13 minute read 7 Mar 2023
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How life sciences businesses transform the tax and finance function

By EY Global

Ernst & Young Global Ltd.

13 minute read 7 Mar 2023

Life sciences organizations operate in a complex industry – one that looks set to become more challenging, including the tax perspective.

In brief

  • Life sciences organizations were central to fighting COVID-19. However, as the world moves forward they are faced with a host of challenges.
  • Shifts in supply chains, expiring patents and evolving legislation creates pressures for the wider enterprise, and tax and finance are being equally impacted.
  • Organizations are reimagining their tax and finance models to provide value to the business and create resilience for the future.

The COVID-19 pandemic thrust the health and life sciences sector into the global spotlight. The crisis demanded a rapid response, and companies in the biopharma and biotech industries stepped up to innovate their way out of the COVID-19 pandemic through efficacious vaccines and therapeutics at a global level.

Even before the pandemic, the life sciences sector was attracting attention with a cumulative $1.5t of M&A activity in the past 10 years – $261b of that was in 2019 alone1. And there’s plenty of innovation in the pipeline, ready to shape health care in the post-pandemic world, including cell and gene therapy, which now has almost 2,000 products in some stage of clinical development. Meanwhile, the mRNA technology found in the latest vaccines underpins more than 200 products currently in clinical trials for a range of illnesses including cancer, respiratory disease and heart failure. “Then there are next-generation antibodies, and protein degradation technologies in which small molecules specifically target disease-causing proteins for destruction,” says Arda Ural, PhD, EY Americas Industry Markets Leader, Health Sciences and Wellness.

Yet behind the attention-grabbing figures and innovation, the sector is facing four major trends that are set to shape operations in the coming decade, all of which will have a major effect on organizations’ tax and finance functions.

1. The biologics patent cliff

Intellectual Property (IP) is a cornerstone of success in life sciences. Yet patent cliffs projected to hit the top-line around 2024-26 are creating huge pressures on revenue and costs. Take biologics – powerful drugs isolated from natural sources that are used to treat numerous diseases, including autoimmune conditions or cancer. As the patents run their course, manufacturers are being challenged by biosimilars – copies of their proprietary drugs. To shore up the pipeline, companies are taking robust steps to free up and allocate capital to R&D and strategic partnerships.

2. Strategic partnerships

The period of mega-mergers may be largely in the past – there have only been eight in the past 10 years2 – but bolt-on acquisitions and focused M&A continue at pace. According to the 2022 EY Firepower M&A Report, major biopharmas have deployed roughly 1.5 times more firepower on alliances than on M&A since the beginning of 2020. This trend of focused portfolios has been, in part, driven by capital created through disposal of non-core business units by way of dispositions or spin-offs, which companies continue to consider. The total Firepower of the industry is now measured at $1.4tn up from $1.2tn from before the pandemic.

3. Supply chain resilience

In the wake of massive geopolitical upheaval, plus the changing competitive landscape, life sciences companies are focusing on delinking supply chains, decentralizing their operations, and building regionalized capabilities. Even those that have traditionally had an in-house manufacturing focus are looking to technology and third parties to provide the additional capacity they need. This is a major shift or global decoupling and its effect goes beyond the pharmaceutical business. This long-term transformation will have material effect on how the industry reimagines its supply chain with risk and cost in mind.

4. Legislation

Life sciences companies can expect a significant uptick in the volume of tax compliance and controversy from incoming legislation – like BEPS 2.0 and Pillar Two – as they have complex supply chains, legal entity charts and IP structures that make legal entity reporting and forecasting especially complex and ripe for tax controversy. Additionally, they tend to have decentralized tax operating models, often with several service providers supporting diverse local country tax and related reporting needs. The diverse approach is further often complicated by the realities of multiple enterprise resource planning (ERP) systems and a lack of central data.

Yet that’s not all. Life sciences companies are having to navigate these sector trends while focusing to attract, retain and retrain key talent; scrambling to transform their technology and data capabilities for the rapidly changing world; and struggling to cut costs across the board. In 2022, for example, 119 biopharma companies laid off staff, including some large companies with headquarters in the US and Europe3.

Taken together, these factors leave life sciences working to achieve much more with much less.

 

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1

Chapter #1

The impact on tax and finance

Everything from M&A to new tax laws and regulations are having an impact on life sciences companies.

The impact of this disruption is felt very keenly in life science’s tax and finance functions, and is only expected to get worse. As capital is directed to R&D and M&A, for many companies, it leaves less available to invest in enabling functions. Meanwhile, the trend toward an increased level of bolt-on acquisitions, joint ventures, strategic partnerships, and spin-offs means the volume of data sources and data manipulation requirements is increasing along with the augmented volume of transactions and compliance requirements.

The challenge for tax and finance teams is further exacerbated by continual proposed global tax legislation that could fundamentally transform international tax compliance requirements, and expand sustainability responsibilities, resulting in additional compliance and reporting. These realities of increased change and heightened filing requirements exist simultaneously with cost reduction pressures, so headcount and departmenal funding are not likely to expand to match the workload, thereby increasing organizational risk.

Ana Maria Romero, EY US-East Operating Model Effectiveness Transfer Pricing Leader for Life Sciences, points out that as a highly profitable, IP-driven sector, transfer pricing is already a significant component of the tax planning and compliance work performed by life sciences tax departments. Global tax reforms, such as BEPS 2.0 will have major implications for transfer pricing and every aspect of the tax lifecycle – from provision to planning to compliance, and ultimately to controversy. 

“Tax departments are likely to find themselves struggling with increased compliance requirements arising from BEPS 2.0,” says Romero. In addition, “they could find themselves managing hundreds of transfer pricing audits at the same time.” Most companies, she says, lack resources and funding to take on this additional workload.

In response, many life sciences organizations are now starting to reimagine their tax and finance functions to realign tax and technology capabilities with the contemporary cost pressures on routine activities. The EY 2022 Tax and Finance Operations (TFO) Survey found that 84% of companies in the sector plan to do so, while 95% said their organization would be reallocating budgets over the next two years, from routine activities such as tax compliance, to strategic activities including legislative planning and controversy. 

Life sciences tax departments are transforming

84%

of life science companies say they’re reimagining their tax and finance functions.

However, the survey also revealed that life sciences tax and finance functions face several key barriers to delivering on their purpose and vision: 37% said they lack a sustainable plan for data and technology; 32% cited the inability to identify, evaluate and respond to legislative and regulatory change; and 24% pointed to the inability to hire and retain required talent. 

  • Four steps to take to achieve transformation

    As a starting point, the C-suite and tax and finance leaders in life sciences organizations are advised to do the following:

    1. Run a data gap or impact assessment on your changing reporting and compliance requirements

    Whether for BEPS 2.0 or domestic minimum taxes based on BEPS 2.0, (public) country-by-country reporting or ESG, figure out what your data needs are going to be, where you’re going to get that data from, and what effect it will have on your systems and enterprise resource planning. And especially if you’re in the process of – or are considering – an ERP update.

    2. Step back and assess your current state

    Look at those data requirements and perform a tax technology gap assessment. What are the opportunities for making your tax and finance processes more efficient through automation? Ask how you can provide the greatest ROI and have the highest impact, as quickly as possible. Establish an implementation plan for how you’ll get where you need to be.

    3. Decide which activities you wish to keep in house and which ones you should immediately consider for co-sourcing

    Keep those activities where you want to be best in class, and where you believe you can make significant impact in terms of risk management, planning, M&A, etc., and that add tangible value to the organization. Everything else should be evaluated for co-sourcing.

    4. Educate leadership on tax needs early and often

    Communicate what data you need from IT, the ERP, and various other functions when legislative and regulatory changes are proposed, rather than when they are the verge of being implemented. Tax leaders need to be very clear and concise when communicating their needs to the C-suite. And what they need is a seat at the table during any IT transformation.

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Chapter #2

Legislative and regulatory change

The life science’s profitability means it will be materially affected by tax reforms.

With the regulatory landscape shifting fast, the reporting requirements will only increase. As discussed above, life sciences is a highly profitable sector, which leaves it exposed to tax legislative changes and to increased levels of controversy, as governments seek to recoup tax revenues in the wake of COVID-19 recovery and amid other disruption.

Yet the digitalization of reporting will also be important here. Complying with increasingly common digital tax filing requirements will further increase the workload, cost and risk profile of the life sciences tax and finance function.

According to the EY TFO Survey, companies are responding with an estimated average spend of $10.6m in tax technology over the next five years, while many are also turning to third parties for support – with 46% saying that the most significant benefit of partnering with a provider to co-source their multi-country tax compliance and statutory reporting activities is reduced risk, followed by cost reduction (31%).

The technology challenge

As well as tax authorities demanding increased volumes of digital data, some in real-time, companies in the sector can expect huge pressure in the system due to the volume of data and required calculations from a raft of new regulations.

“Large multinational companies are already now having to access, transform and extract insights from significant volumes of data that they've not historically had to think much about,” says Rick Fonte, EY Global Health Sciences & Wellnesss Tax Leader. “Can they even access that data from their current systems efficiently? If so, can they transform and organize the data so that it’s usable across all provision, planning and compliance processes – so people can actually make sense of it and draw meaning from it?”

Companies on average already spend 40-70% of their time on gathering and making data useful – a data point that seems so contradictory to the automation capabilities available today. “Once you take into account BEPS 2.0 and ESG, the data challenge becomes more complex and onerous,” Fonte adds.

While automation is one of the key enablers, current technology uptake among life sciences organizations generally lags. For instance, only 27% use cloud-based platforms extensively, and only 20% use automation extensively. Many IT systems and processes were set up for how finance runs the business, not taking into consideration the granularity of the data and reporting required for tax.

Many organizations will be looking to upgrade their ERP systems in the near future. In response, life sciences tax functions need to ensure their data and technology needs are communicated and incorporated into the early planning phases of any ERP project. “This isn’t a tax department problem; it’s an overall company problem,” says Ronald van den Brekel, EY Global Head of Transfer Pricing Strategy and Innovation. “The data sources are going to come from finance, HR and legal, and the systems need to be built to accommodate that fact.”

Tax teams have an opportunity, through these upgrades, to create the proper tax detail. Take, for example, stock keeping unit (SKU) level pricing inclusive of full transfer pricing being developed into the ERP. Doing so also benefits the broader business by helping functions including financial planning and analysis be able to forecast profitability more accurately.

Then there’s the co-sourcing option. According to the EY TFO Survey, the most significant benefits of partnering with a provider to build a comprehensive data and technology transformation strategy and solution for the in-house tax function are reduced tax risk profile (48%) and increased value (29%).

“Nobody’s going it alone, nor should they be, let’s put it that way,” says Fonte. Some of the biggest organizations who still have well-funded and resourced IT and technology infrastructures may try to build new solutions themselves, he says. But even they are relying much more heavily on external advisors and third-party tools, especially in light of the requirements of BEPS 2.0 Pillar 2. “The tax rules are too complex, they are changing quickly. As a result, it is often expensive and too risky to internally build and maintain custom in-house solutions.” 

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Chapter #3

Navigating talent

Attracting and retaining tax and finance professionals is a challenge for life sciences companies.

Another challenge facing life sciences organizations is how to attract and retain tax and finance specialists, even as the workload becomes more challenging. This arguably has been made worse by The Great Resignation – the trend of people leaving roles for a change of lifestyle, or to seek greater purpose and fulfillment.

The escalating legislative, data and compliance requirements, the uptick in bolt-on acqusitions and other strategic collaborations, and the focus on supply chain resiliency and alternative business models all have tax impacts, which means more work. Yet many organizations still have the same number of people, many of whom lack the additional digital skills required in today’s environment, all trying to figure out how to do more with less budget.

“People are getting burned out, there are a lot more options in terms of employers and work locations, so if the work environment is deemed unhealthy or not rewarding, people will leave,” Fonte says. “So, many companies are experiencing significant turnover and a challenging and competitive recruiting environment, and that revolving door is another strain on the department.”

At the same time, the type of people these organizations need is evolving, too. In order to add value, tax professionals now need to be data- and tech-savvy – 92% of respondents to the TFO Survey said that tax and finance personnel will have to augment their tax technical skills with data, process and technology skills in the next three years, from a moderate to very large extent. 

Upskilling tax

92%

Of survey respondents say tax and finance personnel need sharper technical skills.

There’s also a desire to shift talent focus from routine to strategic processes – respondents feel that 76% are spending an inappropriate amount of time on data, and 67% said the same about tax compliance. This is work that could easily be co-sourced in order to spend more time on high-value activities including communications with stakeholders, tax planning, and risk management. 

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Chapter #4

The evolving ESG picture

Life sciences companies should focus on qualifying for incentives.

Life sciences leaders are more actively embracing the ESG agenda, acknowledging that it reflects the tastes of existing and prospective employees, investors, customers and ecosystem partners. As a result, time spent by tax and finance functions on governance and reporting to key stakeholders is set to increase significantly.

Life sciences companies will need to focus on identifying and quantifying the sustainability-driven incentives and funding available to their firms, while also determining the impact of proposed or implemented sustainability taxes.

This modeling will also need to consider the direct and indirect tax impact of changes to a company’s development or supply chain of products. Furthermore, the trend of making more data available to more parties discussed above will be the amplified by the governance pillar of ESG.

Life sciences tax and finance functions will need to actively participate in their company’s reporting strategy to ensure that there is consideration of potential tax risks of public reports on sustainability. Tax and finance functions will have an opportunity to properly convey a comprehensive picture of the social and tax contributions (both direct and indirect) that are made. Lastly, tax functions will need to not only assess the impacts but distinguish a process to identify required tax filings needed to comply with new sustainability measures in all of the locales that they operate.

The ability to meet the expectations of shareholders will be significantly dependent on the availability of data, much of which is not typically sensitized or analyzed by the tax and finance function today. In order to have the flexibility model or report the requisite sustainability information to public authorities, or shareholders, enabling functions will need to assess their data gaps and collaborate on their data strategy. Centralized access to data, paired with proper establishment of key analytics, will be the gold standard for tax and finance functions to manage the pace of change that will be driven by internal and external sustainability pressures.

New tech-driven data analysis and reporting systems offer these companies an opportunity to harness the data to show their true contribution, helping them present themselves as they wish to be seen. 

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Chapter #5

Outsourcing, co-sourcing or a hybrid approach?

Life sciences should take stock of what they need to operate effectively.

 

Life sciences organizations are facing an unprecedented confluence of challenges – and a distinct set of sector-specific cost pressures. They are deploying whatever capital they can into acquisitions and product development, not their back-office functions. Yet, while expressing an intention to transform their tax and finance functions, 87% are planning to reduce budgets – by an average of 5.4%. Meanwhile, 82% are more likely than not to co-source select tax and finance activities in the next 24 months. 

Budget pressures

87%

Of life sciences companies are planning to reduce budgets – by an average of 5.4%.

Those life sciences companies with large international footprints are likely to co-source and/or seek technology solutions for their international indirect tax compliance – VAT and GST – as it involves a lot of filings including monthly, quarterly and annual, significant volume, and highly transactional and data-intensive work, says Fonte. “Co-sourcing corporate income tax filings for all but maybe a select number of a company’s largest markets also represents low-hanging fruit and is often one of the first areas to be considered, often in connection with indirect taxes.”

“For the US market, both US and non-US headquarted companies, we are seeing a continued trend toward co-sourcing sales and use tax filings, property taxes, business licensing. These areas are high volume and very data intensive, often high touch in terms of the volumes of inquiries received from the authorities, and which can be significantly enabled through available tax technology tools and platforms.”

It’s worth noting that co-sourcing is not a one-size-fits-all proposition. Rather, it’s a unique response to the needs and challenges of each organization. A company’s co-sourcing strategy will depend on myriad company-specific factors, including its geographical footprint; complexity; turnover; how many people they have and want to retain; the skill sets and experiences of the people they have; the current state of their technology and systems (including the number of ERP systems they operate); their ability to access reliable data; where they’ve already made investments, etc.

Which means life sciences companies may each approach co-sourcing in very different ways. “Some companies will package it up and roll it out as part of a single, large transformation effort, often as part of a broader finance transformation,” Fonte says. “But more and more, we’re seeing companies take the time to develop a holistic technology and tax operating model approach, which they implement in a planful way over a period of several years, because it manages the impact, cost and disruption to the organization.” 

He says many companies may believe they are already doing this because they have a bunch of firms hired by their local market finance or tax teams performing a variety of tax activities. “To be clear, that’s not what we consider to be co-sourcing, that’s organized chaos. Without a centralized approach you’ve lost all ability to drive cost and process efficiencies, access and leverage centralized data and analytics, and have in place a governance model capable of enabling global visibility and risk management.”

Summary

While the life sciences sector played a leading role in helping the world navigate and emerge from the COVID-19 pandemic, organizations are now facing myriad cost and resource pressures that will require transformation of enterprise-wide operating models. Included in this transformation will be tax and finance functions, who will have to deal with the tax and reporting implications of supply chain disruption, cost-reduction pressures, shifting industry trends and the introduction of new global tax legislation. While undoubtedly challenging, it provides tax and finance with the opportunity to add genuine value to an organization and set it on a path forward.

About this article

By EY Global

Ernst & Young Global Ltd.