Tax Reform Bill Largely a Plus for Big Pharma

The tax reform bill proposed by Republicans and passed by the House this week contains benefits for many in the pharmaceutical industry. The reduction in the corporate tax rate from 35% to 21% will benefit all cash-flow-positive businesses, and the new, lower 15.5% rate for repatriating cash held overseas is likely to result in large companies becoming flush with cash, allowing them to buy back stock, increase shareholder returns, and fuel a wave of merger and acquisition (M&A) activity. The tax bill was backed by many CEOs of big pharma companies and the trade group Biotechnology Innovation Organization (BIO).

“Life should be good for the biggest players and for the smaller, nimbler drug developers,” writes John Engle in Seeking Alpha. However, the tax changes are likely to have negative effects on development-stage companies—especially in biotech—that are spending large amounts of capital on new product development and that have high annual losses. For companies that are largely in the development phase of their business lifecycle, the loss of some tax advantages might prove to be a negative; for example, when they are thought to be buyout targets and the value of a potential deal will be lowered. For companies in the middle, with 1 or more commercial products, and especially for companies trying to pursue commercialization on their own, the playing field is likely to get tougher. “Long-term, the reforms will benefit large players and small development firms, but may make the transition to commercialization more challenging,” Engle writes.

One of the most important aspects of the new tax bill for pharma creates a new, lower tax rate of 15.5% for cash repatriated from overseas. For American companies holding a great deal of cash overseas (such as Amgen, Gilead, Pfizer, and Merck, which together are likely to bring back almost $100 billion of overseas cash), the new deduction encourages them to bring home the money.

This will free up huge amounts of funds, allowing companies to post better returns to shareholders. This tax law change is supposed to help create American jobs as companies invest in new development and production in the United States, but if history is an example, that may not be likely to happen: in 2004 to 2005, during the last such tax holiday, firms spent 94 cents of every dollar brought back on share buybacks and dividends, according to the Wall Street Journal. Analysts predict that the huge amount of cash brought back to the United States will be used largely to offer share buybacks and dividends and to be used to buy smaller companies in biotech in order to acquire new, high-earning products. In anticipation of the tax bill becoming law, Pfizer has already announced it is raising its quarterly dividend rate 6% and authorized $10 billion in share buybacks.

Another important change in the tax bill that is likely to have a serious effect on pharmaceutical companies is the slashing of the tax credit for companies developing orphan drugs and drugs that treat rare diseases. Companies used to be able to use a tax credit covering 50% of the cost of testing and conducting clinical trials for drugs treating rare diseases; the new tax law cuts that deduction in half, to 25%. According to The New York Times, the tax credit is one of a group of incentives that supporters say have led to the approval of more than 500 new drugs for rare diseases that each affect fewer than 200,000 people. But the Orphan Drug program has also come under scrutiny because critics say that some major drug companies exploited it by obtaining the orphan designation for billion-dollar blockbuster drugs like Humira for treating rheumatoid arthritis, which was already on the market.