Obamacare Medical Device Tax Still Baffling Business

March 20, 2013

It is March 20th, 79 days since Obamacare’s medical device tax went into effect, and firms are still not sure if they are in compliance, according to Tax Analysts (subscription required):

John Seabrook of Deloitte Tax LLP said he thinks there are still many manufacturers that have not made deposits (of the tax). "Some companies are putting a lot of time and effort into compliance, but many more are still struggling," he said. "Companies should be making deposits now," he added, saying that he thinks failing to make deposits would not be considered a good-faith attempt at compliance.

Lew Fernandez of PricewaterhouseCoopers LLP said some manufacturers will probably overpay the tax in the early going, in part because it is hard to calculate some items that should be deducted from the tax base, such as rebates, price adjustments, warranty costs, and training provided by the manufacturer. Overpayments can be claimed as credits against the tax or refunds.

This is even after the IRS has published guidance twice to manufacturers on the tax in late 2012, assuming they would have enough time to prepare.

The reason there is still so much confusion is that the medical device tax is very complex. It places a large burden on medical device manufacturers to calculate and determine their tax liability.

One of the biggest complexities in the law is the “constructive sales pricing.” Normally, firms will pay tax on the sale price of their taxable medical device. Constructive pricing is supposed to allow manufacturers that do not normally make sales to outside companies to “construct” a sales price in order to levy the tax based on fair market pricing and safe harbor rules. (I know- it already sounds confusing).

However, this is proving to be even more difficult due to the complexity inherent in the medical device industry: “Compared with other industries subject to similar taxes, the medical device industry is newer, is not as integrated, has complex distribution channels, and sells a wider variety of products.”

Firms will need to spend a lot of money and resources in order to just figure out on what price they must pay their taxes, making the total cost of this tax much more than the $29 billion dollars it is supposed to raise over the next ten years. The additional resources lost due to compliance are a loss to society that could have gone to more productive uses, such as research and development or hiring more workers.

As one could imagine, this complexity will have different burdens on different size manufacturers. Small firms that do not have the additional resources to hire accounting firms to navigate the constructive pricing regulations will be hit a lot harder as they have to shift more resources from production to compliance.  Indeed, the total cost of this tax is likely to exceed 100 percent of profits for many small companies.  As a result, medical innovation will take a hit.

Complexity is one costly aspect of tax policy that is often overlooked. If the cost of complying with the tax makes up a substantial portion of the tax’s total cost, there is something fundamentally wrong. Good tax policy should not have provisions that take more than 80 days for an industry of more than 12,000 companies to figure out.

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