The R&D Tax Credit Aspects of the Pet Industry



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        The pet industry has tripled in the past 15 years. Overall pet-related spending is expected to reach an all-time high of $58.5 billion in 2014. This phenomenon can be explained by an increasing concern for pet well being, which translates into a surge in demand for food, medications, and veterinary care products.

        Throughout the country, a growing number of companies support pet ownership by developing innovative solutions for animal care. The present article will discuss recent examples of pet-related innovation and present the federal R&D tax credit opportunity available for companies engaged in such efforts.

 

The Research & Development Tax Credit

        Enacted in 1981, the Federal Research and Development (R&D) Tax Credit allows a credit of up to 13 percent of eligible spending for new and improved products and processes. Qualified research must meet the following four criteria:

  • New or improved products, processes, or software
  • Technological in nature
  • Elimination of uncertainty
  • Process of experimentation

        Eligible costs include employee wages, cost of supplies, cost of testing, contract research expenses, and costs associated with developing a patent.  On December 18, 2015 President Obama signed the bill making the R&D Tax Credit permanent.  Beginning in 2016, the R&D credit can be used to offset Alternative Minimum tax and startup businesses can utilize the credit against payroll taxes


Great Times for the Pet Industry

        Some say that the United States is the most pet-loving country in the world. According to the 2013-2014 National Pet Owners Survey, pet ownership in the country is at a record: in 2012, 68 percent of American households owned a pet.

        This growth in the companion animal population comes hand in hand with a humanization phenomenon. The latest U.S. Pet Ownership & Demographics Sourcebook revealed that, in 2011, six-out-of-ten pet owners considered their pets to be family members. The undeniable emotional affection that people nurture toward their favorite animals has been translated into “financial affection”. As a result, billions of dollars are being poured into the pet care industry, which is expected to keep thriving for years to come.
   
        Overall spending in the pet industry reached a record-breaking amount of $55.7 billion in 2013. The American Pet Products Association expects this indicator to rise by at least 4.9 percent in 2014, totaling $58.5 billion. The following table depicts the estimated cost breakdown for 2014 in comparison to previous years:



        As demonstrated above, consumers’ growing interest in their pets’ wellbeing has created a surge in demand for food, medications, and veterinary care products. In the words of Bob Vetere, president and CEO of the American Pet Products Association, “Health and wellness-related themes represent the most powerful trends across all segments of the [pet] industry and will continue to do so again this year."


Pet Industry Innovation

        The more people see their pets as family members, the more they are willing to spend vast amounts of money to meet their needs and desires. This trend has fueled an expansion and diversification of the pet industry, particularly through the development of novel products and services.
 
Pet Food
        Nutrition is an essential component of pet health. For this reason, pet food has been an important area for innovation, which has enabled the multiplication of new and improved products. Recent examples include pet food lines containing Ester C, for immune system support, and omega-3, for dog’s skin and coat.

         Current market trends include natural and organic ingredients, eco-friendly processes, and a renewed focus on health and wellness, as well as on taste and flavor. The following table illustrates the magnitude of the R&D investments of three major pet food companies from 2013 to 2015:



        In an attempt to tap into the very lucrative pet market, pet food companies are creating innovative products that emulate owners’ dietary preferences and lifestyles. Studies have shown that pet owners are “ingredient-focused” and tend to choose premium products based on the health and wellness standards they apply to their own food choices. According to market research firm Mintel, 12 percent of new pet foods in the U.S. used gourmet ingredients in 2012, while only 3 percent did so in 2005.

        In January 2013, Nestle introduced the Pro Plan Sport dog food, containing the necessary amounts of fat and protein to support pets that take part in their owners’ active lifestyles, such as running long distances and hiking. Adepts of the raw diet can now choose from a variety of raw pet food products. Oma's Pride from Connecticut, for instance, dehydrates raw meats to preserve flavor and nutrients. Similarly, San Francisco-based Rawr produces cat food using raw, all-natural, locally sourced meats and vegetables.
 
        Based in Franklin, Tennessee, Nutro Company is an interesting example of pet food innovation. A subsidiary of Mars Incorporated, Nutro has been in business since 1926. The company focuses on natural pet nutrition and argues that natural ingredients are healthier, safer, and tastier. Nutro’s Natural Choice pet food is naturally preserved with vitamin E and never uses chemicals like BHS, BHT, etc.  It also contains no artificial colors or flavors, no chicken by-product meal, corn, corn gluten meal, wheat, rice flour, soy protein or menadione.

        Mars Petcare and The Nutro Company are building an $87 million Global Innovation Center in Thompson’s Station, Tennessee. The 90-acres campus, which will include four buildings, will host a 28,000-square-foot health and nutrition center. Examples of research efforts should include the creation of food to help with pet obesity and the development a better understanding of nutrition for smaller dogs, which are increasingly popular.
 
        Headquartered in Minneapolis, food-processing company Cargill is the largest privately held corporation in the U.S. The company’s Animal Nutritional Innovation Campus was founded in 1958 and has since gained global recognition.
 
        Cargill’s commitment to state-of-the-art R&D has led to a deep understanding of the nutrient needs of animals and the nutrient composition of the ingredients used to meet such needs. The company bases its innovative formulation systems on groundbreaking Near Infrared Reflectance Spectroscopy (NIRS), a technology that uses light to measure nutrients in ingredient samples. When it comes to pet food, Cargill has focused its innovative efforts on daily nutrient requirements and palatability. The company’s Loyall premium pet foods, for instance, use the proprietary Opticook process to generate less digestive upset and more available nutrition. Similarly, the Dogui and Cati pet food lines are designed to support the health of pets by helping them maintain optimal weight while providing the necessary vitamins and proteins.

        Pet food has also been an important area of research for American universities, particularly when it comes to scrutinizing the nutritional value of different dietary alternatives. Among the best veterinary schools in the country, UC Davis College of Veterinary Medicine recently analyzed 200 recipes for homemade dog food in the largest-ever nutritional evaluation of its kind. The study concluded that, even though many owners prefer to prepare their pets’ food, homemade recipes tend to be a poor choice. Only nine out of the 200 recipes provided all the essential nutrients in concentrations that met the minimum standards established for adult dogs by the Association of American Feed Control Officials.
            
        Likewise, Veterinarians at Colorado State University have researched the consequences of recent dietary trends for pets, particularly the so-called “Paleo for Pets”, or the “ancestral diet”, whose main ingredients are raw meat, bones and organs, typically from sources such as beef, lamb, chicken, and turkey. Their studies pointed toward a variety of risks associated with raw food diets for pets, including 1) an increased risk of contamination with harmful bacteria; 2) nutritional imbalances; and 3) the risk of fractured teeth and intestinal trauma when using bones.

 

New Drugs and Treatments

        The U.S. Food and Drug Administration’s Center for Veterinary Medicine has acknowledged the emergence of three important technologies in animal drug and therapy development.

I.    Stem Cell Therapies can one day change treatment for everything, from heart problems to herniated disks. Today, however, there are more stem cell treatments available for pets than for humans. Due to a relative lack of regulation, animal treatments involving stem cells have been rapidly evolving. They have presented varying levels of effectiveness, from subtle improvements to dramatic changes. Virtually all the commercially available therapies for pets use adult stem cells from fat tissues or bone marrow, which are believed to serve as biological paramedics, rushing to an injured part of the body and secreting proteins that fight inflammation, reduce scarring, and trigger healing. The stem cell procedure to treat arthritis has been particularly successful, improving the mobility and reducing the pain of many dogs. Ongoing studies aim at using stem cells to treat virtually everything, from dry eyes to spinal cord injuries.

        Although the FDA remains cautious regarding the safety and effectiveness of stem cells in veterinary regenerative medicine, a growing number of companies are investing in this emerging alternative. This is the case of California-based Vet-Stem, which has treated more than 10,000 animals over a decade, most of them for arthritis and other orthopedic diseases. The company receives samples of fat tissues from veterinarians and returns the desired stem cells in 48 hours. Likewise, MedVet America, from Kentucky, sells $595 kits that allow veterinarians to process stem cells themselves.

 II.    Though still very recent, the application of nanotechnology to veterinary pharmacology and diagnostic capabilities has shown great promise. Possible areas for innovation include diagnostic tools (nanoprobes), targeted delivery of medications, therapeutic nanomaterials, vaccine antigen vectors, in vivo imagery, and traceability of products of animal origin.

        The research community is particularly focused on using nanotechnology as a new means for drug and vaccine delivery to animals. Studies have aimed at using viral nanoparticles – scaffolds for recombinant viral proteins – as vaccine vectors. Other important areas for research are the nanoencapsulation of active substances, including via oral administration; the improvement of solubility, bioavailability, and efficacy duration of active substances by reducing their toxicity threshold; and the enhancement of vaccine efficacy.

        Further research is necessary to assess the health and environmental risks involved in the application of nanotechnology to veterinarian medicine. Risk assessment methods should contemplate the development of new measuring tools, standardization initiatives, scientific monitoring systems, and communication efforts. DA’s Center for Veterinary Medicine has worked on new protocols for the approval and regulation of nanopharmaceuticals.

III.        Proteomic and genomic clinical biomarkers are also an important area for animal health innovation. In medicine, biomarkers are measurable indicators of the severity or presence of some disease state.

        FDA’s Center for Veterinary Medicine has investigated the use of biomarkers for veterinary purposes. The Medical Countermeasures Initiative (MCMi), for instance, aims to utilize microarrays to rapidly characterize antibiotic resistant genes of bacterial bio-threat agents. Other studies have advocated the use of biomarkers in the diagnosis of heart diseases in dogs and cats. According to a 2013 research by Mark Oyama, a professor at the University of Pennsylvania, biomarker assays can greatly contribute to the accurate differentiation of cardiac and noncardiac causes of respiratory signs and to the detection of preclinical cardiomyopathy. Biomarker testing can also help assess the risk of morbidity and mortality in animals with cardiac disease.

        These new technologies come hand in hand with a new approach to pet healthcare. A growing number of startups aim to develop innovative, revolutionary drugs for dogs and cats. With a combined focus on pets and biotechnology, these emerging players are different from big companies, which work mostly with livestock. When it comes to companion animals, the industry has traditionally limited its offerings to vaccines and treatments for fleas and worms. Instead, this new generation of startups hopes to treat diseases like cancer and arthritis.

        California-based Kindred Biosciences, for instance, is currently developing treatments for osteoarthritis, atopic dermatitis, and pain in dogs. The idea is to reverse the usual scenario where drugs for humans are tested on animals. Going against the tide, the company purchases the active pharmaceutical ingredients of human generic drugs and uses them as basis for new veterinary drugs. Lower development costs should eventually translate into lower drug costs. Kindred Bio’s innovative approach aims to create both effective and appetizing drugs for pets, such as a beef-flavored chewable version of Diacerein, a generic drug used to treat arthritis in humans. Since its initial public offering, in December 2013, the company has raised over $114 million.
 
Headquartered in Kansas City, KS, Aratana Therapeutics is yet another example of innovation in biotech drugs for pets. The company has recently initiated two nationwide market development studies to evaluate its monoclonal antibody for canine T-cell lymphoma, AT-005. Aratana has acquired two other startups, Vet Therapeutics, which was developing antibodies, and Okapi, specialized in antiviral drugs.

        More traditional players in the animal drug industry have also enjoyed their share of success. Pfizer’s animal health unit Zoetis rose $2.2 billion in its initial public offering in January 2013, becoming then the largest IPO from a U.S. company since Facebook. Trying to anticipate the constantly evolving needs of companion animal owners, Zoetis is engaged in innovation aimed at providing better care for pets. Examples of groundbreaking products include Convenia, the first antimicrobial for the treatment of common bacterial skin infections in cats and dogs that provides an assured course of treatment in a single injection, and Palladia, the first drug to be approved by the FDA for treating mast cell cancer tumors in dogs.


Veterinary Care Products and Technology Solutions

        Though significant progress has been made in the pet drug segment, medications are not the only alternative to improve pets’ wellbeing. Innovative efforts have enabled the multiplication of products aimed at answering to a wide variety of needs.

        Headquartered in California, Big Heart Pet Brands has a clear strategy: to win the pet industry game with innovation. The company’s last three product introductions have not only generated more than $100 million in sales over their first two years of existence, but they have also created entirely new product categories. Most of Big Heart Pet Brands’ $2 billion yearly sales come from new products, which are developed by dedicated innovation teams through complex, data-driven research. Recent products include the Milk Bone Brushing, a dental treat clinically proven as effective in cleaning teeth as toothbrushes.

        Another interesting example comes from Colorado-based company Kyjen, which created the Slo-Bowl, a hard-plastic food dish shaped like mazes and labyrinths, which prevent dogs from inhaling their food, a common habit that can be fatal.
 
        Innovation can also help responding to the emotional needs of pets. The iCPooch, for instance, is a video-chat/treat dispenser that works via smartphone, tablet, or computer and serves as a remedy for separation anxiety when owners leave their pets at home.
 
        Created by the manufacturer of dog toys Kong, the Anxiety-Reducing Shirt is yet another innovative solution for pets’ disquiet. Made from a stretchy black fabric, the shirt is designed to soothe dogs with gentle pressure, simulating a hug.

        The veterinary supply business is yet another blooming field for innovation. With 15 state-of-the-art distribution facilities and over 400 partners in the animal health industry, Henry Schein has developed cutting edge solutions for practice management. Headquartered in Melville, NY, the company has created a cloud-based service for inventory control and the AVImark veterinary software system, a practice management solution currently used by over 9,500 veterinary clinics.


Conclusion

        The growth in the population of companion animals comes together with a humanization trend. Pets are increasingly seen as members of the family who deserve to be treated as such. Consequently, pet owners are willing to spend considerable amounts of money to guarantee the well being of their cats and dogs. Innovation is key to responding to a growing demand for pet food, drugs, and veterinary products that effectively meet the needs of our four-legged friends. Federal R&D tax credits are available to assist companies engaged in pet-related innovation.

Article Citation List

   


Authors

Charles R Goulding Attorney/CPA, is the President of R&D Tax Savers.

Andressa Bonafé is a Tax Analyst with R&D Tax Savers.

Charles G Goulding is the Manager of R&D Tax Savers.