Accounting and Tax Treatment for Annual Fee Imposed on Branded Prescription Drug Sales

Background
An annual fee has been imposed on the pharmaceutical manufacturing industry by the Patient Protection and Affordable Care Act, for each calendar year beginning on or after Jan. 1, 2011. The total fee will range from $2.5 to $4.1 billion per year for the industry, and will be allocated among manufacturers and importers (covered entities) with aggregate branded prescription drug sales of over $5 million to specified government programs. The fee is based on the covered entity’s branded prescription drug sales taken into account for the preceding calendar year, expressed as a percentage of the aggregate sales taken into account for all covered entities for the same period. The fee is then calculated by the Internal Revenue Service (IRS) by applying this ratio to the applicable amount as specified in the statute.

A covered entity is any manufacturer or importer with gross receipts from branded prescription drug sales to specified government programs or pursuant to coverage under those programs. These programs are the Medicare Part B and Part D programs, Medicaid, any program under which branded prescription drugs are procured by the Department of Veterans Affairs, the Department of Defense, and the TRICARE retail pharmacy program. The fee is imposed for each calendar year beginning on or after Jan. 1, 2011. A covered entity’s portion of the annual fee is payable no later than Sept. 30 of the applicable fee year and is not tax deductible.

Accounting treatment
The Financial Accounting Standards Board recently issued Accounting Standards Update (ASU) 2010-27, Other Expenses (Topic 720): Fees Paid to the Federal Government by Pharmaceutical Manufacturers, to address questions concerning how pharmaceutical manufacturers should recognize and classify fees mandated by the act in their income statements. The amendments in the ASU specify that:

• The liability for the fee should be estimated and recorded in full upon the first qualifying sale with a corresponding deferred cost that is amortized to expense using a straight-line method of allocation, unless another method better allocates the fee over the calendar year that it is payable
• The annual fee should be presented as an operating expense

The amendments in the ASU are applicable to calendar years beginning after Dec. 31, 2010, when the fee initially becomes effective. The decisions in the ASU were based on the unique facts and circumstances of the fee to be paid by pharmaceutical manufacturers; accordingly, an entity should apply judgment when evaluating the facts and circumstances of other fee arrangements before analogizing to those decisions.

ASU 2010-27 is available at the FASB website.

Tax treatment
The IRS recently released Notice 2011-9, which supersedes its initial guidance (Notice 2010-71). In Notice 2011-9, the IRS proposes a methodology for calculating the annual fee, and states that it will then use the proposed methodology to provide each covered entity with a preliminary 2011 fee calculation. The IRS and Treasury intend that a covered entity’s preliminary fee calculation for 2011 will serve a basis for comments by the covered entity on the proposed methodology.

Affected taxpayers (covered entities) are to complete and submit Form 8947, Report of Branded Prescription Drug Information, by Feb. 11, 2011, to report 2009 calendar year sales of branded prescription drugs to specified government programs. The IRS will use the information submitted by covered entities on Form 8947 and sales data provided by the specified government programs to calculate the preliminary fee. The IRS will then send each covered entity notification of: 1) the covered entity’s preliminary fee; 2) the covered entity’s branded prescription drug sales, identified by National Drug Code (NDC) for each program; 3) the branded prescription drug sales for all programs reduced by a set statutory percentage; and 4) the aggregate branded prescription drug sales taken into account for all covered entities. The IRS will send each covered entity notification of its preliminary fee calculation by May 16, 2011. The IRS will send the final fee calculation to each covered entity by Aug. 15, 2011.

Form 8947 is used to report the following information for each covered entity:

1. Name, address and employer identification number (EIN) of the covered entity. A covered entity is either unaffiliated (a single-person covered entity) or a controlled group (under which all persons are treated as a single employer). In the case a controlled group is treated as a single covered entity, they must identify a “designated entity” to act for the group. An affiliated group that files a consolidated federal income tax return will be treated as a controlled group, and its common parent as identified on the tax return for the sales year will be the designated entity. A designated entity will act for the controlled group in filing the Form 8947, and will give the name, address and EIN of each member of the controlled group that is a manufacturer or importer with gross receipts from branded prescription drugs to specified government programs as of Dec. 31 of the sales year. The designated entity's name is listed first on the form.
2. All the NDCs for branded prescription drugs in which the covered entity is identified in the labeler code as of the end of the day on Dec. 31 of the sales year.
3. The brand name and NDC for each orphan drug for which a credit was allowed for any taxable year under section 45C of the Internal Revenue Code. The credit is considered allowed for any particular drug if any person claimed the credit, even if that person — that entity — was not part of the covered entity at the time the credit was claimed.
4. The rebates for each NDC paid in the sales year by the covered entity to Medicare Part D with respect to sales occurring in that sales year. For this purpose, because pharmaceutical manufacturers generally compile rebate information at an aggregate entity level for tax purposes, rather than at the drug product level, rebates are to be reported for drugs dispensed in the 2009 sales year if paid before the Form 8947 is filed.
5. The state supplemental rebates for each NDC paid in the sales year by the covered entity with respect to sales under Medicaid occurring in that sales year. Rebates invoiced by states for drugs reimbursed in the 2009 sales year are to be reported if paid before the Form 8947 is filed.

Rebate information will be taken into account in calculating a covered entity’s annual fee for 2011 only if it is reported on a timely filed Form 8947. Form 8947 is available at the IRS website.

Importantly, branded prescription drug sales do not include those of orphan drugs for which the covered entity claimed a section 45C credit, whether on an original or amended return. Pharmaceutical manufacturers who have not already done so should file amended returns before the filing of Form 8947 in order to claim the section 45C credit for any open prior year in which they could have claimed it, thereby reducing the amount of branded prescription drug sales subject to the annual fee.

As mentioned above, Form 8947 must be submitted to the IRS by Feb. 11, 2011 for 2009 calendar year sales information. Notice 2011-9 makes it clear that affected taxpayers will be required to provide substantial amounts of information to the government. As such, if you require any assistance with either the filing of Form 8947, information related to Notice 2011-9 or identification of section 45C credit opportunities, please contact McGladrey Managing Director John Lanza at 212.372.1307.