This article focuses on certain crucial expectations of the pharmaceutical industry from the proposed Budget in the areas of indirect taxation, direct taxation and transfer pricing.
M.K. Narayanaswamy and Karishma Popat
As per the CENVAT Credit Rules, 2004, manufacturers of are required to maintain separate accounts for receipt, consumption and inventory of inputs and input services meant for use in the production of both dutiable and exempted final products and claim input credit only in respect of consumption for manufacturing of dutiable final products.
The objective of the provision is that duty paid on inputs or input services used in exempted goods should not be adjusted against duty payable on taxable products. This is reasonable. The law also contemplates cases where the manufacturer finds it difficult to maintain such records and allows him the option of not maintaining such records under Rule 6(3).
Rule 6(3) has two parts. Under Rule 6(3)(a), for certain specified goods such as naphtha and newsprint, if the manufacturer opts not to maintain separate records for common inputs, the rule provides that manufacturer shall, while clearing the exempted goods, pay Cenvat attributable to such exempted goods. This is an eminently reasonable provision.
However, under Rule 6(3)(b) which is applicable to all goods not specified under Rule 6(3)(a), the rules are harsh and provide that if manufacturer does not keep separate records, even the otherwise exempted products become subject to a tax of 10% of the value of goods instead of merely paying Cenvat attributable to such exempted products.
A small example can illustrate the harshness of this measure. Assume a manufacturer makes two products, A and B, of which the former is subject to excise, while the latter is exempt. See illustration: The Rule 6(3) Anomaly
The duty liability rises substantially for merely not keeping separate records for the same level of economic activity. In fact, an unintended use of a very negligible quantity of common input (on which Cenvat credit has been availed) for manufacture of an exempted product would have disastrous consequences. Such a patently iniquitous and harsh provision should not find a place in the statute book of any democratic country. Fortunately, the solution of removing such inequity and absurdity is fairly very simple — merely delete Rule 6 (3) (b) and subject all goods to Rule 6 (3) (a) only.
Pharmaceutical products are subject to a high dose of indirect taxation at 16.48% excise duty and VAT at 4%. Since these products are essential for the health of the nation, it is necessary to reduce the cost of treatment. The pharmaceutical industry expects excise duty on all pharmaceutical products to be reduced to 8%.
In the pharmaceutical industry, a crucial and effective way of educating doctors about new products and continuing promotion of existing ones is through distribution of physician’s samples. These are invariably marked “Physician’s Samples, Not For Sale’ and thus cannot be sold in the market. Since the physician’s samples have no sale value, they should be totally exempt from excise duty, just as they are already exempt from VAT.
Service tax legislation provides for maintenance of separate accounts for input/ input services used for rendering both taxable and exempt output services for utilisation of credit on such input/ input services.
At present, service provider is expected to maintain details of receipt and consumption, inventory of the inputs and input services meant for utilization in rendering taxable services. However, in case separate accounts are not maintained, the service provider shall be allowed to utilize tax credit for payment of service tax on any output service only to the extent of an amount not exceeding 20% of the amount of service tax payable on such output service.
In practice it is difficult to ascertain details of receipt and consumption of input services in rendering taxable and exempt services. Hence , even if a small portion of output services are exempt, the service provider becomes eligible to claim input tax credit to the extent of only 20% of the amount of service tax payable.
To mitigate the hardship so caused, the service provider should be allowed to apportion the total input tax credit in the ratio of value of taxable services and that of exempted services rendered and take credit in respect of input credit apportioned to taxable services on the above basis.
Deductions for R&D
Given the recent nature of the pharmaceutical industry and the fact that it is all set to take-off not only in India but globally, it would be the appropriate time for the Government to provide the necessary thrust and budgetary support to nurture R&D efforts in India. This has indeed been the general expectation of all the companies in the pharmaceutical industry.
The industry is expecting a raise in the rate of weighted deduction available to R&D under Section 352(AB) of the Income Tax Act, 1961 from the current 150% to at least 200%. Further, the current provisions cover only expenditure incidental to R&D carried on at the in-house R&D facility. The industry in general also expects that its scope be widened, so as to also include within its fold all expenditure incidental to basic research such as clinical trials and bio-equivalence studies. that are done outside the R&D facility, whether in India or overseas. Further, the expenditure incurred on obtaining approvals from any regulatory authority / filing an application for a patent outside India should also be considered for the weighted deduction.
With reference to the provisions regarding scientific research — deduction under Section 80IB(8A) — the provisions for granting 100% deduction, in respect of the profits earned by any company should be renewed and extended up to 31 March 2012, with a view to encouraging more such companies to focus on long-term R&D.
A key transfer pricing issue arising for multinational pharmaceutical companies is comparison of import of active ingredient prices with Chinese or similar low cost imports. In general the industry believes that, this leads to indirectly challenging the business decisions or strategies (such as governing quality aspects, which cannot be achieved through Chinese imports). Given the recent controversies on the subject and the issues involved, the industry expects that, the government should bring in Advance Pricing Arrangements at the earliest. This would enable bringing in certainty in the transfer pricing policies that multinational companies could implement and thereby also certainty in the international business operations.
M. K. Narayanaswamy is accounting director, Aventis Pharma Ltd, Karishma Popat is partner, Grant Thornton India. Views expressed are personal