By Dr. J. Harold McClure, New York, NY
Gilead Sciences today announced its pricing plan for its COVID-19 therapy, remdesivir, in preparation for it to begin charging for the drug in July. The announcement comes as a bit of a surprise, as many analysts predicted that prices for developed nations would be set higher.
Remdesivir may prove to be an important therapy for COVID-19 and thus extremely profitable to Gilead.
An interesting issue for transfer pricing practitioners is where Gilead’s potentially massive profits from remdesivir will be taxed.
The transfer pricing treatment of Gilead Sciences’ blockbuster HIV and hepatitis C virus (HCV) drugs, provide a good background for what may be the transfer pricing issues for the production and distribution of remdesivir.
Gilead’s transfer pricing for HIV drugs and the Zantac litigation
Gilead’s HIV treatments include Atripla, Complera, Stribild, Truvada, and Viread. The US parent did the initial research and development (R&D) through phase II trials. Phase III trials for European patients were funded by its Irish affiliate, Gilead Ireland Research Limited, which was also responsible for marketing efforts in Europe.
By 2013, worldwide sales of Gilead’s HIV products passed $9 billion, dominating their product sales that year. Cost of production represented 26.4 percent of sales, while operating expenses represented 15.7 percent of sales. In other words, these products were highly profitable.
Since Gilead Sciences relies on third-party manufacturers, the routine returns to production and distribution would be modest under arm’s length pricing.
Given the considerable residual profits for these products, the key intercompany pricing issue would be what represented an arm’s length royalty rate for the use of the US-owned product intangibles.
A similar question was raised in GlaxoSmithKline Holdings (Americas) Inc. v. Commissioner. Much of the discussion of this litigation assumed that the UK parent owned the product intangibles, while the US affiliate was responsible for the upfront marketing as well as distribution activities.
The profitability of Zantac was similar to the profitability of Gilead’s HIV products, and Glaxo’s transfer pricing policies granted the US affiliate a considerable portion of residual profits as compensation for its upfront marketing activities.
The IRS, however, was able to assert a large transfer pricing adjustment despite the fact that the original transfer pricing policy granted the US affiliate with a high operating margin. While the original transfer pricing policy granted the UK parent with royalties equal to 30 percent of sales, the IRS position lowered the royalty rate to only 15 percent of sales.
The key economic lesson from this litigation is that the value of phase II rights is considerably less than the value of the product’s intangibles after regulatory approval.
If the US affiliate paid for the phase III clinical trials leading to FDA approval, then the owner of the phase II trials should charge the lower royalty rate to the US affiliate as this licensee not only owns the marketing intangibles but was also responsible for the cost and risks associated with phase III trials.
If the US affiliate paid for the phase III clinical trials leading to FDA approval, then the owner of the phase II trials should charge the lower royalty rate to the US affiliate as this licensee not only owns the marketing intangibles but was also responsible for the cost and risks associated with phase III trials.
In the case of the HIV products, Gilead’s Irish unit was similarly responsible for both the phase III trials and the upfront marketing.
The HCV controversy
Gilead Sciences purchased Pharmasset in 2011 for $11 billion, which eventually led to some incredibly profitable treatments for the HCV. Gilead’s acquisition of Pharmasset was funded by its Irish affiliate. As such, the Irish affiliate became the owner of the phase II rights.
Gilead Sciences sales rose to over $32 billion by 2015 as sales of its HCV products, including Harvoni and Sovaldi, were very successful.
The profit margins for HCV products were also very high. The success of these products drew a stinging rebuke from the Americans for Tax Fairness (“Gilead Sciences: Price Gouger, Tax Dodger,” July 13, 2016 – americansfortaxfairness.org/new-report-gilead-sciences-price-gouger-tax-dodger):
Prescription drug maker Gilead Sciences is raking in billions of dollars a year in windfall profits from public health programs and consumers for exorbitantly priced hepatitis C (HCV) medications developed with taxpayer dollars. It then shifts those profits to offshore tax havens, allowing it to dodge nearly $10 billion in US taxes by the end of 2015 … California-based Gilead is the sixth most valuable pharmaceutical company in the world, with a market value of $146 billion last year. Its enormous profits come primarily from two life-saving HCV drugs. Sovaldi went on the market in December 2013 at a cost of $1,000 per pill, or $84,000 for a full 12-week treatment. The actual manufacturing cost for a 12-week course of Sovaldi has been estimated at between $100 and $1,400. A combination treatment known as Harvoni, which pairs Sovaldi with another drug, debuted a year later at $1,125 per pill, or $94,500 for a full treatment. Competition and negotiations with purchasers have since forced the price of Gilead’s drugs down significantly from their original list prices, but the prices are still high enough to be considered profiteering and to cause hardship for consumers. And in June, 2016, the company announced that it would be pricing its newest HCV drug, Epclusa, at almost $75,000 per treatment, or about $900 per pill.
This passage focuses on the pricing of a very valuable patented product rather than transfer pricing issues.
The passage notes the nearly $100 billion rise in Gilead Science’s market value during the early years of these HCV products indicating the dramatic changes in market valuations when a phase II treatment purchased for only $11 billion becomes the first to market in a race with other developers of potential HCV treatments.
In other words, Gilead’s Irish affiliate took the phase III and marketing risks and reaped an enormous return when this risky venture turned out to be successful. Other competitors subsequently introduced lower-priced treatments, reducing Gilead Sciences HCV sales, profits, and market valuation.
The Americans for Tax Fairness report notes that much of these HCV profits received by Gilead Sciences in 2014 and 2015 were captured by Gilead’s Irish unit, but does little to explain whether or not the transfer pricing was abusive.
We know the affiliate purchased the phase II rights, and we also know that the value of their HCV intangibles rose tremendously after FDA approval.
Questions remain as to which legal entity incurred the cost of phase III trials and upfront marketing.
Remdesivir – the next blockbuster drug?
On April 29, Dr. Anthony Fauci announced remdesivir’s promising results from phase III clinical trials.
A few days later, on May 1, the FDA issued an Emergency Use Authorization for remdesivir as a treatment for hospitalized COVID-19 patients. Remdesivir became the first drug to be recommended by EU health authorities as a treatment for COVID-19. Moreover, trials have begun on a new, inhalable version of remdesivir, which has shown promise.
Remdesivir will be only part of the fight against COVID-19, but the World Health Organization is already calling for an increase in the global production of this treatment.
Gilead Sciences CEO Daniel O’Day discussed the production issues in his April 29, letter to shareholders:
On the supply side, we are working to build a global consortium of pharmaceutical and chemical manufacturers to expand global capacity and production. It will be essential for countries to work together to create enough supply for people all over the world and we look forward to these collaborative efforts. In the event of regulatory action, we are in discussions with various groups about how we might bring remdesivir to the developing world.
Gilead Sciences has worked with third-party manufacturers for its HIV and HCV products as well. Gilead Sciences had already produced 1.5 million vials or doses, which it donated to critically ill patients worldwide The fact that Gilead Sciences donated its initial 1.5 million doses means it will not profit in the early stages. In fact, the production of the doses that Gilead Sciences chose to donate implies a form of upfront investment in marketing.Each patient may require between 5 and 10 doses. The Institute for Clinical and Economic Research released an analysis of the potential pricing for remdesivir (“Alternative Pricing Models for remdesivir and Other Potential Treatments for COVID-19”).
One approach considered what a third-party contract manufacturer might charge:
For remdesivir, we used evidence on the cost of producing the next course of therapy from an article by Hill et all in the Journal of Virus Eradication (2020). Their methods sought to determine the “minimum” costs of production by calculating the cost of active pharmaceutical ingredients, which is combined with costs of excipients, formulation, packaging and a small profit margin. Their analysis calculated a total cost of producing the “final finished product” of $9.32 US for a 10-day course of treatment. We rounded that amount up to $10 for a 10-day course. If a 5-day course of treatment becomes a recommended course of therapy, then the marginal cost would accordingly shrink to $5
This calculation does not factor in the cost of R&D or the potential for exploiting Gilead Science’s patent protection. The report also estimates a value-based price known as cost effectiveness analysis:
In this preliminary modeling exercise, remdesivir extends life and improves quality of life versus standard of care. In public health emergencies, cost-effectiveness analysis thresholds are often scaled downward, and we feel the pricing estimate related to the threshold of $50,000 per incremental quality adjusted life year (and equal value of a life-year gained) is the most policy-relevant consideration. In the case of remdesivir, the initial ICER-COVID model suggests a price of approximately $4,500 per treatment course, whether that course is 10 or 5 days
Pricing remdesivir
According to today’s announcement, Gilead Sciences will begin charging for the use of remdesivir in developed nations on July 1. Government programs such as Medicare will be charged $390 per vial, while private insurance companies will be charged $520 per vial.
Most patients treated with remdesivir will receive a five-day treatment course using six vials of remdesivir. That would bring the government cost to $2340 for patients on the five-day treatment and $3120 for commercially insured patients.
The longer, ten-day treatment course will cost governments $4290 per patient and $5720 for a US patient with private insurance. Gilead Sciences noted that this pricing was less than the estimated value of remdisivir but these prices far exceed the economic cost of production.
On May 5, Gilead announced how it intends to expand global production (Gilead Sciences Statement on Expanding Global Supply of Investigational Antiviral remdesivir:
Gilead is in discussions with some of the world’s leading chemical and pharmaceutical manufacturing companies about their ability, under voluntary licenses, to produce remdesivir for Europe, Asia and the developing world through at least 2022. The company is also negotiating long-term voluntary licenses with several generic drugmakers in India and Pakistan to produce remdesivir for developing countries. Gilead will provide appropriate technology transfers to facilitate this production. Finally, the company is in active discussions with the Medicines Patent Pool, which Gilead has partnered with for many years, to license remdesivir for developing countries.
This passage notes not only Gilead Science’s intent to rely on third party manufacturing but also the possibility that it may pursue different pricing strategies for nations in the developed world as opposed to developing nations.
R&D funding
To the degree that Gilead Sciences can command premium profit margins from the production and sale of remdesivir, the transfer pricing implications of who funded the R&D will be paramount.
The early R&D on remdesivir contemplated that it might be a treatment against other diseases such as Ebola.
While other treatments were chosen to address Ebola, this research provided insights into the safe use of remdesivir as well as how it operates.
In early 2020, remdesivir was approved for phase III trials, which were conducted globally.
Research will likely continue as to the efficacy of this potential treatment. We may once again have a situation where one legal entity owns the phase II rights while other entities conducted the phase III trials that led to regulatory approval.
The key to understanding the appropriate transfer pricing policies is to grasp which entity owned the phase II rights versus which entities performed and funded the phase III trials.
If the phase II rights are separate from the phase III rights in terms of ownership, the economic question becomes how to split the value of product intangibles between phase II rights versus phase III rights.
If remdesivir turns out to be profitable, Gilead Sciences will need to determine and document what represents arm’s length transfer pricing policies.
—Dr. J. Harold McClure is an economist based in New York, NY.
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