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Will a 'Huge Tax Cut' Ease Burden for MedTech Players?

Zacks Equity Research

After months of discussions, House Republicans has finally passed the much-controversial $1.5-trillion tax-reform bill by a vote of 227 to 205 on Nov 16. The members of the Senate Finance Committee voted 14 to 12 to approve their version of the tax package on Nov 16. This paves the way for the full Senate to hold a debate on the bill once the session resumes post-Thanksgiving. However, Republicans are going to make every effort to get the bill signed by President Trump before Christmas.

Overwhelmed with the House victory, Trump said before a cabinet meeting that, “We’re going to give the American people a huge tax cut for Christmas — hopefully that will be a great, big, beautiful Christmas present.”

Meanwhile, investors keen on the MedTech space are closely following the developments with the hope that the final tax stature may result in the abolition of the infamous MedTech tax. Before delving deeper into that, let us take a look at the primary objectives of the bills.

A Brief on the House and Senate Bills

As per an article by Thomas Kaplan and Alan Rappeport, published in The New York Times, the House bill proposes a reduction in corporate tax rates to 20% from 35%. It also shrinks the number of tax brackets from seven to four. Alongside, the bill intends to introduce an international tax system for the nation, more consistent with the tax structure of the rest of the world.

It might also revoke or scale back many well-accepted deductions, including one for state and local taxes. The bill also focuses on doubling the standard deduction claimed by most tax payers. At the same time, it roots for the lifting of the child tax credit from $1,000 to $1600. Simultaneously, it calls for complete eradication of the estate tax and allowance of roughly $10,000 in property tax deduction.

Meanwhile, the Senate Bill raises the child tax credit to $2,000. It also cuts the top marginal tax rate from 39.6% to 38.5%. Also, the tax cuts for individuals are supposed to expire by the end of 2025. At the same time, the plan does not propagate a complete repeal of estate taxes. In fact, it calls for the abolishment of the Individual Mandate provision of the Affordable Care Act (ACA) under which majority of the people will be required to have health insurance or pay a penalty.

Considering the differences in the bills, it is a challenging task for the Republicans to come to a neutral ground and decide on the final structure.

Tax Reform Bills: Boon or Bane for MedTech?

According to a Business Insider report, the Republican tax plan repeals an itemized deduction that applies to healthcare expenses. This will affect families with high healthcare expenditure as these expenses will not be deducted from their taxes. Hence, most people will refrain from opting for expensive healthcare or MedTech procedures.  

A report by The Hill says that the Section 4303 of the Republican tax bill plan imposes a 20% excise tax on goods manufactured overseas by subsidiaries of U.S. companies. Under the U.S. tax code, Puerto Rico is considered a foreign land which implies that U.S. parent companies will have to pay excise taxes if they purchase from their subsidiaries in the island. In this regard, the FDA recently found that around 30% of Puerto Rico’s gross domestic product was driven by pharmaceuticals and medical devices in 2016. Undoubtedly, the latest tax plan has created an uproar among MedTech players who might witness a huge reduction in their turnover following the approval of the bill.

While the reduction in corporate taxes will lead to extensive research and development and creation of expensive cutting-edge MedTech products, the question over its effectiveness looms large. This is because with a higher number of uninsured and lesser deductions on healthcare expenses, the industry is likely to witness a shrink in customer base post-enactment, indicating a decline in demand for expensive medical procedures and devices.

No matter how the policy shapes up, it will prove beneficial to some and challenging to other players in the MedTech space. Meanwhile, it’s best for investors to stay on the sidelines until the tax situation stabilizes.

Bills Mum on Medical Device Tax Repeal

The community has been hopeful since Trump proposed policies that entailed the abolition of the infamous 2.3% medical device sales tax. This dreaded tax, which was commonly addressed as ‘fund of the ACA’, dealt a heavy blow to the medical device industry since its enactment in 2013. This tax is imposed on the selling price instead of net profit, amounting to a stupendous sum, wiping out almost a quarter of the profit for medical technology companies.

Realizing the severe linkage effect of this tax among the MedTech bigwigs as well as small players, the U.S. House and Senate temporarily suspended it for two years at the beginning of 2015. Thus, the reimposition of the tax on Jan 1, 2018 is much feared by medical device stalwarts.

A report by FierceMedical Device released at that time revealed that Johnson & Johnson JNJ made a payment of $180 million as medical device sales tax in 2014. Medtronic plc MDT, Covidien and Smith & Nephew plc SNN shelled out $112 million, $60 million and $25 million, respectively, in that year.

 

 

The situation for smaller companies has been much worse.

In this context, ABIOMED, Inc.’s ABMD CEO Michael Minogue quote (in an article by Cheryl Swanson published by The Motley Fool) is quite pertinent. He stated "I don't think taxing the innovators and taxing the group of companies that provide innovation for healthcare is a smart idea, but the biggest concern I have, and what's unprecedented, is to tax companies that are not yet profitable, and in our industry where 70% of the companies are not yet profitable, this is going to have detrimental effects in their job growth, in their survival."

 

 

Per data provided by the medical device trade group (in a Ken Blackwell article published by The Daily Caller), the partial two-year repeal of the MedTech tax had resulted in around an 83% rise in research and development (R&D) investments by MedTech players. The comeback of the tax will lead to a $15-billion rise in taxes in 2018, largely discouraging R&D activities.

Undoubtedly, the future of the U.S. MedTech industry depends on the Republicans’ decision on the 2.3% medical device tax.

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