Injecting new lifeMay 16, 2013
Cost reduction and cash-flow management have become topics of increasing importance for major life science companies over recent years. However, a relatively underutilized area for generating savings is VAT.
In recent years, some of the major life science companies have begun to focus on this area in order to reduce net VAT cost and optimize cash flow.
Industry leading practice
A number of factors are causing multinational businesses to focus on managing VAT more globally, including better awareness and understanding of both the complexities and amount of VAT to be managed and the benefits of having higher standards of VAT management.
Better management minimizes the risks of large VAT assessments, of which there have been many in the industry, while increasing the ability to secure refunds, improve cash flow and reduce cost.
Not only is VAT throughput, use of shared service centers and VAT cash flow of ever increasing importance in the complex supply chains of the life sciences industry, an ability to manage significant irrecoverable VAT costs in key areas such as clinical trials and emerging markets only add to the increasing importance of VAT in the sector.
On the operational side, apart from the ongoing challenge of building the complex supply chains in ERP systems or tax engines, another critical development is the use of shared service centers. Invariably these centers offer great savings due to the unified processes and lower labor costs.
However, from a VAT point of view, local knowledge is often lost and errors with processing invoices are, in fact, increasing. This requires a stringent process and control environment characterized by specific VAT automation, data analytics and workflow management.
The key here is to find the technology solution that fits the business and means that a strategy should be developed to make the right choices.
Greater patient connectivity — the VAT impact
As supply chains move toward more business-to-consumer (B2C) flows, there will be a significant impact on a life science company’s VAT footprint, especially if these changes are combined with a centralized cross-border selling model.
Within the EU, sales to private individuals are subject to VAT in the country of dispatch, unless registration limits are exceeded in the member state of the customer or where a voluntary registration is sought.
In the latter case, VAT is charged in the country where the customer resides, resulting in the possibility of multiple VAT registrations in many EU member states and adherence to local administrative rules. This will affect a company’s ERP system and setup, increasing the overall compliance burden.
It is therefore important that the tax or finance function is made aware of such critical business model changes in a timely fashion to ensure compliance with the rules of each state.
VAT exemptions on personalized medicines
The shift to more personalized medicines brings possible VAT exemptions. While this is good news for the customer, the downside for companies is that all associated VAT on costs, including research and development (R&D), will be non-recoverable.
This may have a severe impact on the company’s cost model. The gross margin of the new product will come under pressure and could be negative in some cases. We expect this trend to continue, especially in the EU, with some member states already applying such an exemption on personalized medicine.
VAT on clinical trials and CRO management
As more and more clinical trials move to emerging markets, there is an increase in irrecoverable VAT due to the high import rates on pharmaceutical products. These amounts are irrecoverable because the importer does not take title to the clinical materials or resell them in the market, which is a usual condition for VAT recovery in emerging markets.
This applies whether the importer is a clinical research organization (CRO) or local affiliate. It is therefore important to verify local rules on recovery, try to utilize specific applicable regimes to minimize VAT, or attempt to restructure the transaction to recover VAT through an affiliate.
Another method for managing indirect tax is to develop a global policy around valuations for “non-commercialized” shipments, such as clinical trial materials.
VAT issues on major acquisitions and disposals
With the sector experiencing increased mergers and acquisitions activity, careful consideration should be given to the increasing technical complexity surrounding VAT recovery on acquisition costs and share deals.
For example, the European Court of Justice case law is becoming more and more stringent on this point. Proper structuring of the deal in advance is critical to prevent unexpected VAT costs later on.
Optimizing VAT throughput in complex pharmaceutical supply chains and changing business models
Supply chains within the life sciences industry remain very complex, with legislation struggling to keep pace with developments. This often results in complex VAT outcomes and difficulties in setting up transactions in ERP systems.
When this is coupled with centralized selling and manufacturing models, it often means that a single entity requires a multitude of VAT registrations with an increased administrative burden. It is still possible to plan and utilize certain reliefs that mitigate cash flow, but obviously proper consideration is crucial prior to implementation.
In conclusion, while VAT is, in essence, a simple tax, individual country rules and interpretations result in a complexity that is likely to test the tax management resources of any organization.
Historically, while the response by business to managing the tax has been varied, many companies have left the accounting and compliance responsibility for VAT to the finance department and have relied on the tax department to deal with issues as they arise. This is a reactive approach, meaning in many cases that it is too late for appropriate action to be taken to secure refunds or mitigate penalties.
Given the amount of VAT that has to be managed each year by companies in the life sciences sector, and the industry-specific additional VAT issues that must be dealt with, there is a clear and direct benefit from taking a proactive approach to managing VAT for the benefit of the organization.
The full version of this article was first published in the Ernst & Young Indirect Tax Briefing, Issue 6, December 2012 (pdf, 4.96 MB)
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