The R&D Tax Credit Aspects of Biological Drugs

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        After a decade of glooming perspectives, the pharmaceutical industry is making a strategic shift towards biologics. Biological drugs are not only a source of targeted and personalized treatments but also a promising field for innovation.

        This article will discuss the reappraisal of pharmaceutical R&D and examine the innovative prospects around biological medicines. Moreover, it will present the tax credit opportunities available for companies engaged in eligible biologics R&D activities. 

The Research & Development Tax Credit

Enacted in 1981, the federal Research and Development (R&D) Tax Credit allows a credit of up to 13% 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 19, 2014, President Obama signed the bill extending the R&D Tax Credit for 2014 tax year.

The Reappraisal of Pharmaceutical R&D

        Recent years have brought a wave of optimism over the pharmaceutical industry. Research and development productivity is rising and the perception of long-term trends is increasingly positive.  The confident view of pharma stocks, however, hasn't been around for long. The last decade was haunted by the feeling that experimental drugs were not a good investment. As a result, pharmaceutical companies were poorly valued - often at slightly higher than expected sales of existing products.

        In a few words, the last decade witnessed a victory of skepticism over innovation. Even though the sales of "blockbuster" drugs enabled companies to invest in new industrialized R&D techniques, which used machines to identify potential new products, efforts proved worthless and returns on investment were disappointing. In a context of "patent cliffs" and consequent new approved
            medicinescompetition from generics, one could have believed pharmaceutical companies to be doomed. 

        Fortunately, the winds have been changing for the pharmaceutical industry. After a period of pessimism, investors seem willing to reward commitments to science and innovation. The proof: since 2012 the price of various pharmaceutical companies in the equity market has mounted. In the words of Flemming Ornskov, chief executive at Shire Pharmaceuticals, "Science is back in the high street. There is a return to the realization that innovation is the key driver. (...) it is about creating a differentiated product with people focused on medical need and comparative data."
        Evidence supports this renewed emphasis on R&D. In 2012, the U.S. Food and Drug Administration approved 39 new drugs, an exceptionally high number, since 1996. Figure 1 below, originally published by the Center for Drug Evaluation and Research, presents the number of new medicines approved per year since 2003. Novel medicines are referred to as new molecular entities (NMEs).   

        The accompanying Figure 1, originally published by the Center for Drug Evaluation and Research, presents the number of new medicines approved per year since 2003. Novel medicines are referred to as new molecular entities (NMEs).

        Optimism is not restricted to the U.S. The Deutsche Bank expects the European-based pharmaceutical companies to generate around $27billion from new products over the next three years.  The unavoidable question is, what has changed?

The Drugs of the Future

        A recent shift towards biological drugs can help explain the surge in pharmaceutical R&D productivity. The pursuit of more effective and personalized treatments has lead to a new focus on complex molecules. As a result, pharmaceutical companies are showing unprecedented interest in buying biotechnology companies or licensing their products. Roche and Sanofi, which recently made acquisitions in the biotech field (Genentech and Genzyme, respectively), exemplify this trend.

        Also referred to as biologics, proteins, specialty drugs, or "large molecules", biological medicines are medications derived from living material - human, animal, or microorganism. Different from chemically derived drugs, which constitute "small molecules" and present clear-cut chemical structures, biological medicines can be composed of up to 20,000 atoms. With 100 to 1,000 the size of traditional drugs, biologics are much more complex and harder to replicate. Such drugs also interact differently with the body than other medications and are most commonly administered by injection or infusion. 

        Generally speaking, the benefit/risk comparison for biologics can be significantly better than traditional drugs, often resulting in abbreviated recoveries. This is possible because, unlike chemical-based medicines, biologics are more targeted to diseases. Developed through genetic modification, such drugs present high accuracy as they search for the diseased cells to be treated. Moreover, by accounting for genetic differences, biologics can provide more "personalized" treatments, specially designed for certain subgroups of patients. 

        Most biologics currently used are monoclonal antibodies (MABs), including the world's second bestselling drug, Humira. Different from regular antibodies, which are a part of every immune system, MABs are modified in order to treat specific diseases. Thus, they are able to find the diseased area of the body, including cancer cells. This targeted approach allows for safer and more effective treatments with fewer side effects.   
According to IMS Health, biological drugs already represent about 25% of the $320 billion spent on medications in the U.S. every year.  Expectations are that this segment will continue to grow, commanding an even larger share of the prescription drug market in the years to come. 

        Biological drugs have been largely used to treat a number of conditions, such as rheumatoid arthritis and psoriasis, cancer, blood irregularities, and autoimmune and neurological disorders. The cancer treatments Avastin, Herceptin, and Rituxan, as well as the drugs for rheumatoid arthritis and psoriasis, Humira and Enbrel, are good examples of highly diffused biological medicines. 
Currently, half of the world's ten top-selling drugs are biologics.

Figure 2 below, recently published by professional prognosticator, EvaluatePharma, presents the complete list of top 10 U.S. drugs:

Product Company Sales
Humira Abbvie 4.4
Abilify Otsuka Holdings 4.1
Seretide/Advair GlaxoSmithKline 4.0
Lantus Sanofi 4.0
Enbrel Amgen 4.0
Cymbalta Eli Lilly 3.9
Remicade Johnson&Johnson 3.6
Rituxan Roche 3.3
Neulasta Amgen 3.2
Crestor AstraZeneca 3.2

Biologics R&D

        Biological drugs have emerged as promising alternatives for pharmaceutical companies struggling with patent expirations. The acquisition of Weyth by the giant Pfizer, in 2009, was a clear example of this strategic shift.  More recently, Merck announced the construction of a new biologics research facility in Kenilworth, NJ. This was seen as an attempt to overcome the patent loss of the company's successful Singular.

        Companies engaged in biologics R&D activities may be entitled to significant federal tax credits. The following paragraphs list a few promising domains for innovation efforts:

I.    Disease understanding: Understanding the mechanisms involved in different diseases is key to the development of innovative biological treatments as well as to the improvement of existing ones. MedImmune, the global biologics R&D arm of AstraZeneca, specifies a few indispensable aspects of disease understanding, notably, therapeutic area-specific biology, cell biology, pharmacology, pharmacokinetics, pharmacodynamics, and translational science. 

II.    Engineering new therapeutic antibodies: As a result of R&D efforts, scientists have been able to harness the innate power of antibodies in order to create medicines, particularly against cancer. A few molecular engineering techniques stand out as promising areas for innovation. 

        Glycoengineered antibodies, for instance, have modified sugar molecules that contribute to enhancing the immune system's ability to attack cancer cells.  Similarly, bi-specific antibodies have shown promise as a source of therapy. Designed to recognize two different targets, they may one day constitute powerful tools to fight the multiple mechanisms of cancer.

        Some cancer cells, however, do not respond well to typical two armed antibodies. For this reason, R&D efforts have also focused on developing one-armed or monovalent antibodies. 

III.    Access to data: Access to larger volumes of information is at the heart of the emergence of biological drugs. Enhanced capacity of collecting and processing biomedical data has favored the development of innovative therapies. The use of systematic techniques such as electronic medical records and databases can greatly contribute to further advances in this domain. Particularly, the conversion to electronic records will help reduce the gap between Big Data of DNA research and biological therapies, fostering innovation. 

        Currently, specific medical software has been developed to assist biologics R&D efforts. Merck & Co., for instance, has worked in partnership with PerkinElmer Informatics to develop a workflow management solution specially tailored for its biologics research. The resulting integrated platform supports structured data, results, and sample tracking in biological drugs R&D. The company expects to benefit from this improved data capturing ability, particularly as a means of assessing productivity and engaging in comparative analyses. 

IV.    Neurological therapies: With the aging of the baby-boom generation, neurological diseases, such as Alzheimer's, affect a growing number of people.  Therefore, biological therapies for brain disorders are an important field for R&D activities.

        One major obstacle has hindered the development of such therapies, namely, the blood-brain barrier (BBB). The BBB guarantees the separation of blood and brain extracellular fluid in the central nervous system. It also obstructs the delivery of therapeutic agents to certain regions of the brain. 

        Recent research in mouse models has shown the potential of bi-specific antibodies using the transferrin receptor (TfR) to boost antibody uptake in the brain. However, safety liabilities need to be addressed before TfR-based therapeutics are successfully developed. 

V.    Antibody-Drug Conjugates:
According to the American Cancer Society a total of 1,660,290 new cancer cases and 580,350 cancer deaths are projected to occur in the United States in 2013.   Even though important R&D efforts are underway, the challenge of balancing benefits and side effects in cancer treatments is yet to be overcome.

        Antibody-drug conjugates (ADCs) are an emerging option for targeted treatment of cancer. ADCs are monoclonal antibodies (mAbs) linked to a biologically active cytoxic (anticancer) payload or drug by chemical linkers with labile bonds. By combining the unique targeting capabilities of mAbs and the cancer-killing properties of cytoxic drugs, ACDs reduce the impact of chemotherapy on healthy cells. 

        ACDs research and development activities have proved very promising. This new line of therapy, often referred to as highly potent biopharmaceutical drugs, is very technically challenging, as it must combine innovations from biotechnology and chemistry.  Genentech, a leading biotechnology company headquartered in South San Francisco, CA, currently has 15 ACDs being studied for 11 types of cancer.

VI.    Biosimilars:
  Biosimilar drugs are copycat "generic" versions of brand-name biologic drugs.  As a biological drug, biosimilars are derived from living material - human, animal, or microorganism, which makes them more complex and expensive than traditional drugs. A majority of U.S. states have passed laws favoring biosimilars and the Food and Drug Administration recently approved the first biosimilar drug for distribution in the United States.  The widespread introduction of biosimilars could mean lower health care expenses therefore benefiting patients, insurers, and the government.

        Many of these biosimilars have been available in Europe for almost a decade, however, the approval of the drugs in the U.S. has been slow coming because until now regulators couldn't figure out how to approve knockoffs that were highly similar but not exact replicas.  In Europe, biosimilars typically cost 15% to 30% less than the brands which they replicate.  The cost competitiveness of biosimilars could therefore trigger more competition, which would drive down costs in the U.S. which currently spends $376 billion a year on pharmaceuticals .   It is estimated that the lower priced biosimilar drugs could save the U.S. $47 billion over the next ten years.  Companies investing in biosimilar R&D must focus on safety concerns and on getting the necessary FDA approvals for commercialization.


        Biological drugs have restored faith in pharmaceutical innovation. By combining more effective treatments and reduced side effects, biologics are conquering an ever-growing share of the prescription drug market. Investments in R&D activities have shown great promise, particularly when it comes to disease understanding, molecular engineering, data gathering and processing, and the development of biosimilars. Federal R&D tax credits are available to assist companies investing in eligible biologics innovation activities.

Article Citation List



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 a practicing attorney with experience in R&D tax credit projects for a host of industries.

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