The R&D tax credit is tailor-made for the pharmaceutical industry since substantial research and experimentation activities are needed to successfully introduce pharmaceutical drugs to the consumer. Although the R&D tax credit was created for industries like the pharmaceutical industry, especially in drug discovery and development, many pharmaceutical companies still aren’t taking advantage of this business incentive. Common Pharmaceutical R&D Tax Credit OpportunitiesHistorically, pharmaceutical companies have been reluctant to pursue R&D tax credits for two reasons: either they believe it’s too difficult to document R&D activities and related expenditures, or they fear the IRS or state taxing authorities questioning and disallowing their claims.
However, due to the very nature of the business, pharmaceutical companies are the perfect candidates for claiming and sustaining R&D tax credits. These credits are available to help offset your tax liability, increase cash flow, lower your effective tax rate and support future drug development projects.
The U.S. Food and Drug Administration (FDA) tightly regulates the pharmaceutical industry, and your organization must follow certain processes and procedures to be in compliance. This fact alone provides opportunities for pharmaceutical companies to adequately document and support their R&D credit claims.
Drug Discovery And Development R&D Activities
The typical new drug discovery and development process includes these four stages, which have many direct and indirect research expenses:
1. Preclinical/Discovery Research – During this first stage, new compounds are discovered and thoroughly researched.
2. Clinical Development – Stage two is conducted in three phases:
Phase I – First trials in humans test a compound for safety, tolerance and pharmacokinetics. The trials usually employ normal, healthy volunteers.
Phase II – Pilot studies are conducted to determine efficacy and safety in selected populations of patients with the disease or condition to be treated, diagnosed or prevented. Dose and dosing regimens are also assigned for magnitude and duration of effect during this phase.
Phase III – Expanded clinical trials intended to gather additional evidence of effectiveness for specific indications are carried out to understand safety and drug-related adverse effects.
3. Regulatory Review – The New Drug Application (NDA) is submitted to a regulatory agency, such as the FDA, for marketing and manufacturing approval.
4. Post-Marketing – This includes all activities occurring after the appropriate regulatory agency has granted approval to market, such as Phase IV studies performed to determine the incidence of adverse reactions, the long-term effect of a drug, studying a patient population not previously studied, and marketing comparisons against other products and uses.
R&D activities take place at each stage of drug discovery and development, and the IRS has acknowledged that these activities qualify for the R&D tax credit.
In fact, the IRS developed a separate audit techniques guide (ATG) specifically for the pharmaceutical industry to provide general guidance for agents and managers examining pharmaceutical R&D tax credits. These guidelines provide helpful information to pharmaceutical industry taxpayers, as they identify audit areas that have the lowest and highest probability for sustainability.
The nature of the drug discovery and development activities for pharmaceutical companies generally do not give rise to suspicions about whether the company is conducting qualified research. The real audit issue is actually substantiating expenses that qualify for the R&D tax credit.
To substantiate R&D expenses, you need a deep understanding of the product development phases, basic auditing techniques and an analysis of the risks. That’s why it is highly recommended that you partner with an R&D tax credit expert to minimize your audit burden and maximize your tax savings.
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