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Managing Partner, Law Offices of OMP
Pharma Marketing: Quo Vadis?
There is hardly anything more characteristic of Government regulation in present day Ukraine than the treatment of marketing agreements concluded between pharmaceutical producers and pharmacy chains. Over the past three years the situation has gone from outrageous to ridiculous. The natural outcome is an impasse of sorts. The industry is waiting for the next move by the regulators. The latter are undecided and unpredictable. The problem is unresolved. What is worse, the state authorities do not seem to have anything resembling a strategy.
The discussion below is an attempt to trace the problem from its origins right up to recent developments. Special focus is placed on the varying interests of all the parties involved.
It seems that there has always been something schizophrenic about marketing agreements in Ukraine. Both pharmacy chains and pharma producers were always keen to use them. The terms were straightforward and simple. The producers paid the sellers for the increase in sales. No frills, as simple as that. The remuneration depended on the volume of sales. Of course, there were a few exceptions. These, however, mainly occurred in addition to, and not instead of, the main arrangement. (At times, producers wanted to be nice to all the retailers and were ready to pay a little something to all of them irrespective of the achievement of the targeted volumes.)
It became more complicated when the parties wanted to document their arrangements. The wording more often than not (which is to say, almost always) differed from the substance. Indeed, the most widely-used approach has been (and still is) not to mention any percentage of sales as the basis for remuneration at all. Instead, producers paid retailers for zillions of different services. Often, pharmacies provided information reports worth thousands and even hundreds of thousands of hryvnias. Even more widespread were payments for the visits of the field force. Thousands of visits to each chain. Then, of course, there were priceless publications of promotional materials.
There have always been several reasons for the above mismatch of form and substance. Producers were wary of the possible persecution of the marketing agreements by the Ukrainian authorities. Indeed, their fears have been justified by the ever recurring attention of the antimonopoly agency to any payments made by them to either distributors or retailers. Over the past ten years, the agency could never formulate their overall policy with respect to marketing agreements. As a result, their official statements, initiatives or enquiries were lacking in consistency and resembled a witch-hunt more than anything else.
Retailers shared the above fears. Still, the main driving force for their lack of enthusiasm about documenting actual marketing arrangements appeared to be somewhat different. Unlike producers, pharmacy chains were subject to fewer, if any, compliance requirements. They could afford riskier tax planning strategies. One of these was to have marketing fees paid to tax-exempt intermediaries, mainly individual entrepreneurs. Payments for multiple services appeared to suit such tax plans better than simple performance-linked fees.
Risks of Marketing Duality
Whatever the reasons, any agreements deviating from reality have inbuilt legal and tax risks. Marketing agreements in the pharma field are no exception. While it is highly unlikely is that a party to them will abuse the mismatch of form and substance in court, as antimonopoly and tax investigations might prove devastating.
In terms of tax, marketing agreements are a nightmare. There are three major problems with their tax accounting. First, consider the often obviously inflated prices of various services deemed to be provided under such agreements (information research and analysis, marketing studies, sales statistics, etc.). More often than not the price of the same services provided to the same producer by different pharmacy chains would differ dramatically (if no internal restraints and common sense is exercised the difference may well be 200% or 300%).
The other common malaise of these agreements is the frequency with which certain services are provided. The common examples would be visits by a field force to pharmacy chains or presentations made to pharmacists. With the ever growing amount of fees payable under these agreements, the number of such visits or meetings has the tendency of shooting up to thousands per each chain. It remains unclear whether one can reasonably justify such frequency, not to mention other mind traps. For example, whether the same information was used for all the visits or whether the pharmacists, if questioned, would ever remember what all those meetings were about.
The hottest tax issue with marketing agreements is payments made to private entrepreneurs. As discussed above, one of the main reasons why pharmacies insist on the present form of marketing agreements is their desire to insert intermediaries. These intermediaries are either individual entrepreneurs paying the 5% flat tax or legal entities paying the same flat tax. More often than not individual entrepreneurs have little connection to the pharmacies using them. In many instances, there are doubts that such intermediaries ever pay anything to the relevant pharmacies. In view of the restrictions set by Ukrainian tax law on the maximum amount of income earned by payers of the flat tax, many individual entrepreneurs are used for one marketing service agreement with just one producer. All of the above creates the impression of an artificial scheme the sole purpose of which is tax avoidance.
Previously, the Ukrainian tax authorities have been quite reserved in their treatment of pharma marketing agreements. That approach is changing now. With the general crackdown on individual entrepreneurs and abuse of their tax privileges by big businesses, the companies paying individual entrepreneurs under marketing agreements start receiving requests from the fiscal agency to re-consider their tax accounting of such expenses. Often such requests are satisfied and the respective payments are struck from tax-deductible expenses. The fear is that this is just the beginning.
The main tax risk is that the fiscal authorities would start scrutinizing the services deemed to have been provided under marketing agreements. If that happens, it might prove difficult to justify payments for many services. The irony of the situation is that all payments are valid but for the contractual wording. Unfortunately, the Ukrainian tax authorities might have a strong incentive to disregard the substance and just find faults with the form.
In their present form, pharma marketing agreements can easily be challenged by the Ukrainian antimonopoly authorities. Any subsequent witch-hunt might trigger scrutiny of the mismatch. Why would anyone indeed pay for thousands of unnecessary visits to pharmacies or for hundreds of the same presentations shown to the same pharmacists? Well, unless, of course, this is payment for something else. This agency has always been good at interpreting what else might have been paid for. As is the case with the tax authorities, unfortunately, the risk is that the interpretation would have an anti-industry bias. It is not inconceivable that the paying producers might be suspected or even accused of misusing such payments to manipulate the market or abuse their dominant market position.
Is AMCU To Blame?
The AMCU is not the only reason why the marketing agreements are so artificial. Nonetheless, it is one of the main culprits. This agency has created the perfect excuse for the pharmacies and the perfect bugaboo for the industry to continue with the questionable practice of dual nature marketing agreements.
The antimonopoly authorities never seemed to have any strategy regarding marketing agreements. Instead, they have been trying to apply scare tactics in order to achieve short-term political goals. The main objective appears to have unvaryingly been reducing the price of medicines for the population.
There is no solid evidence that marketing agreements have ever had any tangible influence on the cost of pharmaceuticals. There is overwhelming evidence that the prices skyrocketed following the sharp devaluation of the national currency. However, this has never bothered the antimonopoly agency. Instead, its officials first tried to claim that marketing services should be provided at cost. Following the uneasy dispute with the industry the claim was taken back. Instead, the agency warned that such agreements should be concluded on equal terms and reserved its right to go after agreements with dominant market players. These vague criteria have never been further developed by officials.
Finally, at the end of 2016 the antimonopoly authorities conceded in their market research that Ukrainian law did not regulate marketing agreements. This admission effectively means that these agreements, by and of themselves, may not violate Ukrainian law. Furthermore, contracting parties are free to agree on any terms. Ukrainian law does not restrict contractual terms. Importantly, the antimonopoly authorities should investigate marketing agreements only on an individual basis to the extent they violate or appear to violate Ukrainian antimonopoly regulations.
The latest development in the AMCU’s stand on marketing agreements is undoubtedly a move in the right direction. However, it is the history of the stand-off that is more important to the industry. As is too often the case with the Ukrainian authorities, there was arguably little legal basis for the antimonopoly agency to go after marketing agreements. Unfortunately, this did not stop the officials from trying to meddle in them. Their attempts to achieve political goals outside the scope of their powers would have a lasting effect on the industry. They feed the air of uncertainty and lawlessness when anybody and anything can be prosecuted or outlawed at the whim of the regulator.
Following the past three years of the stand-off with the AMCU, it is quite difficult for producers to argue with retailers who do not want to conclude marketing agreements with remuneration linked to the percentage of sales for the fear of reprisals from the antimonopoly authorities. It was the officials themselves who wanted “cost-based” pricing, although they could not justify that claim later and duly withdrew it.
None of the driving forces of the mismatch of form and substance of the marketing agreements in pharma is gone. If anything, the latest decisions by the AMCU prove that the agency is still searching for its policy line on pharma. We might be in for many more unexpected twists and turns. One of the current focuses appears to be market abuse by producers of leading medicines. It is quite likely that marketing budgets would draw the attention of the regulator.
At the same time, the risks brought by the mismatch are now higher than even a year ago. The Ukrainian tax authorities have always focused on marketing services as potential money laundering and a tool for tax abuse. Combining marketing services and individual entrepreneurs often invites tax audits. Even without individual entrepreneurs, producers and retailers might be hard pressed to justify many of the services.
It is high time the industry reconsidered its attitude towards marketing agreements. The ideal world scenario would be to describe the real arrangements of the parties, i.e. remuneration linked to sales. While the above might not be achievable with all the pharmacies, it is definitely worth trying to pursue.
One of the strategies of minimizing the risks of antimonopoly is to try and obtain clearance from the antimonopoly agency for a particular marketing agreement used by the producer. It should be noted, however, that such clearance would apply only to the wording submitted to the AMCU and only to the extent that real life arrangements do not deviate from it substantially.
For those pharmacies refusing to change the old ways and the producers willing to put up with the associated risks, it is important to mitigate at least the most serious tax risks. Thus, the risk of criminal charges may be effectively mitigated by producers if they insist on the provision by pharmacies of comfort letters or copies of agency agreements with individual entrepreneurs. Furthermore, it is advisable to discontinue the practice of disparate payments for the same services provided by different pharmacy chains. At the very least, the difference should be obvious and based on sound business rationale. (It is not unusual that bigger pharmacies would charge more than smaller ones. However, the difference should not defy common sense.)
Whatever the marketing arrangement, we would recommend exercising care in those cases where the producer is promoting a market dominant product or explicitly attempting to increase its market share to the clear detriment of its competitors.