This session will highlight relevant planning and controversy considerations for the life science sector, as well as legislative developments impacting federal taxation

1. 22nd Annual Health Sciences
Tax Conference
Domestic tax planning amid corporate tax reform
and heightened IRS controversy
December 5, 2012

2. Disclaimer
► Any US tax advice contained herein was not intended or
written to be used, and cannot be used, for the purpose of
avoiding penalties that may be imposed under the Internal
Revenue Code or applicable state or local tax law
provisions.
Page 2 Domestic tax planning amid corporate tax reform and heightened IRS controversy

3. Disclaimer
Ernst & Young refers to the global organization of member firms of Ernst & Young
Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-
serving member firm of Ernst & Young Global Limited operating in the US. For more
information about our organization, please visit www.ey.com.
This presentation is © 2012 Ernst & Young LLP. All rights reserved. No part of this
document may be reproduced, transmitted or otherwise distributed in any form or by
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transmission or distribution of this form or any of the material herein is prohibited and
is in violation of US and international law. Ernst & Young LLP expressly disclaims any
liability in connection with use of this presentation or its contents by any third party.
Views expressed in this presentation are not necessarily those of Ernst & Young LLP.
Page 3 Domestic tax planning amid corporate tax reform and heightened IRS controversy

4. Presenters
► Joseph Chirichella ► Keith Nickels
Senior Director Ernst & Young LLP
Becton, Dickinson and Co. New York, NY
+1 212 773 6719
keith.nickels@ey.com
► Kristine Mora
Ernst & Young LLP ► Millie Chun
Washington, DC Ernst & Young LLP
+1 202 327 6092 Iselin, NJ
kristine.mora@ey.com +1 732 516 4104
millie.chun@ey.com
Page 4 Domestic tax planning amid corporate tax reform and heightened IRS controversy

5. Agenda
► Domestic tax planning amid corporate tax reform and
heightened Internal Revenue Service (IRS) controversy
► Research credit
► Legislative update
► Examination insights
► International incentive considerations
► Inventory
► Legislative and regulatory updates
► Section 263A Uniform Capitalization (UNICAP)
► Self-constructed assets
► Last-in, first-out (LIFO)
► Section 199 domestic manufacturing deduction
► Legislative update
► Examination and planning insights
Page 5 Domestic tax planning amid corporate tax reform and heightened IRS controversy

6. Research credit

7. Research credit discussion topics
Legislative update from Washington
IRS Large Business & International (LB&I) research credit examination insights
Implementation and examination techniques to consider
Open discussion on IRS examination issue
Other considerations
International research and development (R&D) incentive considerations
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8. Legislative update from Washington
► Prospects for extension
► Avoiding the fiscal cliff
► Business extenders package
► Likelihood of extension in December lame-duck Congress
► Implications of the expiration
► Financial statement issues
► Fiscal year filers
► Comprehensive tax reform
► Elimination of “tax expenditures” impacting the health care industry
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9. IRS LB&I research credit examination
insights
► LB&I examination and guidance initiatives
► LB&I initiatives
► Research credit stakeholder meetings
► Status of Tier 1 program
► Issue Practice Group (IPG)
► Subject matter experts (SMEs) will be agents who spend no more
than 25% of their time on the issue.
► Research credits will be grouped with general business credits.
► Local teams should have more discretion over the research
credit issue.
Page 9 Domestic tax planning amid corporate tax reform and heightened IRS controversy

10. Implementation and examination techniques
► Use of Pre-Filing Agreements (PFAs)
► Health science industry well-suited for PFAs
► Benefits
► Working with the IRS
► Common goal
► Currency
► Methodology certainty for four years (roll back)
► Availability of records and personnel
► Less contentious
► Resource savings
Page 10 Domestic tax planning amid corporate tax reform and heightened IRS controversy

11. Implementation and examination techniques
► Use of statistical sampling
► Time and costs are considerations.
► Complexity and cost of complete review of some small populations
make sampling appropriate.
► Health sciences industry potential applications
► Consider audit guideline “risk” ratings (see next slide)
► Sample “high risk” employees by department and development phase
► Sample high-level management employees
► Sample projects to minimize documentation effort
► Use of electronic surveys to facilitate process
► See illustration of web-based survey (page 13)
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12. Audit guideline risk ratings illustration
Research credit levels of risk
Department Level of risk in each product development phase
Pre-clinical Clinical Post-clinical
Biology Low 1
Pharmacology Low 1
Chemistry Low 1
Drug Metabolism Low 1
Pharma Development Low/High 1
Analytical Chemistry Low 1 1
Pharma Tech Med 1 1&2
Drug Safety Med/High 1 1&2
Biostatistics Low 1&2 1&2
Clinical R&D Med 1&2 1&2
Medical Services High 2&3 2&3
Medical Affairs High 2&3 2&3
Regulatory Affairs High 4 4
Drug Surveillance High 4 4
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13. Web-based survey illustration
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14. Open discussion on IRS exam issues
► Intra-group reimbursements
► Foreign parent and US subsidiary contract with third party to
develop new drug
► US subsidiary makes payment to third party
► Foreign parent reimburses US subsidiary
► Collaboration agreement
► Up-front payments
► Milestone payments
► Phase IV development activities
► Allocation of domestic vs rest-of-world clinical trial costs
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15. Other considerations
► Impact of research spending on cost-sharing
arrangements
► Section 864(f) source allocations
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16. International R&D incentive considerations
Canada UK
Incentive type: Tax credit Incentive type: Superdeduction
Description: 20% tax credit on all Description: Superdeduction of 130%
allowable R&D expenditures of qualified expenditures for large
How to obtain: Form T661 and T2 companies (higher percentage for
Schedule 31 must be filed and small and medium-sized enterprises),
completed within 12 months of the 100% write-off of capital expenditures
deadline for income tax filing, or 18 (RDA), tax savings
months after the taxation year-end for How to obtain: The taxpayer must file
corporations. France the claim with the CT600 up to two
Incentive type: Tax credit
years after the end of the accounting
Description: 30% tax credit can be which it relates.
period to
carried forward three years and if not
utilized, cash reimbursement is
available. Eligible expenses are
Belgium capped at 100m euros (5% for the
Incentive type: Investment deduction Brazil
expenses above the cap) China
(ID) or investment tax credit (ITC) Incentiveto obtain: The taxpayer is not type: Superdeduction
How type: Superdeduction Incentive
Description: ID of 13.5% of Description: Incremental deduction
required to seek government Description: 150% superdeduction on
investment amount (20.5% of on qualifying R&D expenditure up to
pre-approval. qualifying R&D expenses
depreciation) or ITC of 33.99% 200% (160% base, 180% with hiring
How to obtain: The taxpayer must
Capitalized R&D expenditures requirement and 200% with
apply for approval with the Science &
include patents, intangible assets, registered patent requirement)
Technology Bureau and tax
real estate and personal property. How to obtain: Companies must have authorities.
How to obtain: A tax ruling may be a tax clearance certificate, regarding
obtained from Belgian tax authorities the whole calendar year in which the
in order to secure eligibility for ID or incentive is taken, to qualify for the
ITC. superdeduction.
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17. Inventory

18. Inventory agenda
► Legislative/regulatory update
► Section 263A (UNICAP)
► Overview
► Proposed regulations for negative Section 263A costs
► Self-constructed assets
► LIFO
► Other inventory planning
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19. Inventory accounting —
legislative/regulatory update
► Proposed regulations
► Sales-based royalties
► Vendor allowances
► Retail inventory method
► Negative 263A costs
► President’s fiscal 2013 budget proposals:
► LIFO repeal
► Lower of cost or market (LCM) repeal
► Sub-normal goods write-downs repeal
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20. UNICAP planning: why now?
► Mandatory compliance in order to fall within automatic
change procedures for the tangible property regulations
► Other considerations:
► Bonus depreciation
► Reduce taxable income
► Remediate potential exposure
► Net operating loss (NOL) companies
► Newly acquired entities
► Changes to book inventory costing methods
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21. UNICAP planning: common opportunities
► Opportunities:
► Adopt a burden rate method or new proposed modified simplified
production method (if finalized)
► Embedded costs
► R&D
► Depreciation on temporarily idle facilities
► Warranty and product liability
► Policy-making/budgeting
► Elect the historic absorption ratio
► Lock in a low rate
► Reduce administrative effort
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22. UNICAP planning: potential exposures
► Common exposure areas
► Book/tax differences are not allocated
► Absorption ratio has not been updated
► Operations have changed since last UNICAP study
► Contract manufacturing for retailers or distributors
► Service providers should be treated as producers
► Following book capitalization for self-constructed assets
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23. Other 263A considerations —
self-constructed assets
► Applies to real or tangible personal property produced by
the taxpayer and therefore applies to property produced
by a company for use in its trade or business
(self-constructed asset)
► Definition includes construct, build, install, manufacture, develop,
improve
► For example, the installation of an elevator or air conditioning system
into a company-owned building
► Includes capitalizable improvements
► The taxpayer must capitalize the required costs into the installed
property and an allocable share of mixed service costs (general
and administrative).
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24. Other 263A considerations —
self-constructed assets
► Applies to taxpayers that have property produced by a
contractor
► The company that contracts to have property constructed for it is
treated as self-constructing the asset to the extent it makes
progress payments or otherwise incurs cost with respect to the
property.
► Indirect costs incurred by the company (e.g., construction period
interest, oversight and general and administrative expenses) for
which the property is being produced must be capitalized by that
company as a cost of the property.
► Currently, most self-constructed asset Section 263A
changes are non-automatic and must be filed by the last
day of the tax year.
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25. UNICAP: negative 263A costs —
proposed regulations
► A negative amount generally occurs when a taxpayer
capitalizes a cost as a Section 471 cost that is greater
than the amount required to be capitalized for tax
purposes, which the taxpayer seeks to remove from
inventory cost using its 263A formula.
► In Notice 2007-29, the IRS stated that, pending the
issuance of additional guidance, it would not challenge the
inclusion of negative amounts in calculating additional
costs under Section 263A or the permissibility of
aggregate negative additional Section 263A costs.
Page 25 Domestic tax planning amid corporate tax reform and heightened IRS controversy

26. UNICAP: negative 263A costs —
proposed regulations
► Proposed regulations that generally prohibit the inclusion
of negative additional 263A costs subject to a few
exceptions:
► Small taxpayers
► Simplified resale method
► Modified simplified production method (discussed on next slide)
► All other taxpayers must reduce Section 471 costs using a
method that approximates the manner in which the
taxpayer originally capitalized the costs.
► The proposed regulations would generally prohibit treating
cash or trade discounts under Reg. Section 1.471-3(b) as
negative amounts under either simplified method.
Page 26 Domestic tax planning amid corporate tax reform and heightened IRS controversy

27. UNICAP: negative 263A costs —
proposed regulations
► New modified simplified production method
► Two absorption ratios
► Preproduction
► Production
► Allows negative additional Section 263A treatment
► Reduce the distortions
► May be favorable but additional work if currently using simplified
production methods
► Pre-production costs applied to raw material AND raw material content
of work in process (WIP) and finished goods
► Many of the benefits of burden rate methods, but with less work
Page 27 Domestic tax planning amid corporate tax reform and heightened IRS controversy

28. UNICAP: negative 263A costs —
proposed regulations
► Adopt a new definition of Section 471 costs
► Applies to all taxpayers regardless of the methods used
► All costs, other than interest, that a taxpayer capitalizes to its
inventory in its financial statements
► Must include direct labor and direct material
► Consistent with what most taxpayers are currently doing
in practice
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29. LIFO planning: why now?
► Maximize LIFO reserve
► Merger and acquisition activity
► Preserve LIFO reserve when LIFO inventory is moved
between entities
► Adopt LIFO for private or foreign-owned companies
► Before 2012 financial statements issued
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30. LIFO planning: common opportunities
► Opportunities
► Automate LIFO computations
► Adopt LIFO for additional inventory
► Change from internal to external inflation indexes or vice versa
► Terminate LIFO for deflationary goods (e.g., pools with debit
LIFO reserve)
► Reconstruct base-year cost if inflationary; do not reconstruct if
deflationary
► Change pooling methodology
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31. LIFO planning: potential exposures
► Potential exposure areas
► Pooling methodology not appropriate (e.g., purchased for resale
inventory included in manufactured pool)
► In-transit or other inventory not on LIFO
► Item definition not detailed enough (internal index)
► Inventory not assigned to appropriate producer price index
commodity codes (inventory price index computation)
► Book LCM (Lower of Cost or Market) reserves not reversed for tax
purposes
Page 31 Domestic tax planning amid corporate tax reform and heightened IRS controversy

32. Other inventory planning
► Reduce taxable income
► Inventory write-downs (non-LIFO taxpayers only)
► Lower of cost or market
► Subnormal goods (e.g., expired products, obsolete inventory)
► Retail inventory method
► Inventory shrink
► Charitable contributions of inventory
► Chargebacks
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33. Other inventory planning
► Reverse tax planning (e.g., expiring federal tax credit,
NOL, etc.)
► Stop taking inventory write-downs
► Correct UNICAP method or establish methods for entities not
currently doing a calculation
► Adopt unfavorable UNICAP methods
► Minimize LIFO deduction
Page 33 Domestic tax planning amid corporate tax reform and heightened IRS controversy

34. Section 199

35. Section 199 agenda
► Legislative/regulatory update
► Contract manufacturing
► Benefits and burdens — industry director directive (IDD)
► Controversy update
► Other planning considerations
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36. Section 199 — legislative/regulatory update
► President Obama’s fiscal 2013 budget proposals:
► Broadening deduction for “advanced” technology manufacturing
activities
► Eliminating deduction against income derived from the production
of oil, gas, coal and other hard mineral fossil fuels
► CCA 201208029 (released February 24, 2012)
► Gross receipts derived from sale of leasehold rights are not
domestic production gross receipts.
► Rev. Rul. 2011-24
► Guidance on characterizing gross receipts from
telecommunications services
Page 36 Domestic tax planning amid corporate tax reform and heightened IRS controversy

37. Section 199 — contract manufacturing;
benefits and burdens IDD
► LB&I-4-0112-001 (released February 1, 2012)
► IDD was issued to aid examiners in determining whether a
taxpayer has the benefits and burdens of ownership under a
contract manufacturing arrangement.
► IDD provides a three-step process for examiners to use in
determining whether a taxpayer has the benefits and burdens of
ownership.
► Steps are related to contract terms, production activities and
economic risks.
► Step 1 — contract terms
► Did the taxpayer have title to the WIP (Work in Progress?
► Did the taxpayer have risk of loss over the WIP?
► Was the taxpayer primarily responsible for insuring the WIP?
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38. Section 199 — contract manufacturing;
benefits and burdens IDD
► LB&I-4-0112-001
► Step 2 — production activities
► Did the taxpayer develop the qualifying activity process (determined
without regard to who designed the property, provided the
specifications for the property or holds intellectual rights to the
property)?
► Did the taxpayer exercise oversight and direction over the employees
engaged in the qualifying activity (determined without regard to who
designed the property, provided the specifications for the property or
holds intellectual rights to the property)?
► Did the taxpayer conduct more than 50% of the quality control tests
over the WIP while the qualifying activity was occurring?
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39. Section 199 — contract manufacturing;
benefits and burdens IDD
► LB&I-4-0112-001
► Step 3 — economic risks
► Was the taxpayer primarily liable under the “make-good” provisions of
the contract, for example, the warranty, quality of work, spoilage,
overconsumption or indemnification provisions?
► Did the taxpayer provide more than 50%, based on cost, of the raw
materials and components used to produce the property?
► Did the taxpayer have the greater opportunity for profit increase or
decrease from production efficiencies and fluctuations in the cost of
labor and factory overhead?
Page 39 Domestic tax planning amid corporate tax reform and heightened IRS controversy

40. Section 199 — controversy update
► Tier 1 — program dissolved
► Manufacturing
► Substantial in nature
► Mere repackaging
► Contract manufacturing
► Calculations
► Section 263A
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41. Section 199 — opportunities and
other planning considerations
► Opportunities
► Expense allocation and apportionment
► Facts and circumstances approach vs. safe harbor
► State tax considerations
► Other considerations
► Corporate rate reduction
► Impact of tangible property regulations
Page 41 Domestic tax planning amid corporate tax reform and heightened IRS controversy