A Prescription For Change: Navigating Tax Reform In 2017

By Kathleen Michael, PwC, Partner, US Pharmaceutical and Life Sciences Tax Sector Leader

Proposed changes to the tax code could have a pervasive impact on Pharma’s business strategy

The beginning of a new year is often a time to look ahead with anticipation for what the next twelve months will bring – both opportunities and challenges.  During 2017, pharmaceutical and life sciences (PLS) companies will face a wave of change impacting their businesses including: potential ACA repeal, increases in emerging technologies and new entrants, and continued pressure on pricing.  Adding to this already challenging environment, PLS companies must closely monitor the ongoing tax reform debate.    

I truly believe that 2017 will bring significant and fundamental change to the tax world.  While the specific details remain to be seen, the election of President-elect Donald Trump along with GOP majorities in both the House of Representatives and Senate suggest the probability of comprehensive tax reform has never been higher. In June 2016, the House Ways and Means Committee and Speaker Paul Ryan unveiled a Better Way for Tax Reform in an effort to modernize and simplify the existing tax code. The ‘blueprint’, as it is known, goes well beyond the incremental changes we saw over the last 30 years and harkens back to the sweeping changes made with the Tax Reform Act of 1986.

The proposed changes transcend the tax world and will impact all aspects of businesses including: supply chain, capital structures, pricing and deal modeling, to name a few.  With this in mind, I wanted to share my thoughts on how PLS companies may be most impacted and can prepare for the changes to come:

• Reduction in the corporate income tax rate: A reduction in the corporate tax rate from 35% to 20% likely will benefit many PLS companies and provide opportunities for tax planning.  Pre-enactment planning should be considered, including accelerating deductions, credits and other attributes into periods where the current 35% rate applies and deferring income to periods where the lower rate will apply.  The rate reduction will likely have financial statement impacts to uncertain tax positions, deferred taxes, and effective tax rates, and will also impact forecasts communicated internally and externally to the extent effective tax rates included reflect current law.  All of these impacts will need to be evaluated.
• Border adjustable consumption-type tax: The proposed ‘border adjustable, destination-based, business cash-flow’ tax system would likely tax imports of goods and services and exempt exports. This new system would also likely apply to intangibles and related royalty flows.  The impact on PLS companies will depend on their supply chain structures and whether exchange rates or prices adjust in response to this new aspect of the tax code.  Affected companies should examine the current state of their supply chain in light of this new tax system and determine the impact to their after-tax results.  Important first steps include mapping out existing physical asset footprints and physical and financial transaction flows and evaluating the tax treatment under both current and proposed tax law.
• New business income tax rate for pass-through entities:  Collaboration agreements, alliances, joint ventures and formal partnerships are increasingly common in the PLS industry and I expect this trend to continue in 2017. The House blueprint proposes a 25% rate for pass-throughs. Entity level taxation for pass-through entities is a major change and PLS companies should consider the types of entities they use to structure alternative deals.
• Full expensing of tangible and intangible property: PLS companies will likely benefit from full expensing of tangible and intangible property. However, land would be excluded, and it is uncertain how inventory would be treated. The House Republican tax reform blueprint states that the last-in-first-out inventory method will be retained, but inventory accounting issues require further consideration. The full expensing of intangible assets could impact the way deals are modeled and structured given the large portion of value typically placed on intangible assets in the industry.
• No net interest deduction: The corporate tax deduction for interest expense has been a part of U.S. tax law since 1894 and has been an important factor considered by companies when choosing between debt and equity financing alternatives.  PLS companies often incur debt to make acquisitions and support investment in research and development; they currently deduct the related interest expense. To prepare for the elimination of the deduction for interest expense, PLS companies should assess the tax impacts of their current capital structure and consider alternative financing options going forward.
• Loss of most business tax credits and deductions: Although most business tax credits and deductions are expected to be repealed, they will likely be offset by the reduced corporate income tax rate. The research and development credit will likely be retained – and possibly enhanced – to provide a continued benefit for PLS companies. Importantly and at this time, the House blueprint does not explicitly address the Orphan Drug Credit, which provides a significant benefit for companies in that therapeutic area.
• Mandatory deemed repatriation of US companies untaxed post-1986 foreign earnings and profit (E&P): The PLS industry reported over $400 billion of unremitted earnings in 2015.  Mandatory deemed repatriation is a critical area of focus, and the impact of the one-time mandatory repatriation tax will depend on the specific company, as well as the repatriation tax rates ultimately enacted. Affected companies should consider pre-enactment dividend / foreign tax credit planning opportunities, and ‘controlled foreign corporation’ earnings and profit reduction through accounting method changes. Companies also should consider the impact on financial statements.
• Repeal of Affordable Care Act (ACA): PLS companies likely would benefit from the repeal of the pharmaceutical tax and medical device excise tax; however, the timing for a repeal and replace is uncertain and may not be linked to comprehensive tax reform.

Post-election transitions present uncertainty, opportunity and implications for any industry, to which healthcare is no exception. The significance of the United States market and the high volume of trade between its partners make reform of the current tax system a top issue for PLS organizations—one for which they must prepare.

About The Author:

Kathy is a Tax Partner with PwC and has over 30 years of tax experience specializing in serving multinational companies. Kathy is the US Pharmaceutical and Life Sciences Tax Leader and is our Florham Park, NJ Tax Practice Leader. She advises clients on federal, state, local, and international income tax matters. In her role as a lead tax engagement partner on multinational companies, she has dealt with complex matters such as international restructurings, mergers and acquisitions, as well as tax controversy in various jurisdictions.

Kathy has extensive experience in accounting for income taxes and has dealt with complex tax accounting issues. She has advised clients on risk in the tax area and controls with respect to SOX 404 compliance. In her role as a lead tax engagement partner, Ms. Michael is responsible for overseeing tax services provided to her clients and overall management of tax teams. She effectively works with the PwC global network and is responsible for coordination of tax services on a global basis with client engagement teams.

In addition, Kathy is actively involved with PwC’s diversity initiatives and currently leads our Metro Women’s Initiatives Committee and was formerly the Diversity Leader in our Florham Park tax practice.