The Hindu Business Line : Pharmaceuticals: Hopes on R&D, tax incentives

The proposal to extend income-tax benefits to profits of scientific R&D companies may help a larger universe of pharma companies to reap tax exemptions.

Kumar Shankar Roy

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The prospect of greater regulation of drug prices in the domestic market, a depreciating dollar and pressure on pricing in large markets such as the US, has left the Indian pharmaceutical industry at the crossroads.

In the last nine months, only players with wider geographical presence (with a multiple currency exposure) and with a formulations-based business have managed to clock reasonable financial performance. Thus, the pharmaceutical industry has pinned its hopes on a host of R&D and tax incentives, which if approved in the Budget, would help the players to free up cash flows through tax savings to fund research activities that do not generate immediate earnings.

Extension for EOUs

Although revenues of the top-15 pharma companies have grown by 15 per cent (includes substantial gains from foreign-currency denominated loans) and profits by 27 per cent for the nine months ended December 2007, the figures in isolation can be deceiving, as there has been huge divergence within the group. Pharma being a sector that relies significantly on exports, tax incentives dealing with foreign exchange earnings of companies may help bolster realisations in an otherwise challenging environment.

Income-tax rules that allow exemption of profits emanating from a 100 per cent export-oriented unit (EOU) from tax, are set to expire by April 2009. Pharma companies may save significant sums if the proposal extended beyond FY 2009.

Though the special economic zone (SEZ) route remains an alternative to EOUs, smaller companies may not be able to explore this capital intensive option; public opposition has also been stalling some SEZs. EOUs look to be the more suitable vehicle in that scenario.

Weighted deduction

For companies that are focussed on innovation, tax exemptions and incentives on R&D spends may help companies buy time during the long gestation period which is usually involved in generating payoffs from research efforts. Even optimistic estimates suggest that the recent research efforts of Indian pharma companies may bear fruit only by 2011-12.

Larger companies in the pharma space in the past year have lined up plans or have actually spun off their R&D divisions, involved in drug discovery, into a separate company. In this light, the industry demand for extension of 150 per cent weighted average deduction on R&D expenditure (leading to income tax exemption) to non-manufacturing entities, would especially help standalone R&D companies such as Sun Pharma Advanced Research Company, NPIL Research and Development as well as Ranbaxy Life Science Research. However, the scope of the deduction currently does not cover standalone R&D companies without manufacturing units.

Another expectation is for the deduction umbrella on R&D expenses to be raised from 150 per cent to 200 per cent. These demands stem from the innovative chemical entity research (over 30 new chemical entities worked upon) being undertaken by companies requiring different strategies and thus outlays on the effort. Generally, pharmaceutical companies incur research and development spends in the range of 5-10 per cent of revenues. But innovative R&D-focussed entities would have to incur much larger spends stretching over periods of up to 12 years.

The proposal to extend income-tax benefits to profits of scientific R&D companies (which not only do innovation, but also focus on other forms of research) may help a larger universe of pharma companies to reap tax exemptions. Players are looking for an extension of this provision by another five years till 2012. Typically, stakeholders in R&D focussed companies do not enjoy meaningful earnings or dividends, till a successful deal is stitched together. With companies exploring options in areas such as oncology which require larger investments compared to other therapeutic areas, the exemption on income-tax will act as compensation. With Indian companies increasingly developing early stage molecules that could be used for further leads, the payments are usually in the form of minor upfront fees as well as larger royalties and milestone compensations, in case of successful commercialisation. This is where exemption of future income from intellectual property (new chemical entities) from taxes, will help.

Duty relief

Apart from R&D, proposals to reduce the MRP based excise duty on medicines from 16 per cent to 8 per cent and total excise exemption on 354 drugs specified in the national list of essential medicines have also been mooted, as measures to moderate drug prices. Lesser excise duty will not only mean cheaper drugs for consumers but also allow some breathing space to smaller players, who have been unable to undertake cost-cutting measures to compensate for high retail margins.

The duty exemption for listed essential drugs will allow companies to generate higher growth for their price controlled drugs, revenues from which have grown by a mere 1 per cent in last 12 months.

More Stories on : Pharmaceuticals | Budget | Research & Development

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