Pharma Industry

Content

• Transfer pricing Environment in India

• Pharma Transfer Pricing Issues

• Select Global Case Laws

• Dispute Resolution

• Legislative & Regulatory

Development

• Way Forward

Slide 2
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

Slide 3
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

Slide 4
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.

Slide 5
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 6
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 7
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

Slide 8
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

Slide 9
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
Slide 10
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

Slide 11
Select Global Case Laws
Glaxo, USA
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 12
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

Slide 13
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 • 1.6% operating margin on sales
• Marketing • 13.1% mark-up on costs
• Detailing and Selling • 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 14
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
Slide 15
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

Slide 16
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.

Slide 17
Legislative and Regulatory Developments

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

Slide 18
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

Slide 19