Corporate tax related expectations
Expenditure on R&D activities
With the talent pool and knowledge base, Indian industry has a potential to participate and contribute in global innovation. There are several things the GOI can do to give a fillip to the R&D space:
- While India is perceived as an attractive destination to outsource R&D activities in view of availability of highly skilled personnel, to put India in a leading position, there is a need to provide impetus to such activities in the form of tax and fiscal benefits in addition to policy initiatives. The GOI can play its role by providing tax benefits such as export linked incentives to units engaged in the business of R&D, contract R&D and clinical research organisations. Further, benefits in the form of research tax credits which can be used to offset future tax liability, similar to those given in developed economies, can also be considered.
- The scope of 200 per cent weighted deduction allowed for in-house R&D facility approved by Department of Scientific and Industrial Research (DSIR) should be extended to cover significant expenditure incurred on consulting / legal fees for filings in USA for NCE (new chemicals entities) and ANDA (abbreviated new drug applications, preparations of dossiers, etc. for defending patent rights. Also, while approving the expenditure, the DSIR has been taking a narrow view that only expenditure incurred on activities undertaken within the premises of the R&D facility are eligible for weighted deduction. Thus, expenditure incurred on clinical trials and bioequivalence studies which by their very nature are conducted outside the laboratory are denied weighted deduction. Necessary instruction/ clarification should be provided by GOI considering various practical difficulties faced by the companies in claiming the intended benefit.
Taxation of royalty receipts
Budget 2013 increased the tax rate applicable to royalty earned by foreign companies from 10 per cent to significantly higher rate of 25 per cent even if the agreements were signed prior to the amendment. This has adversely impacted many companies which had entered into agreements factoring the 10 per cent rate. The industry wishes that the revised rate should be made applicable only to those agreements entered post March 31, 2013. Alternatively, the government may consider restricting the higher rate applicability only to notified jurisdictional areas.
Expenditure on freebies to doctors
As a tool for educating, creating awareness of new medicines/ technologies among the doctors, pharma companies reach out to doctors by providing sponsorships, grants, etc. Medical Council of India had prescribed regulations for certain activities which are not permissible to be undertaken by healthcare practitioners. In view of the circular issued by the Central Board of Direct Taxes considering expenditure incurred on such non-permissible activities to be in violation of law, tax officers deny deduction on ad-hoc basis. The circular is vague on the scope of expenses and manner of administration which leaves the tax officers to sit in judgement on matters to which their expertise does not extend, then leading to unnecessary litigation. In this regard, GOI can rationalise the provisions by providing for claim of expenditure on a self-certification basis or on the basis of specified documents such as CA certificate in hassle free manner.
Tax holiday for hospitals
Tax holiday benefit has been the great source of support for setting up hospital in India which were functional before March 2013. Setting up cost of a hospital involves huge capital and takes almost four to five years to reach breakeven. Hence, it is an industry demand to extend tax holiday benefit for 10 years instead of existing five years to enable companies to claim the benefit. It should also be extended to hospitals set up after March 31, 2013. Currently, hospitals set up in metro areas are specifically excluded from claiming tax holiday. Providing the benefit of tax deductions to hospital set up in metros could play a crucial role in promoting medical tourism in India.
Depreciation
Current 15 per cent depreciation rate applicable to medical/ surgical/ pathological equipment (other than life saving equipment eligible for depreciation at 40 per cent) assumes a life of 15-20 years which is highly unrealistic. The depreciation rate should be increased to 60 per cent to incentivise hospitals to upgrade their healthcare infrastructure consistently and provide patients with the latest technology.
Transfer pricing related expectations:
Margins
Transfer pricing is another area needing special attention for pharma industry. Pharma companies are witnessing difficulties in complying with conflicting regulations of Transfer Pricing and Customs (Special Valuation Branch). From a transfer pricing perspective, companies dealing in active pharmaceuticals ingredients (APIs)/ finished drug formulations (FDFs) imported from related parties are expected to maintain higher margins/ lower import prices, whereas Customs demands higher import prices. GOI should provide necessary clarifications to harmonise these regulations.
Transfer pricing adjustments
The pharma industry undertakes huge investments for infrastructure required for setting up a new unit and creating awareness about products. Further, it also experiences very stringent regulations for validation while launching a product/ module. Accordingly, such companies incur losses during the initial years of set up. However, revenue authorities disregard the start-up phase of companies and nature of expenditure and disallow the expenses incurred in the initial year. The industry expects due consideration to the companies for expenses incurred in year of launch and specific guidelines to be prescribed to account for the cyclic nature of expenditure.
Safe Harbour Rules (SHR)
The Central Board of Direct Taxes has issued draft SHR which provides for classes of transactions or certain margins or threshold limit which shall be accepted by revenue authorities for transfer pricing provisions. The rules provide safe harbour for contract R&D with insignificant risk for development of generic pharma product as cost plus 29 per cent.
While it is accepted that safe harbour generally propounds a higher than arm’s length margin as a cost to taxpayers for the reduced compliance burden and certainty of tax outflows, the quantum of the premium as per the SHR appears to be high from a taxpayers perspective and ought to be reduced to a smaller number.
Indirect tax related expectations
In 2008, abatement rate of 35 per cent was introduced on medicaments while calculating the assessable value for excise duty. However, pharma companies expect to receive 40-50 per cent of abatement in order to recover its costs like other industries.
Considering the need to make available life-saving drugs to the patients at reduced prices and bring down the cost of treatment for these ailments, GOI can consider providing customs duty exemptions to all life saving drugs and reducing the duty on medical devices. Also, diagnosis being an important aspect in detecting, preventing and curing diseases, industry expects to receive custom or excise duty exemption on the diagnostic equipment and consumables.
Further, the levy of excise duty on API @ 12 per cent (plus three per cent cess) and on output of six per cent (plus three per cent cess) has led to accumulation of Cenvat credit in the books of manufacturers especially those who are not engaged in exports and cater only to the domestic market. Further, there are no provisions to recover the accumulated Cenvat credit, which becomes a cost to the manufacturers. The Government could consider rationalising the duty structure by reducing excise duty on inputs from 12 per cent to six per cent. Alternatively, GOI should also provide for refund mechanism to enable pharma companies to claim excess credit.
To summarise, there is immense potential for the Indian pharma industry to contribute in sustainable growth of the country. It is already reeling under challenges of regulatory and price control issues and government’s active support to overcome these challenges and make further contribution. This government had made right noises during election campaign and the first few days of its reign and has encouraged business fraternity to express their demands and concerns. The forthcoming budget will tell how much of the wish list will materialise.
(Isha Shah, senior tax professional, EY contributed to the article)
(Views expressed are personal)
– Hitesh Sharma, Partner & National Leader, Life Sciences Practice, Ernst & Young