[IMGCAP(1)]There are a great variety of medicines to treat the common cold. The scientific advancements in pharmaceutical development during the past several decades have been tremendous, resulting in the discovery of medicines to treat many medical conditions that previously were considered untreatable (many, but not all).

There are still a great number of diseases, often very rare or uncommon, that affect many Americans, for which therapeutic treatments are yet to be discovered.

Of course, no one wants to hear a devastating verdict from their physician that there is no therapeutic treatment for a particular medical condition you or your family member might have.

Pharmaceutical companies, like companies in all other industries, are in the business of generating profits. Developing treatments for rare diseases and conditions can be as expensive as developing medicines to treat any other disease. The expenses incurred by pharmaceutical companies for drug design, preclinical and clinical testing of medicines for rare diseases may be difficult to recover if sales of a particular product are limited to a relatively small patient population.

This situation has been recognized by governments of many industrialized economies, including the United States, the European Union and Japan, and led to a wide variety of government incentives for pharmaceutical companies to aid drug development initiatives for rare diseases and conditions. These incentives include sales and market exclusivity, accelerated drug approval processes, patent protection and certain specialized tax incentives.

In 1983, President Reagan signed into law the Orphan Drug Act, which received bipartisan support in Congress. Among the various provisions of the Act was the orphan drug tax credit, a tax credit offered to pharmaceutical companies as a tax incentive to facilitate development of treatments for rare diseases and conditions. This tax credit is viewed as a very lucrative incentive. It is computed as 50 percent of the costs incurred by a pharmaceutical company to conduct clinical testing of drugs for rare diseases and conditions, including the costs of clinical testing conducted outside of the United States under certain circumstances. By far, the costs associated with clinical trials comprise the largest portion of the overall drug development costs for any pharmaceutical company.

To qualify for the orphan drug tax credit, a drug candidate has to be designated as an orphan drug by the U.S. Food and Drug Administration. Since its enactment, over three decades the FDA has received applications for over 3,000 pharmaceutical products to treat various rare diseases and conditions, over 450 of which received orphan drug designations.

In comparison, according to the FDA Office of Orphan Products Development, less than a handful of such drugs were developed in the United States during the decade immediately preceding the enactment of the Act. Recently, pharmaceutical companies developed therapeutic treatments for various rare diseases, including Adcetris for treatment of Hodgkin lymphoma, Kalydeco for cystic fibrosis, and Arzerra for chronic lymphocytic leukemia, among others. By this indication alone, there is little doubt that the orphan drug program has been a success, according to the FDA.

Unfortunately, the orphan drug tax credit is at risk of being discontinued despite it being permanent in the Internal Revenue Code. The discussion draft of the Tax Reform Act of 2014, introduced by Representative Dave Camp, R-Mich., and released by the House Ways and Means Committee that he chairs, would repeal this provision of the Code in exchange for lowering tax rates and simplification of the overall tax system. Based on an analysis of the discussion draft by the Joint Committee on Taxation, the elimination of the orphan drug tax credit is anticipated to provide budgetary savings of $9.1 billion over the next decade.

On June 5, 2014, Senators Ron Wyden, D-Ore., and Orrin Hatch, R-Utah, the leaders of the Senate Finance Committee, announced three hearings on the comprehensive tax reform, including modernizing U.S. corporate taxation. The purpose of these discussions is to simplify the U.S. tax code to promote long-term growth and ensure economic prosperity for the American people, according to the official release. Whether these discussions will result in favorable recommendations regarding the fate of the orphan drug tax credit has yet to be seen.

Costs associated with developing and clinical testing of treatments for rare diseases and conditions are not a significant expense item for major pharmaceutical companies when viewed in comparison with similar costs for non-orphan drug indications. Hence, the expectation that these companies will be involved in supporting the orphan drug tax credit extensively is considered to be rather low given the uncertainty of whether the development and clinical testing expenses could be recovered even with the credit.

There are many other challenges for pharmaceutical companies in the United States, including attempts to control pharmaceutical product pricing and increased scrutiny during the regulatory process of approval of medicines. Simply put, whether the orphan drug tax credit remains part of the Internal Revenue Code does not seem high on the list of priorities for major pharmaceutical companies.

For smaller pharmaceutical companies, especially for a handful of those that specialize in developing medicines for rare diseases, abolishment of the orphan drug tax credit could result in complete termination of their drug development programs. These smaller pharmaceutical companies will either cease to exist or develop medicines for non-orphan drug indications instead.

It is unknown if the small patient groups that have benefited from orphan drugs—much less society in general—will resist the abolition of the orphan drug tax credit. By definition, rare diseases affect a very limited portion of the population, in contrast to widespread cardiovascular diseases and various cancers.

The orphan drug tax credit law relies on the research tax credit provisions of the Internal Revenue Code. In fact, the main difference between the two credits is how they are computed, not which research and development activities can qualify. Historically, the research tax credit has received bipartisan support in Congress and from many presidential administrations and was extended 14 times.

Budgetary offsets have never been considered a priority as the research tax credit has been recognized as a measure that favors technological change and innovation in this country, including advancements in medical sciences, all of which increase the potential for greater tax revenue in the long run. The orphan drug tax credit has received less attention because of its permanent nature and its applicability to just one industry.

Surprisingly, despite his support for the research and development tax incentives in the past, President Obama threatened to veto the research tax credit bill passed by the House, citing the necessity for a budgetary offset to the increased spending should the research tax credit become permanent. It is even more surprising, since President Obama voted in favor of extending the research tax credit in 2006 and 2008 without any budgetary offsets when he was a senator.

The role of any government is to defend and promote the interests of all its citizens and to administer programs that are beneficial to all, including those who are underrepresented. It is hard to believe that the orphan drug tax credit law may be eliminated by legislators even if a suitable budgetary offset is nowhere to be found.

Should the U.S. tax system compare lost revenue to lost hopes and lost lives?

Dr. Alexander Korniakov, PhD, CPA, is the senior vice president of research credit and other tax incentives at Fortisure Consulting LP, a consulting firm located at 1900 South Norfolk Street in San Mateo, Calif. Dr. Korniakov holds a master’s degree in financial engineering and a doctorate degree in chemical engineering, both from the New York University Polytechnic School of Engineering. He is licensed as a Certified Public Accountant.

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