As if the medical device excise tax isn’t confusing enough on its own, introduce a contract manufacturer into the mix and things can start to get a little crazy.
The medical device excise tax legislation does not specifically address which party is considered the manufacturer when a contract manufacturer relationship exists. However, the IRS has previously addressed these issues with companies in the auto and fishing-lure industries. We are able to look to these cases for guidance on the excise tax on medical devices, but keep in mind that the IRS will look at each relationship on a facts and circumstances basis in making a determination.
In prior cases, the IRS has generally relied on two over-arching factors in determining which party is the manufacturer for purposes of the tax:
The IRS has tended to base its decisions on the “right to control production and sale of the article” factor. In addressing this control factor, the IRS looks at the following:
To illustrate, take one case where a patent holder of auto accessories (Company X) contracted a third party manufacturer (Company Z). Company X required a certain amount of output from Company Z. Their agreement, however, allowed Company X to go elsewhere if the output requirement could not be met. Furthermore, Company Z was allowed to produce accessories in excess of Company X’s requirements, but Company X controlled which territories Company Z was allowed to sell to. Since Company X controlled the amounts to be manufactured and where the product could be sold, it was deemed to be the manufacturer and was thus responsible for the tax.
There are other cases where the contract manufacturer is deemed to be the manufacturer for purposes of the excise tax. In one of those cases, no restrictions were placed on the amount of output, and the manufacturer was free to sell to other companies. In this instance, the contract manufacturer was deemed to be the manufacturer.
The OEM-contract manufacture relationship dynamic will certainly present additional challenges for the medical device tax. It is important that companies review their contract manufacturing arrangements and agreements and consult their business advisors to clear up any uncertainties.
Mitchell Kopelman is the partner in charge of the technology and life sciences practice at Habif, Arogeti, & Wynne (Atlanta). He focuses on helping medical device companies with R&D tax credit studies, mergers and acquisitions, and proactive tax and accounting planning. He also works with companies as they expand globally or enter the United States. Kopelman graduated from Georgia State University with a bachelor’s degree in accounting. He can be reached at email@example.com.
Ori Epstein is a tax manager in Habif, Arogeti, & Wynne’s technology and life sciences practice. He regularly speaks at medical device industry conferences on topics such as the excise tax, business trends within the medical device industry, and tax planning and preparation for medical device companies. Epstein graduated from the University of Georgia with a bachelor’s degree in accounting and a master’s of accounting with a concentration in tax. E-mail him at firstname.lastname@example.org.
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