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PwC Report Warns Drugmakers of Potential Tax Pitfalls of Personalized Medicine

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By Turna Ray

With the dearth of innovative products nudging big pharma's focus from pursuing the "blockbuster strategy" to developing personalized treatments for subpopulations, the healthcare industry needs to embrace new research and development structures and enter into complex collaboration deals — all of which can lead to higher taxes unless industry plans carefully, according to a report from a major professional services firm.

Earlier this month, PricewaterhouseCoopers released a report, titled "Pharma 2020: Taxing times ahead — Which path will you take?" projecting that the "global financial crisis, government pressure, changing market dynamics for an industry experiencing significant change, and rapidly evolving healthcare reforms are likely to drive up the effective tax rate for the pharmaceutical and life sciences industry."

In a survey conducted by PwC of 35 senior tax executives from pharma, biotech, and medical device companies, 62 percent of those polled consider an increase in the effective tax rate for the pharmaceutical and life sciences industry "inevitable." Additionally, 63 percent of these executives said that unless industry finds ways to operate "more efficiently and transform their approach to R&D and sales and marketing," the cost of these increased taxes might have to be passed on to consumers.

Personalized medicine is a major driver transforming the way the healthcare industry does business. A separate PwC report released this month estimated that individualized healthcare stands to grow at 11 percent annually to as much $452 billion by 2015 [see PGx Reporter 12-09-2009].

However, while pharmacogenomics promises cheaper and more efficient clinical trials in the long run, the changing business paradigm has "significant tax implications" in the immediate term, Michael Swanick, global pharmaceutical and life sciences tax leader at PwC, told Pharmacogenomics Reporter this week.

"The demand for personalized medicine is growing, and pharmaceutical companies are investing more and more in specialist therapies as the genomic sciences advance," Swanick said. "The advent of personalized medicine is one of the reasons that the pharmaceutical industry is facing rising taxes."

It is well known that there is a dearth of new drug candidates in pharma pipelines and that approximately $65 billion worth of pharmaceuticals, representing 25 percent of drug sales, are expected to go off patent between 2008 and 2013. These factors are among the reasons behind pharma's increasing focus on personalized medicine. Furthermore, payors are increasingly demanding evidence showing drugs and devices improve outcomes as a condition for reimbursement.

"For years, pharmaceutical companies have decided what their products are worth and have priced them accordingly, investing little effort in understanding the payor’s perspective. But the balance of power is shifting," Swanick said. "With healthcare costs rising, both government and private payors are becoming the ultimate arbiters of pricing and value, reimbursement and prescribing decisions."

In Swanick's view, while shifts in drug development strategy spurred by personalized medicine will cause tax increases for industry, payors' demand for improved outcomes (also realized through investments in personalized treatments) might also be tied to tax incentives.

"Congress has a history of authorizing tax credits to stimulate scientific innovation that promises societal benefit, but we think they will increasingly tie these tax incentives to improvements in outcomes as a part of comparative effectiveness," Swanick noted. "Without these incentives, pharmaceutical and life sciences companies may be unable or unwilling to invest in promising lines of research because of the uncertainties about their costs and return on investment."

Sixty-two percent of tax executives polled by PwC said they are looking to maximize tax credits and other incentives for healthcare industry R&D.

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With reimbursement being tied to outcomes improvement, the share of profits for industry will come from services, not necessarily products. This, in turn, will require industry players to engage in complex collaborations that will need to be carefully structured with an eye on tax pitfalls, Swanick pointed out.

Drug/diagnostic co-development strategies — thought to be the centerpiece of personalized medicine — are fueling some these collaborations in a healthcare industry intent on proving its products are clinically useful and therefore worth the price. But as the flurry of recent M&A activity shows, these collaborations are getting increasingly complicated, all of which has tax implications.

For instance, Monogram, the maker of the Trofile assay accompanying Pfizer's HIV drug Selzentry, was acquired this year by Laboratory Corporation of America. Meanwhile, Pfizer and GlaxoSmithKline this year spun off their HIV/AIDS drugs franchise into a separate firm, called ViiV Healthcare, which will now house Selzentry and another personalized GSK drug, Epizicom, which combines lamivudine and the genetically targeted abacavir.

The FDA last year updated the labeling for abacavir to include information about the increased risk of fatal hypersensitivity reaction in HIV patients who have the HLA-B*5701 allele [see PGx Reporter 07-30-2008]. LabCorp also markets an HLA-B*5701 test for hypersensitivity reaction.

According to CEO Dominique Limet, ViiV Healthcare’s unique structure has the potential to “re-energize” the pharmaceutical industry’s involvement in driving HIV treatment innovation and improving access. However, under ViiV, it is currently unclear how the drug/diagnostic co-marketing arrangements will be handled for these pharmacogenetically guided drugs.

On the one hand, with these increased M&A activities, industry is pooling resources for expanded access to different disease markets and diversifying drug pipelines. But more players mean divergent interests at the negotiating table, requiring careful coordination between different geographic locales, R&D timelines, and marketing plans.

The tangle of elaborate collaborations in the healthcare industry "will become even more pronounced over the next 10 years," Swanick said. "New technologies are facilitating the collection of vast quantities of outcomes data and the virtualization of large parts of the R&D process.

"But any company that wants to capitalize on these advances will have to collaborate with numerous other agencies, including hospitals, clinics, academic institutions, bioinformatics firms, and technology providers," Swanick continued. "Moreover, some of the alliances it strikes are likely to involve multiple entities, staggered levels of profit-sharing, and dissimilar participatory rights between the parties — all factors that will add to the intricacy of its tax arrangements."

In Swanick's view, drug firms will likely outsource manufacturing of drugs for the general population to low-tax jurisdictions, but remain closely involved in complex, genomically guided personalized drug development.

Pharma "will outsource the production of mass-market medicines to contract manufacturers in low-cost, low-tax jurisdictions, but they will manufacture and distribute complex specialist therapies themselves," Swanick said. "That, in turn, could have major ramifications for many companies’ effective tax rates. Making specialist therapies in end markets where tax rates may be higher could substantially increase the taxes they pay."

Going forward, PwC believes tax planning is critical to the survival and success of pharma and biotech firms.

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"In many areas of the world, increasing spending on R&D can reduce a company's effective tax rate, as many jurisdictions offer incentives (including tax credits) for such spending," Swanick said in an e-mail. "Many jurisdictions offer tax incentives to companies making investments to encourage local growth."

But in order to benefit from these incentives, the drug industry may have to open itself up to more compliance requirements from these various governments, he noted. Also "licensing deals and acquisitions may bear other unintended tax costs that adversely impact the effective tax rate. Carefully structuring such deals is essential to ensure alignment of a company’s business goals with optimal tax treatment," Swanick noted.

Some in the industry are beginning to plan for impending tax hikes in the face of changing R&D paradigms and are consulting tax specialists early in their product-development strategies.

In its survey of 35 senior tax executives, more than 50 percent said they are now being consulted early on by senior management in strategic business decisions, and have influence over the direction of the company. Still, 34 percent said they are consulted "late in the game," while 9 percent said they are informed after strategic business decisions are already made.

Nearly 100 percent of those polled believe the demand for tax specialists in the healthcare industry will grow substantially as tax issues become more complex, PwC reported.

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