Recent US tax reform raises significant issues for life sciences firms and their tax advisors.
Life sciences companies thought they were busy enough dealing with the digital revolution while their tax departments coped with e-filings and even e-audits. But new this year, they have been confronted by a corporate tax revolution in the US.
Data, data everywhere, changing products and their taxation
Imagine a diabetes patient in 2000 taking a standardized medicine to manage blood sugar. It is the same dose of the same medicine that millions of other patients take. More recently, that patient could have an implantable sensor that logs data about drug absorption, metabolism and other systems for a doctor’s review.
Taking the high-tech approach further, a patient can undergo high-throughput screening, a method of drug discovery using robotics, data processing and sensitive detectors to quickly conduct millions of chemical, genetic or pharmacological tests. Here we enter the field known as personalized medicine.
As the activities that deliver medical value change, so does the taxation of that value. In the traditional arrangement, a significant portion of a medicine’s taxable value was assigned to intellectual property (IP) in an offshore jurisdiction and properly taxed at the foreign rate. As medicine becomes more personalized, much of that value is still IP, but its value has moved closer to the patient and some of it is more likely to be taxed locally at local rates.
Another digital development that moves taxable value is 3D printing. When a medical device breaks, the hospital can order a new part to be shipped from abroad, or it could be 3D printed on site. The hospital administrator may consider it a matter of time and shipping cost saved, but it also changes the taxation of that transaction.
For pills, 3D printing is not an option with current technology, but it’s not inconceivable that finishing, filling and packaging of medicines could happen someday soon in a pharmacy. Many years ago, pharmacists routinely performed such tasks, and if they start doing so again, they may shift some value closer to the patient.
US tax reform scrambles business models
Against the backdrop of these revolutionary changes in technology that affect life sciences operations and taxation, why would one country’s tax code reform be so significant?
It’s true that global life sciences companies have always adjusted to countries’ ever-changing tax codes, but US tax reform is different for two simple reasons: the US is the world’s biggest consumer of life sciences products, and it’s also the headquarters country of many large life sciences firms. In combination, those economic realities make the recent US tax reform a monumental challenge for the life sciences sector and its tax advisors.
In the media, national tax systems are often labeled as “worldwide” to mean that income earned abroad is taxable, or “territorial” to mean that only domestic income is taxable. In reality, many countries’ tax codes have worldwide and territorial features, and on that spectrum, the US code had always leaned toward worldwide.
Starting in 2018, the US’s new quasi-territorial system levies a 21% rate on corporate income (down from 35%) plus, an average tax rate of approximately 7% state-level corporate tax that is deductible from federal income, resulting in a new combined effective tax rate of about 26%.
Especially important to life sciences firms is a new deduction for C-type corporations that earn income abroad on intangible property held in the US. This deduction for so-called foreign-derived intangible income (FDII) brings the tax rate on that income down from 21% to 13.125% at the federal level, or about 19% when combined with state taxes. These significant tax cuts are forcing life sciences companies to reconsider even the most fundamental decisions about their business models.