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Published online by Cambridge University Press: 26 June 2018
Independent Consultant in Alexandria, Virginia, USA. This paper is based on my study of economic issues in the pharmaceutical industry for over 30 years. In general, my research has been supported by individual research-based pharmaceutical companies or organisations representing groups of such companies. Economists at NERA Economic Consulting in Washington, DC provided background support for sections of this paper. Of course, the conclusions are my own and do not necessarily reflect opinions of current or former staff at NERA Economic Consulting.
1 Primary forms of exclusivity could include composition of matter patents or other forms of exclusivity such as provided, for example, by a Cooperative Research and Development Agreement (“CRADA”) in the US CRADAs exist to encourage commercial development of technologies created through government funded research and development (“R&D”) programs. Primary forms of exclusivity effectively exclude any other company from selling a version of the product.
2 My conclusions on value apply to controlled transactions where the relevant intellectual property is owned by an Affiliate located outside the US as well. A payment for the intellectual property is made to the non-US Affiliate. The owner of the intellectual property does not have the capability to manufacture, market, or distribute the product.
3 Affiliate owns the residual intellectual property and International represents the aggregation of all other entities performing other functions.
4 Available at <www.irs.gov/pub/irs-apa/482_regs.pdf>. I also considered the Final §6662 Transfer Pricing Penalty Rules (TD 8656), 61 Fed. Reg. 4876, issued 9 February 1996. There are international guidelines that are relevant, see OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017, issued 10 July 2017, <dx.doi.org/10.1787/tpg-2017-en>.
5 Reg. Sec. 1.482-1(b)(1).
6 The internal data should include agreements negotiated by the company including negotiated by any entities the company acquired over time.
7 “Intangible property related to generics or with no valid claim” only includes royalties in which an agreement does not explicitly state the type of intellectual property covered. Any agreement which explicitly states a specific type of intellectual property that is related to generics or has no valid patent claim are categorised as non-composition of matter intellectual property.
8 Net Sales represent the total amount received by International upon the sale of finished products to third parties, reduced by sales returns and allowances, including trade, quantity and cash discounts and any other adjustments, including price adjustments, billing errors, rejected goods, damaged goods, recalls, returns, rebates, chargeback rebates, fees, reimbursements or similar payments granted or given to wholesalers or other distributors, or buying groups.
9 The arm’s length royalty rate for relevant intellectual property other than trademark should be applied only once and covers all relevant intellectual property other than the trademark.
10 Chapter 10. Patentability of Inventions, U.S. Code Browse Title 35 – Patents, GPO Access, United States Code, last updated 23 December 2008, <frwebgate.access.gpo.gov/cgi-bin/usc.cgi?ACTION=BROWSE&title=35usc>. Other forms of exclusivity may such as CRADAs may be available to pharmaceutical companies.
11 Chapter 10. Patentability of Inventions, U.S. Code Browse Title 35 – Patents, GPO Access, United States Code, last updated 23 December 2008.
12 WH Schacht, “Follow-On Biologics: Intellectual Property and Innovation Issues,” CRS Report to Congress, 17 January 2008, <www.biosimilars.com/CRS_FOBs.pdf>.
13 E Sherwood, “Generic Drugs,” Center for Drug Evaluation and Research, <www.fda.gov/downloads/Drugs/DevelopmentApprovalProcess/SmallBusinessAssistance/ucm127615.pdf>.
14 Patent protection for a drug once it is launched typically lasts 11 years. See “Greater Access to Generic Drugs,” FDA, <www.fda.gov/drugs/resourcesforyou/consumers/ucm143545.htm>; and “Patent System in the Pharmaceutical Industry”, PharmaInfo.net, 20 June 2008, <www.pharmainfo.net/reviews/patent-system-pharmaceutical-industry>.
15 “Patent System in the Pharmaceutical Industry” supra, note 14.
16 “Patent System in the Pharmaceutical Industry” supra, note 14.
17 “Patent System in the Pharmaceutical Industry” supra, note 14.
18 For a complete description of the generic drug requirements in the US see “Greater Access to Generic Drugs” FDA, <www.fda.gov/drugs/resourcesforyou/consumers/ucm143545.htm>. This description applies to small molecule pharmaceutical products. US and foreign regulatory authorities are publishing standards for approving biosimilar versions of large molecule pharmaceutical products.
19 Kesselheim, AS, Murtagh, L, and Mello, MM, “‘Pay for Delay’ Settlements of Disputes over Pharmaceutical Patents” (2011) 365(15) The New England Journal of Medicine 1439 CrossRefGoogle Scholar, downloaded from nejm.com on 13 October 2011.
20 Burdon, M and Sloper, K, “The Art of Using Secondary Patents to Improve Protection” (2003) 3(3) International Journal of Medical Marketing 226 CrossRefGoogle Scholar, <www.olswang.com/pdfs/Bios_Jul03.pdf>.
21 Levin, RC, Klevorick, AK, Nelson, RR, Winter, SG, “Appropriating the Returns from Industrial Research and Development” (1987) 3 Brookings Papers on Economic Activity 783 CrossRefGoogle Scholar.
22 “General Information Concerning Patents”, PTO, last modified 10 November 2011, <www.uspto.gov/patents/resources/general_info_concerning_patents.jsp>.
23 I identified instances where arm’s length compensation is paid to the intellectual property owner although the underlying product is not protected by primary exclusivity.
24 Reg. Sec. 1.482-1(c).
25 Reg. Sec. 1.482-1(c)(2).
26 Reg. Sec. 1.482-4(c)(1).
27 Reg. Sec. 1.482-4(c)(2)(iii)(B)(1).
28 Reg. Sec. 1.482-4(c)(2)(iii)(B)(1)(ii).
29 Reg. Sec. 1.482-4(c)(2)(iii)(B)(2).
30 Reg. Sec. 1.482-5(a) and Reg. Sec. 1.482-5(b)(1).
31 Reg. Sec. 1.482-5(b)(4) defines specific profit level indicators as the rate of return on capital employed, financial ratios such as the ratio of operating profits to sales or the ratio of gross profit to operating expenses, and other profit level indicators.
32 Reg. Sec. 1.482-5(b)(2)(i) defines the tested party as the participant in the controlled transaction for which the most reliable data are available and for which reliable data regarding uncontrolled comparables can be located.
33 Reg. Sec. 1.482-6(a) and Reg. Sec. 1.482-6(c)(1).
34 According to Reg. Sec. 1.482-6(a), a controlled party’s operating profits should be derived from the most narrowly identifiable business activity for which data are available that includes the controlled transaction.
35 Reg. Sec. 1.482-6(b).
36 Reg. Sec. 1.482-6(c)(2).
37 Reg. Sec. 1.482-1(d)(1).
38 Reg. Sec. 1.482-6(c)(3)(i)(A).
39 Reg. Sec. 1.482-6(c)(3)(i)(B).
40 Reg. Sec. 1.482-4(d)(1).
41 Reg. Sec. 1.482-1(d)(1).
42 “In order for the intangible property involved in an uncontrolled transaction to be considered comparable to the intangible property involved in the controlled transaction, both intangibles must – (i) be used in connection with similar products or processes within the same general industry or market; and (ii) have similar profit potential.” Reg. Sec. 1.482-4(c)(2)(iii)(B)(1).
43 See, for example, Saha, A, Grabowski, H, Birnbaum, H, Greenberg, P, and Bizan, O, “Generic Competition in the U.S. Pharmaceutical Industry” (2006) 13(1) International Journal of the Economics of Business 15 CrossRefGoogle Scholar.
44 Reg. Sec. 1.482-5(a).
45 Reg. Sec. 1.482-5(a).
46 Reg. Sec. 1.482-5(c)(2)(iii).
47 Reg. Sec. 1.482-5(c)(2)(iv).
48 Reg. Sec. 1.482-5(b)(2)(i).
49 Reg. Sec. 1.482-1(c)(2)(i).
50 Reg. Sec. 1.482-6(c)(2).
51 Reg. Sec. 1.482-1(d)(1).
52 Reg. Sec. 1.482-6(c)(3)(i)(A).
53 Reg. Sec. 1.482-6(c)(3)(i)(B).
54 Reg. Sec. 1.482-1(c)(2).
55 See Example 8 (iii) in Reg. Sec. 1.482-8.
56 Midpoint royalty rates were calculated as the average of the upper and lower bounds when a range of royalty rates was given in a particular agreement.
57 This category includes agreements stating that the licensor is responsible for functions related to manufacturing or supply, but the compensation is detailed in a separate arm’s length agreement(s). Agreements that outline compensation for relevant intellectual property as well as manufacturing or supply were not included in my sample given that the compensation could not be reliably segmented by function.
58 This category includes agreements that segment the intellectual property licensed and specific separate royalty rates for relevant intellectual property and the composition of matter patent(s). Agreements that do not segment compensation for relevant and non-relevant intellectual property were not included in my sample given that compensation could not be reliably segmented by type relevant and non-relevant intellectual property.
59 Agreements that are royalty-free, but include other forms of compensation were excluded from my sample given that I did not have sufficient information to calculate effective royalty rates.
60 When a range of royalty rates was given, I relied upon the midpoint royalty rate.
61 Wooldridge, JM, Introductory Econometrics: A Modern Approach (2nd edn, South-Western 2003) p 25 Google Scholar.
62 ibid.
63 It represents all other factors that affect y besides xi and xii . Wooldridge, supra, note 61, p 25.
64 Levin, Klevorick, Nelson and Winter, supra, note 21, p 810.