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Pharmaceutical industry: A dose of reality

Pharmaceutical industry: A dose of reality

FOR years, African countries have paid exorbitant amounts for pharmaceuticals developed in the US, including drugs such as AZT, which is used to treat Aids.

The reasoning was always that it cost pharmaceutical companies upwards of US$1bn to create these drugs — and these costs must be recouped.

But a new investigation of the murky tax breaks used by the industry tell another story entirely.

Take the case of Puerto Rico, a small island in the Caribbean which is officially a US territory. It may seem unlikely, but in the late 1990s and early 2000s, Puerto Rico became a destination for drug companies seeking to make use of its status as a tax haven. There, one of the small coastal towns, called Barceloneta, was even dubbed “Ciudad Viagra”, as it churned out 100m of Pfizer’s little blue pills.

In 2000, there were 77 pharmaceutical companies in Puerto Rico, and by 2004, 19 of the world’s top 25 prescription drugs were manufactured on the island.

The reason: multinationals keen to avoid corporate taxes could fully repatriate their profits back to the US mainland. Puerto Rico also had a rather generous regime in which companies could make tax-free income generated by intangible assets, such as pharmaceutical patents.

It worked: for an island with a population of only 3.5m people, it was providing about 170,000 manufacturing jobs by the 1990s.

American lawmakers began to get antsy, and by 1994 the US Government Accountability Office said the laws which made it possible for multinationals to set up shop in Puerto Rico were costing $3.9bn/year.

So the US gradually phased out those laws, closing the taps completely in 2006. It hardly mattered, as Big Pharma simply routed their profits through new safe harbours, and their profits remain barely taxed.

Puerto Rico still provides incentives to companies like Pfizer, including an exemption from income, property, municipal and other taxes (where a tax is levied, such as an excise, it is just 1%). These tax exemptions don’t expire until 2029.

But when repatriation benefits changed, so did Pfizer’s corporate structure, transferring both drug production and patent ownership elsewhere.

Between 1996 and 2014, the number of manufacturing jobs in Puerto Rico fell by about half.

An analysis of the public disclosures of nine pharmaceutical companies show they ducked paying about $140bn in taxes by holding more than $405bn of their income offshore. Pfizer led the pack with $25.9bn in avoided tax, followed by Merck ($21bn) and Johnson & Johnson ($18.6bn).

The true cost of developing drugs is intentionally opaque, but it’s clear that pharmaceutical companies rely on intangible assets such as patents and trademarks, which are often financed, subsidised and developed by public institutions.

This analysis reveals a fundamental truth about the global economy: land and other genuinely scarce items are no longer the most valuable assets in the world. Instead, about 80% of corporate market value is located in intellectual property, which is considered an intangible asset.

For companies that are heavily dependent on intangibles, such as Pfizer — with a market cap of $191bn — the company’s actual book value, with intangibles stripped out, is about $5.9bn in the red.

Bristol-Myers Squibb and Eli Lilly show similarly high market caps — $105bn and $85bn respectively — as compared to their net assets of only $6bn and $10.7bn.

In fact, by 2009, just 7% of an estimated $27.3trillion in corporate intangible capital was disclosed to governments and investors on financial statements, according to Brand Finance, a valuation consultancy.

Of course, the financial accounting process for patents is trickier than for other assets.

In practice, pharmaceutical giants develop patents, which they can then shift multiple times to a subsidiary in any country, depending on the tax planning structure devised by the company’s accountants. Legally, patents aren’t constrained to the jurisdiction where they were developed.

Again, consider Viagra: in July 1999, the Viagra patent was logged under the ownership of an entity called Pfizer Research & Development, which was based in Ireland and Belgium. Ireland at the time offered 0% tax within certain structures, while Belgium provided an 80% tax deduction from patent incomes.

The actual drug ingredients are manufactured in Ireland’s Ringaskiddy hub, but it was in the Isle of Man, a UK tax haven, that Pfizer’s Ringaskiddy Production Company was incorporated (later dissolved). Later, two holding companies based in the US state of Delaware were created as conduits for income from Pfizer’s intangible assets such as patents to flow back to the US.

Effectively, the company is able to use the patent owner, such as Pfizer Ireland, to charge its other subsidiaries royalties, which can then be remitted to any bank account of its choice. This strategy reduces the pretax profits by creating artificial expenses.

The bottom line is that income is siphoned to offshore entities, while any debts or costs are registered in nontax haven jurisdictions, including the US.

Presumably for the same reason, Pfizer Ireland is also the proud owner of other blockbuster drugs such as the cholesterol medicine Lipitor (atorvastatin).

Generating $10.7bn in revenue in 2010 and more than $140bn since its creation, Lipitor was developed by Warner-Lambert, a company purchased by Pfizer in 2000 for $90bn.

Pfizer’s intangible assets, listed at $35bn, disclose only those assets such as Lipitor that are acquired from other companies. Pfizer does not disclose the value of those intangible assets internally developed, such as Viagra.

In what is the accounting world’s biggest blind spot, these assets are also not disclosed in annual reports. Brand Finance acknowledges: “Most high-value, internally generated, intangible assets never appear in conventional balance sheets.”

Internally developed intangibles are the assets most prone to financial fudging as the value is wholly determined by the company.

In all, Pfizer maintains about $74bn in offshore capital, using more than 200 entities based in tax havens, chiefly those specialising in shifting profit from intangible assets around places like Delaware, the Netherlands, Luxembourg and Ireland.

The reasons are simple: In the Netherlands, taxes on intangible assets are just 5%. In Luxembourg, taxes are reduced by 80% if transactions occur within subsidiaries of the same parent company, and Delaware, the mothership of intangible asset fudging, boasts a complete exemption for intangible assets provided money dances around holding companies engaged in “management”.

(Pfizer had not responded to questions at the time of publication, while Merck, Abbott, AbbVie, Amgen, Eli Lilly and BMS declined or failed to respond to interview requests.)

Pfizer’s $25.9bn tax scheme, though the largest, was not the only one.

Research suggests that other pharmaceutical companies make similar savings through these mechanisms. These include:

• Merck ($21bn);

• Novartis ($19.2bn);

• Johnson & Johnson ($18.6bn);

• Amgen ($10.5bn);

• Bristol-Myers Squibb ($8.4bn);

• Eli Lilly ($8.2bn);

• AbbVie ($8bn);

• Abbott ($8bn);

• Gilead ($5.5bn);

• Baxter ($4.2bn);

• Celgene ($2.3bn); and

• McKesson ($1.4bn).

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