23 rd Annual Health Sciences Tax Conference

Transcription

1 23 rd Annual Health Sciences Tax Conference Emerging markets: practical guidance for the life sciences industry December 11, 2013

2 Non-reliance disclosure Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. These slides are for educational purposes only and are not intended, and should not be relied upon, as tax or accounting advice. Page 2

3 Disclaimer EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. Ernst & Young LLP is a clientserving member firm of Ernst & Young Global Limited operating in the US. For more information about our organization, please visit ey.com. This presentation is 2013 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are not necessarily those of Ernst & Young LLP. Page 3

4 Presenters Matthew Andrew FEA/Ernst & Young/SG One Raffles Quay, North Tower, Level , Singapore Ana P. Mingramm Ernst & Young LLP 5 Times Square New York, NY ana.mingramm@ey.com Page 4

5 Today s agenda 1. Emerging markets current state and trends 2. Tax, regulatory and legal considerations 3. The response: models that work in emerging markets Review of the models Issues to be addressed 4. Wrap up and questions Page 5

6 Big pharma s firepower is declining But specialty pharma and biotech are increasing Source: Ernst & Young LLP based on company financial report data as reported in Capital IQ. Data labels show percent change in firepower relative to Page 6

7 Why has big pharma s firepower declined? The worst of the patent cliff has arrived pharma s market cap has fallen Market cap Acquired market cap debt levels have increased and spending on non-research and development (R&D) items is up M&A Dividends and stock buybacks R&D Sources: Company Reports, Cap IQ Page 7

8 There remains a growth gap for big pharma US$100b in 2015 Big pharma sales needed to keep pace with global drug market Growth gap Analysts forecast of big pharma sales Big pharma sales Sources: Big pharma sales, Capital IQ; global drug market sales, IMS Health Page 8

9 Bridging the growth gap entails an emerging markets strategy CAGR: Compound Annual Growth Rate Source: IMS IMS defines pharmerging countries as those with more than US$1 billion in spending growth from 2012 to 2016 and a per capita gross domestic product of less than US$25,000. The 17 pharmerging countries are China, Brazil, Russia, India, Mexico, Turkey, Poland, Venezuela, Argentina, Indonesia, South Africa, Thailand, Romania, Egypt, Ukraine, Pakistan and Vietnam. Page 9

10 Generics are the key to global pharma growth Will big pharma buy? Pfizer, Merck, Abbott established products Generics projected to account for nearly 80% of both global and emerging market growth 1,200 Generics will account for 79% of global growth between 2011 and 2016 Generics will account for 81% of emerging market growth between 2011 and Global pharma spend (in US$b) 1, E EM pharma spend (in US$b) E Brand Generic Brand Generic Source: IMS Health, July 2012 Page 10

11 Tax, regulatory and legal backdrop Page 11

12 Asia-Pacific Tax policy developments New transfer pricing (TP) rules Australia, Malaysia, Philippines and Vietnam PER-22 in Indonesia New incentives regimes (Invest KL, BoI, etc.) Tougher incentives conditions Advanced pricing agreements across Asia-Pacific Domestic law and guidance International policy (concluded) UN TP manual Updated UN model treaty Greater application of Chapter IX Increasing treaty protection Foreign Account Tax Compliance Act Exchange of information Training Improving treaties (e.g., HK) Bilateral agreements International policy (proposed, under review) Base erosion and profit shifting action plan Organisation for Economic Co-operation and Development (OECD) Chapter VI OECD documentation Revised OECD Article VII Page 12

13 Asia-Pacific Tax considerations for key countries Considerations Emerging markets China Indonesia India Hong Kong Developed markets Malaysia Philippines Singapore Thailand Business licenses x x x x x x x x Permanent establishment (PE) Conversion and exit tax Value-added tax (VAT)/goods and services tax (GST)/ sales tax x x x x x x x x x x x x x x x x x x x Importer of record x x x x x x x Customs valuation x x x x x x x Export controls x x x x x x Exchange controls x x x x x x Remittance issues x x x Page 13

14 Asia-Pacific: regulatory and commercial considerations: China investments are often JVs Big pharma and China domestic firms partnership deals ( ) Types of partnerships in Co-development Co-marketing 18% 42% 37 In- and out-licensing Co-development and co-marketing 17% 17% Others 3% Broad collaborations 3% Source: Bioassociate Consulting & Management Ltd. Source: Bioassociate Consulting & Management Ltd. Partnership with domestic companies has always been an important route of entry in China for multinational company pharma companies. An analysis of various partnerships in 2011 clearly indicates that the dominant form of collaboration has been the co-development of various drugs in China. Since the regulatory system in China is complex, many companies prefer having a local partner for their ventures. A joint venture (JV) with a local firm helps big pharma companies enhance production capacity, as well as expand geographic footprint to reach out to the vast landscape of China. Page 14

15 Latin America Overview of tax trends Significant tax reforms in the region Mexico Brazil Anti-avoidance rules Active increase in tax treaties throughout the region Enforcement and tax audit activities Page 15

16 Latin America Overview of Regulatory Framework Regulatory registrations Import permits Product registrations Distribution Manufacturing Packaging and labeling Corporate reorganizations and supply chain changes require regulatory approvals Long period for approval (up to one or two years) Burdensome documentation requirements Dossiers Legal agreements Details of manufacturing processes Strict control and audits by regulatory authorities Page 16

17 Transactions deal sentiment scorecard Sentiment is increasingly positive Bolt-on acquisitions Latin America Reimbursement pricing and data Health information technology (IT) Services Chronic disease solutions Divestitures Working capital management Mega-deals Cost-cutting Source: Ernst & Young LLP, based on investor presentations, meetings and conversations around the 2013 JP Morgan Healthcare Conference Page 17

18 The models and issues Page 18

19 Typical tax effective supply chain management (TESCM) structures for pharma industry High Global pharma US big pharma Full principal + intellectual property (IP) Value Biotech Licensing (principal as manufacturer (PAM) or contract manufacturing organization (CMO)) Cost sharing Low Low Potential business impact High Common structuring options for pharma/life sciences Page 19

20 Some examples: Biotech companies cost sharing US supply chain Suppliers Product USCo IP Product US MarketingCo Products US customers Platform payments (upfront) Platform contribution Cost sharing (ongoing) Non-US supply chain Suppliers Non-USCo IP Product Non-US MarketingCo Products Non-US customers Pertinent features: USCo purchases raw materials from suppliers, manufactures products and sells products to US MarketingCo for its on-sell to US customers. Similarly, Non-USCo purchases raw materials from suppliers, manufactures products and sells products to Non-US MarketingCo for its on-sell to non-us customers. USCo and Non-USCo may outsource manufacturing activities to third-party manufacturers. USCo and Non-USCo enter into cost sharing arrangement, under which: Manufacturing R&D Logistics USCo makes platform contributions (i.e., the existing IP) to a Non-USCo located in a low-tax jurisdiction. Non- USCo makes platform payments to the USCo. USCo and Non-USCo share ongoing development costs based on reasonably anticipated benefits. Marketing and distribution Page 20

21 Some examples: big pharma: licensing discoveries principal as manufacturer (PAM) Suppliers Raw materials Toll Manufacturer (finishing) Tolling services USCo IP License PAM Manufacturer Products Logistics Hub Products MarketingCo Products Customers R&D Full-fledged manufacturing Logistics Marketing and distribution Pertinent features: USCo licenses the IP to principal PAM Manufacturer and receives a royalty at a percentage of net sales. PAM Manufacturer purchases raw materials from suppliers, manufactures products and sells products to the Logistics Hub. The Logistics Hub engages Toll Manufacturers to conduct finishing work (low value add). The Logistics Hub sells finished products to local MarketingCos for their on-sell to customers. PAM Manufacturer earns the residual profit and often locates in a low-tax jurisdiction. The Logistics Hub and MarketingCos take limited risks and earn profit at a fixed margin. Page 21

22 Some examples: big pharma: licensing discoveries contract manufacturing (CMO) USCo R&D Suppliers IP Raw materials API (CMO) License Contract manufacturing Products Tolling services Toll Manufacturer (finishing) Toll manufacturing Non-US Principal Products MarketingCo Business strategy and planning Marketing strategy and brand management Strategic sourcing Supply chain management Production scheduling Quality control Products Local marketing and distribution Customers Pertinent features: USCo licenses the IP to Non-US Principal and receives a royalty at a percentage of net sales. Active Pharmaceutical Ingredients (API) (CMO) purchases raw materials from suppliers and contract manufacture products for Non-US Principal. Upon receiving products from API, Non-US Principal consigns the products to Toll Manufacturer for finishing. Non-US Principal sells finished products to local MarketingCos for their on-sell to customers. Non-US Principal earns the residual profit and locates in a low-tax jurisdiction. The API and Toll Manufacturers earn a profit at a cost, plus mark-up. The MarketingCos take limited risks and earn profit at a fixed margin. Page 22

23 Some examples: Global pharma: IP management and alignment Global HQ HQ services Products Non-US Principal IP Products MarketingCo Products Customers Raw materials Suppliers API (CMO) Contract manufacturing Tolling services Toll Manufacturer (finishing) Toll manufacturing Business strategy and planning Marketing strategy and brand management Strategic sourcing Supply chain management Production scheduling Quality control R&D Local marketing and distribution Pertinent features: Transaction flows are similar to those of US big pharma (licensing US discoveries CMO). R&D activities are performed or financed by the Non-US Principal. Non-US Principal takes the economic ownership and risks of IP. This model often applies where patent box regime is available. Page 23

24 IP management: typical TESCM structures for pharma and life sciences industry Typical pharma and life sciences IP Marketing: trade name/mark, brand name, physician relationships, know-how Manufacturing: patent, invention, formula, process, know-how, technical data, unique biotechnology, quality systems Approvals: regulatory approvals, pricing authority approvals, business licenses Page 24

25 Centralized IP ownership and development Step 1 development of new IP Step 1 New IP Principal (SG) 1 2 Contract R&D The model 1. R&D services performed by a contract R&D service provider for a cost-plus return 2. Principal will legally and economically own IP and earn commensurate returns through royalties and product prices The group IP developed refers to product IP for the product sales model the integrated solutions outsourcing model will be remunerated via service fees Role of the Principal 1. Research for new IP (trade and marketing intangibles) 2. Development of new IP (trade and marketing intangibles) 3. Local market customization and promotion The Principal will both fund and economically own the IP, directing the research and development of the contract R&D company Page 25

26 Centralized IP ownership and development Step 2 migration of existing IP to the Principal Step 1 New IP Principal (SG) 1 2 Contract R&D providers Step 2 For future group IP, a tax-efficient structure could involve the set-up of a contract R&D company owned by a new principal who would own the new IP developed. Existing IP can then be transferred to the new Principal under the steps below. Option 1 Option 2 Run Up/Run Down Model Outright Sale Model 1 1 New IP Company The Model 1. No transfer of IP ownership at start 2 Existing IP/Contract R&D Companies 2. Contract R&D for The transactional net margin method (TNMM) for future IP 3. New IP funded by Principal/IP co 4. Old IP is replaced by new IP over time Lower issues than outright sale, but exit charge, conversion risks in this model TP risks on licenses, contract R&D 2 New IP Company Contract R&D Companies The Model 1. Full transfer of IP ownership at start 2. Contract R&D for transactional net margin method for future IP 3. New IP funded by Principal/IP co who owns rights Valuation, capital/income, writing-down allowance claw back and deductibility are key issues TP risks on sale, contract R&D Page 26

27 Many clients are further considering regional hub operations in Asia Suppliers Internal supply chain processes End users API Other materials Procurement Finished goods Non-API ingredients Operations: Manufacturing/services provision R&D & IP management Clinical trials processes and management Physical supply chain, packaging and distribution of product to markets Sales Opportunities across the supply chain Reduce spend Leveraging purchasing skills, rationalizing suppliers Optimize the physical supply chain Centralized packaging center Logistics and warehousing management Inventory/capacity management Protect and develop brands Coordinated IP management and brand development strategy Management of issues re generics Centralization of services and risk management Where there are existing supply chain functions across Asia, value can be created through establishing an optimized operating structure. Page 27

28 Potential models: regional hub model Model one buy/sell regional hub, for each region 1. How the models are assessed Title transfer Finished goods Office Title transfer Finished goods Key activities 1. Each RDC performs regional distribution, supply chain and hub functions, taking title, in its own region 2. Local Op. Cos perform limited distribution functions and take limited risks 3. Model requires analysis for feasibility from an operations perspective, and: Direct tax implications Customs and indirect tax implications Manufacturing sites Office Other regional hubs (global ex-asia) Office Asia Regional Hub (Location to be determined) Title transfer Office Operating companies (Asia-Pacific) Office Manufacturing Key outputs 1. Assessment of operational tax issues and risks for each of the two models 2. First stage recommendations to move forward Finished goods Operating companies (global ex-asia) Customers (per region) Page 28

29 Potential models: global hub model with value-added service (VAS) Model two buy/sell global hub for Asia, branch or entity providing VAS Key activities Key outputs 1. How the models are assessed 1. RDC performs regional distribution, supply chain and hub functions, taking title, with Dubai branch supporting for local activities 2. Local Op. Cos perform limited distribution functions and take limited risks 3. Model requires analysis for feasibility from an operations perspective, and: Direct tax implications Customs and indirect tax implications 1. Assessment of operational tax issues and risks for each of the two models 2. First stage recommendations to move forward Manufacturing sites Office Customers (for local region) Title transfer Finished goods Title transfer Office Global hub Office Regional branch or entity providing valueadded services Office Finished goods Sales companies (if applicable) Title transfer Finished goods Manufacturing Page 29

30 Latin America The regional challenge Country-by-country discussion. one common structure would generally not fit all countries Brazil possible Mexico is tried and true Income tax Treaty network not extensive impact on permanent establishment (PE) risks Some countries have grey and black lists VAT/customs/indirect taxes Main challenge in Brazil TP Differences in TP legislation across the region Generally, no formal conversion rules Regulatory constraints Foreign exchange controls (Venezuela, Argentina) Page 30

31 Latin America Contract manufacturer versus toller Contract manufacturing is generally feasible in the region Tolling structures more complex Permanent establishment, VAT issues and other indirect tax issues Various restrictions for local market sales Low-tax, full-fledged manufacturers Free trade zones and other incentives Limited risk distributors (LRD) Higher customs duties and VAT Free Trade Agreement (FTA) within the region Service principal structures High withholding taxes in the region Deductibility restrictions Page 31

32 Principal considerations US Co Principal/ treaty country location European Principal Switzerland, Belgium, the Netherlands, Luxembourg, United Kingdom Latin America (LATAM) Principal Panama Panama/ other branch Combination of a European Principal with a LATAM branch E.g., Swiss Principal with a Panama branch Page 32

33 Contract manufacturing model Foreign supplier Principal 5. Sale of finished goods Foreign customer 1. Sale of raw material 3. Contract mfg agreement 4. Sale of finished goods 6. Sale of finished goods Local LATAM supplier 2. Sale of raw material LATAM Mfg Local LRD Legal transfer Physical delivery Key tax considerations Local third-party customer 7. Sale of finished goods 1. TP 2. TP, indirect tax and customs 3. Consider other domestic indirect taxes implications 4. Tax incentives available: Brazil (Manaus) Colombia (free trade zone) Argentina (Tierra del Fuego) 5. Funding issues Page 33

34 Toll manufacturing model Foreign supplier 1. Sale of raw material Principal 4. Sale of finished goods Foreign customer 2. Sale of raw material 3. Toll manufacturing agreement 5. Sale of finished goods Local LATAM supplier Legal transfer Physical delivery LATAM Mfg Local related party distributor 6. Sale of finished goods Key tax considerations 1. PE issues 2. VAT and other indirect tax issues VAT on tolling fee VAT and indirect taxes on importation 3. Inventory provided by the Principal on a consignment basis 4. Transfer pricing 5. Tax incentives available Mexico (Maquiladora) 6. No funding is needed to acquire inventory as it is provided by the Principal 7. Regulatory approvals Local third-party customer Page 34

35 Brazil Overview of alternatives Flows Export market Local market Export and local market Imported raw material (RM) 1. Contract manufacturing Use of drawback 2. Toll manufacturing Use of drawback 1. Contract manufacturing 2. Toll manufacturing Use of drawback Use of DAC 1. Contract manufacturing 2. Toll manufacturing Use of DAC Locally sourced RM 1. Contract manufacturing Export finance alternative 2. Toll manufacturing Use of bonded warehouse (DAC) 1. Contract manufacturing Use of DAC 1. Contract manufacturing Use of DAC Imported and locally sourced RM 1. Contract manufacturing Use of drawback Use of DAC 2. Contract manufacturing For domestic market (for locally sourced RM) 3. Toll manufacturing For export and domestic market (for imported RM) Page 35

36 Contract manufacturing for domestic market (for locally sourced RM) and toll manufacturing for export and domestic market (for imported RM) Non-Brazilian supplier 6. Sale of raw material Principal 8. Sale of finished goods Non-Brazilian customer 2. Contract mfg agreement 7. Toll mfg agreement 3. Sale of finished goods 4. Sale of finished goods Brazilian supplier 1. Sale of raw material BR Mfg BR distributor Legal transfer Physical delivery DAC Brazilian customer 5. Sale of finished goods Practical considerations IT system Can IT system track manufacturing separately? Inventory controls Risk management TP implications Review of customs requirements Regulatory considerations Page 36

37 How is the choice of location determined? Undertake location and cost assessment Steps How it is undertaken 1 Agree potential locations and agree assessment criteria and weighting 2 Evaluate scores (collecting additional data, if required) 3 Review and sign-off results Vietnam and Malaysia increasing in importance For agreed locations, review 4 activities and cost criteria Sign off model and results Key outputs Key outputs 1 Overview of the key location considerations 2 Review of the models undertaken 3 Recommendation of feasible scenarios Page 37

38 How is the choice of location determined? The location assessment involves assessing the following data points The cost assessment involves assessing the following data points Location assessment Data points required Location assessment Data points required Metric 1 Business environment Metric 2 Legal aspects Metric 3 Quality of infrastructure Political, economic stability, corruption Economic freedom, competitiveness IP protection regime, data security Labor legislation Airport/shipping access, overall quality Utilities, IT, telecoms and office quality Office space costs Order processing costs Corporate tax rate Tax incentive availability Market proximity Outsourcing costs Cost/quality of office space third-party rates Unit labour cost rates in various countries Corporate tax rates in the different locations Headline rates before tax incentives, deductions Overview of reductions in rates possible Distance to key customers/suppliers Metric 4 Human resources Talent availability, wage flexibility, relations Language, relocation attractiveness Inventory holding costs Transportation Third-party logistics and service provider rates Cost of capital in various countries Page 38

39 How are FTA benefits optimized in a global or regional hub structure? Claim current benefits Map strategic opportunities Restructure supply chain In this case, the impact of setting up the regional or global hub should be considered in light of customs declaration, administration and FTA coverage Through having regional distribution centers import and export product, preferential duties may be available Given the existing initiative, the choice of a regional or global hub should be taken in light of potential FTA savings A global or regional hub may provide different opportunities and challenges in respect of the FTA claims: A regional hub is likely to offer better FTA coverage in the region Examples include intra-asean trade, ASEAN-China FTAs, or intra-eu trade within Europe North American Free Trade Agreement Duty rates on pharmaceuticals are generally higher in Asia, particularly on finished products Not all countries sign up for reduced duty rates on pharmaceutical products under World Trade Organisation guidance This is dependent on the regional hub qualifying under the rules of origin on import It may, if 40% regional value content (for example) This requires manufacturing in-region under a regional hub model Page 39

40 Key takeaways Page 40

41 Key takeaways The industry is changing, with developing generics businesses and capitalizing on emerging markets in Asia being key success factors. Commercial and tax strategy must be aligned to maximize value and return on investment but the tax policy environment is becoming more complex. This includes indirect and direct taxes the former is becoming increasingly important as they manage lower selling points and tighter margins. Regionalized strategy for Asia operations is becoming more common with regional hubs and this involves tax complexities and issues to manage. Singapore most common location, but others such as Vietnam and Malaysia are becoming more important. Page 41

42 Questions? Page 42