How life sciences businesses are transforming their tax and finance functions

In brief

• Life sciences are shifting focus to biologics and advanced technologies amid supply chain challenges.
• Firms are increasingly co-sourcing to streamline tax and finance operations in response to regulatory changes.
• Investment in data management and technology is critical for optimizing operations and handling compliance.

The past five years have been pivotal for the life sciences sector. Vulnerabilities inherent in legacy supply chains and geopolitical unrest have resulted in a pivot to alternative supply chain models and accelerated the adoption of technology across the value chain, including generative artificial intelligence (GenAI).  

At the same time, many companies are continuing to focus on optimizing their product portfolios and have sold or spun off their generics and consumer brands in order to focus on what is new, what is growing, and where the next breakthrough may be coming from.  

Many of the larger players are also beginning to reduce investments in small molecules in exchange for greater investments in their biologics portfolio due in part to the US Inflation Reduction Act’s drug price negotiation provisions. Essentially, redirectly precious working capital to research and development (R&D) and mergers and acquisitions (M&A), with the highest potential return on investment. Meanwhile, the impact of patent expiry dates on existing blockbuster drugs and competition from generics continues, resulting in significant concerns over future revenues.

Advances in life sciences are also having a knock-on impact on costs. “Global raw material supply and complex shipping and storage for products with unique requirements or limited stability are putting cost pressures on already stretched supply chains,” explains Derron Stark, EY-Parthenon Managing Director, Strategy and Transactions. “And solving the age-old question of end-to-end supply chain visibility remains a priority alongside risk monitoring and risk proofing disruptions to the supply chain where possible.”

Life sciences firms are also not immune to the pressures and challenges that face other sectors. Broader macroeconomic factors and the global economic slowdown in 2022 and 2023, including high energy costs, inflation and rising interest rates have led businesses to scrutinize their cost base.

The current reality is that life sciences businesses are being pressed by multiple financial constraints, including higher labor costs, transportation, fuel and energy cost increases, as well as the costs of implementing new technology. Furthermore, there is mounting pressure and need to reallocate money spent on enabling and other supporting functions to R&D, supply chain, manufacturing and M&A.  

These cost pressures, increased regulatory complexity – not least through the arrival of the OECD’s Base Erosion and Profit Shifting (BEPS) 2.0 project – and technological advances are pushing life sciences organizations to examine many of their business functions. This includes performing much more aggressive assessments of their tax and finance operations, including making the most efficient use of co-sourcing. 

In order to assess how tax and finance teams are meeting the ever-present challenge of “doing more with less”, it’s important to look at some of the more specific challenges they face. The EY Global Tax and Finance Operations (TFO) survey identified three key areas of focus, which we will examine here in more detail: the talent challenge; the legislative landscape; and the role of data, AI and technology.

BEPS 2.0 is also having a talent impact in that it is creating a whole new set of tax accounting rules. Running tax calculations and managing data has become far more labor intensive than it used to be.

“It’s become a lot harder to find the relevant skillsets in the market,” says Matt Gengler, EY Senior Manager, Intercompany Effectiveness. “And not only is it difficult to hire and retain these people, others are retiring and there’s a lack of people coming into the profession, especially as you start to move away from the tax technical side of things and more into the systems data and automation side, which people aren't as comfortable with. It requires a whole new set of skills.”

Against this background, it is unsurprising that 61% of life sciences respondents agreed that one of the most significant benefits of co-sourcing is that it drives effective talent management, allowing teams to focus on higher-value work, including focusing on data and analytics to drive value for the organization, which in itself can be attractive to tax professionals from the perspective of skills development and pathway for promotion.

The legislative landscape

Life sciences is one of the most stringently regulated sectors and already bears significant regulatory requirements burden. For tax and finance functions, that burden is set to increase significantly through the implementation of the OECD’s BEPS 2.0 project, including both Pillar One and Pillar Two.

A long time coming, many aspects of BEPS Pillar Two – which provide for a global minimum tax rate – became effective for businesses with tax years beginning in January 2024. The TFO survey, which took place in 2023, shows that 95% expect a moderate to significant change to tax and business operations from BEPS 2.0. Those expectations are now becoming a reality as many companies are having to forecast and document their estimated Pillar Two liability as part of the Q1 2024 tax provision process.

“It's the first time that businesses have to include BEPS-related estimates in their financial statements, so there is bound to be uncertainty as to the impact,” says Colleen Sebra, EY Tax Technology and Transformation. “Companies will have done their modeling and leveraged their 2023 numbers under the safe harbor rules, where possible, and thus mitigate any top-up tax issues for now. But the whole process is only going to become more complex in the years ahead.” 

“In fact, we are already seeing some data-related challenges in connection with the Q1 2024 tax provision processes,” says Rick Fonte, EY Global Life Sciences and Healthcare Tax Leader. “The transitional CbCR safe harbor calculation is a good example, as running the calculation using 2023 data as a proxy is a lot different than running it based on a 2024 full-year forecast.

“Historically, CbCR [country-by-country reporting] was information reporting only, and most companies don’t have a set process to forecast this data, particularly intercompany revenue and profit forecasting which would require forecasting by legal entity. So, there is a lot to do to get to a forecasted CbCR calculation,” adds Ana Maria Romero.

“This lack of robust legal entity forecasting capability will also result in broader challenges in connection with running the overall GloBE [Global Anti-Base Erosion] calculations, especially as we get closer to year-end.”

As much as skills shortages are going to be problematic for tax functions in a BEPS context, the need for data control and consistency is going to be central to delivering success. And this goes beyond just Pillar Two.

“You’re basically dealing with a third set of books to calculate what your Pillar Two liability is going to be because it's not straight US GAAP, but rather US GAAP with an OECD spin to it,” explains Jill Schwieterman, EY America’s Global Compliance & Reporting Leader, Ernst & Young LLP. “This creates a lot of complexity from a transfer pricing perspective, as that modified GAAP needs to start with the right transfer pricing, which is not necessarily what is in the US books. And so it puts a lot of pressure into getting your transfer pricing right during the year, as opposed to doing adjustments at year-end.”

Another potential issue comes from Amount B under Pillar One, which aims to simplify existing transfer pricing rules and will affect anyone that already follows the OECD’s transfer pricing guidelines. The challenge here is that while it’s in the OECD’s guidelines, it is optional for countries, which has the potential to create all manner of inconsistencies.  Another challenge is that there is still pending guidance on scoping that may impact which companies are in or out of scope for Amount B.

Given this scenario, the fact that there may or may not be a treaty in place, and the fact that current status quo transfer pricing might set a return higher than Amount B or lower than Amount B, there are 72 distinct potential outcomes between two jurisdictions associated with distribution returns. This is particularly relevant with regards to the point above on the GloBE calculation requiring parity across jurisdictions for transfer pricing purposes as it not only increases the complexity of potential transfer pricing controversy but also the complexity of the GloBE calculation and potential exposure to double taxation.

BEPS more broadly could present significant risk of controversy. Many life sciences businesses will hope to get advance pricing agreements (APAs) in place because they don't want to deal with the uncertainty that comes with countries taking their own spin on the rules.

Indeed, in the 2024 EY International Tax and Transfer Pricing Survey, 59% of life sciences businesses say unilateral APAs will be very useful to managing transfer pricing controversy over the next three years – more than double the 29% who said so in the 2021 survey.

“It’s important for companies to get a handle on what their exposure to BEPS is, and data is absolutely critical here,” says Gengler. “The reality, however, is that the more data that is required to complete calculations, the more companies are going to struggle. It’s a vicious circle. In order to get an APA in place, for instance, a company will need the data. This is certainly one of the key reasons why tax and finance functions are looking at co-sourcing.”

The role of data, AI and technology

As much as life sciences organizations use advanced and ever-evolving technology to drive the frontiers of healthcare, it’s equally essential that they leverage such technologies in the tax and finance function in order to optimize operations and minimize manual activities, improve quality, drive value through insights, overcome cost constraints and ensure compliance with all regulatory and legislative requirements.

The TFO survey, however, indicates that there is work to be done in this area, with 43% of respondents saying that the inability to execute a sustainable plan for data and technology is the biggest barrier preventing their tax and finance function from delivering its purpose and vision.

“One key problem is that tax and finance functions are often under-invested in the first place,” says Kathy Denardo, EY Americas Finance Managed Services Leader.

“It’s absolutely clear that the complexity of operating a tax and finance function is increasing – and is only heading in one direction – so, the investment needs to be greater.”

The challenge for many life sciences businesses is where that investment should be made. For small and mid-sized organizations, the cost of building the technology themselves is generally prohibitive, with co-sourcing or outsourcing proving to be the most viable option.

“Even for large organizations, cost is an issue, as well as access to resources,” says Fonte. “The increased complexities of the business including their tax profile, the number of disparate systems and the volumes of data make it extremely challenging to support fast evolving data and technology needs.  As a result, when considering cost and viability, most companies will need to evaluate some type of assistance model ranging from design-build to outsourcing of certain data management activities.”

Against a backdrop of cost cutting – with 92% of companies planning to freeze or reduce the cost of their tax and finance function – deciding the most strategic place to spend their money is key.

There are, however, many questions that businesses need to ask before any decision is made – not least where they currently stand, where the data is, are they using multiple providers, is there a lack of consistency in data and are there incompatible technologies? Have they been “bolting on” technology with no cohesive strategy?

“All of this aside, one thing for certain is that businesses need to be driving toward data centralization and platforming,” says Denardo. “There are so many functions within the wider tax and finance function, and everyone has their own separate goal. As a result, functions in different countries may be operating in different ways without a consistent approach to data.”

Utilizing technology, be that in-house or through a co-sourcing partnership, can also play a critical role in navigating cost constraints. AI, for instance, can help with processing some of the more mundane tasks, allowing tax teams to focus on higher-value work. It can also be helpful in managing controversy.

“From a controversy perspective, some governments now have transactional data through e-invoicing, they've got indirect tax data through indirect returns, and so on,” says Romero. “There is just so much more data and so much more transparency, and the authorities are going to be asking questions as they get better with technology and analyzing the data that they have access to. Businesses must be on top of their data so that they can respond to these questions.”

A cohesive and centralized approach, often facilitated by working with one single global provider, can play a significant role in managing these controversies.

Building the most efficient sourcing strategy

Against this backdrop, it’s not surprising that 93% of respondents in the TFO survey say they are changing their tax and finance operating models. Central to this will be which services and processes they will retain in-house and those they will outsource or co-source to an external provider.

According to the survey, 88% say they are more likely than not to co-source select tax and finance activities within the next 24 months. But this sits within a broader reimagining of sourcing models.

“There are so many questions that businesses need to ask themselves around effective sourcing strategies,” says Sebra. “What should be insourced, co-sourced or outsourced? How many people should you have internally and where should those people be located? Should you leverage centers of excellence? Is your shared service center, if you use one, going to provide value to tax? With all the advances in technology, should you just automate operations?”

“For external providers, it's not just a case of lifting and shifting and taking on existing processes that clients are using today,” says Gengler. “It's transforming those processes and making them more efficient and productive for the data intensity and data needs that are coming in the future, and what's required from a compliance perspective. And sometimes clients may not realize that until you talk through it with them.”

The key shift in a sourcing strategy is the need to move to an end-to-end view, rather than different parts of the tax and finance function, often in different jurisdictions, operating autonomously.

“Ultimately, that is the approach that businesses have to take,” says Romero. “If you don't connect the dots across an organization and people are operating in silos, you can very easily put yourself in a position where you get into very complicated discussions in a controversy. And critically, the tax and finance function has to be locked at the hip with the business. So, connect the dots within your department, and then within the overall company.”

As life sciences businesses continue to push the boundaries of what is possible, it’s imperative that tax and finance functions provide a robust foundation on which those businesses can operate, even in the face of talent, regulatory and technology challenges.

“For many, that may begin with a step back and a re-evaluation of the focus of their operating model – what they own and how they can leverage others,” says Denardo. 

Summary

This article explores transformative shifts in the life sciences sector, emphasizing the adaptation to new supply chain models, accelerated technology adoption, and heightened focus on biologics over small molecules. It details the sector's response to financial pressures, regulatory complexities, and technological advancements, underlining a strategic pivot toward improving tax and finance operations through co-sourcing and improved data management. It underscores the imperative for life sciences firms to adapt rapidly to maintain operational efficiency and navigate the evolving economic and regulatory environment effectively.