Major tax implications for industry emerging
December 2, 2009 – 4:07 pm by Steven NilesHealthcare reform and changing business models could have profound tax implications for the pharmaceutical industry.
Yesterday, PricewaterhouseCoopers announced a new report called “Pharma 2020: Taxing times ahead – Which path will you take?”, which looks at the forces that are driving up the effective tax rate for pharmaceutical and life sciences companies. The company calculated the effective tax rate of the top pharmaceutical and life sciences companies and found significant differences, which may make the industry as a whole or sub-sectors of it a likely target for increased taxes.
The report identifies several market forces making tax issues more complex. For one, the global recession has made tax authorities hungry for new revenue sources to overcome growing budget deficits and potential new costs associated with healthcare reform initiatives. As a result, they are focused on the use of tax havens that allow multinational organizations to move profits offshore.
Second, 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. Pharmaceutical and life sciences companies not only could face new and higher taxes as a service provider, but they will have less ability to allocate profits to lower-tax rate locations.
Third, the need to fill the shrinking drug pipeline has fueled a resurgence in mergers and acquisitions, in-licensing arrangements, and formation of partnerships and joint ventures, which all come with significant tax implications, depending on how a company accounts for acquisition-related items, structures royalty payments, and shares profits and losses among different legal entities and locations.
Fourth, pharmaceutical and life sciences companies are interested in locating intellectual property 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 PricewaterhouseCoopers, this trend may drive profit growth to the East, but companies will need to balance increased income with higher tax rates and potential price controls.
As part of PwC’s Pharma 2020 series examining key forces reshaping the pharmaceutical marketplace, this latest report looks at trends projecting out over the next decade. I’m in the process of preparing my Agenda 2010 feature for the January issue of Med Ad News, so I spoke with Michael Swanick, PwC’s global pharmaceutical and life sciences tax leader, to learn more about the tax trends that will affect the industry with a particular focus on some of the shorter-term implications. My conversation with Mr. Swanick follows.
Med Ad News: What particular trends will have tax implications for the industry heading into 2010?
Michael Swanick: One of the challenging issues in the short term is the combination of the economic crisis, at least in this jurisdiction, and healthcare reform. It begs the question about financing and funding those reforms.
We’re seeing it clearly in some of the examples that are coming through Washington as we speak, and we think that collectively, it probably translates into higher taxes for companies in this sector. It almost seems to us inevitable. Somehow this healthcare reform has to be funded, and they’re going to anyplace they can, to be honest with you. It seems that policy has been shelved, and everything is focused on where can we get revenue to fund these healthcare reforms.
We’re seeing it in some of the proposals where you’ve got specific taxes on the pharma companies and the medical device companies that they’ve been tagged to fund, in the case of pharma, something like $2.5 billion a year, and the medical device those numbers are around $2+ billion that they’ve been hit with. Excise taxes and things like that. And you saw it with some proposals on insurance plans, where you have these Cadillac plans where they’re being hit with taxes if the plans are too rich.
So you see the administration and the government, particularly in this country, looking to raise revenue and drive up taxes, and we think that trend could continue. We’ve got a request for more coverage and better quality coverage in this sector. Those things come with a cost, and nobody wants to pay for it. We’ve got a nation that doesn’t want to have their taxes increase. That seems like you’re going to find yourself migrating toward the corporate taxes.
Med Ad News: Is this trend across industries, or is it unique to pharma?
Michael Swanick: To answer your first question, the legislation that’s being proposed does not necessarily, in general, focus on pharma and life science companies. It’s changes to our tax code that will capture all corporate groups. With one exception I mentioned: they specifically targeted pharma and life sciences companies for those specific taxes to fund a portion of the revenue in there. So that’s one exception to what I just said.
The other thing that becomes particularly challenging if not punitive for the pharma and life science companies is that these companies, particularly the large corporate groups, tend to be very international, and the biggest fund-raising piece of the proposal are focused on international provisions, which will impact this sector the most.
So, it’s going to affect all big companies and international companies, but given that most of the major pharma companies are international, they’re going to feel the pain particularly because they’re doing business overseas and some of the biggest revenue raisers are focused on that structure. That is, companies that are doing business that have a lot of earnings and profits off shore, and what the administration is trying to get at is, if you’re going to leave the money off shore, we’re going to tweak our tax code to defer some of your expenses until you repatriate that money to the U.S. And that will particularly hit the multi-national groups, including the pharma companies.
Med Ad News: Are the smaller specialty and emerging companies more insulated from tax increases?
Michael Swanick: I would say so. I would say the smaller, wholly domestic companies. We’re seeing some proposals in the R&D, for example. I think they created a special R&D credit for small start ups who have less than 250 employees and things like that. The administration is still trying to be benign and helpful to these companies to promote growth, to increase investment and intellectual property here in the U.S. So from that perspective, they are probably a little bit protected from some of these big revenue-raising provisions.
The other point too that’s worthy of mention is that you just got an administration in Washington, you have the G20 group that’s very focused on this concept of tax havens. It seems that a lot of the governments are very concerned about the use of low-tax jurisdictions. That includes countries that the pharma company invests heavily in. They’re taking advantage of the environment in Ireland, Singapore, and Puerto Rico and places like that. It’s not clear and there’s not consensus among all those governing bodies and leaders as to what’s a tax haven, but it seems that anybody that has a low rate is being characterized as a tax haven.
So, for example, we’ve seen such traditional countries like Switzerland and Ireland being tagged in some lists as tax havens. Those are very normal and traditional countries that the pharma companies have operated in that have been flagged, so there’s a lot of concern about whether they’ll continue to be included in that group, and if so, what does that mean from a corporate, commercial, and tax perspective.
Med Ad News: In terms of what the industry can do about all this, your report lays out some suggestions, but in terms of timing, are these things that should be thought about in the short term? Or are they more longer-term fixes?
Michael Swanick: As we speak, most of the corporate groups are very concerned about the trend in the administration and the policy and proposals on taxes at the moment. And very concerned meaning that they are trying to do a lot about it. Number one, they have their people studying the proposals very hard and quantifying the impact on their taxes and in general their income statements and financials, etc. Which is a logical reaction. But they’re maybe more proactive than they historically have been in terms of communicating the impact of these proposals to their representatives in Congress in trying to make a compelling argument about competition and leveling the playing field.
On that latter point, I would say the argument is that their competitors, i.e. the Swiss pharmas, UK pharmas, and a number of other non-U.S. based pharmaceutical companies have a much more benign tax regime to oversee the taxation of overseas profits, for example. It seems the U.S. is probably saying, if you’re going to keep your profits offshore, we’re going to penalize you by up ticking your taxes a little bit by deferring these taxes. So therefore you might say the effort of lobbying and communication and communicating with the representatives has escalated to a great degree. That’s something we’re seeing a lot.
Then, thirdly, they’re asking themselves, maybe they need to change the way they’re doing business. The historical, let’s manufacture offshore and then sell into the U.S. model with the blockbuster driving a lot of the profits there might need to change. And if the blockbuster model is expiring and there’s this escalation of personalized medicine, these companies are probably saying we need to abandon the historical model of operating and move toward a change.
There is a holistic look at where do we want to do our R&D, where do we want to own our IP, how do we get closer to the market. How do we service in this personalized medicine arena better than we’ve historically done? What we’re seeing is corporations reassessing the way they structure themselves, what’s their strategy for everything from R&D to sales and marketing to their ownership structure. And knowing that change is coming and they have to be out in front and planning for it.
Med Ad News: These efforts they’re undertaking, is it important for them to publicize the fact that they are making these changes to prevent the fear among their shareholders that a report like yours might generate?
Michael Swanick: That’s interesting you say that, because there is a lot of discussion in the financial realm about disclosure. Everybody is trying to be more transparent and avoid the surprise, particularly to their shareholders. And we have seen disclosures and some financial statements about the proposed legislation in Washington clearly just as a heads up, if you will, to give their shareholders and investors an upfront notification that if this is enacted, it could have a pretty negative impact on the bottom line vis a vis increased taxes. But I haven’t seen any requirement to do so other than just good financial reporting standards. But I don’t know that we’ve seen any U.S. GAAP changes or anything that would require such disclosures. But good governance folks are looking at it and asking themselves, is this impactful to such an extent that we should disclose it to our shareholders?
But that’s kind of like the proposed Washington legislation. In terms of the planning and anticipation that corporations are doing, perhaps in anticipation of these changes, I don’t think we’re seeing anything in that regard. Corporations are just doing their work and trying to handicapping the likelihood of passage of some of this legislation.
Tags: Agenda 2010, PricewaterhouseCoopers, tax, trends
