How life sciences businesses transform the tax and finance function

The impact of this disruption is felt very keenly in life science’s tax and finance functions, and is only expected to get worse. As capital is directed to R&D and M&A, for many companies, it leaves less available to invest in enabling functions. Meanwhile, the trend toward an increased level of bolt-on acquisitions, joint ventures, strategic partnerships, and spin-offs means the volume of data sources and data manipulation requirements is increasing along with the augmented volume of transactions and compliance requirements.

The challenge for tax and finance teams is further exacerbated by continual proposed global tax legislation that could fundamentally transform international tax compliance requirements, and expand sustainability responsibilities, resulting in additional compliance and reporting. These realities of increased change and heightened filing requirements exist simultaneously with cost reduction pressures, so headcount and departmenal funding are not likely to expand to match the workload, thereby increasing organizational risk.

Ana Maria Romero, EY US-East Operating Model Effectiveness Transfer Pricing Leader for Life Sciences, points out that as a highly profitable, IP-driven sector, transfer pricing is already a significant component of the tax planning and compliance work performed by life sciences tax departments. Global tax reforms, such as BEPS 2.0 will have major implications for transfer pricing and every aspect of the tax lifecycle – from provision to planning to compliance, and ultimately to controversy. 

“Tax departments are likely to find themselves struggling with increased compliance requirements arising from BEPS 2.0,” says Romero. In addition, “they could find themselves managing hundreds of transfer pricing audits at the same time.” Most companies, she says, lack resources and funding to take on this additional workload.

In response, many life sciences organizations are now starting to reimagine their tax and finance functions to realign tax and technology capabilities with the contemporary cost pressures on routine activities. The EY 2022 Tax and Finance Operations (TFO) Survey found that 84% of companies in the sector plan to do so, while 95% said their organization would be reallocating budgets over the next two years, from routine activities such as tax compliance, to strategic activities including legislative planning and controversy. 

However, the survey also revealed that life sciences tax and finance functions face several key barriers to delivering on their purpose and vision: 37% said they lack a sustainable plan for data and technology; 32% cited the inability to identify, evaluate and respond to legislative and regulatory change; and 24% pointed to the inability to hire and retain required talent. 

With the regulatory landscape shifting fast, the reporting requirements will only increase. As discussed above, life sciences is a highly profitable sector, which leaves it exposed to tax legislative changes and to increased levels of controversy, as governments seek to recoup tax revenues in the wake of COVID-19 recovery and amid other disruption.

Yet the digitalization of reporting will also be important here. Complying with increasingly common digital tax filing requirements will further increase the workload, cost and risk profile of the life sciences tax and finance function.

According to the EY TFO Survey, companies are responding with an estimated average spend of $10.6m in tax technology over the next five years, while many are also turning to third parties for support – with 46% saying that the most significant benefit of partnering with a provider to co-source their multi-country tax compliance and statutory reporting activities is reduced risk, followed by cost reduction (31%).

The technology challenge

As well as tax authorities demanding increased volumes of digital data, some in real-time, companies in the sector can expect huge pressure in the system due to the volume of data and required calculations from a raft of new regulations.

“Large multinational companies are already now having to access, transform and extract insights from significant volumes of data that they've not historically had to think much about,” says Rick Fonte, EY Global Health Sciences & Wellnesss Tax Leader. “Can they even access that data from their current systems efficiently? If so, can they transform and organize the data so that it’s usable across all provision, planning and compliance processes – so people can actually make sense of it and draw meaning from it?”

Companies on average already spend 40-70% of their time on gathering and making data useful – a data point that seems so contradictory to the automation capabilities available today. “Once you take into account BEPS 2.0 and ESG, the data challenge becomes more complex and onerous,” Fonte adds.

While automation is one of the key enablers, current technology uptake among life sciences organizations generally lags. For instance, only 27% use cloud-based platforms extensively, and only 20% use automation extensively. Many IT systems and processes were set up for how finance runs the business, not taking into consideration the granularity of the data and reporting required for tax.

Many organizations will be looking to upgrade their ERP systems in the near future. In response, life sciences tax functions need to ensure their data and technology needs are communicated and incorporated into the early planning phases of any ERP project. “This isn’t a tax department problem; it’s an overall company problem,” says Ronald van den Brekel, EY Global Head of Transfer Pricing Strategy and Innovation. “The data sources are going to come from finance, HR and legal, and the systems need to be built to accommodate that fact.”

Tax teams have an opportunity, through these upgrades, to create the proper tax detail. Take, for example, stock keeping unit (SKU) level pricing inclusive of full transfer pricing being developed into the ERP. Doing so also benefits the broader business by helping functions including financial planning and analysis be able to forecast profitability more accurately.

Then there’s the co-sourcing option. According to the EY TFO Survey, the most significant benefits of partnering with a provider to build a comprehensive data and technology transformation strategy and solution for the in-house tax function are reduced tax risk profile (48%) and increased value (29%).

“Nobody’s going it alone, nor should they be, let’s put it that way,” says Fonte. Some of the biggest organizations who still have well-funded and resourced IT and technology infrastructures may try to build new solutions themselves, he says. But even they are relying much more heavily on external advisors and third-party tools, especially in light of the requirements of BEPS 2.0 Pillar 2. “The tax rules are too complex, they are changing quickly. As a result, it is often expensive and too risky to internally build and maintain custom in-house solutions.” 

Another challenge facing life sciences organizations is how to attract and retain tax and finance specialists, even as the workload becomes more challenging. This arguably has been made worse by The Great Resignation – the trend of people leaving roles for a change of lifestyle, or to seek greater purpose and fulfillment.

The escalating legislative, data and compliance requirements, the uptick in bolt-on acqusitions and other strategic collaborations, and the focus on supply chain resiliency and alternative business models all have tax impacts, which means more work. Yet many organizations still have the same number of people, many of whom lack the additional digital skills required in today’s environment, all trying to figure out how to do more with less budget.

“People are getting burned out, there are a lot more options in terms of employers and work locations, so if the work environment is deemed unhealthy or not rewarding, people will leave,” Fonte says. “So, many companies are experiencing significant turnover and a challenging and competitive recruiting environment, and that revolving door is another strain on the department.”

At the same time, the type of people these organizations need is evolving, too. In order to add value, tax professionals now need to be data- and tech-savvy – 92% of respondents to the TFO Survey said that tax and finance personnel will have to augment their tax technical skills with data, process and technology skills in the next three years, from a moderate to very large extent. 

There’s also a desire to shift talent focus from routine to strategic processes – respondents feel that 76% are spending an inappropriate amount of time on data, and 67% said the same about tax compliance. This is work that could easily be co-sourced in order to spend more time on high-value activities including communications with stakeholders, tax planning, and risk management. 

Life sciences leaders are more actively embracing the ESG agenda, acknowledging that it reflects the tastes of existing and prospective employees, investors, customers and ecosystem partners. As a result, time spent by tax and finance functions on governance and reporting to key stakeholders is set to increase significantly.

Life sciences companies will need to focus on identifying and quantifying the sustainability-driven incentives and funding available to their firms, while also determining the impact of proposed or implemented sustainability taxes.

This modeling will also need to consider the direct and indirect tax impact of changes to a company’s development or supply chain of products. Furthermore, the trend of making more data available to more parties discussed above will be the amplified by the governance pillar of ESG.

Life sciences tax and finance functions will need to actively participate in their company’s reporting strategy to ensure that there is consideration of potential tax risks of public reports on sustainability. Tax and finance functions will have an opportunity to properly convey a comprehensive picture of the social and tax contributions (both direct and indirect) that are made. Lastly, tax functions will need to not only assess the impacts but distinguish a process to identify required tax filings needed to comply with new sustainability measures in all of the locales that they operate.

The ability to meet the expectations of shareholders will be significantly dependent on the availability of data, much of which is not typically sensitized or analyzed by the tax and finance function today. In order to have the flexibility model or report the requisite sustainability information to public authorities, or shareholders, enabling functions will need to assess their data gaps and collaborate on their data strategy. Centralized access to data, paired with proper establishment of key analytics, will be the gold standard for tax and finance functions to manage the pace of change that will be driven by internal and external sustainability pressures.

New tech-driven data analysis and reporting systems offer these companies an opportunity to harness the data to show their true contribution, helping them present themselves as they wish to be seen. 

Life sciences organizations are facing an unprecedented confluence of challenges – and a distinct set of sector-specific cost pressures. They are deploying whatever capital they can into acquisitions and product development, not their back-office functions. Yet, while expressing an intention to transform their tax and finance functions, 87% are planning to reduce budgets – by an average of 5.4%. Meanwhile, 82% are more likely than not to co-source select tax and finance activities in the next 24 months. 

Those life sciences companies with large international footprints are likely to co-source and/or seek technology solutions for their international indirect tax compliance – VAT and GST – as it involves a lot of filings including monthly, quarterly and annual, significant volume, and highly transactional and data-intensive work, says Fonte. “Co-sourcing corporate income tax filings for all but maybe a select number of a company’s largest markets also represents low-hanging fruit and is often one of the first areas to be considered, often in connection with indirect taxes.”

“For the US market, both US and non-US headquarted companies, we are seeing a continued trend toward co-sourcing sales and use tax filings, property taxes, business licensing. These areas are high volume and very data intensive, often high touch in terms of the volumes of inquiries received from the authorities, and which can be significantly enabled through available tax technology tools and platforms.”

It’s worth noting that co-sourcing is not a one-size-fits-all proposition. Rather, it’s a unique response to the needs and challenges of each organization. A company’s co-sourcing strategy will depend on myriad company-specific factors, including its geographical footprint; complexity; turnover; how many people they have and want to retain; the skill sets and experiences of the people they have; the current state of their technology and systems (including the number of ERP systems they operate); their ability to access reliable data; where they’ve already made investments, etc.

Which means life sciences companies may each approach co-sourcing in very different ways. “Some companies will package it up and roll it out as part of a single, large transformation effort, often as part of a broader finance transformation,” Fonte says. “But more and more, we’re seeing companies take the time to develop a holistic technology and tax operating model approach, which they implement in a planful way over a period of several years, because it manages the impact, cost and disruption to the organization.” 

He says many companies may believe they are already doing this because they have a bunch of firms hired by their local market finance or tax teams performing a variety of tax activities. “To be clear, that’s not what we consider to be co-sourcing, that’s organized chaos. Without a centralized approach you’ve lost all ability to drive cost and process efficiencies, access and leverage centralized data and analytics, and have in place a governance model capable of enabling global visibility and risk management.”