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What pharma supply chain transformation means for tax

As pharma supply chains evolve in a disrupted global operating environment, a light is being shined on the flaws of existing supply chains. 

In brief

  • Disruption to the pharma supply chain has necessitated the move to more resilient supply models that have broad implications for tax structure and strategy.
  • Entering new market locations brings a number of corporate tax and transfer pricing considerations, including shifts in reporting standards.
  • Creating visibility and resilience in the supply chain can create transfer pricing planning opportunities, but also add to intercompany pricing arrangements. 

The pharmaceutical supply chain is evolving. The disrupted global operating environment shone a bright light on the weaknesses of existing supply chains. Now, companies are doing their best to incorporate those lessons, while a complex geopolitical environment and high inflation are increasing the need for operational resilience. Adjusting to a technology-driven future and incorporating alternative supply chain models will have implications across the business, changing tax structures and creating new value drivers that will be important to pharmaceutical companies and their tax and transfer pricing teams. The EY article, “Why digital supply chain visibility should be a pharma priority,” further highlights the importance of improving supply chain visibility.

The future of pharma supply chains is shifting some manufacturing closer to the end market while also expanding relationships with third-party suppliers and diversifying geographically to create dual supply. In response, the industry is starting to implement smart localization strategies, enhance end-to-end visibility and introduce greater efficiencies through collaborations to create more transparency in the intricate web of upstream suppliers.

New models will likely shift away from taxing the profits attributed to a single manufacturing location toward multi-hub models with increased reliance on external manufacturers and dual-manufacturing locations, creating new opportunities for transfer pricing and tax structures. In addition, artificial intelligence (AI)-driven supply chains of the future are placing greater emphasis on the collection and analysis of data, creating a new value driver that will impact transfer pricing policy and strategy.

Tax considerations of potential resilience strategies

Supply chain leaders are considering several potential resilience strategies, creating a range of impact on existing tax positions depending on the strategy that is pursued. Resilience measures expected to have a direct impact on current tax and transfer pricing positions include:

  • Smart localization strategies: the impact of smart localization strategies will vary depending on which nodes of the supply chain or manufacturing process are changed.
  • End-to-end supply chain visibility: the potential opportunities to realign tax planning as manufacturing decision-making, is enabled by data vs. physical manufacturing location.
  • Joint manufacturing: the tax impact is dependent on which node of the manufacturing process is being evaluated.
  • End-to-end localization: the direct impact to current tax strategies due to multiple active pharmaceutical ingredient (API) manufacturing locations, challenge the existing value chain paradigm, particularly with respect to the investment required for API manufacturing and associated return.

New value drivers impact transfer pricing characterization and profit allocation


Operational shifts in the supply chain can impact transfer pricing characterization and profit allocation of existing entities, requiring the valuing of new functions and intangibles. Tax professionals should understand the full value chain and new value drivers of the supply chain evolution. The shift to an AI-driven supply chain will place greater emphasis on the commercial scale-up activities, particularly how data-driven supply chain analytics will likely inform decision-making going forward.


The importance of the procurement function became particularly apparent during 2020-21 when companies were affected by unforeseen shortages of basic raw materials (including ethanol and magnesium) and consumables (among others, single-use bio-reactor bags, known as biobags; glass vials; and sterile filters). To prevent future supply chain disruption, many pharmaceutical companies are investing in talent and technology to anticipate supply chain risk related to raw materials and building contingency plans (e.g., dual sourcing) to deploy should these risks materialize. With any change to the supply chain, tax professionals will have to revisit profit allocation among the future state entities involved based on their respective functions, risks, and assets and take into consideration any local legal or tax regulations, which may be more complex than the current model.


One example of a smart localization strategy takes advantage of a hub and spoke model, where certain manufacturing and supply chain activities are moved closer to the local market. Depending on which activities are localized, there could be direct tax impact related to value attribution. For instance, packaging operations are generally routine activities while API and formulation steps are generally attributed more value in the supply chain, and a principal company jurisdiction will often have a lower effective tax rate than the local market jurisdiction. In that case, limiting localization to more routine activities such as packaging and labeling could be advantageous.


For instance, consider a traditional large pharmaceutical company that currently has manufacturing and procurement relationships with a related-party licensed manufacturer in Puerto Rico. To make its supply chain more resilient and improve visibility, the company decides to expand beyond this exclusive relationship and implement a dual-sourcing model, shifting part of these operations to a new structure with a Swiss principal model that includes a procurement hub and European- and Asian-based contract manufacturers.


This change of manufacturing location creates operational benefits, including its proximity to the European and Asian markets, as well as a more stable and reliable infrastructure and a more business-friendly environment. It also has a variety of considerations for tax and transfer pricing professionals.


The current state supply chain and associated transfer pricing policy for the Puerto Rico-licensed manufacturer is relatively simple. Puerto Rico procures its own raw materials and semi-finished goods, uses its own workforce to manufacture finished goods, and sells finished goods to third-party and related-party distributors. After paying a royalty for use of patent and technology intellectual property (IP), Puerto Rico retains the residual income associated with the sale of the finished products. As the pharma company moves to a more dispersed supply chain, revisiting the profit allocation among entities will be particularly important as the manufacturing execution will now be separate from the supply chain and manufacturing leadership and procurement functions based in Switzerland.


Operational considerations for tax professionals


Establishing a principal entity in a new location requires the alignment of governance models with existing operating models. Tax professionals will need to consider the organizational structure, including the location of employees, their employing entities, and whether location transfers will be necessary to build robust substance to support the principal characterization. Tax professionals should connect with HR teams to get full visibility into how employees are geographically dispersed. Understanding from the business regarding what employees have significant functional contributions, including accountability and decision-making roles to manage risks and drive value creation.


If the principal will also have IP ownership, tax professionals should consider if legal entities have sufficient substance with respect to research and development or other functions that contribute to the development of IP, in line with the guidance provided in the Organisation for Economic Co-operation and Development’s (OECD’s) development, enhancement, maintenance, protection and exploitation of intangibles (DEMPE) concept, introduced in 2015. The team should also assess what corporate, payroll, or investment tax incentives or credits may change.


When evaluating and implementing potential changes to financial or physical supply chain flows, companies should also consider indirect tax and customs implications. Adjustments to financial flows, including rights licensed in changes to IP remuneration, can result in increases (or decreases) to customs value thus impacting both duty liability and import VAT/GST. Changes to physical flow and trade lanes will similarly impact both duty spend as well as potential planning opportunities, such as Free Trade Agreements and Foreign/Free Trade Zones. These additional costs or potential benefits should be appropriately considered in financial models to allow companies to understand the full supply chain impacts of tax and business decisions.


Many of the same considerations that are taken to enter a market need to be thought about as a company exits an existing market. Tax professionals should consider the BEPS 2.0 implications of exiting a market and understand the potential exit tax consequences of transferring functions, assets, such as intellectual property, or risks to a new structure.


What tax and transfer pricing professionals can do right now


Historically, statutory and effective tax rates have been part of the decision-making process in determining the location for a new entity. Yet, new guidance from the OECD’s anti-tax avoidance plan, BEPS 2.0, effectively sets a 15% global minimum tax for multinational corporations and minimizes the incentive to relocate in the jurisdiction with the lowest tax rate. Companies should consider selecting a principal location that best aligns with how the business intends to operate, with tax as only one of many considerations.


Other things for companies to evaluate when moving to a new location will be changes in accounting standards, shifts in legal entity structure, and the character of income on any new transaction flows. 


Pharmaceutical companies looking to create visibility and resilience in their supply chains need to involve their tax and transfer pricing teams early in the process. Executive teams need to consider the tax implications of new locations or business relationships as they explore ways to create a proactive risk management strategy for the supply chain. 

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