pharma industry – transfer pricing perspective sanjay tolia december 12, 2008

Pharma Industry – Transfer pricing Perspective

Sanjay ToliaDecember 12, 2008

PricewaterhouseCoopersDecember 2008

Slide 2

Content

• Transfer pricing Environment in

India

• Pharma Transfer Pricing Issues

• Select Global Case Laws

• Dispute Resolution

• Legislative & Regulatory

Development

• Way Forward

Transfer Pricing Environment in India


Slide 4

• 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



Slide 5

Current

• Manufacturing

• Distribution

• Marketing

• Services

Emerging

• Business Restructuring

• Marketing Intangibles

• Intellectual Property Transfers

• Permanent Establishments

• Convergence with Customs

• Guarantees

Shift in Focus


Pharma TP Issues


Slide 7

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

Pharma TP issues


Slide 8

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.

Pharma TP issues


Slide 9

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)


Slide 10

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)


Slide 11

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

Select Global Case Laws


Slide 13

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

Select Global Case LawsGlaxo, USA


Slide 14


• 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



Slide 15


• 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



Slide 16

IRS Theory

• In economic substance, Glaxo US is the owner of the relevant trademarks and marketing intangibles

• 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

• Glaxo agrees to pay tax and interest of $3.4 billion

• Resolves all transfer pricing controversy regarding the heritage products through 2005



Slide 17

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

Select Global Case LawsRoche, Australia


Slide 18

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


Slide 19

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



Slide 20

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


Dispute Resolution


Slide 22

• 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.

Dispute Resolution - Global


Slide 23

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

Legislative & Regulatory Developments


Slide 25

United States

• Cost Sharing Regulations to be issued by end of year

• Global Dealing and Services Regulations to follow

Organization for Economic Cooperation and Development

• Transfer Pricing Aspects of Business Restructurings (Discussion Draft)

Germany

• Ordinance on Business Restructurings

China

• Documentation rules expected to be issue by end of year

Legislative and Regulatory Developments


Slide 26

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

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Thank You

pharma industry – transfer pricing perspective sanjay tolia december 12, 2008

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