Pharmaceutical R&D: Tax and Funding Incentives

Much of the pharmaceutical industry’s work involves pharmaceutical R&D: the discovery, development, production, and marketing of drugs for use as medications to either cure patients, alleviate their symptoms or vaccinate them to prevent illnesses. These pharmaceutical drugs are subject to a variety of laws and regulations regarding their patenting, testing, safety, efficacy, and marketing. For drug development, clinical trials (Phase 1,2,3, etc.) start with testing for safety in a few human subjects, then expand to many study participants (potentially tens of thousands), with the aim being to find out more about side effects, observe how well the treatment works, and compare the new treatment with the standard treatment.

Information from the Federal Government’s Australian Clinical Trials website (as of January 2021) states that Australia has many advantages as a place for conducting clinical trials. It is home to some of the world’s best researchers and health professionals, has world-class research infrastructure, a stable socio-political environment, and high standards that ensure confidence in the scientific conclusions reached by clinical trials conducted in Australia. Australia has a robust intellectual property system and a simple and efficient regulatory regime — the Therapeutic Goods Administration (TGA), which is Australia’s equivalent of the FDA in the United States. The Australian Government’s commitment to the pharmaceutical sector through improving the clinical trials’ environment is evident in the considerable financial resources it has dedicated to the Research & Development Tax Incentive (RDTI), which encourages more industry investment in R&D by providing businesses investing in eligible R&D with the following generous tax offsets:
• a 43.5 per cent refundable R&D tax offset (i.e., 43.5c per $1 of eligible R&D) for companies with aggregated annual turnover of less than A$20 million; and
• a 38.5 per cent non-refundable R&D tax offset (equivalent to 38.5c per $1 of eligible R&D) for all other eligible companies.

Other benefits under the new RDTI include:
• Clinical trials (e.g. Phase 1, 2, and 3) can be eligible R&D activities under the program and are considered for eligibility under the same rules as any other activity (generally, Phase 4 clinical trials being conducted to meet regulatory requirements will not be eligible).
• The Incentive provides for increased access by international companies. In particular, there is no requirement to hold the intellectual property in Australia.
• Increased level of expenditure that can be claimed on R&D activities undertaken overseas in support of Australian R&D projects, under certain conditions (i.e., when an “Overseas Finding” granted by Innovation and Science Australia states that this can be done).

Given all this information, it is clear that the financial boost from the RDTI can significantly lower the cost of R&D for global pharmaceutical companies.

A 2016 study conducted in the United States found that, although the amount of money spent on Phase II/III trials depends on numerous factors (therapeutic area being studied and types of clinical procedures are the key drivers), Phase II studies may cost as much as US$20 million, and Phase III as much as US$53 million. And given that the entire process of developing a drug (from preclinical research to marketing) can take approximately 12 to 18 years and often costs well over US$1 billion, programs like the RDTI are essential for encouraging pharmaceutical research, which will also have many flow-on effects for the wider economy.

Commercial pharmaceutical research is often done in some form of partnership with academic institutions, thus enabling the pharmaceutical companies to benefit from the state-of-the-art research facilities and the expertise of personnel dedicated to research. Some examples of Australian tertiary institutes partnering with commercial entities for pharmaceutical research include Monash University and University of Melbourne in Victoria, University of Queensland, and the University of South Australia.

According to the information available on their website, the University of South Australia’s Pharmaceutical Innovation and Development Group (PIDG) has worked with 15 different Australian and foreign (US- and UK-based) commercial partners in pharmaceutical research. As a reminder, with the permission of an Overseas Finding granted by Innovation and Science Australia, the RDTI does allow for certain activities to be conducted overseas; for example, when it is proven that the knowledge/personnel/equipment/facilities/specific population samples are not available in Australia. This flexibility in the RDTI legislation means that many Australian affiliates of foreign pharmaceutical companies can perform research both here and overseas when necessary, while still being able to claim the RDTI.

In most cases, a company is only entitled to a tax offset for R&D activities conducted for itself; that is, when it is the major benefactor of the expenditure on R&D activities. This can be determined by examining enabling agreements such as any in-licence of the background intellectual property and any funding agreements which, in turn, control the extent to which R&D activities are conducted for the R&D entity compared to the extent to which they are conducted for any other entity (some exceptions apply where an Australian resident is conducting activities for an overseas parent company). For whom the R&D activities are conducted can be determined objectively by analysing three key criteria being:

1. who effectively owns the newly developed know-how or intellectual property or other results arising from the R&D entity’s expenditure on R&D activities;
2. who has effective control over the conduct of the R&D activities; and
3. who bears the financial burden of conducting the R&D activities.