Road map to emerging markets: spotting opportunities and issues in health sciences

22nd Annual Health Sciences
Tax Conference
Road map to emerging markets: spotting
opportunities and issues in health sciences

December 5, 2012

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 Road map to emerging markets: spotting opportunities
and issues in health sciences

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Panelists

► Haroon Cheema ► Frank de Meijer
Director and International Tax Counsel Ernst & Young Terco
Merck & Co., Inc. São Paulo, Brazil
Whitehouse Station, NJ +55 11 2573 3413
frank-de.meijer@br.ey.com

► Ana Mingramm
► Chris Finnerty Ernst & Young LLP
Ernst & Young LLP New York, NY
New York, NY +1 212 773 9190
+1 212 773 7479 ana.mingramm@ey.com
chris.finnerty@ey.com
► Tejas Mody
Ernst & Young LLP
New York, NY
+1 212 773 4496
tejas.mody@ey.com


Agenda

► Emerging-markets overview

► Major emerging-markets tax trends:
► Transfer pricing (TP) under increased scrutiny
► Anti-avoidance challenges
► Tax administration and practice tightened

► Mergers and acquisitions

► Other regional developments and opportunities


Emerging-markets overview — faster growth
than developed markets
Pharmaceutical sales in
Pharmaceutical sales in emerging-markets
developed markets

450 600

400
500
350 CAGR: 2.00%

300 400
Sales (US$b)

Sales (US$b)
CAGR: 11.2%
250
300
200

150 200

100 CAGR: 15.6%
100
50

0 0
2007 2008 2013F 2020F 2006 2020F
Brazil Russia India China Mexico Turkey Korea EU 5 US

Source: IMS Health, July 2012 *Compound annual growth rate (CAGR)


Emerging-markets overview — struggles
ahead?
► Eli Lilly & Co.: emerging market revenue falls 4%

► Pfizer Inc.: scales back emerging-markets growth estimates

► Ernst & Young LLP: predicts $47 billion shortfall between forecasted
sales and achievable sales for “Big Pharma”

► Emerging market growth drivers:
► Local competition for products and staff
► Construction of factories to facilitate sales approvals
► Pharmaceutical policy changes

Tax considerations are becoming increasingly more important for life
sciences companies doing business in the emerging-markets.
Source: Wall Street Journal, August 20, 2012


Emerging-markets overview — evolving tax
landscape
1
► Transfer pricing audits
► Permanent establishment
► Tax residency
► Beneficial ownership
Regular tax Tax scrutiny of ► Specific anti-avoidance rules
inspections non-residents
Expanded ► General anti-

jurisdictions avoidance/substance over form

Tightened More Alignment with 3
2
enforcement sophisticated international ► Transfer pricing practices
► Taxpayers’ information practices
gathering and exchange ► Advance pricing agreements

► Tax internal control and ► Exchange of information
tax risk profiling agreements
► Strengthening of tax Increased Continuous ► Tax-free reorganizations
Tax reform
administration and collection disclosures change ► International Financial
changes
► Various transaction disclosure Reporting Standards
forms
► Limitation of benefits/anti-treaty
► Changes to tax administration and collection
shopping clauses in tax treaties
► Evolving guidance
4
► Renegotiated tax treaties


Major emerging-markets tax trends —
transfer pricing under increased scrutiny

transfer pricing, Asia-Pacific
India
► Increasingly aggressive transfer pricing enforcement

► Key industry issues in recent transfer pricing audits concerning:
► Need to satisfy benefits test for management fee payout
► Basis of royalty determination; legal vs economic ownership
► Clinical data management, construed high end, 27% to 30% markup
► Clinical trial coordination, construed high-end research and
development, 22% to 25% markup
► Import prices of active pharmaceutical ingredients (APIs)/finished
dosage formulations (FDFs)
► Comparable uncontrolled price of generics deployed in audits

► Advertising, marketing and promotion expenses
► Compensation for marketing intangible in India


► Recent legislative changes to transfer pricing provisions:
► Scope of term international transaction enhanced; meaning of term
intangible property clarified
► Transfer pricing made applicable to specified domestic
transactions
► Procedural and penalty provisions tightened
► Recent introduction of advance pricing agreement (APA) rules
into India law:
► Alternate route to domestic appellate process
► Provision for unilateral, bilateral or multilateral APAs


China
► Rapid growth in transfer pricing audit resources at the local
state tax bureau and State Administration of Taxation (SAT)
headquarters level
► Stricter TP enforcement according to Guoshuihan [2011]
Circular 167
► Industry focus on automotive, consumer products,
pharmaceuticals, real estate, hospitality and logistics
► Marketing intangibles and location savings key audit issues

► Three-pronged approach to enforcement:
► Administration: change from investigation afterwards to precaution beforehand
► Service: actively promote APAs and mutual agreement procedures
► Investigation: deepen investigation and enhance intensity (industry focus)


transfer pricing, Asia-Pacific APAs
► Increasing use in the region: mainland China, Singapore,
Japan, South Korea, Taiwan, Indonesia, Hong Kong and India.
Taxpayer benefit Tax authority benefit
Certainty of outcome Certainty of tax base

Bilateral/multilateral solution — Knowledge-sharing from
elimination of risk of double tax bilateral/multilateral negotiations

Avoidance of costly, protracted audits More detailed understanding of taxpayer

Dedication of more TP technical Alternative approach to TP enforcement
resources by tax authorities

► APAs can provide certainty for significant investment decisions,
tax structuring and host location analysis.


transfer pricing, Latin America
Brazil
► Published on April 4, 2012; effective as of 2013 with the option
to be applied for 2012
► Minimum requirement for the application of the Brazilian
uncontrolled price method (PIC)
► The minimum statutory gross profit margin required when
applying the resale price method (PRL) for the import of goods,
services or rights; ranges from 20%–40% depending on the
industry
► Freight-on-board price as basis for the PRL calculation

► Changes to the deductibility of interest


anti-avoidance challenges

anti-avoidance rules, Asia-Pacific
► Australia, China, Hong Kong, New Zealand and Singapore
have general anti-avoidance rules (GAAR) currently; India is on
the way.
► India, Indonesia, Japan and South Korea do not have GAAR
provisions but rely on targeted anti-abuse rules/specific anti-
abuse rules, substance-over-form and other measures, e.g.,
Limitation of Benefits (LOB)/anti-abuse provisions in tax treaties
to prevent treaty shopping.
► Tax authorities are focusing more on thin capitalization, transfer
pricing and treaty shopping (beneficial ownership).
► Permanent establishment as well as tax residency are
increasingly audit issues.
► Disclosures, documentation and administrative burdens are
increasing steadily in the region.

anti-avoidance rules, Asia-Pacific
India
► GAAR introduced to counter aggressive tax planning; effective
April 1, 2013
► Deferral to April 1, 2016 recommended
► GAAR triggered if main purpose or one of the main purposes
is to obtain tax benefit and a tainted element is present
► Tainted elements test arm’s-length character, misuse or abuse
of law, commercial substance or bonafides of arrangement
► Wide powers to tax authority to disregard or re-characterize
arrangement if GAAR invoked
► Expert Committee (EC) constituted by Prime Minister: release
of draft report (ECR) containing guidelines for implementation
► Provisions likely to be watered down


anti-avoidance rules, Latin America
General trend to adopt substance-over-form approach and require
business purpose:
Brazil
► New interpretations from the taxpayers’ council in Brazil
► Superior Tribunal de Justica interpretation on payment for
imported services; no withholding tax on treaty countries
Mexico
► Tax authorities criteria and recent case law
Peru
► New GAAR (effective July 19, 2012)
Colombia
► Proposed anti-evasion rules


Major emerging-markets tax trends — anti-
avoidance rules, indirect share transfers

indirect share transfers, Asia-Pacific
Australia
► Greater than 50% real estate test applies.
China
► Circular 698: GAAR can be asserted to disregard
intermediaries and recast as a direct equity transfer.
India
► Transfer of shares of foreign company deriving value
substantially from India will be taxed in India as law currently
stands; many issues remain.
► EC recently released draft report of key recommendations.
Indonesia
► Specific indirect transfer rule targets the use of special-
purpose vehicles domiciled in tax havens.

indirect share transfers, Asia-Pacific

Hong Kong, Malaysia, New Zealand, Singapore
► Nonresidents not taxed on capital gains.

Cambodia, Japan, South Korea, Philippines, Thailand,
Vietnam
► Indirect share transfers currently not taxed.


indirect share transfers, Latin America
Mexico
► 50% real estate test

Chile
► New rules effective as of January 1, 2013

Peru
► Subject to tax if Peru represents 50% of the value of the
shares transferred

Panama
► Applicable over Panamanian source income only


tax administration and practice tightened

Major emerging-markets tax trends — tax
administration and practice tightened
► Significant activity in tax audits throughout the region

► Generally aggressive audits and large assessments

► Cross-border transactions and transfer pricing

► Pre-controversy management:
► Need to maintain adequate supporting documentation
► Severe penalties and fines imposed by countries in certain countries
► Need for active involvement at the discovery level

► Exchange of information agreements

Mergers and acquisitions — Latin America

► Investments and acquisitions
► Made through favorable jurisdictions (Netherlands, Spain, Switzerland)
► Leverage strategies available in most jurisdictions
► Goodwill amortization variable among countries (Brazil, Chile)
► Divestments and exit planning
► Capital gains tax on sale of shares:
► Book value possible in limited countries
► Use of tax treaties to limit capital gains tax

► Reorganizations
► Mergers usually tax free
► Tax free spin-offs (de-mergers) generally possible with few exemptions
(Venezuela, Central America, Uruguay)
► Holding period requirement
► Mexico, Argentina, Peru and proposed changes in Colombia


Mergers and acquisitions — Asia-Pacific,
India
► Planning inbound structure:
Mergers and
► Comply with Indian
acquisitions regulations/laws
► Structured through tax-
efficient jurisdictions
Business
Acquisitions ► Hybrid financing possible
reorganizations
but requires structuring
► Tax diligence necessary

Share
Merger Demerger Asset purchase
purchase

► Generally tax neutral subject to conditions
Slump Itemized
sale sale

► Indian acquiring vehicle can be a corporate or a limited liability partnership
► Possible to claim goodwill amortization
► Sell side tax costs and transaction costs to be analyzed


Other regional developments and
opportunities — Latin America

► Significant tax reforms throughout the region
► Argentina
► Significant changes to foreign-exchange controls
► Proposed tax reform for 2013
► Chile
► Tax reform enacted in 2012
► Peru
► Tax reform enacted in 2012
► Colombia
► Proposed tax reform for 2013

► Active increase in tax treaties throughout the region


► Shared service centers and management fees
► Reduction of withholding taxes
► TreatyCo with Panama Branch
► Use of foreign tax credits
► Shared service centers in Mexico or Brazil

► Supply chain opportunities
► Expanding treaty network
► Free trade zones in the region


opportunities — Brazil indirect taxes (ICMS)
► Senate Resolution 13 introduced
► By 2013, Interstate ICMS value added tax (VAT) rate at 4% for
imported goods
► 2012 rate at 7% or 12%
► Reason: use of import state incentives avoided
► Result:
► Huge buildup of ICMS credits in Brazil
► Use of incentives less attractive
► Rising tax costs
► New supply chain planning needed
► Same rules applicable to locally manufactured goods by 2020


Other regional developments and opportunities —
Brazil localization for medical equipment

► High demand for medical equipment in Brazil
► Customs duties low; no local production yet
► Initiatives for local production begun
► High financing costs for users
► Alternative: use of Finame for locally produced equipment
► Bidding process of public hospitals: locally manufactured
equipment preferred even when cost margin is higher (up
to 25%)


Other regional developments and opportunities —
Brazil indirect tax distribution planning

Create own distribution center to save on turn-over tax (PIS/Cofins)
and substitute state VAT (ICMS)

Factory Distributor Consumer

► Low factory price
► Basis for manufacturing taxes:
► Single turn-over tax (PIS/Cofins)
► Advanced ICMS (ST)
► High commercial price
► Manufacturing taxes no longer due


opportunities — future trends in trade Blocs
► Mercosul, CAN and others
► Trend towards protectionism in recent years
► Mercosur maximum external tariff to 35%
► Mercosur trade Bloc appearing continually weaker:
► Fractious relationships between the parties
► Impact on Venezuela’s admission
► Mercosur opposed to entering FTA relationships with US
► US looking for more bilateral agreements
► Mercosur not successful:
► Little growth in export trade between the member states
► Disputes between Argentina and Brazil
► Economic momentum of both Mercosur and CAN slowed
► Truly integrated South America Trade area unlikely in next
5 to 10 years


opportunities — Asia-Pacific

opportunities — indirect taxes, India
► Paradigm shift in taxation of services: all services taxable
except negative/exempt list
► Exemption to export services based on newly introduced place-
of-provision-of-services rules
► Seeming impact on technical testing/clinical trial services

► Cumbersome refund process for exporters of goods
and services
► Import prices of APIs/FDFs subject to investigation by special
valuation branch of India’s Central Board of Excise
and Customs


opportunities — indirect taxes, China
► VAT pilot locations and covered industries
► Pilot locations: Shanghai,
Beijing, Anhui, Jiangsu,
Region Launch date
Fujian, Guangdong
(includes Shēnzhèn), Shanghai January 1, 2012
Tianjin and Hubei
Beijing September 1, 2012
► Pilot services:
Anhui and Jiangsu October 1, 2012
► Transport service
► Certain modern
Fujian and Guangdong November 1, 2012
services industries (includes Shēnzhèn)

► Applicable rates: Tianjin, Zhejiang and December 1, 2012
17%,11%, 6% and 3%, Hubei
depending on different
classes of VAT payers of
the VAT pilot service


Questions?


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