The Pharmaceutical Industry at a Glance Business revenue structure of the pharmaceutical industry in terms of tax burden

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Shinichiro Iida, Senior Researcher, Pharmaceutical Industry Policy Institute

1. Introduction

The pharmaceutical industry contributes to global healthcare by providing innovative new drugs to meet unmet medical needs. The Japanese pharmaceutical industry also contributes to the development of science and technology on a global scale, and contributes to the medical care and health of the entire world by disseminating breakthrough new drugs.

In addition to this, the pharmaceutical industry is a manufacturing industry that produces pharmaceuticals and contributes to the economy in terms of employment, revenue, and tax burden. As a knowledge-intensive industry, it is also a business structure that not only creates added value through the manufacture of bulk pharmaceuticals and products, but also through the licensing of its technology, or intellectual property rights, for which it receives compensation. Technology licensing fees account for a large portion of business revenues, and the economic contribution based on these fees should not be overlooked.

In the latter half of the 2010s, the growth of the Japanese pharmaceutical market showed a leveling off, as did the growth of Japanese pharmaceutical companies in the domestic market. On the other hand, a look at the domestic tax burden shows that it is increasing every ^year1). This means that not only the revenue from the domestic market is important, but also the revenue from the overseas market is assumed to be important.

In this report, as part of the actual contribution of the Japanese pharmaceutical industry to the Japanese economy, we collected accounting data from domestic stand-alone companies and analyzed sales by business segment (overseas product sales, overseas technology consideration, domestic product sales, and domestic technology consideration) that affect the increase in corporate income taxes in order to investigate which businesses contribute most to the increase in corporate income taxes. We attempted to analyze the impact of the increase in income taxes by business segment (overseas product sales, overseas technology consideration, domestic product sales, domestic technology consideration).

Survey Methodology

We conducted a questionnaire survey of 10 domestic pharmaceutical companies regarding their domestic and overseas sales, product or technology sales, and corporate tax amounts (before tax credits) for fiscal years 2017 through 2021 at a working-level meeting of the Taxation Subcommittee of the Industrial Policy Committee of the Japan Pharmaceutical Manufacturers Association (JPMA). The sales and corporate tax amounts were calculated on a non-consolidated basis for each domestic company for the fiscal year of the company. Product sales include not only product sales but also bulk sales, and technology consideration includes royalties as well as milestone income. Although taxable income by each business segment is a direct parameter in the calculation of corporate tax amounts, it is difficult to prepare and collect data and is not effective, so domestic and foreign product sales and technology consideration were considered as explanatory variables. In addition, because overseas sales in so-called consolidated accounting may have indirect relevance to the domestic tax burden, information on business segments in domestic stand-alone companies was examined and analyzed with the cooperation of the companies surveyed. The 10 companies surveyed were Astellas, Eisai, Otsuka Pharmaceutical, Kissei Pharmaceutical, Shionogi, Sumitomo Pharma, Daiichi Sankyo, Takeda Pharmaceuticals, Mitsubishi Tanabe Pharma, and Chugai Pharmaceutical, all of which are members of the Taxation Committee.

The impact on corporate tax increases was estimated by panel data analysis using a fixed-effects model. Domestic sales and overseas sales, or domestic product sales, domestic technology consideration, and overseas product sales and overseas technology consideration were used as explanatory variables. Since firm-specific effects such as the priority level of overseas and domestic sales and the type of expansion are assumed, a fixed-effects model was selected, and the panel of firms was adjusted as a cluster variable. In addition, year effects, such as the effect of economic trends by year, were added as dummy variables. STATA Ver. 14 was used for the statistical analysis.

Results

The amount of corporate tax in the pharmaceutical industry (total of 10 companies) increased by 91.5 billion yen over 5 years from 121.6 billion yen in 2017 to 213.1 billion yen in 2021 (Figure 1).

To investigate which business sales are responsible for these increases in corporate taxes, Figure 1 shows non-consolidated sales of domestic firms divided into overseas sales and domestic sales.

Domestic sales increased slightly by ¥19.6 billion, from ¥3,145.7 billion (2017) to ¥3,165.3 billion (2021). By company, four companies increased and six companies decreased (data omitted). Overseas sales increased by 721.1 billion yen from 1,183.8 billion yen (2017) to 1,904.9 billion yen (2021). By individual company, seven companies increased and three companies decreased (data omitted). The ratio of overseas sales was 27% (in 2017), but increased to 38% in 2021.

Domestic and international sales were further broken down into product and technology consideration, respectively (Figure 2). The majority (over 99%) of domestic sales were product sales, with no significant increase or decrease. Domestic sales of technology consideration were almost nonexistent and had further declined by less than one-third since 2017.

In overseas sales, product sales increased from 602.1 billion yen to 1,021.6 billion yen, while technology consideration increased from 580.7 billion yen to 883.2 billion yen. The ratio of technology consideration to overseas sales did not change significantly over this period, accounting for 46% in 2021, nearly half of overseas business.

The impact of these changes in product sales and technology consideration on corporate income taxes was estimated by linear regression analysis using a fixed-effects model with panel data (total of 50 samples of 10 firms and 5 years) (Tables 1 and 2). Estimation was conducted in two cases: with overseas sales and domestic sales as explanatory variables and with overseas technology consideration, overseas product sales, domestic technology consideration, and domestic product sales as explanatory variables.

When foreign sales and domestic sales were analyzed as explanatory variables (Table 1), both impact factors significantly (P-value = 0.002 and P-value = 0.082, respectively) affected the increase in corporate tax. The marginal effect of overseas sales (the amount of increase in corporate tax for a 1 billion yen increase in the impact factor) was 150 million yen, slightly less than twice as influential as the 0.88 billion yen marginal effect of domestic sales.

The actual increase in each of these sales between 2017 and 2021 was 721.1 billion yen for overseas sales and 19.6 billion yen for domestic sales. The marginal effects of these sales-based increases in corporate income taxes were calculated to be 108.3 billion yen and 1.7 billion yen, respectively, suggesting that 98.5% of the increase in corporate income taxes was due to the increase in overseas sales.

When we analyzed the four factors of overseas technology consideration, overseas product sales, domestic technology consideration, and domestic product sales as explanatory variables (Table 2), all factors except domestic technology consideration significantly affected the increase in corporate tax (P-value = 0.023, P-value = 0.102, and P-value = 0.019, respectively).

The largest marginal effect was on overseas technology consideration at 193 million yen. This was followed by overseas product sales and domestic product sales at 103 million yen and 098 million yen, respectively.

The marginal effect of overseas technology compensation was shown to be about twice as large as that of domestic and foreign product sales. The actual increase in each of these sales between 2017 and 2021 was 302.5 billion yen for overseas technology consideration, 419.5 billion yen for overseas product sales, and 44.6 billion yen for domestic product sales. The marginal effects of these sales-based increases in income taxes are 58.3 billion yen, 43.3 billion yen, and 4.4 billion yen, respectively, indicating that overseas technology considerations have the largest impact on income taxes.

The marginal effect of domestic technology consideration was negative, although not statistically significant. We attempted to minimize firm-specific effects by using a fixed-effects model, but there were some biases: bias due to the fact that factors that affect the increase or decrease of corporate tax amounts were not included as explanatory variables in this estimation model; bias based on multicollinearity due to correlation among explanatory variables; bias in estimating corporate tax data that is not less than zero, but is also less than zero; and bias in estimating corporate tax data that is not less than zero. The bias of the analysis based on linear regression is assumed to have an impact. Although it was difficult to completely eliminate the bias in the estimation, we confirmed the robustness of the estimation results by conducting regression using stepwise explanatory variables and estimation using a non-linearity model (data omitted).

Summary and Discussion

In recent years, corporate income taxes of pharmaceutical companies have increased, with the increase in overseas technology consideration contributing the most to the increase in corporate income taxes. The fact that overseas bulk/product sales and overseas technology consideration were about 50-50 as the business profit structure of the pharmaceutical industry indicated that the Japanese pharmaceutical industry is characterized as having both a business based on the supply of products as a manufacturing industry and a business based on the granting of intellectual property rights.

Although there are occasions when the excess imports of pharmaceutical products are seen as a ^{problem2, 3)}, the trade statistics tabulate exports of pharmaceutical products only (935.3 billion yen in FY2021), so bulk exports and technology consideration are not tabulated. Although only 10 pharmaceutical companies are included in the statistics this time, overseas sales totaled 1,904.9 billion yen, including 1,021.6 billion yen in product and bulk exports and 883.2 billion yen in technology consideration, and the total amount in the government statistics (1,646.3 billion yen) was calculated by adding the technology consideration received (711 billion yen in FY2021) in the Science and Technology Research Survey ^Statistics4) to the trade statistics. This amount was larger than the total of government statistics (1,646.3 billion yen). The pharmaceutical industry earns foreign currency not only through product exports, but also through bulk exports and technology ^exports5), and care should be taken not to overlook their contribution to the tax burden.

The marginal effect of foreign technology compensation was estimated to be about twice as high as the marginal effect of foreign product sales. Since the earnings from technology consideration are expected to be almost free of domestic expenses, they would almost certainly be taxable profits. Therefore, the increase in foreign technology consideration is considered to have had the greatest impact on the increase in the corporate tax rate.

Based on the estimated marginal effect of the foreign technology consideration (0.193), if we assume that all of the foreign technology consideration is taxable income, the share of corporate tax from the foreign technology consideration is estimated to be 19.3%. This was slightly lower than the corporate tax rate for the period under study: 23.4% (FY 2017) to 23.2% (FY 2021). In other words, it can be inferred that the aggregate corporate tax rate was lower than the theoretical corporate tax rate this time, and one possible reason for this is that the corporate tax rate decreased due to the use of loss carryforwards resulting from corporate acquisitions and other events at several companies during this period. Although the present estimation model took into account firm-specific effects as cluster variables, it can be inferred that the marginal effects were estimated low because of the large impact of this factor on corporate tax amounts. In addition, since costs and R&D expenses are subtracted from product sales to generate taxable income, it is assumed that these increased expenses may have had an impact on taxable income. Since these factors affecting taxable income affect the impact of product sales on corporate income tax, it will be necessary to collect data on further factors and analyze them in detail in order to improve the accuracy of the marginal effects of domestic and foreign product sales.

The results of the questionnaire survey and the statistical analysis of the panel data indicate that the business structure of the pharmaceutical industry has been growing in recent years, with product sales and technology compensation gains from overseas, while domestic sales in Japan have remained flat. This growth has been accompanied by an increase in the tax burden on the Japanese taxpayer. In terms of the growth of Japanese pharmaceutical companies and their contribution to tax payment, which is part of the Japanese national interest, continuing to create innovative new drugs and expanding overseas business is an important direction in which industry and policy should be aligned. In addition to the efforts of companies that create new drugs in Japan and own their intellectual property, we hope that strong policy support will be provided throughout the value chain, from drug discovery research to global development, in order to nurture this industry as a key industry in Japan.

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