n-12-77.pdf

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Part III - Administrative, Procedural, and Miscellaneous

Interim Guidance and Request for Comments; Medical Device Excise Tax;
Manufacturers Excise Taxes; Constructive Sale Price; Deposit Penalties

Notice 2012-77

Section 1. PURPOSE

This notice provides interim guidance relating to the excise tax on medical
devices imposed by § 4191 (the “medical device excise tax”) of the Internal Revenue
Code (the “Code”). Specifically, this notice provides interim guidance for determining
price under § 4216(b). This notice also provides interim guidance relating to donated
taxable medical devices, the licensing of taxable medical devices, and the tax treatment
of medical convenience kits. In addition, this notice provides transition relief to medical
device manufacturers from the failure to deposit penalties imposed by § 6656. Finally,
this notice requests comments from taxpayers about the rules described in this notice.

Section 2. BACKGROUND

Section 4191, enacted by section 1405 of the Health Care and Education
Reconciliation Act of 2010, Public Law 111-152 (124 Stat. 1029 (2010)), in conjunction
with the Patient Protection and Affordable Care Act, Public Law 111-148 (124 Stat. 119
(2010)), imposes an excise tax on the sale of certain medical devices. The excise tax
imposed by § 4191 is 2.3% of the price for which the taxable medical device is sold.
The medical device excise tax is codified in chapter 32, subtitle D of the Code (“chapter
32”), which pertains to excise taxes imposed on the sale or use of taxable articles by
manufacturers, producers, and importers (commonly referred to as “manufacturers
excise taxes”). See
§ 48.0-2(a)(4)(i) of the Manufacturers and Retailers Excise Tax
Regulations (the “regulations”) (which defines the term “manufacturer” to include a
“producer” and an “importer”). As a result, the existing chapter 32 rules, including the
regulations issued thereunder, apply to the medical device excise tax.

On December 7, 2012, the Internal Revenue Service (IRS) and the Treasury
Department issued TD 9604, containing final regulations under § 4191. The final
regulations do not address certain issues that the IRS and the Treasury Department
continue to study. These issues include the determination of price under § 4216(b); the

tax treatment of medical software licenses; the taxability of donated medical devices;
and the taxability of medical convenience kits.

The IRS and the Treasury Department may issue additional published guidance
on these issues in the future. The IRS and the Treasury Department recognize,
however, that manufacturers need rules on these issues that will apply on an interim
basis. Sections 3 through 5 of this notice prescribe those interim rules.

In addition, several comments on the proposed regulations requested transition
relief from the deposit penalty under § 6656. In response to those comments, this
notice waives penalties under § 6656 for the first three calendar quarters of 2013.
Section 6 of this notice delineates the scope of this deposit penalty relief.

Unless otherwise stated, existing definitions provided in chapter 32, and the
regulations issued thereunder, apply to this notice.

Section 3. CONSTRUCTIVE SALE PRICE

(a) Overview of Constructive Sale Price. Section 4216 provides rules for
determining “price” for purposes of chapter 32. Those rules treat the price for which a
manufacturer sells a taxable article to an independent wholesale distributor, subject to
certain adjustments, as the applicable price for purposes of imposing the tax. In
general, when a manufacturer sells a taxable article to a purchaser other than an
independent wholesale distributor, § 4216(b) and the regulations thereunder prescribe
rules for constructing a sale price that approximates the price an independent wholesale
distributor would pay to the manufacturer for an identical article. In such situations, tax
is imposed on the constructive sale price as determined under § 4216(b).

The IRS and the Treasury Department recognize that the medical device industry
encompasses a diverse group of manufacturers that produce a broad range of articles.
The IRS and the Treasury Department also recognize that many manufacturers in the
medical device industry do not sell to independent wholesale distributors, and they may
employ more than one distribution chain according to industry practice related to a
particular article. Further, the IRS and the Treasury Department recognize that current
published guidance relating to the constructive sale price rules does not address some
of the types of distribution chains regularly employed in the medical device industry. In
addition, Rev. Rul. 80-273, 1980-2 C.B. 315, which provides a mechanism for
computing the constructive sale price where the articles are sold at retail by
manufacturers who do not sell like articles to wholesale distributors, does not by its
terms apply to § 4191.

(b) Interim Rules. This section provides interim rules for how taxpayers may
apply the constructive sale price rules to certain model distribution chains employed by
some manufacturers in the medical device industry. The IRS and the Treasury

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Department identified the distribution chains addressed in these interim rules through
written comments on the proposed regulations on taxable medical devices and informal
taxpayer inquiries.

If a taxpayer uses one of the distribution chains described in this section, the
taxpayer may apply the rules provided in this section to determine its medical device
excise tax liability. A taxpayer does not need to make any additional or special filing, or
notation on any filing, to apply these rules. If a taxpayer does not apply the rules
provided in this notice, and does not use the actual sale price of the article to calculate
its medical device excise tax liability, then the taxpayer bears the burden of
demonstrating that it used the fair market price of the article to calculate its tax liability.
This approach is consistent with the general rule under which a manufacturer may rebut
the constructive sale price if the manufacturer demonstrates that it sold the article at a
fair market price. Rev. Rul. 89-47, 1989-1 C.B. 295. Taxpayers may apply the rules
provided in this section until the IRS and the Treasury Department issue further
guidance.

For purposes of these rules, a “related party” means that one of the parties is
controlled (in law or fact) by the other, or there is common control of the parties
(regardless of whether such control is actually exercised to influence the sale price).
See
§ 48.4216(b)-2(e)(1). Further, for purposes of these rules, a “reseller” means a
sales company, a leasing company, a distributor, or a retailer. Finally, the application of
constructive sale price rules to calculate the tax base does not shift the liability for
excise tax from the manufacturer to any other person.

The interim rules are as follows:

(1) Sales at retail; no regular sales to independent wholesale distributors.

(A) Description
. In this distribution chain, the manufacturer sells taxable
articles directly to unrelated end-users. The manufacturer does not regularly sell its
taxable articles to independent wholesale distributors.

(B) Interim Rule
. Until the IRS and the Treasury Department issue further
guidance, the constructive sale price for this distribution chain, determined pursuant to
§ 4216(b)(1)(A), is 75% of the actual selling price after taking into account the
adjustments provided by § 4216(a). No further adjustments under § 4216 are allowed.
See
Rev. Rul. 80-273, 1980-2 C.B. 315.

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(2) Sales to unrelated retailers; no regular sales to independent wholesale
distributors.

(A) Description. In this distribution chain, the manufacturer sells taxable
articles to unrelated retailers. The manufacturer does not regularly sell its taxable
articles to independent wholesale distributors.

(B) Interim Rule
. Until the IRS and the Treasury Department issue further
guidance, the constructive sale price for this distribution chain is 90% of the lowest price
for which the articles are sold to unrelated retailers. This computation is made without
adjustment for any exclusion (except for the tax imposed on such article) or
readjustment under § 6416(b)(1)(a) and (e). See
Rev. Rul. 82-211, 1982-2 C.B. 296.

(3) Sales to related retailer; no regular sales to independent wholesale
distributors.

(A) Description
. In this distribution chain, the manufacturer sells taxable
articles to a related retailer. The related retailer sells the articles at retail to unrelated
end-users. The manufacturer and related retailer do not regularly sell the articles to
independent wholesale distributors.

(B) Interim Rule
. Until the IRS and the Treasury Department issue further
guidance, the constructive sale price for this distribution chain, determined pursuant to
§ 4216(b)(1)(C), is 75% of the product of 95% and the actual selling price (that is, the
price at which the article is sold to a person that is not a member of the group of
companies that are related to the manufacturer). The 5% discount is an allowance for
the exclusions from the selling price otherwise allowed under § 4216(a). See
Rev. Rul.
82-211. The additional 25% discount adjusts the selling price to approximate the selling
price to an independent wholesale distributor. See Rev. Rul. 80-273. No further
adjustments under § 4216 are allowed.

(4) Sales to related reseller that leases and sells at retail.

(A) Description
. In this distribution chain, the manufacturer sells taxable
articles to a related reseller. The related reseller sells the articles at retail to unrelated
end-users, and also leases articles to unrelated end-users.

(B) Interim Rule
. Until the IRS and the Treasury Department issue further
guidance, the constructive sale price for this distribution chain, determined pursuant to
§ 4216(b)(1)(C), is 75% of the product of 95% and the actual selling price (that is, the
price at which the article is sold to a person that is not a member of the group of
companies that are related to the manufacturer). The 5% discount is an allowance for
the exclusions from the selling price otherwise allowed under § 4216(a). See
Rev. Rul.
82-211. The additional 25% discount adjusts the selling price to approximate the selling

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price to an independent wholesale distributor. See Rev. Rul. 80-273. No further
adjustments under § 4216 are allowed.

(5) Sales to related reseller that only leases at retail; no regular sales to
independent wholesale distributors.

(A) Description. In this distribution chain, the manufacturer sells taxable
articles to a related reseller. The related reseller leases the articles to unrelated end-
users, but does not sell articles at retail. The manufacturer and related reseller do not
regularly sell the articles to independent wholesale distributors.

(B) Interim Rule
. Until the IRS and the Treasury Department issue further
guidance, the price for this distribution chain is the actual selling price to the related
reseller, provided that the selling price to the related reseller reasonably approximates
the fair market price of the article within the meaning of § 4216.

(c) Applicability to other taxes imposed by chapter 32 of the Code. Until the IRS
and the Treasury Department issue further guidance, all manufacturers subject to the
taxes imposed by chapter 32 of the Code may apply the rules provided in this section to
determine the constructive sale price of taxable articles under Chapter 32 to the extent
that any statute or other published guidance do not already provide rules addressing a
particular fact pattern or situation.

Section 4: SPECIAL CHAPTER 32 RULES APPLICABLE TO THE MEDICAL DEVICE
EXCISE TAX

(a) Sale to Hospital or Doctor’s Office Treated as Sale at Retail for Purposes of
Determining Price

(1) Overview. Section 48.4216(b)-1(c)(1) of the regulations defines “sale at
retail” as the sale of an article to a purchaser who intends to use the article, or to lease it
to another person, rather than resell it. Section 48.4216(b)-1(c)(2) defines “retailer” as a
person engaged in the business of selling articles at retail. Therefore, a sale to a
retailer is a sale of an article to a person engaged in the business of selling articles at
retail. Medical institutions and offices, such as hospitals and doctor’s offices, purchase
taxable articles that are used to treat patients. Sometimes an article is completely
consumed on the premises of a medical institution or office and other times the articles
leave the medical institution or office with the patient. Under the definitions described
above, it is unclear whether a sale of an article to a medical institution or office is a sale
at retail or a sale to a retailer.

(2) Interim Rule. Until the IRS and the Treasury Department issue further
guidance, the IRS will treat the sale of a taxable article to a medical institution or office
as a “sale at retail.”

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(b) Licenses

(1) Overview. In response to the proposed regulations, one commenter
requested clarification on whether the licensing of software that is a taxable medical
device is a taxable event for purposes of § 4191. That commenter requested that the
IRS and the Treasury department treat the licensing of software as a lease.

Under existing chapter 32 rules, the manufacturers excise tax generally
attaches upon the sale or use of a taxable article by the manufacturer. See
§ 48.0-2(b).
Section 4217(a) provides that the lease of a taxable article by the manufacturer is
considered a sale. Neither the existing chapter 32 rules nor the final regulations
address the issue of whether the licensing of a taxable article, such as software that is a
taxable medical device, is a taxable event.

(2) Interim Rule. Until the IRS and the Treasury Department issue further
guidance, the IRS will treat a license of a taxable medical device as a lease of that
taxable medical device as of the date both parties entered into the license agreement.
Accordingly, the rules under §§ 4216(c) and 4217, and §§ 48.4216(c)-1(a), 48.4216(c)-
1(e), 48.4217-1, and 48.4217-2 apply.

(c) Excise Tax Treatment of Donations of Taxable Medical Devices to
Organizations Described in § 170(c)

(1) Overview. The existing chapter 32 rules do not specifically address
whether a donation of a taxable article constitutes a taxable use under § 4218. The IRS
and the Treasury Department will continue to study this issue.

(2) Interim Rules. Until the IRS and the Treasury Department issue further
guidance, taxpayers may rely on the following rules relating to the donation of medical
devices:

(A) Non-taxable use
. The donation of a taxable medical device by the
manufacturer of the device to an eligible donee will not constitute a taxable use as
defined in § 4218 of the Code. However, if at the time of donation, the manufacturer
has reason to believe that the donation is not being made to an eligible donee or that
the article donated will be resold by the eligible donee, the manufacturer is not relieved
from the liability for the tax imposed by § 4191.

(B) Eligible donee
. For purposes of this safe harbor, an eligible donee is
an entity described in §170(c) of the Code.

(C) Subsequent sales of donated articles
. The rules of § 4219 (related to
the application of tax in case of sales by other than the manufacturer) apply to an

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eligible donee that receives a donated taxable medical device and subsequently sells
the taxable medical device.

Section 5. CONVENIENCE KITS

(a) Overview. Under § 4191, a "taxable medical device" is a device defined in
§ 201(h) of the Federal Food, Drug, and Cosmetic Act (FFDCA) that is intended for
humans. Under § 48.4191-2(a) of the regulations, a device defined in section 201(h) of
the FFDCA that is intended for humans means a device that is listed as a device with
the Food and Drug Administration (FDA) under section 510(j) of the FFDCA and 21
CFR Part 807, pursuant to FDA requirements. Finished taxable medical devices are
sometimes packaged together into kits for the convenience of a healthcare provider in
the performance of a medical procedure. Convenience kits that are listed with the FDA
under section 510(j) of the FFDCA and 21 CFR Part 807 are “taxable medical devices”
under the regulations unless they fall within an exemption under § 4191(b) or
§ 48.4191-2(b) of the regulations.

The IRS and the Treasury Department have received numerous written and
informal comments suggesting that the sale of convenience kits by the kit producer
should not be subject to tax under § 4191. The IRS and the Treasury Department are
studying the taxability of convenience kits and intend to issue additional guidance in the
future.

(b) Definition of a “Convenience Kit.” For purposes of this notice, a "convenience
kit" is a set of two or more devices within the meaning of section 201(h) of the FFDCA
that is enclosed in a single package, such as a bag, tray, or box, for the convenience of
a health care professional or the end user. A convenience kit may contain a
combination of devices within the meaning of section 201(h) of the FFDCA and other
articles.

(c) Interim Rule for Domestically-Produced Convenience Kits. Until the IRS and
the Treasury Department issue further guidance, no tax will be imposed upon the sale
of a domestically-produced convenience kit that is a "taxable medical device" under
§ 4191 of the Code and § 48.4191-2(b) of the regulations. During this interim period,
the sale of a taxable medical device that goes into a domestically-produced
convenience kit will be subject to tax upon its sale by the manufacturer or importer,
pursuant to the normal rules of § 4191 and the regulations thereunder; however, the
sale of the convenience kit by the kit producer will not be subject to tax.

(d) Interim Rule for Imported Convenience Kits. Until the IRS and the Treasury
Department issue further guidance, tax is imposed under § 4191 on the sale by an
importer of a convenience kit that is a taxable medical device under § 4191 of the Code
and § 48.4191-2(b), but only on that portion of the importer’s sale price of the

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convenience kit that is properly allocable to the individual taxable medical devices
included in the convenience kit.

(1) Allocation. When an importer sells a convenience kit that is a taxable
medical device, and also sells all of the individual taxable medical devices and
nontaxable articles that are included in the convenience kit, the taxable portion of the
sale price of such convenience kit may be determined by applying to the importer’s sale
price of the convenience kit the ratio that the importer’s separate sale price of the
taxable medical devices in the convenience kit bears to the sum of the sale prices of
both the taxable medical devices and nontaxable articles in the convenience kit.

When an importer sells a convenience kit that is a taxable medical device, but
does not sell all of the individual taxable medical devices and nontaxable articles that
are included in the convenience kit, the taxable portion of the sale price of such
convenience kit may be determined by applying to the importer’s sale price of the
convenience kit the ratio that the cost to the importer of the taxable medical devices in
the convenience kit bears to the sum of the cost to the importer of both the taxable
medical devices and nontaxable articles in the convenience kit. The importer may
determine the cost of the taxable medical devices and the nontaxable articles in the
convenience kit by any reasonable method. Thus, if the cost of the taxable medical
devices represents half of the total cost to the importer of the convenience kit, the tax
applies to half of the price charged by the importer upon the sale of the convenience kit.

(2) Alternative to Allocation. In lieu of allocation, the importer of a
convenience kit that is a taxable medical device may pay tax on the entire price for
which the importer sells the convenience kit.

Section 6: DEPOSIT PENALTY RELIEF

(a) Overview. Section 6302 of the Code authorizes the IRS to establish the
mode and time for collecting certain taxes, including the taxes imposed by chapter 32.
Section 40.6302(c)-1(a) of the Excise Tax Procedural Regulations requires
manufacturers that are liable for excise taxes to make semimonthly deposits of tax
during the period in which the tax liability is incurred.

The deposit for a tax imposed by chapter 32 for each semimonthly period must
not be less than 95% of the amount of net tax liability incurred during the semimonthly
period unless the safe harbor in § 40.6302(c)-1(b)(2)(ii) applies. Under the safe harbor,
any person that filed a Form 720, Quarterly Federal Excise Tax Return, reporting a tax
imposed by chapter 32 for the second preceding calendar quarter is considered to have
met the semimonthly deposit requirement for the current quarter if: (i) the deposit for
each semimonthly period in the current calendar quarter is not less than 1/6 of the net
tax liability reported for the look back quarter: (ii) each deposit is made on time; (iii) the
amount of any underpayment is paid by the due date of the return; and (iv) the person’s

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liability does not include any tax that was not imposed during the look back quarter.
Section 40.6302(c)-1(b)(2)(v) provides that if a person fails to make deposits as
required, the IRS may withdraw the person’s right to use the safe harbor rules of
§ 40.6302(c)-1(b)(2)(ii).

Section 6656 imposes a penalty in the case of any failure by any person to make
timely deposits as required by § 6302. A taxpayer may avoid penalties under § 6656 for
failure to make deposits of taxes if the taxpayer makes an affirmative showing that such
failure is due to reasonable cause and not due to willful neglect. See
§ 6656 and the
corresponding regulations.

The IRS and the Treasury Department recognize that many medical device
manufacturers will still be preparing their systems to comply with the medical device
excise tax when the tax goes into effect on January 1, 2013, including the requirement
to make semimonthly deposits. The first deposit of the medical device excise tax,
covering the first 15 days of January, is due by January 29, 2013. In consideration of
the short time frame between the effective date of the tax and the due date of the first
deposit, and in the interest of sound tax administration, the IRS and the Treasury
Department have decided to provide temporary relief from the § 6656 penalty for the
first three calendar quarters of 2013. The normal rules under § 6656 and the
corresponding regulations will apply with respect to deposits due during the fourth
calendar quarter of 2013 and thereafter.

In addition to the temporary penalty relief, the normal safe harbor rules of
§ 40.6302(c)-1(b)(2)(ii) apply. Beginning in the third quarter of 2013, medical device
manufacturers may use the safe harbor rules of § 40.6302(c)-1(b)(2)(ii) for semimonthly
deposits due during that quarter. For purposes of the safe harbor, the first calendar
quarter of 2013 is the look back quarter for deposits due during the third calendar
quarter.

(b) Interim Rule. During the first three calendar quarters of 2013, the IRS will not
impose the penalty provided in § 6656 on a taxpayer that is liable for the medical device
excise tax that fails to make timely deposits of the medical device excise tax as required
by §§ 40.6302(c)-1 and 40.6302(c)-2 (relating to special deposits required in
September), provided that the taxpayer demonstrates a good faith attempt to comply
with requirements of §§ 40.6302(c)-1 and 40.6302(c)-2 and that the failure was not due
to willful neglect.

Thereafter, a taxpayer may avoid penalties if it makes an affirmative showing that
the failure to deposit is due to reasonable cause and not due to willful neglect. In
addition, during the third and fourth calendar quarters of 2013, the IRS will not exercise
its authority under § 40.6302(c)-1(b)(2)(v) to withdraw the taxpayer’s right to use the
deposit safe harbor rules of § 40.6302(c)-1(b)(2)(ii).

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Section 7. REQUEST FOR COMMENTS

The IRS and the Treasury Department invite comments on the interim rules set
forth in this notice. In particular, the IRS and the Treasury Department request
comments on whether there are distribution chains not described in section 3 of this
notice that are commonly employed by the medical device industry. In addition, the IRS
and the Treasury Department recognize that different segments of the industry use
different distribution chains for different devices and that determination of the price at
which a manufacturer would sell its devices to an independent wholesale distributor
may vary across those segments. The IRS and the Treasury Department request
comments on how the constructive sale price rules might address this segmentation,
including comments on what is a reasonable percentage of the applicable sale price for
determining the constructive sale price for each segment or product. After reviewing the
comments submitted in response to this request and other information collected by the
IRS, the IRS and the Treasury Department will determine an appropriate percentage
allowance for the industry as a whole or, alternatively, for particular segments of the
industry. The IRS and the Treasury Department will announce any such adjustments in
published guidance. Further, the IRS and the Treasury Department request comments
regarding alternative methods for determining price for the distribution chain described
in paragraph (b)(5) of section 3 of this notice (sales to related resellers that lease, but
do not sell, taxable medical devices).

The deadline for submission of comments is March 29, 2013. All materials
submitted will be available for public inspection and copying. Written comments should
be submitted to: Internal Revenue Service, CC:PA:LPD:PR (Notice 2012-77), Room
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC
20044. Submissions may be hand-delivered Monday through Friday between the hours
of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (Notice 2012-77), Courier's Desk, Internal
Revenue Service, 1111 Constitution Avenue, NW., Washington, DC. Comments may
be transmitted electronically via the following e-mail address:
Notice.Comments@irscounsel.treas.gov. Please include "Notice 2012-77" in the
subject line of any electronic communications.

Section 8. EFFECTIVE DATE

This notice is effective on and after January 1, 2013.

Section 9. DRAFTING INFORMATION

The principal author of this notice is Michael H. Beker of the Office of the
Associate Chief Counsel (Passthroughs & Special Industries). For further information
regarding this notice, please contact Mr. Beker at (202) 622-3130 (not a toll-free
number).