OREANDA-NEWS. December 15, 2009. The global financial crisis, government pressure, changing market dynamics for an industry experiencing significant change and rapidly evolving healthcare reforms are likely to drive up the effective tax rate for the pharmaceutical and life sciences industry, according to a report by PricewaterhouseCoopers (PwC) entitled Pharma 2020: Taxing times ahead – Which path will you take?, reported the press-centre of PwC.

The industry’s response to these trends, including diminishing reliance on the 'blockbuster drug model', will make tax planning more complicated and challenging for tax executives working for pharmaceutical and life sciences companies.

In a poll of 35 senior tax executives from pharmaceutical, biotech and medical device companies conducted recently by PricewaterhouseCoopers (PwC):

Six in ten tax leaders agree that an increase in the effective tax rate for the pharmaceutical and life sciences industry is inevitable.

63% of the poll participants agreed that the cost of increased taxes on their organisations might eventually be passed onto consumers unless they find ways to operate more efficiently and transform their approach to R&D and sales & marketing.

62% of tax executives polled said they are looking to maximize tax credits and other incentives for research and development.

All executives polled said they believe that the demand for tax specialists will grow substantially as tax issues for the industry become more complex.

More than half of the respondents said they are now being consulted early on by senior management in strategic business decisions, and thus have influence over the direction of the company. Still, 34% said they are consulted late in the game, and 9% of tax leaders said they are informed after the fact about strategic business decisions that have tax implications for the organisation.

Alina Lavrentieva, partner, leader of pharmaceutical industry practice, PricewaterhouseCoopers in Russia, commented:

“To continue delivering value to shareholders and society, pharmaceutical and life sciences companies must make strategic decisions about how they will drive innovation and profitability, but as they do so, each company's top tax executive needs a prominent seat at the ‘C suite’ table.
“Tax planning will be a critical consideration, not an afterthought, of long–term business plans to grow, buy, merge or sell and it will be one of the most important considerations in deciding where to locate IP (intellectual property), manufacturing and service delivery.”

Focusing on the challenges and opportunities ahead from a tax perspective, the PwC report identifies the following market forces making tax issues more complex.

Economic and government pressure: crackdown on tax havens

The global recession has made tax authorities around the world hungry for new revenue sources to overcome growing budget deficits and potential new costs associated with healthcare reform initiatives. Governments of some countries very concerned and are therefore focused on the use of tax havens that allow multinationals to move profits offshore. Governments will continue to scrutinise transfer pricing practices to limit abuse of intra-company transfers of expenses or profits. Economic substance of offshore operations will become increasingly more important. According to PwC, identification of uncooperative nations may become more common, and corporations that continue to use tax havens could face financial penalties and reputational damage. 

Healthcare market trends: focus on outcomes and personalised medicine

Payers want better value for the money they spend on healthcare and are focussing their efforts on increasing delivery of successful treatments. In response, drug and device makers are shifting from a purely product-centric focus to a service model aimed at improved patient outcomes and prevention or cure, versus ongoing treatment, of disease. As such, with other participants they are packaging traditional products with holistic services including diagnostic, wellness and compliance monitoring. In addition, with the advancement of personalised medicine and tailored approaches to prevention and care, pharmaceutical companies are developing more complex and fragile specialised therapies, many of which need to be manufactured in closer proximity to patients.

By increasing service delivery and locating manufacturing closer to patients, or the end market, both the supply chain and IP will be geographically dispersed. Pharmaceutical and life sciences companies could not only face new and higher taxes as a service provider, but they will have less ability to allocate profits to lower tax rate locations. Furthermore, a decision to locate service providers in end markets could create permanent establishments in multiple tax jurisdictions, increasing the risk of double taxation disputes involving international or intra-company allocations around pricing, royalty rates, interest, management fees, business expense and gross revenue. 

Complex business combinations

The need to fill the shrinking drug pipeline has fuelled a resurgence in mergers and acquisitions (M&A), in-licensing arrangements and formation of partnerships and joint ventures, a trend PwC expects to continue.  Each of these strategies comes with significant tax implications, depending on how a company accounts for acquisition-related items, structures royalty payments, and shares profit and loss among different legal entities and locations.

Competition to attract pharmaceutical and life science investments

Pharmaceutical and life sciences companies are interested in locating IP development in areas that offer economic and tax incentives and to expand their presence in emerging markets that promise growth potential.  International competition is intensifying to attract new investment by pharmaceutical and life sciences companies, particularly from emerging markets, such as China. According to PwC, this trend may further drive profit growth to the East, but companies will need to balance increased income with higher tax rates and potential price controls. 

Alina Lavrentieva concluded:
“To manage effective tax rates, pharmaceutical and life sciences companies will need to develop tax planning consistent with their new business models and carefully balance risk with opportunity. Tax will need to be involved sooner and up front, a trend we are already seeing throughout the industry."