TABLE OF CONTENTS International Transfer Pricing in the Ethical Pharmaceutical Industry Second edition

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1 TABLE OF CONTENTS International Transfer Pricing in the Ethical Pharmaceutical Industry Second edition SUMMARY OF SALIENT POINTS Importance and Competitiveness of the Ethical Pharmaceutical Industry Government Intervention Research and Development (R&D) Risks and Cost of R&D Need to Recover Current R&D from Current Sales of All Products Marketing Marketing and Risk Scientific and Medical Information: Integral part of an Ethical Pharmaceutical Product Government Price Controls Pricing of Ethical Medicines Transfer Prices Transfer Conditions Arm s Length Principle Methods of Arriving at Arm s Length Prices Transfer Prices for Services and Technology Practice of Companies in Determining Transfer Prices Principle Considerations for Determining Transfer Prices Motivation of National Management Persistence of Transfer Prices over Time Geographical Consistency, or Otherwise, of Transfer Prices Effect of Government Price Controls on Transfer Prices Effect of Currency Fluctuations Tax Considerations in Transfer Pricing Intra Multinational Group Negotiations of Transfer Prices Effect of Tax Authorities Pressure on Transfer Prices General Approach of Tax Authorities to Companies Transfer Pricing Burden of Proof Usefulness of OECD Guidelines Penalties Corresponding Adjustments Testing and Defending Transfer Prices on the Arm s Length Basis Comparable Uncontrolled Prices Generic Products Parallel Imports and Pirate Copies, counterfeits Cost based Approaches Resale Price Method Choice of Method Basket Approach Global or Unitary or Profit splitting Approaches US Regulations on Transfers of Technology General Need for Reasonableness and Flexibility

2 PART 1 INTRODUCTION 1 Origin, Purpose, Scope and Basis of Report 2 What is meant by the Ethical Pharmaceutical Industry? PART 2 CHARACTERISTICS OF THE ETHICAL PHARMACEUTICAL INDUSTRY CHAPTER 1 Governing Factors 1.1 Introductory 1.2 General 1.3 From the General Public s Point of View 1.4 From the Investors Point of View 1.5 From the Companies Point of View CHAPTER 2 Special Factors Affecting the Companies Operations 2.1 Competitiveness Competition in General Competition from Generics Competition through Arbitrage from Re and Parallel Importers Competition from Pirate or Counterfeit Products 2.2 Research and Development Importance of R&D Brief Description of Research and Development Research Development Effect of Differences between Research and Development Intertwinement of Research and Development New Chemical Entities Unpredictability of R&D Results R&D Expenditure Time Taken to Develop New Chemical Entities Proportion of R&D Costs to Turnover Payment Out of Current Receipts R&D Costs as a Percentage of Product Sales in Intellectual Property Rights Patents Trademarks, Brands and Domain Names 2.3 Multitude of High Risks 2.4 Marketing Marketing Intangibles Scientific and Medical Support 2.5 The Provision of a Service 2.6 The Need for Sufficient Profits 2.7 Government Intervention

3 CHAPTER 3 Structures and Modes of Operation of Multinational Enterprises in the Ethical Pharmaceutical Industry 3.1 General 3.2 Structures The Importance of the Centre Wholly owned Subsidiaries 3.3 Modes of Operation General Manufacturing Marketing Research and Development Intra Multinational Group Services Central Administration, Co ordination and Control 3.4 Complexity of Structures 3.5 Relative Costs of Various Activities Manufacturing Costs Research and Development Cost Marketing Costs PART 3 HOW MARKET PRICES ARE DETERMINED 1.1 Relevance of Market Pricing to Transfer Pricing Price Bases General Relevance of Prices of Competing Products Relevance of Customers Perception of Value Relevance of Costs Other Pricing Factors Target Price Variation of Price from Market to Market Effect of Government Price Controls 100 PART 4 TRANSFER PRICING IN THE ETHICAL PHARMACEUTICAL INDUSTRY CHAPTER 1 General 1.1 Neutrality of the Terms Transfer Price and Transfer Pricing Ways in Which the Term Transfer Price is Used Interest of Governments in Transfer Prices Incidence of Pharmaceutical Transfer Pricing Amounts of Money Involved in Intra Multinational Group Transfers Need for Acceptable Transfer Prices The OECD and UN Models Methods of Testing for Arm s Length Prices Superiority of Arm s Length Principle Difficulty of Determining Arm s Length Prices 108

4 CHAPTER 2 The Determination of Transfer Prices by Ethical Pharmaceutical Group Companies 2.1 General Background Negotiation of Transfer Prices Considerations Having a Bearing on the Determination of Transfer Prices 112 (i) National Profit Considerations 112 (ii) Motivating Group Company Management 113 (iii) Minority Holdings, etc. 113 (iv) Requirements of Social Legislation, etc. 113 (v) Demonstrating Reasonableness of Transfer Prices Factors Taken into Account in Determining Transfer Prices Basket Transfer Pricing Persistence and Review of Transfer Prices Geographical Consistency or Variation in Transfer Prices Variation of Transfer Price according to Product Form Effect of Government Price Controls on Transfer Prices Currency Fluctuations and Transfer Prices Tax Considerations Transfer Pricing of Products Resale Minus Based Pricing Comparable Uncontrolled Prices Cost based Transfer Pricing Other Methods Transfer Pricing of Intra Multinational Group Services General Services Charged for Directly Services Not Specifically Charged for Influence of Tax Authorities Contract R&D and Manufacturing Transfer Pricing of Results of R&D Transfer Pricing of Intangibles Evaluation of Royalty Rates 137 PART 5 DISCUSSION OF THE GENERAL APPROACH OF TAX AUTHORITIES 1.1 Basic Considerations Disagreement with Competent Authorities Corresponding Adjustments 144 PART 6 TESTING AND DEFENDING TRANSFER PRICES ON THE ARM S LENGTH BASIS CHAPTER 1 General 1.1 Traditional Transaction and Other Methods 1.2 Global or Unitary Approaches

5 1.2.1 Description Criticism Use of Global or Unitary Approach for Preliminary Appraisals Use in Relation to Subordinate Jurisdictions OECD Attitude 1.3 Profit Split Approaches and Functional Analysis CHAPTER 2 Testing and Defending Transfer Prices of Goods 2.1 Resale Minus Method 2.2 Comparable Uncontrolled Prices General Generic Products Parallel Imports Pirate, Counterfeit Products OECD Comments 2.3 Cost based Approaches 2.4 Other Methods Global Allocation of Profits Profit Splits Basket Pricing CHAPTER 3 Testing and Defending Transfer Prices of Intra Multinational Group Services 3.1 General Specific Services Generalized Services 3.2 R&D Services OECD Comment Cost sharing Contract R&D CHAPTER 4 Testing and Defending Transfer Pricing of Technology and Other Intangibles 4.1 General 4.2 Commensurate with Income Royalties Methods US White Paper Rules of Rules in US Draft, Temporary and Final Regulations Adjustability of Royalty Rate US Proposals and Final Regulations Lack of Evidential Basis for Proposals Relaxations of Adjustability Rules Conflict with Arm s Length Principle PART 7 GENERAL SUMMARY AND CONCLUSIONS

6 APPENDICES APPENDIX A THE RESEARCH AND DEVELOPMENT PROCESS A.1 The Pharmaceutical Research and Development Pipeline A.2 The Phases of R&D A.2.1 A Summary of the Phases of a Clinical Trial Programme in the United Kingdom A.2.2. Discovery and Development of a New Medicine A.2.3 The Process of R&D in the US APPENDIX B COST OF DEVELOPING A NEW MEDICINE APPENDIX C TIME TO DEVELOP A NEW MEDICINE APPENDIX D R&D EXPENDITURE D.1 Expenditure as a Proportion of Turnover D.2 Comparison with Other Industries D.2.1 R&D Expenditure for Various Industries in the UK D.2.2 R&D Expenditure as Percentage of Turnover for Industries in Four Countries D.3 Total Amounts of Expenditure on R&D Worldwide D.4 Totals for Individual Multinational Groups D.5 Multinational Groups R&D Expenditure Growth D.6 Capital Expenditure D.7 Increasing Costs of R&D APPENDIX E ATTRIBUTION OF R&D COSTS TO INDIVIDUAL PRODUCTS APPENDIX F BLOCKBUSTERS APPENDIX G INTELLECTUAL PROPERTY RIGHTS AND LICENSING G.1 Patents: Supra national Developments G.2 Patents: Limitations of Patent Protection G.3 Patents: Patent Life Extension G.4 Trademarks, Brands and Domain Names G.4.1 Trademarks and Safety of Medicines G FDA Process on Trademarks G EMEA Process on Trademarks G.4.2 Domain Names G.5 Licensing APPENDIX H US TRANSFER PRICING OF INTANGIBLES

7 H.1 Super royalties : Commensurate with Income Royalties H.2 Types of Intangibles H.3 US Proposals and Regulations Intra Multinational Group Licensing of Intangibles H.4 Problems posed by the US proposals H.4.1 Exact Comparables Method H.4.2 Inexact Comparables Method H.4.3 BALRM Method H.5 Objections to BALRM method H.6 Periodic Adjustments Super royalties, Commensurate with Income Royalties H.7 General Nature of Licensing Agreements H.8 Criticism of US Proposals Concerning Variability of Licence Fees H.9 US Draft, Temporary and Final Regulations H.10 Intangible Property H.11 Comparable Profit Method H.12 Periodic Adjustments of Royalty, etc., Rate H.12.1 Exceptions to the Periodic Adjustment Rule H.13 Practical Problems of the Comparable Profit Method H.14 Conclusion APPENDIX J GOVERNMENT INTERVENTION J.1 Price and Profit Controls, Reimbursement Limitations, Prescribing Controls, Imposed Discounts and Repayments, Expenditure Limitations etc. J.2 Other Countries and Other Controls J.3 Approval of Ethical Pharmaceutical Products for Marketing APPENDIX K MERGERS IN THE INDUSTRY APPENDIX L LOW TAX AREAS: SPECIAL TAX RELIEFS AND FISCAL INCENTIVES IN CERTAIN COUNTRIES L.1 Puerto Rico L.2 Ireland L.3 Singapore L.4 France L.5 Italy L.6 OECD APPENDIX M BACKGROUND MATERIAL M.1 History and Geography of the Research based Pharmaceutical Industry M.2 Pharmaceutical Output M.3 Companies and Ownership M.4 Markets M.5 Consumption M.6 Expenditures on Health and on Medicines

8 APPENDIX N CUSTOMS DUTIES APPENDIX O GENERICS O.1 Generic Names and Brand Names O.2 Categories of Generics APPENDIX P SHAREHOLDING IN AFFILIATES P.1 Major Pharmaceutical Groups Shareholdings in their Affiliates APPENDIX Q STRATEGIC ALLIANCES Q.1 Major Pharmaceutical Groups Joint Ventures, Co marketing arrangements and other Co operations APPENDIX R OECD TRANSFER PRICING REPORTS AND MULTINATIONAL ENTERPRISES R. 1 The so called global methods APPENDIX S COMPETITIVENESS APPENDIX T ILLUSTRATIVE FIGURES APPENDIX U METHODS OF DETERMINING ARM S LENGTH PRICES U1 United States Regulations U2 German Transfer Pricing Principles U OECD Report Transfer Pricing and Multinational Enterprises U OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations U UK Transfer Pricing Legislation APPENDIX V HEALTH ECONOMICS APPENDIX W VISUALIZING CHARTS W1 Transfer Pricing in the Pharmaceutical Industry is of a different nature than in other industries W2 R&D Process for an Ethical Pharmaceutical Product

9 W3 Submissions and Approvals of New Active Substances W4 Median Approval Time for New Active Substances W5 Functional Analysis W6 Cost Plus Method not Applicable! W7 The Market Minus Method W7.1 Transfer Price Transfer Conditions W8 Structure of Market Prices in Europe W9 Pricing and Reimbursement Measures taken by European countries W9.1 Average Time from Pricing and/or Reimbursement Application to Reimbursement W10 International Reference Pricing in Europe W11 Payment for reimbursable Ethical Pharmaceuticals in Europe W12 Loan Manufacturing with Consignment Stocks W13 OECD Member States Transfer Pricing W13.1 Transfer Pricing Documentation Requirements W14 European Union Joint Transfer Pricing Forum W15 Nation States still rule the World W16 World Market Share 2001 and R&D Intensity of Ethical Pharmaceutical Groups W17 Structure of the Domain Name System W18 Input/Output Analysis Production & Sales Company APPENDIX X INDEX OF KEY WORDS AND PHRASES

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