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July 24, 2018

Legal Capsule: India’s Pharmaceutical sector: Facing Headwinds by Economic Laws Practice

Indian pharmaceutical industry accounts for 3.1- 3.6 % (value terms)  and approximately 10% (volume terms) of the global industry and is expected to grow to USD 100 billion by 2025. The pharmaceuticals market in India comprises of medical drugs (generic drugs -70 %; Over-the-counter medicines - 21%; patented drugs - 9%) and medical devices, etc, with prevalence of loan licensee model (drug manufacturing outsourced to licensed manufacturer). This industry has contributed immensely to Indian as well as global healthcare, being material in manufacturing critical, high-quality and low‐cost medicines, with exports of USD 16.84 billion in 2016-17 (expected to reach USD 20 billion by 2020 ). 

Introduction of GST in India in July 2017 with a view to overcoming the tax inefficiencies prevalent under the earlier regime has had far reaching implications for the industry. With the onset of GST, pure economic and commercial considerations have taken prominence over tax cost considerations in deciding the operation and distribution structures, all of which has triggered structural changes within the industry in terms of product plant re-allocation, depot rationalisation, etc. 

Challenges under the GST regime

The GST journey has been a rather bumpy ride for the industry - without undermining the inherent GST-related benefits, it is important to also underscore the corresponding challenges that need to be addressed: 
  • Multiple credit blockages: Contrary to the promise of seamless credit, there are potentially multiple credit blockages qua transactions peculiar to the industry involving distribution of free samples, disposal/ destruction of expired stock, control samples and testing samples. Further, for organisations which have operations spread across different States, having a proper mechanism for distribution of credits pertaining to common expenses (which includes, royalty payments, technical fees, advertisement expenses) to its each location for discharging the output tax liability becomes important. 
  • Inaccuracies in tax rates: Contrary to the objective of replicating the pre-existing rate structure in terms of the ‘equivalence principle’, there have been inaccuracies ,  including for certain orthopaedic and surgical items and life-saving drugs, to name a few, which have been taxed at a higher rate, thereby impacting the transaction costs
  • Suspension of tax concessions: With GST, the tax concessions extended under the earlier tax regime to manufacturing facilities set up in certain backward regions for incentivizing investments, have been suspended mid-way, with only marginal benefit correlated to the GST levied by the Centre being recompensed back.  
  • Anti-profiteering provisions: These provisions, constituted with the benevolent objective of ensuring percolation of tax cuts under GST to the end consumer, have been a nightmare to comply with, owing to limited guidance and complex trade dynamics. Up till now, several entities have been slapped with notices for proving proper compliance, and the threat of prescribed penal consequences continues to loom.  
  • Continuation of several legacy issues: While the industry is in the process of adjusting to these changes, there are certain legacy issues under the erstwhile tax regime which have continued under GST – these include classification of certain OTC medicines as ‘drug’ or ‘cosmetics’, where ‘cosmetics’ attract a significantly higher tax rate, and, treatment of research activities outsourced to India as “exports” (i.e. zero-rated). 

The Indian pharmaceutical industry’s proven track record of achieving continuous growth amidst the challenging environment, complemented by the Indian government’s resolve and commitment to simplifying the tax and regulatory environment is a positive bell weather for this industry.However, challenges continue to loom. 

The industry has had its share of issues with the customs administration in the recent past. Some illustrations include, disputing the valuation of samples imported for non-commercial use (example, for stability testing), the controversial denial of the benefit under Served From India Scheme (“SFIS”) correlated to service exports made by Indian entities (rendering R&D services) to its foreign affiliate entities. Additionally, the extent of scrutiny of cross border transactions (including rigid country by country reporting norms) from an anti-avoidance and transfer pricing perspective, has seen a manifold increase, which is also true for indirect acquisitions of India-based entities. 

New policy initiatives by the government
  • Medical Device Rules, 2017: In an effort to promote domestic manufacturing of medical devices of world standard, the Medical Device Rules, 2017 (“Rules”) were notified on January 31st, 2017. These Rules came into effect on January 1, 2018 and should help the industry by enabling greater access to the market in India as well as abroad. Prior to introduction of the Rules, medical devices were governed solely by the Drugs and Cosmetics Act, 1940 which were not customised to suit the needs of the medical devices industry.
  • New pharma policy:This is expected to bring about exhaustive reform of rules and regulations governing pharma and medical devices with the goal of ensuring that ease of doing business and ease of living can go hand in hand. It is expected that domestic manufacturers will be given a push with policy aimed at encouraging end to end domestic manufacturing, including preference in public procurements. Also, quality control mechanisms would be gradually streamlined to foster better control over quality while at the same time removing systemic bottlenecks.
  • Protecting consumer interest: In light of heightened scrutiny by US regulators, there have been a spate of amendments to the Drugs and Cosmetics Act, 1940 which appear to be aimed at achieving stricter scrutiny of drugs by the Government before their entry into the market.
  • New pharma pricing policy: The government has sought views of experts on whether the National List of Essential Medicines (NLEM) should be linked to the Drug Price Control Order (“DPCO”), to ascertain which drugs are to come under price control and how price caps should be determined. The intent is to overhaul the drug pricing system to ensure a transparent pricing structure for essential medicines.
  • National database of pharma manufacturers: India's drug regulatory body - Central Drugs Standard Control Organization (“CDSCO”) - is creating a national digital database of pharmaceutical manufacturers and their medicines so that regulators can be more effective when acting on problems like drug shortages and quality issues.

Challenges to Indian pharmaceutical industry are manifold, and companies will have to re-invent their strategies to remain relevant in the market. Increased domestic and international regulatory compliance requirements; emerging concerns around data privacy and pricing; increasing M&A and consolidation; heightened concerns from a competition law perspective; emerging policies on pricing, etc. have all added to the headwinds faced by the industry. However, these changes, if legislated and implemented with the proper intent, should help the industry emerge as a potent force on the global landscape.

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