Pharma and life sciences companies face rising tax rates, says PwC

The global financial crisis, government pressure, changing market dynamics for an industry experiencing significant change, and rapidly evolving health care reforms are likely to drive up the effective tax rate for the pharmaceutical and life sciences industry, according to a report released by PricewaterhouseCoopers entitled Pharma 2020: Taxing times ahead - Which path will you take? 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.

The results of a poll of 35 senior tax executives from pharmaceutical, biotechnology and medical device companies conducted last month by PricewaterhouseCoopers showed that:

- Six in ten tax leaders (62% of those polled) agreed that an increase in the effective tax rate for the pharmaceutical and life sciences industry is inevitable.
- 63% agreed that the cost of increased taxes on their organizations might eventually be passed to 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.
- Virtually all executives polled (100%) 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 organization.

"To continue to deliver 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,'" said Michael Swanick, global pharmaceutical and life sciences tax leader at PricewaterhouseCoopers. "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," he noted.

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 are very concerned and are therefore focused on the use of "tax havens" that allow multinationals to move profits offshore. Governments will continue to scrutinize 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.

Health care market trends: focus on outcomes and personalized medicine

Payers want better value for the money they spend on health care and are focusing their efforts on increasing delivery of successful treatments. In response, drug and device makers will begin 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, says PwC. 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 personalized medicine and tailored approaches to prevention and care, pharmaceutical companies are developing more complex and fragile specialized 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 intellectual property will be geographically dispersed. 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. 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 profits and losses among different legal entities and locations.

Competition to attract pharmaceutical and life science investments

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 these firms, 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.

"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," said Simon Friend, global pharmaceutical and life sciences leader at PwC, adding: "Tax will need to be involved sooner and up front, a trend we already are seeing throughout the industry."

In Pharma 2020: Taxing times ahead - Which path will you take? PricewaterhouseCoopers outlines approaches that companies are taking to respond to tax challenges and related implications for their organizations. A full copy of the report is available at www.pwc.com/pharma2020tax. The entire Pharma 2020 series can be found at www.pwc.com/pharma2020.