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Duty Structure in Pharmaceutical Industry Direct taxes

A tax that is paid directly by an individual or organization to the imposing entity, a taxpayer pays a direct tax to a government for different purposes, including real property tax, personal property tax, income tax or taxes on assets. Taxability of income in India is governed by the provisions of Income-tax Act, 1961 ("Act"). There are some benefits provided under the Act that are more specific to the pharmaceutical industry as explained below.

Scientific research and development:

1.) In-house research and development Companies engaged in the business of biotechnology or in the business of manufacture or production of any drugs, pharmaceuticals, chemicals, etc. and who have incurred any expenditure on scientific research (not being expenditure in the nature of cost of any land or building) on in-house research and development facility as approved by the Department of Scientific and Industrial Research, are allowed a deduction of 1.5 times of such expenditure. This is provided in the Section 35 (2AB) of the Income Tax Act. Expenditure on scientific research includes expenditure incurred on clinical drug trial, obtaining approval from any regulatory authority under any Central, State or Provincial Act and filing an application for a patent under the Patents Act, 1970. 2.) Contributions made to other institutions The Indian Income Tax Act (ITA) confers a deduction of 1.25 times of sums paid to any scientific research association (having as its object the undertaking of scientific research) or to any university, college or other institution to be used for scientific research. 3.) Capital expenditure The whole of any expenditure on scientific research (other than expenditure on acquisition of any land) being capital in nature is allowed as a deduction from tax. Further, capital expenditure on scientific research incurred three years immediately prior to the commencement of business is allowed as a deduction in the year in which the business is commenced. 4.) Research and Development Fiscal Incentives India is emerging as the most favoured destinations for collaborative R&D bioinformatics, contract research and manufacturing and clinical research as a result of growing compliance with internationally harmonized standards such as Good Laboratory Practices (GLP), current Good Manufacturing Practices (cGMP) and Good Clinical Practices (GCP).With the application of product patent in the case of pharmaceuticals it is imperative for the Indian industry to accelerate its efforts in R&D in this sector. The present level of spend on R&D (about 5% of turnover) is much lower as compared to most of the developed countries (15

to 20%). With a view to encourage R&D in this sector it is essential to provide suitable incentives to industry. At the same time it is also necessary that the incentives are made use of by those units which are genuinely engaged in R&D

Special Economic Zones:

Special economic zone is a particular area inside a state which acts as foreign territory for tariff and trade operations. Govt. provides tax exemption (IT, Excise, customs, sales etc.), subsidised water and electricity etc. SEZ developers/units are entitled to 100 percent tax holiday for 10 continuous years out of 15 years with the exemption from payment of minimum alternate tax, as well as dividend distribution tax. Expenditure on developing the SEZ shall also be exempt from all duties of customs, excise, CST and service tax.

Indirect taxes:
Indirect Tax or the tax that is levied on goods or services rather than on persons or organizations are of different types in India like Excise Duty, Customs Duty, Service Tax, and Securities Transaction Tax. In India, there are a series of Tax laws and regulations in order to control the indirect taxation, which can be either law, made by the central government or even can be state specific laws. As a result these taxes are an important part of the total cost. There has been the gradual reduction of customs duty levels to match rates prevailing in ASEAN countries, rationalisation of excise duty structure, widening of service tax net in view of increasing significance of the service economy and finally, the introduction of Value Added Tax system with respect to goods at the state level. India with its federal government structure, where powers of taxation are shared between the centre and the states, would have a dual VAT/GST system at the central and the state level. In the intervening transition period, it is a challenge for the businesses to optimise indirect tax cost in the day-to-day business operations.

Customs duty:
Customs duty consists of : 1. Basic Customs Duty (BCD)-10 % in 2012 2. Education cess -2% 3. The above aggregate to an effective rate of customs duty of 12 percent.

Central excise duty:

An excise or excise tax (sometimes called a duty of excise special tax) is commonly referred to as an inland tax on the sale, or production for sale, of specific goods; or, more narrowly, as a tax on a good produced for sale, or sold, within a country or licenses for specific activities
Excise duty rate = 12 % in 2012 from 10 % in 2011

Value Added Tax and CST:

VAT/CST is levied on sale of movable goods in India. Barring Uttar Pradesh, Tamil Nadu and Pondicherry, all the other states in India have implemented VAT regime. Under VAT, tax is levied on each successive sale of goods with credit of tax paid on the purchase (Input Tax Credit or ITC). CST paid on inter-state purchases is not available as a credit. Drugs and medicines are taxed at four percent except Assam where the rate is six percent. Although, it was expected that VAT would bring in uniformity in classification of products, descriptions in the tariff schedule varies from state to state. For example, medical devices are taxed at 12.5 percent in three states, whereas in all other states, the tax rate is four percent. Eleven states have introduced a system of levying tax on MRP at a single point i.e first sale in the state is subject to VAT on the basis of MRP and subsequent sales, in general, are exemp. It should also be noted that states such as Madhya Pradesh, Chattisgarh and Orissa levy entry tax on entry of medicines and devices in to these states. CST rate is four percent against furnishing of prescribed declarations. The rate of tax is 10 percent or the VAT rate prevailing in the originating state, whichever is higher. CST is widely acknowledged as creating barriers to trade and hampering free movement of goods within the country, and is proposed to be gradually phased out by 2010.

Service tax:
Service tax is levied by the Central government on specified services. Service tax is not payable on export of services subject to fulfilment of prescribed conditions. Conversely, services received in India are taxed in the hands of the recipient. The rate of service tax is 12 percent, together with education cess at two percent. Credit of service tax paid on input services and excise duty, CVD and ADC paid on inputs and capital goods is available as a credit to pay service tax on output services.

Issues and solutions:

Pharma industry has to operate under multiple indirect taxes and a fractured VAT chain resulting in a cascading effect. The effective tax rate considering excise duty and VAT on MRP is substantial. The pharma industry has been lobbying for excise duty at eight percent, especially when the duty is levied on MRP. The availability of excise duty holiday for a period of 10 years in select states as discussed above has resulted in many pharma companies shifting the manufacturing base to these states. CST continues to support the stocking point model in each state as against a regional stocking hub, which could be more supply chain efficient. The supply chain continues to be driven by tax benefits as against logistics costs. If the Central government is able to adhere to its roadmap for phasing out CST, pharma industry can plan their supply chain to optimise distribution costs.

The rationale for the State governments to levy VAT on MRP was that since under the Drugs Price Control Order (DPCO), MRP has to be printed exclusive of local taxes, it would be difficult for stockists and chemists to compute the VAT liability. The Central government has amended the DPCO to make it mandatory with effect from October 2, 2006 to print MRP inclusive of local taxes on goods manufactured post October 2, 2006. The Supreme Court, in the context of erstwhile sales tax regime in Rajasthan has held that in a single point sales tax regime, tax cannot be levied on MRP basis as the measure of tax has to be commensurate with the point of taxation. This judgment, though in the context of erstwhile sales tax regime, does raise doubts on the validity of levy of VAT on MRP basis. MRP basis as a measure to levy VAT assumes a linear trade model up to the final consumer and as such is against the basic principles of VAT. The State governments should tax drugs and medicines on the basis of the sale price.

Inconsistent classification:
The description of entry drugs and medicines varies from state to state. Most states levy VAT on life saving drugs, though some states like Kerala have provided exemption to specified life saving drugs. Similarly, medical devices are taxed in most states at four percent. However, in states like Maharashtra, Gujarat and Kerala, medical devices are taxed at 12.5 percent except for a few specified ones. Consistent classification and rate across states is necessary for trade harmony.

Service tax on clinical research:

Outsourcing of clinical research to India is the next big opportunity after the BPO boom. However, pharma majors need to factor in the service tax impact on clinical research. Depending on the scope of activities, services of a clinical research unit can be classified either under technical testing or scientific consultancy or business auxiliary services. The classification assumes importance because to qualify as exports apart from other stipulated conditions, the service should be delivered and used outside India. It would be difficult to comply with this condition in case of classification under technical testing. Service tax at 12.24 percent would affect the viability of outsourcing clinical research to India. The Central Government should exempt clinical research from service tax so as to provide a major boost to outsourcing of clinical research to India.

Trademarks and patents:

In case a right to use trademarks or patents is granted by an entity outside India to an entity in India, the same would be subject to service tax under Intellectual Property services. The contracts in such a case would be considered as executed outside India as the transferor signs the contract outside India. State VAT authorities have contended that such a right to use would also attract VAT as use of the same is in India. This contention is against the Supreme Court decision in 20th century case, wherein, for intangibles, it has been held that transfer of right to use takes

place where the agreement is executed. The dual applicability of VAT, as well as service tax would increase the cost of operations of pharma companies. The above lacunae in indirect taxes regime lead to only one conclusion that GST is the ultimate solutions for businesses in India. The Central and State governments need to be sensitive to the concerns of the pharma industry and ensure that taxes do not affect the competitiveness and the larger social concern of providing medical care at least cost to the masses.

Tax Structure for Pharmaceutical companies

Domestic Corporate Income Taxes Rates:
Domestic Corporations the effective tax rate as well the tax rate with surcharge as is 30%. It should be noted that if the taxable income is greater than Rs. 1 million then a surcharge of 10% of the tax on income is also levied

Foreign Companies income tax rates:

For dividends: - 20% for non-treaty foreign companies and 15% incase of companies under the treaty based in the United States For interest gains: - 20% for non-treaty foreign companies and 15% for companies under the treaty based in the United States For royalties: - 30% for non-treaty foreign companies and 20% for companies under the treaty based in the United States For the technology based services in case of non-treaty foreign companies & 20% for companies under the treaty based in the United States For all other kinds of income and gains: - 55% in case of non-treaty foreign companies and 55% for the companies under the treaty based in the United States Attention should be given on levying inter corporate rates in case holding is minimum Attention should be given on the fact that sanctions of the tax authorities on tax withholding Attention should be given on several of the tax treaties that India signed with other countries and also on the various encouraging tax rates