Life sciences businesses must carefully navigate their way through various development stages, as they seek to bring a new drug, product, or process to market and provide return for their investors. Each phase of development brings with it unique demands as a business evolves, personnel are added, and operations are expanded.
Commercialization of a new drug, product, or process is a particularly exciting time for a life sciences company. The launch of a new product represents the culmination of years of investment in research, development, and clinical trials. As a life sciences company directs its attention towards commercialization, it is faced with a host of new challenges and must make important decisions related to manufacturing, distribution, and supply-chain strategies. It is also common to see an expansion of sales and medical affairs personnel during this period, as the business seeks to market its product and disseminate information regarding the product’s use.
Often times, these activities will significantly broaden a life sciences company’s geographic footprint throughout the U.S. From a state tax perspective, this increased presence can generate additional filing responsibilities, new and substantial compliance burdens, and, in some cases, opportunities for immediate or future savings. Commercialization of a new drug, product, or process is therefore a critical time for a life sciences company to evaluate its state tax compliance processes and positions.
States and localities can impose many different types of taxes on businesses operating within their jurisdictions, including but not limited to: income/franchise taxes, gross receipts taxes, sales and use taxes, and property taxes. To varying degrees, each of these types of taxes can impact life sciences companies. Outlined below are some of the state tax concepts that should be considered as plans for commercialization develop.
Income, franchise and gross receipts taxes
As a company’s interstate activities increase in volume and breadth, the company will likely begin to establish state tax “nexus” in an increasing number of states, resulting in additional state income, franchise, and gross receipts tax filing obligations. From an income tax perspective, life sciences businesses are often in a loss position in the years leading up to and during the commercialization stage. However, it can still be critical to evaluate state income tax nexus and begin filing in multiple states prior to profitability to ensure maximum utilization of any loss carryforwards in future years, as many states do not allow the use of no-nexus year losses to offset current income. Moreover, some states, including Ohio, Oregon, Tennessee, Texas, and Washington, impose franchise taxes and/or gross receipts taxes that are not measured on net income, but are instead measured on net worth, property value, gross receipts, and other bases that do not account for losses. Consequently, life sciences companies can be exposed to unexpected tax liabilities despite the fact that they may be generating significant losses from an income tax perspective. The accurate determination of these tax assets and liabilities can be critical in accounting for a company’s income tax position under ASC 740.
Commercialization is also an opportune time to review a company’s corporate structure to ensure future tax efficiency. In particular, segregation of business activities such as manufacturing (including fill/finish and packaging/labeling), distribution, and sales can sometimes result in reduced effective state tax rates. When planning in this regard, life sciences businesses should consider state specific tax regimes that may provide advantageous structuring alternatives (e.g. Massachusetts Security Corporation). Such planning should also include a review of state tax attributes, such as net operating losses and credits, to ensure they are being efficiently generated and utilized.
Finally, life sciences businesses should review their state income tax apportionment methodologies leading up to and during the commercialization phase. Life sciences companies often generate revenue from various sources (e.g. drug sales, collaboration/research agreements, milestone payments, etc.), and state-specific apportionment rules should be considered in order to properly source each revenue stream for state income tax purposes.
Sales and Use Taxes
An area that can often be overlooked by life sciences companies is multistate sales and use tax compliance. From a selling perspective, sales of prescription drugs are exempt from sales tax in most states. However, some state and local jurisdictions have unique rules to consider. In addition, sales of medical equipment and non-prescribed items may be subject to tax. State rules can be nuanced in this regard and a careful review of transactions should be conducted.
A life sciences company’s purchase activity should also be thoroughly reviewed to ensure that it is taking advantage of any exemptions from sales tax that may be applicable. For example, several states provide exemptions from sales tax on purchases of items used in manufacturing and/or research and development processes. Purchase activity should also be monitored to ensure that the business is self-reporting use taxes where applicable on purchases of items such as software or materials used and consumed in clinical trials.
Commercialization may also be an appropriate time for a business to consider implementing sales/use tax automation software and to evaluate its enterprise resource planning (ERP) system as a whole. These technologies can streamline compliance processes and mitigate the burdens associated with multistate tax compliance.
Credits and incentives
State tax credit and incentive (C&I) opportunities exist for life science companies at nearly every stage of the business cycle, including commercialization. For example, states may offer C&I for manufacturing and research activities performed by life sciences companies. Benefits are often granted for the creation of jobs, job training, and the build out of facilities and plants as well.
Some states offer specific types of exemptions for life sciences companies, including property tax and sales/use tax exemptions. Certain states also have programs in place specific to life sciences companies, through which incentives can be awarded to qualifying businesses.
Timing is critical in order to fully take advantage of many C&I opportunities. Accordingly, it is imperative for life sciences businesses to notify their tax advisors as far in advance as possible when considering business expansion activities, especially with respect to manufacturing and new site selecns.
Nonresident individual income tax compliance
As noted, commercialization often brings about an expansion of medical affairs and sales personnel tasked with traveling amongst the US and the world to generate a market for a product. Employers are technically responsible for tracking the travel of these individuals and withholding personal income taxes based on the rules of the various jurisdictions to which these individuals travel. Executive travel can be of particular concern due to the higher compensation and increased visibility attributable to such individuals. In planning for commercialization, life sciences businesses should consider implementing internal processes to track these activities so that taxes are remitted to the appropriate jurisdictions.
Takeaway
Life sciences companies face many challenges as plans for commercialization of a new drug or product are developed and implemented. Addressing state tax matters during this period can prevent the proliferation of state tax exposures and can even result in substantial tax and/or cash savings for companies that plan appropriately.
RSM’s state and local tax (SALT) team has the industry experience required to provide comprehensive services to businesses in the life sciences space.
