Big Pharma and localization
In early March of 2016, the Turkish General Directorate of Medicines and Pharmacy and Social Security Institution (“SSI”) jointly announced a localization process to the public. This process formally initiated localization activities in the industry to avoid the impact of imported drugs on the current account deficit. The purposes of this process were to increase production of generic drugs by local companies, decrease the current account deficit, reduce the total annual cost of manufacturing drugs in Turkey and increase the number of people employed in manufacturing activities.
As a result of the policy, drugs that can be manufactured in Turkey have been determined and it has been stated that if manufacturing of these drugs in Turkey has not begun by February 2018 they will be removed from the repayment scheme.
Since 2016, many pharmaceutical companies that aim to remain in the Turkish market have increased their investments so that they can manufacture imported drugs in Turkey. The localization process also required multinational pharmaceutical companies to review their transfer pricing policies. Many pharmaceutical companies which have only operated as limited risk distributors, until now, have started to purchase APIs (active pharmaceutical ingredients) and perform new functions and bear new risks related to manufacturing and selling manufactured pharmaceuticals. Therefore, the need to review the transfer pricing policies with regard to new activities has arisen.
Although it is expected that all pharmaceutical companies implement similar policies against changes affecting the whole industry, some companies might perform different functions and bear different risks in their new activities. Accordingly, the transfer pricing policy should be clarified through a detailed function and risk analysis concerning new activities.
In order to carry out systematic and sustainable policies, companies should determine the operations and practices related to new activities in an accurate and feasible way from the beginning of those activities. The durability of operations and practices with a technical background is also more comprehensible and acceptable from tax authorities’ point of view.
Therefore, there are important questions regarding the transfer pricing analysis:
►Who makes the strategic decision
on manufacturing investment?
►Which party has the financial capacity for the manufacturing investment?
►Whether manufacturing will be outsourced to toll manufacturers
►How does the approval mechanism work while determining the toll manufacturer?
►Who monitors, controls and manages the toll manufacturer?
►Is it necessary to purchase additional ingredients apart from the API? If required, who performs the purchasing activities?
►Who bears the risks related to the manufacturing process?
►Was anyone hired for the manufacturing process?
►What is the manufacturing process for the localized pharmaceuticals (due to the aforementioned policy) in pharmaceutical manufacturing companies? Is there any difference for the man- ufacturing process of localized pharmaceuticals?
Answers to these and similar questions produce differences in the transfer pricing policies and implementations related to the new activities of multinational pharmaceutical companies.
In order to determine the arm’s length profit of pharmaceutical companies, especially the ones which set transfer prices according to a certain target profit rate, answers to these questions should be considered and evaluated.
While determining the arm’s length profit and thus the transfer prices of transactions, decisions should be taken after performing a detailed transfer pricing analysis on evaluating the related party transaction to be considered as aggregated or segregated basis.