Industry gets clarity on tax benefits of clinical trials

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The regulations allowing for tax deductions on expenditure for clinical trials in SA were published in April by Finance Minister Nhlanhla Nene.

"This is a significant change given the huge size of the clinical trial industry in SA," says Catalyst Research Solutions MD Dov Paluch. "There is not a lot of early drug development in the country, but SA has built up niche expertise in terms of clinical trials."

Uncertainty about the interpretation of the research and development tax incentive, especially relating to clinical trials, has been plaguing multinational pharmaceutical companies since 2007, when it was introduced.

Chemical patent attorney Darren Margo at Margo Attorneys says many jurisdictions "fall over themselves" to make generous research and development tax incentives available. Unfortunately, that has not been the case in SA.

"Research and development companies in the pharmaceutical field have been so unimpressed - to put it lightly - by the treatment they have received in general (from the government) ... the industry has literally uprooted projects and ran them in other jurisdictions," he says.

Research outside SA

The South African Revenue Service (SARS) argues that most of the research and development for drugs or devices, including the protocols for the trials, is performed outside SA. Therefore clinical trial expenditure does not qualify for the incentive.

Pharmaceutical companies argue that the trials enable them to discover new information relating to the safety and efficacy of the drugs, which brings them into the definition of research and development in terms of the Income Tax Act.

The new regulations allow for clinical trials and multisourced pharmaceutical product development (generics) to qualify for the 150% tax deduction. If a company spends R1m on clinical trials in SA, it qualifies for a R140,000 after-tax benefit.

"In global terms this is quite a decent incentive," says Paluch.

Innovative Pharmaceutical Association of SA scientific and regulatory manager Judy Coates says the value of clinical trials in SA was almost R3bn last year.

"If there were improvements to approval timelines this could have been in the region of R5bn if the trials have not been cancelled or lost because of delays," she says.

Snap survey

In a snap survey by the association, seven of its members indicated that they spent R170m last year on clinical trials, and expected to spend R205m this year.

Large multinational pharmaceutical companies, such as Pfizer and Novartis, are involved in extensive clinical trials research in SA. These trials are fundamental to the development of innovative medicines, vaccines and devices as they determine whether a new treatment is "safe and efficacious".

There are 2,034 clinical trials being done in SA at present.

Although the Innovative Pharmaceutical Association considers the publication of the regulations "incredibly significant", one of its major concerns is the exclusion of "an activity undertaken solely for the purpose of compliance with regulatory requirements".

"Some of the members felt that SARS was using this particular aspect as one of their key arguments for disallowing clinical study costs," says Coates. "It is important for them (SARS) to understand that the studies and data gathered during the studies are to improve safety and efficacy and it is not simply about regulatory compliance."

KPMG tax partner Mohammed Jada says that despite the government's commitment to increase the percentage of gross domestic product (GDP) expenditure on research and development, very little progress has been made.

Although the target is 1% of GDP, it has remained at 0.76% for the past three years. The average of the Organisation for Economic Cooperation and Development countries is 2.4%. In the US and China it is almost 3%.

Only 13 out of 240 companies that applied for the research and development tax incentive in 201314 are from the agricultural sector. They budgeted R82m for research and development, which amounted to less than 1% of the total expenditure of the 240 companies.

"It has been found that GDP growth originating from the agricultural sector is between two and four times more effective in raising incomes of extremely poor people than growth in other sectors of the economy," Jada says.

The acceptance of clinical trials as valid research and development should pave the way for agricultural field trials to also be eligible for the tax incentive, he says.

Legislation hampers incentive uptake

According to industry advisers, legislation is the single most important aspect hampering the uptake of the incentive.

The incentive requires preapproval from the Department of Science and Technology. An adjudication committee consisting of officials from the department, SARS and the Treasury was set up to assess qualifying projects.

Margo says there is not a single attorney on the committee, and there is no appeals process. While the regulations are a way forward, the issues are more structural in nature. The application and adjudication process, and the lack of an appeals process, are the real stumbling blocks, he says.

Science and Technology Minister Naledi Pandor says there is a commitment to increase gross expenditure on research and development to 1.5% of GDP during the current administration.

"These developments are significant in elevating the importance of science, technology and innovation in SA, and putting it on a trajectory that many developed economies embarked on with great success," Pandor wrote in a recent article.

"It has also given impetus to the country's intention of moving our predominantly resource-based economy to a more knowledgebased economy."

Believing that their problems with the tax incentive are not going to be solved soon, many companies have pursued other avenues for government support such as the Support Programme for Industrial Innovation, an initiative of the Department of Trade and Industry.

It offers a grant to companies involved in the development of new technologies. Although the grant is not nearly as attractive as the tax incentive, its committee works efficiently.

Companies know that if they apply for support from the programme, the odds of their getting some reward are very good compared with the tax incentive, Margo says.

Tax claims

In the 2015 Budget Review, the Treasury acknowledged the incentive backlog and the problems this created for business. "Measures will be considered to ensure that taxpayers are not disadvantaged by undue delays by the adjudication committee," it said.

The published regulations have been backdated to October 2012.

Companies that have submitted their applications for incentives will be able to backdate their tax claims.

However, Paluch says companies that were under the impression they did not qualify and did not submit any claims will not be able to do so now. They will be able to claim only in the future.

South African Institute of Tax Professionals deputy CEO Keith Engel says the legal aspects of the incentive preceded the government's understanding of the nature of the research and development that was needed and the types SA is capable of producing. "The result has been longstanding turbulence, with the government trying to balance the need for what they perceived to be value-adding research versus aggressive claims," he says.

"This turbulence is set to continue until government performs a solid business analysis of the research and development sector."

Source: Business Day via I-Net Bridge