Pharma outsourcing industry sees red in Obama’s new tax code

Ending tax sops for overseas operations could hit American companies’ investments in pharma, contract research and manufacturing in India.

Obama’s new tax proposals to end tax breaks for US firms doing business outside have sent a shocker to Indian pharma companies engaged in contract manufacturing and research services.

Obama, recently stated that he didn’t want a tax code that allows American firms to pay less tax to “create a job in Bangalore, India, than if you create one in Buffalo, New York”.

Obama is considering an overhaul in the US tax system, including the elimination of a tax deduction that American firms get when they invest in subsidiaries outside the US, including in India.

The Indian pharma industry, like the IT sector, is very much into the outsourcing business as they provide a wide range of contract services across the drug development value chain including drug discovery, contract manufacturing, clinical trials, data management to overseas companies.

The India pharma industry fears that the new proposals could adversely affect their outsourcing services business as majority of their clients belong to US.

The US pharma majors, apart from increasing the field and scope of activity in India’s potentially lucrative market to an unprecedented level, are locating India as a favourite destination for outsourcing/offshoring several of their core and non-core activities to minimise operational costs.

US-based pharma MNCs save considerable benefits from India operations because the country offers has a highly skilled, large and inexpensive labour force.

For years, pharma MNCs in US have been outsourcing manufacturing and research of drugs and raw materials (active pharmaceutical ingredients) to domestic players like Piramal Healthcare, Torrent, Biocon, Orchid, Shasun, Strides, Claris Life, Jubilant etc.

Besides, there are a growing number of companies which are dedicated to provide contract services like GVK Biosciences, Advinus Therapeutics, Aurigene, Clinigene, Syngene etc.

According to the new proposal by Obama US pharma companies like Pfizer Inc, which have set up overseas subsidiaries in India, will have to pay tax on their earnings earned abroad.

Similarly, US companies who are outsourcing services to overseas destinations like India will be at a disadvantage as their earnings from these countries will now be treated as income, and they would be liable to pay tax on it.

The new proposals, the pharma industry feels, is in contrast to the existing practice wherein companies who are outsourcing services earned tax credits on income earned through those services.

US companies with operations elsewhere, such as in India, are allowed tax exemptions on expenses incurred by way of investment in those units. They are also allowed to defer the effective 35% tax on income they generate from overseas operations. Taxes need to be paid only when such income is brought back to the US in the form of investment or dividends.

Obama’s rationale for change the tax code is because of the incentives American companies will be encouraged to reinvest it in foreign locations, such as India, and expand there, depriving the US of jobs and tax income.

Through deferring tax on foreign income companies will have no incentive to support offshore investment. So, they would instead have to pay taxes in the US on their offshore profits. The US Treasury estimates that the move would generate $60.1 billion (Rs2.97 trillion) in tax revenue between 2011 and 2019.

According to industry body Nasscom estimates, nearly $18 billion a year in the IT sector alone will be affected through this move.

While, the pharma industry fear that new offshoring contracts from 2011 may be affected. If the tax changes get implemented in their proposed form, US companies may prefer to invest in their home country to be eligible for tax benefits.

However, analyst say the impact of Obama proposal could be minimal in the outsourcing sector as it is more of a domestic tax issue. “People don’t make strategic business decisions based on tax rates. Microsoft and IBM will not go back, they are here for the market,” stated Pramod Bhasin, chairman of Nasscom.

Some pharma sector observers prefer to think Obama’s tax proposal is a clear indication of protectionist measures which are going to be a norm in US. This as kind of a wake-up call for India as it will affect investments in pharma, contract research and manufacturing.