What makes transfer pricing an important issue for growing life sciences businesses?

Building a successful life sciences business is a complex journey. It involves:

• Successfully conducting the research and development needed to build a strong and compelling product or service proposition.
• Developing a strong commercial model and market proposition.
• Navigating the regulatory environment – for example, through clinical trials and obtaining the right marketing authorisations.

All this usually needs to be achieved while managing tight funding constraints.

International expansion is also an important part of the growth journey for many life sciences businesses. For some, this will come at the pre-revenue stage. A common example is where the business recruits valuable talent in other countries, a seemingly simple step which can have wide-ranging consequences. For others, international expansion comes as they commercialise and look to sell into other markets. This will often mean an expansion into the US, the world’s largest healthcare market. Since Brexit, it has also become more common for UK life sciences businesses to establish a European entity as an entry point for sales into EU markets.

Compared to businesses in other sectors, this means that life sciences businesses often expand internationally while they are still at an earlier point in their lifecycle and getting that expansion right is especially fundamental to their long-term commercial success.

Why is transfer pricing important to this journey?

Transfer pricing is an internationally agreed approach to working out how profits (or losses) should be recognised across a group. At its heart is the arm’s length principle. Its core idea is that each member of a group entity should earn a similar profit (or loss) to an independent business performing the same role on a similar basis under comparable conditions. There are five specific transfer pricing methods by which this can be achieved, but we’ll focus in this article on the outcome – the profit distribution across the group.

If the transfer pricing is not correct in the accounts, it is usually only possible to adjust the profits of the entity that earned too little profit (or made too big a loss) via the tax return. This typical ‘one-sided’ approach to tax return adjustments means that the same amounts can be taxed twice, consuming valuable additional cash.

Although transfer pricing is a tax concept, the policy adopted often shapes the statutory accounts and financial records across a group. It is also fundamental for accurate profit forecasting of the long-term profit distribution and profit profile across the business.

There can be exemptions from the transfer pricing rules for small businesses or small transactions but, unfortunately, there is no consistent approach internationally. For example:

• The UK has a test based on the group’s employees, revenues and balance sheet.
• Other territories may use thresholds based on consolidated group revenues or transaction values.
• Some countries, like the US, do not offer any exemptions.

For those businesses that do come under scrutiny, enquiries often run for several years, which can place significant strain on management time and resource.

Transfer pricing is also commonly examined as part of a due diligence exercise if the business is sold at a later date. While transfer pricing is not usually a deal breaker, a weak transfer pricing model or gaps in the support for it can lead to price chipping.

Not considering transfer pricing at the right time can also have wider consequences. This can sometimes be the case even where the business has expanded into countries whose local transfer pricing rules do not apply yet. Examples of these wider consequences can include:

• Trapped cash.
• Unintended intercompany balances with the character of loans.
• The establishment of broader long-term fact patterns which materially increase the risk of future challenge by the local tax authority. One specific example would be a local subsidiary which runs at a loss but performs a role for which some level of profit would be expected.

All of this means that the practical answer is often simply to get the group’s transfer pricing right at an early stage.

What key factors make for a strong transfer pricing position?

A strong transfer pricing position plays an important role in managing these risks. It has many elements, but there are five key areas that are particularly important for growing life science businesses:

1. A clear, robust transfer pricing policy position: this should closely follow how your business actually works in practice so that the profits (or losses) are distributed accordingly. Your Intellectual Property (IP) is a particularly important part of this picture, since the transfer pricing rules place significant weight on the key decision-making roles related to IP when deciding where the profits associated with that IP should be taxed.
2. Robust implementation: the key parameters for the transfer pricing model should be clear (and typically, recorded in a legal agreement) and carefully followed in practice.
3. Accurate calculation and invoicing: invoices need to be issued for accurately calculated amounts and with a robust audit trail to your business and financial records.
4. Documentation: you need to be able to explain why your transfer pricing model works the way it does – for example, to respond to a tax enquiry but also for any future due diligence on a sale of the business.
5. Monitoring: your transfer pricing model needs to be kept up-to-date. Put simply, if your business changes, your transfer pricing may well need to change too.

How our transfer pricing experts can help your life sciences business

We have an experienced network of transfer pricing specialists in the UK and across our global network. These specialists work closely with a wider team of industry experts to provide our clients with tailored support based on their individual business and expansion plans.

To discuss transfer pricing for your life sciences business, please contact Graham Bond, Paul Minness or Matt Sims.