Taxing trials

Written by Sachin Menon | Updated: Jun 20 2014, 05:38am hrs
India is emerging as a potential destination for clinical and pre-clinical trials of pharma products due to its multi-ethnic population, skilled medical and para-medical manpower, relatively good hospital network in cities and, of course, lower cost. Bulk of the work by this industry is performed for foreign sponsors (pharma companies). However, the gaps in the service tax law are slowly ensuring that this infant dies an early death due to high service tax cost in the supply chain. The question is whether the upcoming Budget will address the woes of this sunrise industry

Any new drug molecule or a variant of an old molecule, or a new medical implant device (for example, a stent) needs to be tested extensively on animals and humans (referred to as pre-clinical and clinical trials, respectively) before getting any approval from regulatory authorities (drug administrators in any country).

Clinical trials have extensive benefits to India besides the foreign exchange. With all checks and balances in place, the finance minister declared during his Budget speech in 2007 that to make India a preferred destination for drug testing, I propose to exempt clinical trial of new drugs from service tax. But what the mandarins at North Block missed is that bulk of the supply chain in the clinical trial is exposed to service tax even today and more so after the introduction of the negative list regime of service tax from July 1, 2012. As can be seen from the accompanying table, not just the percentage but the actual number of clinical trials conducted in the country is declining.

From March 1, 2007, the government exempted services of technical testing or analysis of newly developed drugs, including vaccines and herbal remedies, on human participants by a clinical research organisation (CRO) approved to conduct trials by the Drug Controller General of India. Similar exemption is continued even under the negative list regime.

The exemption is restricted only to the activity of clinical trials performed by the CRO on new drugs. But it leaves out the trials of already existing drugs and trials of a medical device. It also leaves out the ambit of exemption all other players in the supply chain such as the logistics service provider, hospital, doctor and a data analytics company.

Some of these players like logistics service providers are often directly engaged by sponsors abroad. Till July 2012, such activities were called business support services and were held to be exports as the recipient of the service was outside India and the consideration for the services was received in foreign exchange. But after July 2012, such activities got covered under Rule 4 of the Place of Provision of Service Rules, 2012, as they are performed with respect to goods supplied by the service recipient (sponsor). Since such services are performed in India, they were held taxable in India, losing the benefit of zero rating as exports irrespective of the fact that they earned foreign exchange. Even the units set up as an SEZ or an export-oriented unit are required to discharge service tax on their activities.

The tax cost of 12.36% in the supply chain has the potential to damage the dream of making India a globally preferred and recognised hub for drug testing.

What is required is to have a new look at the sector and components that are bearing the brunt of service taxperhaps unintentionally. The ideal way would be to exempt the whole set of activities in the clinical trial supply chain from the levy service tax. Exempting a supply chain in deserving sectors is what the government has already done in the case of education services where the main services of formal education are put in the negative list while auxiliary education services (which are outsourced by an educational institute) are exempted through a notification. If the government believes that all players in the clinical trial supply chain are covered under the present notification, a clarification to that effect may remove the cloud of doubts in the minds of the industry as well as among officers who have already started investigations in parts of the country. A clarity would make life easy for the industry and the taxmanboth thrust areas of the new government.

The author is partner and head, Indirect Tax, KPMG in India. Views are personal