In a prior article, we discussed the basics of transfer pricing (The Basics of Transfer Pricing). The focus of this article is to provide some insights on transfer pricing unique to pharmaceutical companies and important points to consider. Transfer pricing concerns are significant in the pharmaceutical and life science sector because of the relatively common practice of companies having either subsidiaries or parent companies across the world and the interdependence of companies for various activities such as supply chain, manufacturing, raw materials, distribution, cash management/support, jurisdictional tax compliance, etc.
The key guiding principle for transfer pricing compliance is ensuring that the transactions between multinational entities all occur at arm’s length; that is, the pricing of the transactions between the related entities is done without factoring one entity’s self-interest over the other. An example of this aspect would be to price the sales of raw materials at the same or similar selling price for both the related entity and a third-party customer. Documentation plays a significant role in tracking intercompany transactions, and providing contemporaneously created support for transaction pricing can go a long way in defending the company’s actions across the multiple jurisdictions in which it operates. There are a few transaction classes that we frequently observe with our clients in the life sciences space, which include:
- Intellectual Property
Many foreign parent companies maintain control of intellectual property and their associated licenses, including Abbreviated New Drug Applications (ANDAs) and New Drug Applications (NDAs), which are being marketed within the US by the US subsidiary. Understanding what, if any, fair market value benefits the US subsidiary is gaining by utilizing the foreign-held intangible assets and how to determine a transaction price is important to have decided before commercial transactions begin. Many companies decide to leverage a US subsidiary as a distribution entity only and, therefore, not relinquish any control/access to the underlying intangible assets to the subsidiary.
- Supply Chain and Manufacturing Trends
It is common for pharmaceutical companies to outsource either the manufacturing of finished products or the creation of raw materials to be further refined or manufactured within the US to a foreign subsidiary. Having clear upfront contract terms between the related parties, especially when the taxing jurisdictions have significantly different tax rates, is an important transfer pricing practice.
- Cost Sharing Arrangements
Often, life science companies have back-office facilities overseas that act as purely cost centers for the US parent company, supporting their R&D efforts, manufacturing, or administrative efforts. These cost centers often have no other clients other than the US company, so determining transaction prices is an important aspect of the initial setup of these types of entities. The transaction price recognized in cost-sharing arrangements typically involves billing using the “cost-plus” methodology. The cost-plus method simply takes into account all of the relevant costs of the subsidiary to provide the service in question and adds a profit margin, which is then billed to the parent company. The key point of compliance is to determine the proper markup percentage to ensure that it accurately reflects the economic substance of the underlying transactions.
In summary, a well-documented analysis of intercompany transactions is critical to implementing a transfer pricing policy that different tax authorities will respect. Transfer pricing is a highly complex area, and it is important to understand how these issues can impact your business.
If you have any questions or require additional information, please contact your WG advisor.
