Scoring in a recession

Scoring in a recession

Pharmaceutical companies have flocked to excise free zones and this trend is slated to increase. Usha Sharma analyses.

Indian pharmaceutical industry is highly fragmented with more than 20,000 registered units, of which around 250 are large units and 8000 small scale units, with five central public sector units.

Given this fragmented nature of the market, there is severe price competition in addition to government price control. However, medicines being a crucial need of India’s population, as well as a key source of export revenues, the government was compelled to frame industry-focused policies from time to time to incentivise industry players. One such measure was constituting excise free zones.

In the last few years several Indian pharma companies such as Piramal Healthcare, Alembic, Dr Reddy’s Laboratories, Ranbaxy Laboratories, Alkem, Sun Pharma, Zydus Cadila, Cipla, Mankind Pharma, Ozone, Panacea Biotech, Elder Pharma, Torrent Pharmaceuticals, Plethico Pharmaceuticals, Lupin, Indswift Lab, Unichem Laboratories, Indoco Remedies, Morepen, Klitch Drugs, Nector, Surya, Cachet, Indchemie, Galpha Laboratories, VVF etc. have shifted or partly relocated their manufacturing, formulations and processing operations to tax free-districts of Himachal Pradesh (HP), Uttaranchal, Northern Eastern States, Jammu and Kashmir and so on. The excise free zone in Baddi, HP caters to around 60 percent of the domestic pharma demand, with 180 of the 375 leading pharma companies present in Baddi.

“The objective of introducing such incentives in excise free zones was with the intention of development of the state and to drive the state’s future economic growth by increasing the output and thereby generating employment and income at a higher rate,” says Dr Swati Piramal, Director, Piramal Healthcare.

K S Vasu, Chief Financial Officer and Information Technology Head, Fourrts India Laboratories further explains the inception of the excise free zone’s and evolvement. He remarks, “It was evolved in the year 2003 to help the development of backward and hilly areas like Himachal Pradesh, Uttarakhand and Jammu and Kashmir with tax holiday incentives so that industrialisation would help these states grow.”

Growth centres and Integrated Infrastructure Development Centres (IIDCs) can avail of income tax and excise duty exemptions for a period of 10 years from the start of manufacturing.

As per Himachal Pradesh Infrastructure Development Board (HPIDB) study 2008-09, more or less all excise free zones give incentives to pharma companies for example, an approximate 15 percent of investment subsidy on plant and machinery subject to a maximum limit of Rs 30 lakh, 75 percent subsidy on cost of transportation of finished goods / raw materials from the units to nearest rail head, 100 percent exemption from payment of excise duty for 10 years till 2013.

Other incentives include 100 percent exemption from income tax for five years, 25 percent (individuals) and 30 percent (companies) for five years, GST deferment for eight/five years for new industries in certain areas, concessional central sales tax (CST) at one percent for interstate transactions.

Special priority is given to 100 percent export oriented units (EoUs). In addition, no electricity duty is imposed on captive power generated through diesel generators sets (DG). There is a simplified procedure for inspections only in cases of public interest, while other units are on a self-certification basis, enjoying a 50 percent subsidy on the cost incurred for preparation of feasibility report subject to a maximum of Rs one lakh for large and medium and Rs 50,000 for small units.

Further, 50 percent of the costs incurred on development of prototype is reimbursable, subject to a ceiling of Rs 1,000,000 per patent for R&D work undertaken by a company having a registered office in HP.

Reimbursement of maximum of Rs 15,000 per consignment of samples and a total of Rs 50,000 per unit for SSIs, 50 percent of the cost of publishing marketing brochures for export markets and product literature incurred by industrial units and 20 percent subsidy on purchase of pollution control equipment are the other benefits of being present in this zone.

Out of reach

“The objective of introducing such incentives in excise free zone was with the intention of development of the state and to drive the state’s future economic growth by increasing the output and thereby generating employment and income at a higher rate”

– Dr Swati A Piramal Director

Piramal Healthcare

“Baddi in HP has the maximum share amongst excise free zones in terms of production. Neighbouring countries are more keen on Special Economic Zones (SEZ) to welcome business opportunities rather than excise free zones”

– K S Vasu Chief Financial Officer and Information Technology Head

Fourrts India Laboratories

However, not all pharma companies were in a position to take advantage of these excise free zones and incentives. When central excise duty on pharma products was levied on MRP under the new excise policy announced in 2004, it introduced a new element of volatility in the Indian pharma industry. Initial reactions were subdued as players thought it was a temporary order and would be reversed later on. Two years prior to this, state Food and Drug Administrations (FDA) had forced all units to comply with the new Schedule M requirements. Majority of the units, especially small scale units had just finished renovations on their buildings and improved their quality assurance by adding equipment worth crores in their respective units. The result was that even if many companies wanted to shift to the excise free zones, they delayed their decisions expecting a reversal of the new MRP based excise levy. Also, lack of resources and manpower in family owned businesses was another crucial reason why companies decided not TO relocate their business. A majority of law abiding and quality conscious small and medium units were already under lot of debt from the banks due to the increased cost of upgrading their units to meet the revised Schedule M requirements. Various forums assured the industry that they would get the MRP based excise duty reversed and had number of meetings with finance ministry officials which were unsuccessful.

Compulsion to shift

With the migration of manufacturing units to excise free zones, these pharma companies were able to cut down on manufacturing costs. It has virtually created a compulsion for many small and big pharma companies in the country to relocate their business to excise free zones and its upshot has been seen by industry experts during global slowdown.

Industry players located in such excise free zones have thus observed improvement in working capital due to various subsidies and exemptions; such as nil payment of excise duty, charging of concessional CST rates, no electricity duty on captive power generated through DG sets and subsidy on cost of transportation of finished goods/raw materials from the units to nearest rail head. The advantages have become more obvious during the current credit crunch.

“During the time of global downturn excise free zone—based domestic pharma companies have really performed better in comparison with other Indian pharma companies (who do not have a presence in these zones). The excise free zones have really helped the pharma companies especially in their export activity. The key advantage obtained by Indian pharma companies from excise free zones is its proximity to ports (transport facilities) and this makes it cost effective in terms of logistics. I feel it was the most attractive measure which has helped Indian pharma companies save their pennies during this global crisis,” says Sanjit Prasad, Chief Business Officer MCX’SX.

According to an investment review by the Himachal Pradesh Industry Ministry, Baddi had received an investment of over $250 million from this sector when it was first announced. Baddi now has over 500 pharma manufacturing units and 20 leading Indian pharma companies are slated to invest another $225 million. Globally, pharma companies are restricting their investments however this investment review shows that Indian pharma companies seem to be continuously exploring further business opportunities.

Piramal confirms, “For manufacturers, the importance was product manufacturing at a lower cost than those manufactured by the SSI units located in the non-excise free zones and subsidy in capital investment. The direct tax benefits granted on the profits generated by such units helped in improving the cash flow. This ultimately has brought about a positive impact on the performance.”

This scheme is the sole reason why Baddi has become a pharma manufacturing ‘hot spot’ in India and has got the distinction of becoming the largest pharma manufacturing hub of Asia, feels Piramal. “All the major pharma companies of the country have set up their latest state of the art manufacturing facilities in Baddi,” she remarks.

Deduction

States Section Quantum Period Deadline to begin production Specified Area
Jammu & Kashmir 80IB(4) 100% 5 yrs 31.03.05 (Budget) Entire State
30% 5 yrs (31.03.04 Existing)
North Eastern States* 80IC(2)(a) 100% 10 yrs 3/31/2007 Areas specified
80IC(2)(b) (Pharma Ind. not covered) Entire State
Himachal Pradesh 80IC(2)(a) 100% 5 yrs 3/31/2012 Areas specified
30% 5 yrs
80IC(2)(b) 100% 5 yrs 3/31/2012 Entire State
30% 5 yrs
Uttaranchal 80IC(2)(a) 100% 5 yrs 3/31/2012 Areas specified
30% 5 yrs
80IC(2)(b) 100% 5 yrs 3/31/2012 Entire State
30% 5 yrs
Sikkim** 80IC(2)(a) 100% 10 yrs 3/31/2012 Areas specified
80IC(2)(b) 100% 10 yrs 3/31/2012 Entire State

Big chunkies

As major pharma companies moved their manufacturing base to these duty free zones, the industry witnessed lower tax incidence during the past few years due to tax exemptions. Consequently, the net profit margin increased. States seem to be vying to lay out the ‘Welcome mat’ for pharma entrepreneurs, from all over the country, to partner them in their growth plans. State governments strive to provide them quality infrastructure and business friendly environment for smooth implementation of their investment proposals and projects to eliminate delays. These policies have not only improved common man’s access to better health facilities but has also catalysed the growth of the domestic pharma industry, attracting the attention of MNCs looking out for sizable Indian players to partner with/ acquire. It has also helped reduce the cost of outsourcing activities.

“Large pharma companies are focusing on emerging markets to support top line growth and these companies do create a balanced portfolio to maximise growth. Some global players have started showing interest in branded generic pharma companies especially in emerging markets. Baddi in HP is having the maximum share amongst excise free zones in terms of production. Neighbouring countries are more concerned with special economic zone (SEZ) in welcoming business opportunities rather than these types of excise free zones,” reveals Vasu.

* Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland & Tripura
** For the state of Sikkim, the deadline to begin production was reduced from 31/03/2012 to 31/03/2007 by the Finance Act 2007. This was done on the introduction of Section 80IE for North Eastern States (including Sikkim)

States Quantum Period Deadline to begin production Specified area
North Eastern States* 100% 10 yrs Entire State
Jammu & Kashmir 100% 10 yrs Entire State
Sikkim 100% 10 yrs 3/31/2007 Areas specified
Himachal Pradesh 100% 10 yrs 3/31/2007 Areas specified
Uttaranchal 100% 10 yrs 3/31/2007 Areas specified
Source: Piramal Healthcare

Other facilitators

“The key advantage obtained by Indian pharma companies

from excise free zones is its proximity to ports making it cost effective in terms of logistics. It has helped Indian pharma companies save their pennies during global crisis”

– Sanjit Prasad Chief Business Officer

MCX’SX

Pharmexcil an autonomous export promotion council (EPC) was set up by the Ministry of Commerce and Industry, Government of India, with the objective of focusing on exports of healthcare and pharma products in the global arena. Normally Pharmexcil establishes or extends operations in these zones for developing the pharma industry in excise free zones and shaping trade policies. Every company exporting goods needs to submit its annual returns to Pharmexcil giving details of the exports made during the year. Simultaneously, Pharmexcil also collects the export data from the various ports all over India, informs Piramal.

The trend of industry growth also shows that the announcement of excise and income tax free zones were welcomed by small and medium industries equally, particularly those who were engaged in contract manufacturing who intended to keep their business intact and on the growth track.

Piramal informs that, “A broad overview states that maximum benefit of this programme has been availed by big companies for improvement of operating margins, which is reflective of the fact that most of them have extended their operations to these zones. This is because pharma companies were offered sops such as 100 percent excise exemption for 10 years from the date of manufacturing, income-tax exemption for five years and sales tax levy of just one percent for 10 years.”

Speaking on the same line Vasu avers, “All such SME companies have set up units in these so-called tax heavens; Himachal Pradesh, Uttaranchal, Jammu and Kashmir and North East states to keep going. And small and medium size units who have ventured into contract manufacturing have also migrated to excise free zones to take advantage of the benefits at right time.”

u.sharma@expressindia.com