Switzerland protects its pharmaceutical industry

Article as analysis
While countries in the global South are billions of vaccines short in the battle against the pandemic, pharmaceutical groups shift their exorbitant profits to low-tax jurisdictions.

After a year of pandemic, it became clear this spring that the global pharmaceutical industry is among the big winners of the coronavirus. This is evident from the current business figures and earnings forecasts of many drug-making companies. In this regard, Covid-19 vaccine producers warrant a special look. Moderna, recently announced that it expects to achieve a vaccine sales of 19.2 billion dollars this year. Pfizer announced 26 billion and BioNTech 15 billion. For the first quarter alone, Moderna booked a net profit of 1.2 billion dollars, representing a profit margin of 65 per cent. When we recall that at the onset of the pandemic, vaccine manufacturers and asserted that vaccine production was not being driven by the profit motive, these figures are astonishing. This company’s vaccine is also the most expensive on the market at present.

Is the pharmaceutical industry getting more than it paid?
Upon closer inspection of the business models of the pharmaceutical heavyweights, however, the surprise is somewhat less. The NGO Public Eye recently analysed this in an extensive report (“Big Pharma takes it all”). One key profit maximisation tool used by the drug-making industry is the patenting of the active ingredients in their medicines. According to Public Eye, whereas in 2020 alone 93 billion euros in worldwide public spending went into researching and developing these active ingredients through intensive cooperation with universities, the relevant patents are expected to ensure that the earnings from the sale of the drugs will benefit exclusively those corporations that helped to develop the active ingredients. No third parties may produce or sell the active ingredients without purchasing a license from the patent holders. These rules have been in force for the past 25 years under the TRIPS Agreement (Trade-Related Aspects of Intellectual Property Rights), which was signed in 1995 at the insistence of the rich countries in the North and against the will of most countries in the South. The practice of technological imitation has been prohibited since then. If not before, the TRIPS Agreement did become a global health hazard during the corona pandemic, in that patent protection is inducing an artificial shortage of vaccines, thereby driving up prices and hampering the most equitable and effective possible worldwide distribution.

Those paying the price are chiefly the citizens of low-income countries in the global South, who cannot afford private and expensive healthcare. According to the blog “Our World in Data”, whereas the rich countries of North America and Europe have delivered 58 and 43 vaccines respectively per 100 citizens, in Africa the figure is two. Asia and South America lie somewhere in between with a rate of 18 or 24. But even in rich countries the citizens pay extra for the drug-making industry’s patents. With their taxes not only do they contribute significantly to research and development, but owing to the artificial limitation of the output of many drugs, they must also face higher costs in the health system as a whole. In this regard, Public Eye’s conclusion is alarming: “The absolute necessity of public funding in developing new drugs has never been clearer than in the current pandemic. However, when this reality is ignored in price setting mechanisms, citizens end up paying twice: they heavily subsidise Big Pharma through their taxes, and they are forced to contribute to excessive profits through grossly inflated and under-regulated prices.”

But that is not all. Not only do citizens support the pharmaceutical industry through their taxes – today’s international corporate tax system also affords corporations numerous other advantages in terms of circumventing their tax obligations. Without necessarily breaking current law, corporations are able significantly to reduce their tax liability on profits from intellectual property as well as from other types of company profit. For countries where pharmaceutical groups maintain their head offices as well as financially powerful subsidiaries, these advantages also constitute competition for their global profits. It is mostly small countries in the wealthy North without large markets for drugs that attract corporations by offering the most favourable conditions possible for the import of patents, as well as low taxes on intellectual property profits. This in turn benefits corporate groups, which do not have to pay their taxes primarily in the place where they actually create value through pharmaceutical research and the development of new active ingredients on the one hand, or where they sell their patented drugs on the other. They can do so instead in places where those profits are taxed the lowest.

Low-tax jurisdictions for intellectual property
Switzerland is a strong contender in this competition for the profits of multinational corporations. Measured by population size, it is host to the largest number of the world’s 500 biggest corporations (i.e. 14). These include the Basle-based pharmaceutical heavyweights Novartis and Roche, numbers 3 and 4 in the worldwide big pharma ranking and, behind six commodity giants and the food-producing corporation Nestlé, numbers 7 and 8, among the biggest firms with headquarters in Switzerland. Besides, their main foreign competitors almost invariably have subsidiaries and branches in Switzerland. According to research conducted by the transnational research group “Economists without Borders” with the participation of Californian-French economist Gabriel Zucman, Switzerland shifts as much as 98 billion francs in profits from the potential tax base of other countries annually. This yields tax receipts of 7.3 billion francs. In other words, 38 per cent of the corporate tax revenue accruing to the Confederation, cantons and communes comes from profit shifting. Besides, this 7.3 billion in tax revenue in Switzerland corresponds to over one-third of the total health spending of the world’s 69 poorest countries (19.7 billion dollars).

But these figures presumably do not include profit shifting from many African and Asian countries, as the relevant data systems in these countries are not robust enough to allow for such economic analyses. Considering that many of the commodity and food companies located in those countries also maintain their business and administrative units in Switzerland, it may reasonably be presumed that appreciable sums are also being shifted from those countries to Switzerland. As Zucman and colleagues have shown, the corporate units of foreign companies located in Switzerland have surprisingly low wage bills in relation to the exorbitant profits they generally report. Compared with local companies, their profit margins are usually four times higher. This raises the suspicion that these high profits are not being generated in Switzerland but are being shifted to Switzerland as paper profits.

To engage in such profit shifting, companies exploit anomalies in today’s international corporate taxation system. That system is based on the “arm’s length principle”, which is at the same time its greatest flaw. By that principle, multinational corporations are not taxed as global entities; instead each individual unit of a corporation is still treated as a separate firm under tax law. Countless financial transactions take place daily between the individual corporate entities across the various countries. They relate to services, material goods, participation rights, loans and – of special relevance to the drug-making industry – also intangible assets such as trademarks, licenses and patents.

One key factor in the use of patents as tax optimisation vehicles is that patents are not necessarily applied for and held in the place where the protected invention took place, but in the place where it is fiscally advantageous. This allows subsidiaries of foreign drug manufacturers domiciled in Zug or other low-tax cantons to operate as patent-holders and issue licences for the use of these patents to other companies in the same group.
What is striking is the spectacular labour productivity of the Swiss pharmaceutical industry: according to the industry association Interpharma, its added value per employee is five times the average for the overall economy, which places it in the lead and considerably ahead of the financial sector. Interpharma does not disclose the share of this added value that can be ascribed to intra-company licence payments, fees for specific intra-company services and interest on intra-company loans, but proudly affirms that two-thirds of the overall productivity growth of Switzerland's economy between 2008 and 2018 was attributable to the pharmaceutical industry. At the same time, over 85 per cent of both Roche and Novartis employees are located abroad (as of 2018).

"No borders, no nations" for patents
In the light of these figures, it is no real surprise that most Swiss politicians are especially mindful of the pharmaceutical industry as time and again they must realign Switzerland’s corporate taxation model with evolving international rules on the one hand, and with the needs of the Swiss economy on the other. As of 2020 for example, the most recent corporate tax reform introduced under the TRAF (Federal Act on Tax Reform and AHV Financing) replaced the old tax privileges for holding, domiciliary and mixed companies – also important to the pharmaceutical industry but internationally no longer accepted – with new ones that are in line with current taxation regulations set by the OECD (Organisation for Economic Cooperation and Development), the authoritative multilateral body in this field. The TRAF provided for two major new tax optimisation vehicles geared towards the needs of the pharmaceutical industry: on the one hand, tax relief for research and development (R&D deduction) and on the other, the patent box. Both vehicles make it possible to reduce what is called the assessment basis for a company's taxable profits, in other words, to reduce the portion of profits liable for taxation. This lowers the effective rate at which a company's profits are taxed – a rate derived from a combination of the assessment basis and the statutory tax rate. Whereas the R&D deduction applies at the start of the process of producing the active ingredient, the patent box kicks in at the end: the first vehicle allows for the deduction of R&D costs from profits deriving from products attributable to the corresponding R&D spending. The second allows for a deduction from overall taxable profit of up to a set percentage (which varies from one canton to another) that can be attributed to an invention that qualifies for the patent box. In Switzerland, what this means, at law, is that only profits from patented inventions also developed in Switzerland would qualify for the patent box. But in fact, it is difficult to assign a particular innovation or invention to a particular research location – among other reasons, because patents need not be applied for or held at the place where the invention was made. The same also applies to the allocation of R&D costs.

Pharmaceutical groups can therefore deploy their patent management for tax reduction purposes in a perfectly legal manner. Once again it is the company that wins and the public purse that loses. This illustrates the key importance of patents to the business model of pharmaceutical groups. At the same time too, it shows the central importance of patents to the business model of the Swiss tax authority: the rationale behind location policy is that the resulting low-tax regimes are expected to incentivise companies to book as much of their profits as possible in Switzerland. Despite lower tax rates here, the amounts in profit that become taxable in Switzerland are so great that the tax receipts ultimately accruing to the Swiss fiscal authority will also be substantial. This fiscal dimension of intellectual property may in part explain the Federal Council’s vehement opposition to any temporary waiver of patent protection for Covid vaccines. And this even considering that both the US Administration and the EU Commission have now approved it in a bid to foster vaccine production and so improve access to vaccines for poor countries. Roche CEO Severin Schwan conjures up the notion of East German-style nationalisation of the drug-making companies and opposes the setting of any precedent that would lead to a general relaxation of the current highly restrictive policy on intellectual property and to losses for the tax authorities of some cantons and for the Confederation. But once again the victims of this tax nationalism are the people in the global South, who must consequently wait even longer for their Covid vaccines and, it is worth noting, are dependent on a functioning public health system. It is just such a system that the pharmaceutical groups are undermining when they extract their profits from those countries and shift them to low-tax jurisdictions like Switzerland.