With Device Tax Seeming Inevitable, Groups Align On Small-Firm Protections

Full article reprinted from "The Gray Sheet" - December 14, 2009

Groups representing the device industry have aligned to push an amendment to the Senate health care reform bill to exempt more pre- and low-profit companies from the proposed $20 billion device tax. Read more...

With Device Tax Seeming Inevitable, Groups Align On Small-Firm Protections

Full article reprinted from "The Gray Sheet" - December 14, 2009

The collaboration between AdvaMed, the Medical Device Manufacturers Association and the National Venture Capital Association on a structural revision to the tax is a sign of growing resignation that a targeted industry fee will likely become law.

MDMA's board remains officially opposed to any tax, but the group's CEO, Mark Leahey, acknowledges that it "is looking more and more inevitable that something will take shape."

If Congress passes a health reform bill, "I think a $20 billion tax is likely," he said Dec. 9 at the LifeScience Alley annual meeting in Minneapolis.

The associations are working with moderate Democrats, including Sens. Amy Klobuchar, D-Minn., and Evan Bayh, D-Ind., on language that would exempt the first $100 million in annual revenue from counting toward the tax calculation, and factor in only half of earned revenue between $100 million and $150 million.

This would be a substantial change from the bill's current exclusion of revenues below $5 million and half the amounts between $5 million and $25 million.

The Senate tax is structured as a 10-year, non-tax-deductible fee assessed annually beginning in 2010. A company's tax rate would be based on the ratio of the firm's prior-year qualifying U.S. device revenues to industry-wide qualifying U.S. device revenues. Sales of all Class I devices and of Class II devices that sell at retail for $100 or less would be exempt.

The organizations are also aligned on delaying implementation of the tax until 2013, as the House health reform bill would have it.

"Nobody likes the tax," affirmed Steve Ubl, CEO of AdvaMed, at the LifeScience Alley meeting. But the political headwinds necessitate making the best of a bad situation, he said. "It is lemonade production time, as one CEO recently put it to me.... Right now we are focused on making sure that companies have the time to adjust their operations, [on] relief for small companies, and [on ensuring] that the tax is transparent," Ubl explained.

Focus On Hard-Hit Start-Ups

The device tax has dominated a large majority of industry lobbying efforts since the provision was first proposed by Sen. Max Baucus, D-Mont., in September (The Gray Sheet' Sept. 21, 2009).

It has also led to intra-industry rifts. Members of MDMA, for instance, were troubled that AdvaMed was negotiating for a reduced tax rate (from the original $40 billion over 10 years) rather than holding firm against any tax (The Gray Sheet' Oct. 12, 2009).

And last month St. Jude Medical split from AdvaMed because it disagrees with a structural change that AdvaMed is independently advocating, which would scale the device tax rate for products based on FDA risk classification levels (The Gray Sheet' Nov. 16, 2009). Under the scheme, Class I device sales would have the least weight, while the most weight in the tax calculation would go to Class III product sales, increasing the burden on companies with predominantly Class III products, but, AdvaMed says, giving a break to firms with lower profit margins (see sidebar:"Taxing Based On Risk Class?").

Despite the differences of opinion, all in industry have forwarded the same set of arguments on why the tax is a bad idea: it comes on top of painful Medicare cuts in the reform bills; is based on the faulty logic that device firms will generally experience a major windfall from the reform effort's expansion of the covered population; and that it will hurt innovation, particularly by making it more difficult for early-stage firms and start-ups to reach profitability.

The last point in particular brought AdvaMed, MDMA and NVCA to the same camp, as the VC community hammers the point that a tax makes an already difficult investment environment that much worse.

"I am hoping it is not the straw that breaks the camel's back," Onset Ventures' Leslie Bottorff said in an interview, citing already increasing FDA and reimbursement challenges.

She notes that start-ups will be hardest hit by the tax in part because their businesses tend to be U.S.-focused with greater reliance on higher-risk classification products.

Most importantly, the current Senate tax structure will kick in at full force well before a start-up is profitable, said Bottorff, who is a medical technology general partner for the VC firm.

"Nobody is profitable anymore at $25 million" in sales, she said. "It is not possible with the infrastructure you need to have with a heavily regulated business.

"Most of these companies are not profitable until [they have] in excess of $50 million [in] revenue ... and for a lot of these companies it is in excess of $100 million to $150 million."

Moving the minimum revenue threshold up, as lobbyists are attempting to do, would be helpful, Bottorff said.

But in her view, it would be even better if lawmakers directly tied the tax to profitability, rather than using revenue as a proxy.

"It is crazy to tax it on revenue as opposed to profits," she said.

"Taxes have traditionally been on profitable entities, not on unprofitable ones."

House Bill's Tax Proposal Still Poses Challenge

It is not clear when or if a device tax amendment will be submitted for floor debate during the Senate's ongoing consideration of the broad-based health care reform bill. Calls to Sens. Klobuchar's and Bayh's offices for updates were not returned.

If the legislation is amended to include the more substantial small company exclusions, the next challenge for industry will be to ensure those changes are maintained through a House-Senate conference.

The device tax included in the House health care reform bill, passed in November, is designed to collect $20 billion from 2013-2019 through a flat 2.5% point-of-sale tax-deductible levy (with exceptions for retail products). This structure, which is not tied to a company's overall sales, makes it significantly more difficult to include revenue-based exclusions (The Gray Sheet' Nov. 2, 2009).

- David Filmore

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