if — as appears possible —  FDA only required listing and did not also require LDTs to comply with other pre-marketing and post-marketing requirements.  In  such a case,  LDTs would still not be subject to the full array of requirements applicable to most medical devices, a situation that would further demonstrate the difference between LDTs and medical devices and set LDTs apart from taxable medical devices.


ACLA urges therefore that the regulations be crafted to ensure that LDTs are not made taxable medical devices automatically, if the FDA requires their listing at some point in the future. In order to avoid this unfair result, the regulations should simply exempt LDTs from the medical device tax to ensure that Congressional intent is not thwarted. Such an exemption would prevent unintended consequences if FDA sought at some future time to regulate LDTs as medical devices and included a requirement for listing. Furthermore, such an exemption would also help ensure that Congressional intent was achieved. And, because the tax would still be paid on the sales of the components of the LDT, the tax itself would not be avoided.


B. Constructive Price Rules for Imposing the Tax on LDTs Should be Based on the Cost of the Components Necessary to Perform the Test in Order to Ensure Consistent Treatment of Laboratory Tests


In the event some LDTs are determined to be subject to the device tax, notwithstanding our proposals above, a number of questions that relate to how the tax should be calculated for

LDTs will still need to be addressed. For the reasons discussed below, we expect that in those situations in which the excise tax is imposed on an LDT, the tax will be imposed as a result of the “use provisions” of Code Section 4218. The critical issue in applying the tax in such cases is determining the proper price on which to base the tax. Further guidance is needed on how to establish the constructive price for the LDT, because there is usually no product that can be used as a benchmark in establishing the price. In particular, the constructive price should be set to properly reflect the cost of components and should not be based on the amount received for the performance of each test, which is payment for the entire service. (For the purposes of this discussion, “components” would include the reagents and supplies used to perform the test, but would not include other, more general costs, such as labor and overhead.) This approach would ensure that kits and LDTs were taxed in the same way. In the case of a kit, under the proposed regulations, the device tax would be imposed when the kit is sold, and would not include the revenues earned on the testing services performed using the kit. Similarly, basing the tax on the cost of the components used to perform the LOT would ensure that the revenues earned on performing the test service are not subject to the tax.


These issues are discussed further below.


1.  Application of the Provisions of Code Section 4218 to LDTs

Section 4191(a) imposes 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.” Thus, to be subject to the tax, two requirements  must be met. First there must be a taxable medical device. Additionally, in order for the tax to apply, there must be a sale of the taxable device. In the case of LDTs, however, the LDT is not actually sold. Although laboratories make the results of the performance of the testing service available to ordering physicians, laboratories never sell the LDT itself in the same way that a manufacturer sells a test “kit.” Thus, there is no product for sale that should be subject to tax.

The absence of any sale of a device would, ACLA believes, be determinative on this issue were it not for a pre-existing provision in Chapter 32 of the Code, which creates some confusion. Section 4191 was placed into Chapter 32 of the Code, which relates generally to manufacturer’s excise taxes. Thus, in general, the pre-existing rules in Chapter 32 also apply to the medical device tax. It is, in fact, one of the pre-existing provisions of Chapter 32 — Section 4128 — that has created the issue discussed here. Section 4218 imposes a tax on the ç, as opposed to the sale, of another otherwise taxable article.    If this section applies, subsection 4128(c) states that the tax on the article will be computed “on the price at which such or similar articles are sold, in the ordinary course of trade.”

Section 4218 generally operates as a backstop to the manufacturers’ excise taxes in order to prevent avoidance of the tax when a manufacturer uses a taxable product itself (instead of purchasing the product subject to the tax from another manufacturer). However the situations in which the tax on use applies for other manufacturers’ excise taxes under Chapter 32 of the Code are far different than those at issue here. For example, the manufacturer of gasoline may actually use the gasoline in its own operation (e.g., to provide fuel for vehicles used by employees of the manufacturer in the course of business). If the use tax did not apply, the fuel would not be subject to tax in the same way as if it had been purchased from a third party. Similarly, a maker of tires might use some of those tires itself, rather than selling them. In those cases, Section 4218 is designed to ensure that those taxpayer uses of products become subject to the tax, even though no third-party sale occurs. Applying these concepts to an LDT is difficult, as often there are no comparable device sales to use as a benchmark in establishing a price. Therefore, there is no readily available way to identify what wholesale price should be used in calculating the tax.


2.  Determination of the Constructive Sales Price

The proposed regulations rely on pre-existing guidance under the excise tax rules to determine the sales price. Treasury Regulations generally seek to impose the use tax on the “lowest established wholesale price” for the article at the time of use.9 If the manufacturer does not regularly sell the article at wholesale in arm’s length transactions, which will generally be the case with respect to LDTs that are taxable devices, then a constructive sale price is to be determined by the IRS, taking into account the selling practices and price structures of manufacturers, producers, and importers of similar articles.’0 Rulings on determining the constructive sales price have been issued by the IRS under Section 4218, as well as on constructive sales price issues under Section 4216 (which deals with sales other than sales at wholesale in arm’s length transactions).

The pre-existing guidance on determining constructive sales price does not adequately address how a sales price should be determined with respect to taxable LDTs, which include a service component in addition to the cost of the medical device components used to perform the service. LDTs present unique issues compared to products that are subject to current excise taxes (e.g., gas) and other taxable medical devices (such as an MM device). Additional guidance is needed to specifically address LDTs that recognizes these distinctions so that laboratories that perform LDTs can properly apply the tax.

First, for LDTs, there is no similar article that is sold in the ordinary course of trade. The formulation set out in Section 4218 is relatively easy to apply in the case of most other taxable devices (or other products subject to an excise tax, such as gas) because those products are routinely sold in commerce. However, LDTs are not sold in commerce and there is often no comparable product on whose price the tax can be based.

In addition, a constructive sales price for an LDT should recognize that the performance of an EDT is a separate service that is not subject to the tax. As noted above, the laboratory does not create a test “kit” when it performs an EDT.  Rather the lab simply performs the test using components that it purchases from manufacturers or that it creates itself.” When the laboratory bills for the test, it is billing, and reimbursed, for the entire service. It would be inappropriate to base the computation of  the tax on the total reimbursement received from third-party payors because that reimbursement is a reflection of the value of the test service performed by the laboratory, not what would be earned on a wholesale level sale of the LDT components if sold as medical  devices.   The price of the  service —   whether  performed  using  a test kit  or an LDT includes additional laboratory costs such as specimen collection, test performance, result delivery, overhead, sales, marketing, regulatory compliance, personnel costs, rents, supplies and many other expenditures related to the performance of the test. All of these expenses are added to the cost of the kit or the inputs for the LDTs to develop the “price” for the service. Taxing an EDT on this “final” price would overtax LDTs compared to laboratory testing performed with kits and create an inequity in the market. For example, while the tax must be paid on the sale of an x-ray machine, no one would suggest the price on which the tax is calculated should include the amount that is paid for an x-ray procedure performed using that device (or that the tax should be imposed each time an x-ray procedure is performed). Rather, the tax is imposed only on the device that is used to perform the procedure and not on the sale price of the procedure each time it is performed.

In the case of EDTs, the cost of the reagents and other supply inputs used to perform the test will come closest to approximating the price of the “taxable medical device” used to perform the test and will provide parity with respect to tests that are performed with kits.  This approach is also consistent with the purpose of the use tax, which is designed to operate as a back stop to the manufacturers’ excise taxes in order to prevent avoidance of the tax when a manufacturer uses a taxable product  itself (instead  of purchasing  the product  subject to the tax  from another manufacturer).  2

Calculation of these costs will be an exceedingly complex task and will  have  to  be applied to thousands of LDTs. As a result, ACLA has several suggestions for better and more efficient ways to resolve these problems. First, by far the simplest  and most  direct  approach would be to impose the tax on the manufacturer upon the sale of the EDT components (to the extent they are taxable devices). In this way, the need for calculation of a constructive price on the laboratory’s EDT would be avoided. Furthermore, payment  of the tax based  on the sale of the inputs would ensure that the tax is not avoided. Such an approach would provide the greatest consistency with respect to taxation of laboratory tests, as well as  minimize  administrative burdens for both the IRS and taxpayers. This approach is also consistent with the proposal for an exemption for EDTs, discussed  above.

If this approach is not adopted, then ACLA requests that IRS  establish  a process  by which laboratories can seek guidance either individually or through associations such as ACLA to review how a constructive price should be determined. As noted, the calculation of the tax will be extremely difficult and laboratories (and, we expect, other entities) may need significant additional guidance before such calculations are even possible. In relying  on  pre-existing guidance on constructive price issues, the proposed regulations provide insufficient guidance on how a price would be determined with respect to taxable medical devices in general, and LDTs in particular. We emphasize that the excise tax regime is new to entities that are subject to the tax and these entities do not have familiarity with the pre-existing rules. Further, the pre-existing guidance was developed for other industries, and therefore it does not adequately address the situations that are unique to the medical device and laboratory industries and their  sales processes.  In addition, the items and services that may be  considered  taxable medical  devices are very broad, and each has unique characteristics. Thus, taxpayers need much more specific guidance as to how the tax would be applied in particular  circumstances,  including  an opportunity to discuss in advance with the IRS the appropriate method for determining price and an opportunity for input on specific methodologies that are likely to be used by affected parties. Ultimately, as discussed above, any guidance should ensure that the tax is properly imposed on the cost of the laboratory’s purchased inputs, rather than on the amount paid to the laboratory for each test service performed using an LUT. As explained above, the reimbursement for the laboratory service is not an appropriate price.





Thank you for your assistance. If you have any further questions, please feel free to contact us.


Alan Mertz


(See attachments in PDF at top of page)


See the original PDF file here.

Print page / Save as PDF