How Will U.S. Tax Reform Impact Pharma/Biotech Industry?

Tax reform has been grabbing headlines since the election campaign last year. However, the plan has been modified quite a few times. With a Congressional vote expected this week to move the tax reform bill forward, let’s revisit some aspects of the bill and their impact on the biotech/pharma industry.

Corporate Tax Cut

The bill in its current form proposes to cut the tax rate for corporates from 35% to 20%. Although it is higher than the originally proposed 15%, a 15-point cut will also help companies to save a considerable amount in tax payment in the United States.The bill also proposes a full exemption on future dividend/income from a company’s foreign subsidiaries.

Currently, if foreign income is repatriated, it is taxed at 35% with a full credit of the local levies. However, the change will allow foreign subsidiaries to send the cash back to the parent company after just paying local taxes.

This will leave some extra cash in the hands of these companies to fund their capital expenditures, acquisitions and share buybacks among others. The lower tax rate and inflow of foreign income may lead to a rise in mergers & acquisitions (M&A), which have been relatively low so far in 2017. Pharma sector acquisitions so far this year include Johnson & Johnson’s (NYSE:JNJ) buyout of Actellion and Gilead Sciences, Inc.’s (NASDAQ:GILD) takeover of Kite Pharma.

Minimum Tax on Foreign Earnings

While the bill cuts tax rates and removes tax on dividends from foreign subsidiaries, it proposes to implement “minimum tax” on foreign incomes. Under the current tax plan, the companies can defer tax payment by parking its foreign profits in the host country. However, if minimum tax is imposed, there will be no deferral route to skip taxes. The companies will have to pay taxes (difference of minimum tax & local taxes) every year, which will increase the tax bill of U.S. based companies.

This proposed tax may improve the competitiveness of foreign pharma companies like Swiss giants AstraZeneca (NYSE:AZN) and Novartis (NYSE:NVS) against their U.S.-based counterparts.

However, the rate of this tax has yet to be decided.

Cash Repatriation Window

The current tax plan allows multinational companies to keep their foreign cash in the host country and thereby defer tax liability in the United States. However, the proposed minimum tax will stop the deferral system. The companies that have hoarded cash in low-tax countries will be allowed to repatriate at a much lower rate.

This move will also increase domestic cash for the companies. The biotech companies may utilize the extra cash to fund their clinical studies or make a strategic acquisition to strengthen their portfolio.

Deductions

The tax reform proposes to expense capital expenditure excluding costs for structures like plants and warehouses in the current year rather than deferring it over 5-15 years as allowed currently. The large pharma companies areexpected to have a huge pile of cash available with them upon a potential tax reform.

Any acquisition or setting up of a manufacturing facility will help the companies to lower the tax bill in the near term. However, the reform will partially limit the deduction of interest on debt in tax calculation. The deduction limit is yet to be set.

Moreover, presently the companies can claim a tax credit for half of the research cost related to development of drugs for rare diseases. This credit may get eliminated if the reform passes. This will hurt the small biotech companies, which could have recouped some of their development costs.

Although the Senate budget committee has voted the bill for a full vote of the house, many are still sceptical about the tax reform. Many still believe that this will add to the country’s fiscal deficit. Some also argue that lower federal revenues, a result of lower taxes will strain healthcare funds.

Moreover, healthcare costs are expected to increase in the future as the United States will see an increase in the number of aged people, which will further dent healthcare funds. Congress is still divided on the impact of the tax reform over the long term.

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