Pharma Industry – Transfer pricing Perspective
Sanjay Tolia
December 12, 2008
PwC
Content
•
Transfer pricing Environment in
India
•
Pharma Transfer Pricing Issues
•
Select Global Case Laws
•
Dispute Resolution
•
Legislative & Regulatory
Development
•
Way Forward
PricewaterhouseCoopers
December 2008
Slide 2
Transfer Pricing Environment in India
Transfer Pricing Environment in India
•
Fourth round of TP audit completed
•
Enhanced team
•
Increased information sharing and awareness
•
High volume of cases with limited time-frame
•
Aggressive positions adopted
•
Favorable ITAT rulings
PricewaterhouseCoopers
December 2008
Slide 4
Transfer Pricing Environment in India
Shift in Focus
Current
•
Manufacturing
•
Distribution
•
Marketing
•
Services
PricewaterhouseCoopers
Emerging
•
Business Restructuring
•
Marketing Intangibles
•
Intellectual Property
Transfers
•
Permanent
Establishments
•
Convergence with
Customs
•
Guarantees
December 2008
Slide 5
Pharma TP Issues
Pharma TP issues
Comparability of Active Pharmaceutical Ingredients (API’s)
• Comparability with:
-
generic API; and
-
same/similar API’s imported by third parties, available on customs
databases
Clinical Trial Services
• Role may vary from mere facilitation/co-ordination v/s responsibility for the
completion of the trials
• Difficulties arise in identifying appropriate comparable companies
PricewaterhouseCoopers
December 2008
Slide 7
Pharma TP issues
Contract R&D and Contract manufacturing services
• Relatively high mark-ups insisted by the revenue
• Difficulty in identifying appropriate comparable companies;
• Contract research vs. co-developing drugs with foreign partners based on
revenue sharing models
- Publicly available information databases do not provide results of
companies purely engaged in contract research activities
- Difficult to ascertain whether potential comparables are engaged in
contract research, or are co-developing drugs with foreign partners
based on revenue sharing models.
PricewaterhouseCoopers
December 2008
Slide 8
Pharma TP issues
Other Issues
•
Product Analysis vis-à-vis basket of products approach
•
Drugs Prices Control Order (DPCO).
- Price control under the DPCO may cause product margins of
pharmaceutical companies to come under pressure
- Where the pricing of raw material inputs procured from associated
enterprises is sought to be reviewed by the application of profit based
transfer pricing methods, the identification of comparable companies
entails challenges
•
Distribution
- Start-up losses
- Use of profit level indicator (Gross margin vs net margin)
PricewaterhouseCoopers
December 2008
Slide 9
Other TP issues
Business Restructuring
•
Involvement of operational teams to document local rationale for change
•
TP documentation to address transition aspects
•
Any disposal of intangible assets reflecting the migration from a full risk
function to a lower risk business
•
Valuation of intangibles, exit charge, pre-transition planning
•
Possible creation of Permanent Establishment (PE)
PricewaterhouseCoopers
December 2008
Slide 10
Other TP Issues
Guarantee Fees
•
TP issues when parent company guarantees its subsidiary’s external
borrowings
•
Benefit test required before an inter-company fee can be paid to the
parent, for issuing the corporate guarantee
•
Arm’s length profit element to be earned on guarantee transactions
•
Thin capitalization
PricewaterhouseCoopers
December 2008
Slide 11
Select Global Case Laws
Select Global Case Laws
Glaxo, USA
Relevant known facts:
•
UK parent with subsidiaries in several locations including the US
•
UK parent conducted breakthrough R&D and developed the “heritage
products” including Zantac
•
UK parent owns patents on heritage products
•
Heritage products all introduced in markets outside the US before US
introduction
•
UK parent is apparently the legal owner of global trademark rights to the
heritage products
PricewaterhouseCoopers
December 2008
Slide 13
Select Global Case Laws
Glaxo, USA
Relevant known facts:
•
Bulk chemical produced by non-US affiliate of Glaxo UK (Singapore)
•
Glaxo US licenses product intangibles from Glaxo UK, initially for a
royalty equal to 10% of sales
•
Glaxo US performs fill / finish and market and distributes the heritage
products in the US
•
Glaxo US performs some R&D. Apparently some US R&D involves
clinical trials related to heritage products including Zantac. Glaxo UK
reimburses for some US R&D
•
Glaxo US asserts that marketing plans, materials etc. developed in the
UK and used in other markets before use in US
December 2008
PricewaterhouseCoopers
Slide 14
Select Global Case Laws
Glaxo, USA
Relevant known facts:
•
When introduced in US, Zantac has a direct competitor (Tagamet) which
is well established in the market and is the world’s largest selling
pharmaceutical product.
•
Zantac has therapeutic advantages over Tagamet
•
Zantac replaces Tagamet as the ulcer treatment of choice within two
years of US introduction and becomes the world’s largest selling
pharmaceutical product, a status it holds for several years
•
When it becomes clear Zantac is a blockbuster, royalty rate paid by Glaxo
US is increased
PricewaterhouseCoopers
December 2008
Slide 15
Select Global Case Laws
Glaxo, USA
IRS Theory
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In economic substance, Glaxo US is the owner of the relevant
trademarks and marketing intangibles
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Royalties paid by Glaxo US should be capped at their original level and
cannot subsequently be increased
•
Amount of the deficiency should be treated as a loan to Glaxo UK from
Glaxo US and interest income should be imputed on that loan at market
rates
Reported settlement terms
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Glaxo agrees to pay tax and interest of $3.4 billion
•
Resolves all transfer pricing controversy regarding the heritage products
through 2005
PricewaterhouseCoopers
December 2008
Slide 16
Select Global Case Laws
Roche, Australia
Relevant known facts
•
Roche Products Pty Ltd (‘Roche Australia’) is the Australian subsidiary of
the multinational pharmaceutical company, Roche Holdings in
Switzerland (‘Roche Switzerland’) Reported settlement terms.
•
Audit period covered 11 income tax years 1993 to 2003
•
Australian Tax Office (‘ATO’) increased Roche Australia’s taxable income
over the audit period by A$ 130 million.
•
Independent US transfer pricing experts were used by Roche and ATO to
support their positions
PricewaterhouseCoopers
December 2008
Slide 17
Select Global Case Laws
Roche, Australia
Relevant known facts
•
ATO’s Approach
- Application of TNMM: Identified return for each function
Function
•
Arm’s length return
Distribution, Marketing and selling
• Distribution
• Marketing
• Detailing and Selling
• 1.6% operating margin on sales
• 13.1% mark-up on costs
• 6.6% mark-up on costs
Secondary manufacturing
12.6% mark up on costs
Clinical Trials
7.9% on costs
Arm’s length mark-up- Aggregation and consolidation arrived at by Built
up approach
PricewaterhouseCoopers
December 2008
Slide 18
Select Global Case Laws
Roche, Australia
Roche Australia argued
•
CUP was the most appropriate
•
Identified internal comparable transactions during assessment and made
adjustments for the following differences:
- Currency
- Payment terms
- Packaging
•
Demonstrated based on CUP Analysis, that Roche Australia had paid
less than the ALP
•
Thus no adjustment was warranted
PricewaterhouseCoopers
December 2008
Slide 19
Select Global Case Laws
Roche, Australia
Decision
•
TNMM & Build up approach of the ATO disliked and rejected by the
Judge
•
Roche Australia’s methodology of internal GM comparability not
appreciated by the Judge
•
The Judge after considering comparable gross margins was most
persuaded by evidence of negotiation with third parties which was 40%
•
Increase in taxable income was A$ 45 million as against the adjustment
made by the ATO
PricewaterhouseCoopers
December 2008
Slide 20
Dispute Resolution
Dispute Resolution - Global
•
Audits, tax adjustments, Advanced Pricing Arrangement (APA’s), Mutual
Agreement Procedure (MAP) cases and arbitration proceedings appear
to be on the rise around the world
•
Fundamental international tax principles (such as the arm’s length
standard) are under attack
•
Taxpayers are increasingly confronted with substantial tax risks and
uncertain tax positions worldwide
•
Pressure is growing on traditional and new dispute resolution techniques
(eg: mandatory binding arbitration)
•
As the volume of APA and MAP cases increases, competent authorities
worldwide appear to face difficult and complex challenges – resulting in
backlog of cases that are substantial and increasing.
PricewaterhouseCoopers
December 2008
Slide 22
Dispute Resolution – Indian Scenario
Mutual Agreement Procedure (MAP)
•
A remedy available under the DTAA, independent of remedies available
under domestic tax law to resolve tax disputes
-
Decision not binding on taxpayer
-
Can be simultaneously pursued with domestic appeals
-
Demand stayed till dispute resolved (US & UK)Advanced Pricing
Arrangement (APA) regime
•
A committee has been formed to study best practices in APA’s and make
suggestions for an APA model to be introduced in India
•
Views sought from tax consultants, multinational corporations, industry
representatives, etc
PricewaterhouseCoopers
December 2008
Slide 23
Legislative & Regulatory Developments
Legislative and Regulatory Developments
United States
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Cost Sharing Regulations to be issued by end of year
•
Global Dealing and Services Regulations to follow
Organization for Economic Cooperation and Development
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Transfer Pricing Aspects of Business Restructurings (Discussion Draft)
Germany
•
Ordinance on Business Restructurings
China
•
Documentation rules expected to be issue by end of year
PricewaterhouseCoopers
December 2008
Slide 25
Way Forward
Corporates must:
• Proactive – not reactive
• Adopt Coordinated and centralized
approach.
• Involve operational teams in tax and TP
planning and documentation process
• Holistic solutions – not fragmented
responses
• Global awareness and vision – not myopic
• Harmonize TP documentation with other
regulatory requirements
PricewaterhouseCoopers
December 2008
Slide 26
Thank You
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