Tax Benefits to High-Tech Companies - Research Paper Example

Tax Benefits to High-Tech Companies The Chinese government aims to boost the Pharmaceutical Company by providing them with numerous benefits. The articles of different Provinces of China provide diverse benefits for this purpose, although they are on similar lines. 'High-Technology Innovative Enterprises' (HTIE) is defined differently by the different provincial governments giving them necessary tax benefits. However, the definitions of theses firms are more or less on similar lines in all the provinces. The Shanghai Article 6.3 published on 2nd June 2001, states that a minimum of thirty percent of the employers (employees) of High-Technology Innovative Enterprises should have at least completed their graduation and these types of firms should have at least ten percent of work force who are R&D staff. Theses firms are additionally required to set aside a minimum of 5.5% of the total revenue for R&D expenses. This Shanghai province necessitates a minimum expenditure of 4%, on similar lines to the Fuji Province which necessitates that the minimum R&D expenditure for such firms should be 5%, an increase of 2% from the earlier 3% prior to 1999. On similar lines, different provinces provide different benefits to the HTIE, with the basic structure remaining the same. These Articles of diverse provinces outline several benefits including tax reductions, discounts on capital purchase, lending support by the government and other operation priorities related to the pharmaceutical HTIE units. The Shenzhen Article 2.2 gives numerous benefits to HTIE units that have operated for more than a decade. The government promises that the income tax for the first and the second year of operation would be waived off completely, and would be reduced by fifty percent by the time they reached the eighth year of functioning. Article 2.3 states that for products concerning National innovation, twenty-five percent of the total share of the local government tax should be returned by a minimum of fifty percent by the municipal government for three years in a row. Article 3.3 further affirms that financial support as debt would be provided by the government to the tune of twenty percent to the HTIE firms. Article A-4.2 assures a discount between ten-twenty percent on rent and A-13.5 assures HTIE firms to have a priority on exports. Article-A/10 reduces the taxes on R&D expenditure. Although the basic vision and goals of the provinces remain the same, slight differences occur in terms of percentage numbers among the provinces of Shanghai, Fuji, Shangxi and the Zhejiang. The role of the government in supporting the HTI Enterprises is obvious by the measures taken to provide aid and support to these enterprises. However, the benefits mentioned in the Articles are applied universally, as a whole to diverse industries, including Information Technology, Bio-technology, Modern agriculture, Environment protection along with the Pharmaceutical Industry (Article 5, Shanghai, 2001-7-2). The government ignores the fact that the pharmaceutical and biotechnology industry play a crucial role in R&D spending with nearly fifty leading Chinese global firms spending 16.4% of their total revenue on R&D activities whereas only four-to-six percent was set aside for the HTIE qualified units in China. The figure of 4-6& is understandably sufficient for other industries' innovation and development, but not so for the Pharmaceutical industry. It is therefore necessary to segregate the Pharmaceutical industry from the HTIE, providing it with a distinct status and consequently separate substantial waivers and rewards by the government for these actual innovative Pharmaceutical enterprises to flourish and prosper. Price Ceiling In China, the unequal distribution of medication is a serious social problem because of the differences in the price of drugs and regional incomes. In the year 2000, China ranked fourth last among 191 countries of WHO with regard to health service equality and accessibility. The 2003 national health census, confirmed that 48.9% patients do not go to hospitals for treatment and 29.6% who should be hospitalized, do not do so. A substantial 44.8% of the total population in urban areas and 79.1% in rural areas do have any health insurance. In a move to provide the population living in poverty with better access to drugs and health service, the central government (from 1999 to 2006), considered high profit margin as an important factor for high drug prices, enforced sixteen drug price reductions(Article A-17). In the beginning, the government set fixed profit margins for drug firms and distribution channels by calculating the manufacturing expense itself. Later, the SFDA prepared a list of price-controlled drugs and continuously adjusted the numbers. Until 2007, the prices of a minimum of one thousand seven hundred and sixty eight drugs have been controlled. In addition to this, the government authority has taken measures to set up categories of fundamental drug lists in 1996 comprising of 2,033 drugs [Y3], and expanded and revised it in 1998, 2000, 2002, and 2004. Although these policies substantially reduce the profits of domestic firms, whether they have been successful in delivering benefits to the consumers, is a debatable matter. On a theoretical basis, if the government turns the fixed-profit-margins to Price ceilings, the results should be positive. However, the real picture is quite different from what it ought to be! Hospitals Hospitals remain a major channel of drug distribution []. A case study of the Shandong Hospital (Qingyue Meng et. Al, 2005), revealed that the new 'retail price control policy' failed to have a positive impact on containment of hospital drug expenditure (Steven White and Xielin Liu, 2001). This study also revealed a decrease in the drug price index, from 1.5% in 2001 to 3.6% in 2004. Compared to this, the average increase in hospital services was 8.2%, much more than drug price drop (Y3). Thus we see that the effect of price control system has been offset by several other factors and the expenses on manufacture seem to exceed its real benefits to the patients. Secondly, even though the Chinese CPI increased dramatically the recent years, the suggested prices in government handbook are largely delayed and not up to the mark (). Table 1.1 shows that, in 2003, the industry profit rate reduced in response to the dramatic rise in the CPI. The increase of price in raw materials is only one of the factors that influenced the profit under a ceiling policy and the table illustrates the correlation between the two. Some experts have urged an enhanced coordinated procedure to keep the prices in the government list corresponding to market trend as quickly as possible. Table 1.1 Chinese Pharmaceutical Industry Net Income Rate vs. CPIi from the year 1997 to 2006; censured 6140 enterprises by SFDA Southern Center, 2006 Thirdly, the government implements a serious policy to encourage patent drugs and R&D by giving them a different and easier pricing regulatory. However, Xielin Liu and Anhui Jin (2005), point the discrimination of the government between domestic firms and foreign joint ventures in real applications stating that some foreign drugs are given such policy benefits even when they do not hold respective patents in China (A17). Revised portion Investment adjusted profit There are serious problems in the Chinese pharmaceutical industry concerning the tariff vulnerability and price vulnerability. Name Gross Margin Net Income Pharma Investment Leverage LRG Shanghai 7.37% 1.07% 0.83% 0.24% 120 LRG Taiji Group 23.90% 3.41% 2.58% 0.83% 38.8 LRG Hai'erbin 31.65% 6.29% 5.90% 0.39% 16.9 LRG Guangzhou 15.81% 3.79% 3.49% 0.30% 28.7 MID Jingling 28.38% 25.44% 10.63% 14.81% 9.4 MID Ao Dong 63.30% 178.93% 10.62% 168.31% 9.4 MID Haiwang Bio 15.01% 2.47% 0.25% 2.22% 400 MID JD Angli 38.77% 9.18% 0.85% 8.33% 117.6 MID Zhejiang 14.13% 2.22% 1.94% 0.28% 51.5 MID Jiu Zhi Tang 45.77% 9.12% 2.76% 6.36% 36.2 MID YN Baiyao 27.49% 10.43% 10.33% 0.10% 9.7 SML Da'an Gene 57.58% 18.69% 17.03% 1.66% 5.9 SML Tian Tan Bio 64.74% 34.14% 34.73% -0.59% 2.9 SML Shuang Lu 62.90% 62.49% 41.86% 20.63% 2.4 SML Hua Bang 65.22% 37.02% 16.09% 20.93% 6.2 Sample Group 21.10% 8.21% 4.29% 3.92% 23.1 Industry 31.58% 9.67% 7.74*1 1.93%* 12.9 Table 1 Basic financial ratios and leverage degree of 15 selected firms An example of this is the profit that the company Jilin Ao Dong made from its external investments, which is minimized by 2 percent in the financial year 2005 as compared to the financial year 2007. A study of the four largest firms in the table above, have shown an increase in the profitability of the business, from 3.08 percent to 3.45 percent, an increase of 11.93 percent which was primarily due to investment. The four bottom listed companies too registered a jump of 37.84 percent, from 27.28 percent to 37.61 percent. The seven middle listed companies too reportedly produced 75 percent of their income from investment activities. The actual net profits were reported to be to the tune of 20 percent, out of which only 5.63 percent had been generated from the actual pharmaceutical business. Thus, the business performance was not actually as good as was being projected in the reports. Gauging by the above disclosures, we can safely conclude that the net profits of the pharmaceutical industry are over-stated by 20 percent to 60 percent for the financial year 2007. The evidence for this fact can be gathered by the miss-representation and mismatch of numbers in the profits of core businesses as compared with the final profit report of the SFDA. Every over-statement of profits by 20 percent increases the leverage effect by 25 percent. Considering the occurrence of such a 20 percent bubble in the profits of the pharmaceutical industry, it can be wisely assumed that an absolute removal of tariffs will greatly diminish the profit earnings by a huge 70.56 percent. A study of the fifteen companies reveals that the complete elimination of tariff could not only substantially reduce profits, but also completely wipe them away by 100 percent. Importing Tariff and WTO In early 2001, the tariff for drug import was 20% and it has been reduced to 5-8% in 2005. Six years after joining WTO, in 2007, it became 3-6% and is expected to reach zero in the near future (China Customs), and this reduction in Tariff has had a great impact on the domestic performance. To illustrate the degree to which domestic firms are vulnerable to this tariff reduction, sensitivity of profit-to-price was calculated. To simplify the calculation, it was assumed that the industry as a whole was a single company. From Jan to Nov, 2007, pharmaceutical industry made a net profit 9.7% as most Chinese firms engaged in large-volume but low-profit generic drugs (SFDA). A decrease of 2% on average prices in response to cheaper imported drugs caused a 20.62% slump in profits. The Global Chinese giants such as Pfizer, GSK, and Novartis, are more tolerant to the competition and tariff reduction, since a 2% drop in prices, only results in 5.00%, 8.44% and 10.28% decline in their net profit, respectively. If the tariff were to go to zero (as predicted), a further 3-6% decline is possible. In this case, the domestic industry would suffer 30% to 62% slump from the existing current profit. If no strategic actions are promptly taken, a majority of domestic firms can be out raced by irreversible tariff reductions, within five years. References 1. Alex Scott, 2004. China Threatens to Close Plants Failing GMP Standard. Chemical Week. Iss 17, page26 2. Bianca Piachaud, 2005. Outsourcing Technology. Research Technology Management, No. 48, 40-46. 3. B. Bowonder et al., 2005. R&D Spending Patterns of Global Firms. Research Technology Management, No 5, 51-59. 4. Chin-Tsai Lin and Chang-Tzu Chiang, 2007. Evaluating the performance of sponsored Chinese Herbal Medicine Research. Scientometrics, No 1, 67-84. 5. Faiz Kermani and Yibing Zhou, 2007. China commits itself to biotech in healthcare. Drug Discovery Today. No.13, 501-503 6. John A. Veron et al., 2007. Pharmaceutical Manufacturing Efficiency, Drug Prices and Public Health: Examining the Causal Links. Drug Information Jounal, No.41, 229-239. 7. Li Xuesheng and Stuart O Schweizer, 1998. The Health Market. 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