The changes made by the Tax Cuts and Jobs Act vary in their impact to life sciences businesses. The most significant provisions involve the one-time tax on unrepatriated earnings, the R&D credit and the Orphan Drug Credit, and they can affect business strategies, financing, and investment. Planning now is critical for optimal results.
Take the next steps with tax credits
The popular R&D tax credit was left unchanged and continues to offer a 20% credit rate under the regular method and a 14% rate for the alternative simplified method. Because the credit rates haven’t changed but tax rates have, the credit has become more valuable. This increase in value is due to a rule in the internal revenue code that disallows a deduction for any research costs used to calculate the credit. In the past, the loss of deduction meant taxpayers received only 65% of the credit’s value. In light of the new 21% corporate rate, taxpayers will now enjoy 79% of the credit’s value.
Taxpayers will no longer be allowed to expense R&D costs beginning in 2022.
The one downside is that taxpayers will no longer be allowed to expense R&D costs beginning in 2022. Instead, they will have to capitalize and amortize them over five years. Lawmakers could delay or repeal this change in future years, but if not, companies may eventually look to accelerate research activities before the change takes effect.
Another change especially relevant to life science companies relates to the clinical testing expenses for certain drugs and rare diseases, commonly referred to as the Orphan Drug Credit. The ODC is intended to encourage the development of drugs for uncommon diseases and conditions in the U.S. Tax reform reduced the credit rate from 50% to 25% for tax years beginning after 2017. In addition, taxpayers will be able to elect to reduce the ODC in lieu of reducing the qualified clinical testing expenses by the amount of the credit. If applicable, the reduced ODC rate of 25% continues to remain a valuable credit and is still generally more lucrative than the 20% R&D credit rate.
Multinationals act on repatriation tax
In another major change, U.S. multinational companies must pay a one-time repatriation tax of 8% to 15.5% on all previously untaxed foreign earnings, after which they can return funds earned and held overseas to the U.S. tax-free. Most companies will then face significantly lower tax rates of U.S. tax on future earnings. The pharmaceutical and medical device industries are two of the industries most affected by the changes.
U.S. multinational companies must pay a one-time repatriation tax of 8% to 15.5% on all previously untaxed foreign earnings.
The media have widely covered companies’ announcements of plans to pay the new repatriation tax. Apple said it would pay $38 billion in repatriation taxes. At the J.P. Morgan Healthcare Conference in January 2018, Medtronic CEO Omar Ishrak
said the medical device company will now be able to access nearly all of its cash versus only 55 percent. He said he expects the repatriation to cost Medtronic $2 billion to $3 billion over eight years.
Despite the repatriation tax, multinationals are expected to have a cash influx. Some observers are expecting economic growth, while others wonder whether deal-making and enrichment may result.
New technology development is a desired outcome, although life sciences companies certainly may acquire a company that aligns with their operations. Although acquisition may be a more cost-efficient way to expand operations, the changes are intended to spark economic development and investment in new lines of business.
The repatriation tax plan should be connected to long-standing operational objectives. Tax doesn't drive the equation; long-term profitability does. Most multinational life sciences companies are in Asia, Europe, and the U.S., and are looking for ways to streamline those operations. The U.S. may not be the sole area of investment for a lot of these companies. The primary investment driver will continue to be the best markets for their products to be sold.
The primary investment driver will continue to be the best markets for their products to be sold.
Medical device companies are evaluating the best way to produce certain medical devices and which locations are best suited to serve their markets. For now, the medical device tax is on hold again, so companies are deciding where to position themselves and invest dollars.
On the distribution side, companies may want to rethink where they’re developing their products. For example, the goal is to centralize product development in low-tax-impact countries – and now the U.S. is becoming one of them – to avoid ancillary taxes. However, excise taxes, like the one previously imposed on medical devices, can be significant, thereby increasing the overall cost of the product. Further analysis is necessary to evaluate the entire economic impact surrounding these issues and move profits generated by subsidiaries back to the U.S.
The international changes were intended to encourage repatriation of money to the U.S. and spark domestic re-investment. Companies should view their future sources of revenues and profits worldwide in conjunction with their entire global profile to ensure those sources are properly situated.
Before this change was enacted, many life sciences companies had already worked through various scenarios to determine how tax reform would influence their operations. A primary concern has been computing accurate earnings per share while gaining the most benefit in their 2017 financial statements.
Life sciences companies should evaluate other emerging changes and think through how those changes will affect future operations. For example, definitions are being changed – such as what is considered a controlled foreign corporation. Life sciences companies may discover that without any changes to their ownership of some of their foreign subsidiaries, those subsidiaries could be taxed in the U.S. or considered to be controlled U.S. foreign subsidiaries. Companies need to assess how changes could affect them and their tax structure for 2018 and beyond.
What should you do next?
- View your future sources of revenues and profits worldwide in conjunction with your entire global profile to ensure those sources are properly situated.
- On the distribution side, companies may want to rethink where they are developing their products.
- Life sciences companies should evaluate other emerging changes and think through how those changes will affect future operations.
For more information, contact:
Principal, Advisory Services; National Sector Leader for Life Sciences
T +1 215 814 4000