Pharma Sector: Booster Shot Budget?

The Indian Pharma sector has kept growing despite the turbulence in the global economy. While the defensive nature of sector is one reason for this, it should also be remembered that Indian pharma companies have been aggressively bidding for their share in the global pharma market. The patent expiry of many drugs in the USA has provided a much-required opportunity for Indian companies to increase their global presence. Now, the Indian pharma companies are dominating the generics market in the US. They are also seen testing the generics market in other regulated markets like Europe, Japan and Australia. Besides, they are also making their presence felt in other parts of the world like Russia and the CIS countries, Africa, South America, Eastern Europe and the Rest of Asia.

At this time of the year, when the Indian pharma companies are spreading their wings at a global level, the Research and Development (R&D) costs are increasing. This is an expense incurred by the companies for their future growth. From thousands of experiments, a single molecule may be discovered. In the bio-pharma business, the process is further complicated and expensive. The raw materials and equipments required for this business are largely imported, for which custom duty is charged.

With competition increasing in the pharma space, R&D has become a very vital operation. The investments are huge, and the success rate is proportionately low. R&D expenses do not necessarily fetch immediate returns. However, the inability to carry on R&D activity will shrink the growth of the industry significantly.

Currently, only in-house expenses are eligible for weighted deduction (tax exemption) at 200% of the costs under Section 35(2AB). This fiscal benefit is expiring on 31st March, 2012. Expenses such as those for clinical trials, bioequivalence studies and regulatory and patent approvals are not included under the same.

Table 1: Current Tax Structure

On the other hand, healthcare-related services currently remain underdeveloped in the country. The benefits of healthcare have not yet reached the masses, as there is huge funding required to build more hospitals and related services in the semi-urban and rural areas. To boost healthcare in the country, the sector is asking for infrastructure sector status, which will enable it to avail of long-term finances at low interest rates.

In last year’s budget, the customs duty on certain drugs was reduced from 10% to 5%. However, the MAT rate was increased to 18.5%, which was taken negatively by the industry.

Though the 2011-12 budget was mainly seen as neutral by the Pharma sector, the Healthcare index appreciated by 3% after the budget day. As of today, the Healthcare index stands 12% higher from the closing of the budget.

In a challenging business environment, there are some stocks that appreciated on the day after the budget, and have continued to rise till date.

Table 2: Stocks That Appreciated Post-Budget

On the back of this, it will be interesting to see the demands put forward by the sector.

Demands Related To R&D Expenses

• On the back of the R&D expenses incurred by pharma companies, the govt. should make a provision under which 50% of the total income tax paid by the company in last the 10 years can be paid back to it, or at least can be provided to an R&D organisation for 20 years at a nominal rate.
• The pharma industry is seeking the extension of Section 35(2AB) at least for next 5 years. This is currently slated to expire by the end of the current fiscal.
• The R&D expenses incurred (other than in-house activities), should also be eligible for tax exemption under Section 35(2AB). The land and the building used for R&D activity should also be eligible for weighted deduction under the said section.
• The percentage of weighted deduction on the contribution made to an exclusive R&D company for carrying out R&D activity should be increased from the current 125% to 175%.
• Large scale Monoclonal Anti Bodies plants should be treated like R&D units for the next 5-10 years. The current 30% duty on imported equipments should also be removed for the same number of years to facilitate large scale manufacturing plants in the country.

Other Demands

• For Active Pharma Ingredients (API), the excise duty needs to be reduced from 10% to 5%. The current abatement of 35% should also be increased to 45% to cover the trade margins, R&D costs, etc. The basic customs duty on the formulations should also be reduced to 5%.
• Tax benefits granted for SEZ units should continue in the GST.
• All medical devices used in the life saving treatments should be exempted from customs duty. Customs duty on radiopharmaceuticals used in diagnostics should also be waived off.

DSIJ Opinion

From the demands put forth by the industry, we understand that it is mainly looking to get the govt.’s nod for its R&D expenses. In the past few budgets, the govt. has not paid enough attention towards this, except for increasing the quantum of the weighted deduction from 150% to 200%.

We, at DSIJ, are of the opinion that Section 35(2AB) should be extended, as this will favour more R&D-related activities and will also prompt small to medium scale pharma companies to increase their R&D-related activities. However, we remain sceptical about adding the expenses related to clinical trials, land and building, foreign equipments and imported raw materials to the list.

As the new pharma drug policy is expected to commence this year, we believe that the recommendation of the duty waiver on life saving drugs may not be taken up.

The govt.'s main objective is to reduce the fiscal deficit, and hence, the duty exemption on formulations, APIs and bulk drugs is also not likely to be taken up. Pharma companies operating in the international space are making profits, and hence, it is most likely that the duty waivers on these drug classes would be ignored. We also believe that the govt. may not exempt the SEZ units of pharma companies from GST, as this will result in lower tax receipts.

The long-pending demand to give infrastructure status to the healthcare sector may end up being sidelined in this budget as well.