Features of the excise tax on the pharmaceutical ethanol: current issues

Sekushin Aleksei Yur'evich Postgraduate student; Department of Taxes and Tax Administration; Financial University under the Government of the Russian Federation Consultant; DRT Consulting 15 Verkhnyaya Maslovka str., Moscow, 127083, Russia aleksey.sekushin@gmail.com Other publications by this author

Introduction

In July 2024, a large-scale Federal Law No. 176-FZ dated 07/12/2024 "On Amendments to Parts One and Two of the Tax Code of the Russian Federation, Certain Legislative Acts of the Russian Federation and the Invalidation of Certain Provisions of Legislative Acts of the Russian Federation" was introduced. One of the main changes introduced by this Federal Law is the excise tax on the pharmaceutical substance of ethyl alcohol. According to the explanatory note to the act, the excise tax on the pharmaceutical substance of ethyl alcohol was introduced to curb excise tax evasion schemes in the production of various alcoholic products through the use of ethyl alcohol for medical purposes other than its intended purpose. According to statistics, from 2020 to the first half of 2023, 76 million liters of medical alcohol were withdrawn into the shadow market for the production of alcoholic beverages (https://www.rbc.ru/economics/10/11/2023/654a40979a794738809f9ca4 – date of request: 12/29/2024). Similar statistics are also provided by another source (https://www.vedomosti.ru/business/articles/2024/05/28/1039839-minfin-planiruet-vvesti-aktsiz-na-meditsinskii-spirt-i-spirtosoderzhaschie-lekarstva – date of request: 12/29/2024). These volumes of medical alcohol use in the production of illegal alcoholic beverages demonstrate the relevance of the problem discussed in the article. Companies purchase medical alcohol outside the legal framework and illegally use it for the production of alcoholic beverages^[1]. The quality of these alcoholic products can be extremely low due to illegal operations^[2]. The purpose of the legislator in this case is to make the sale of medical alcohol economically unprofitable for the illegal production of alcoholic beverages. At the same time, the legislator notes that an increase in the tax burden on pharmaceutical companies that produce medicines from the list of pharmaceutical products is excluded. Thus, according to the federal law under consideration, the excise tax on the pharmaceutical substance of ethyl alcohol is introduced for the purpose of introducing into the legal field and controlling the sale of medical alcohol. In addition, the ideology of the new norm presupposes the alignment of competitive conditions between legal producers of alcoholic beverages and those who receive tax savings due to "exciseless" alcohol.

The purpose of the study is to analyze the mechanism of excise taxation of the pharmaceutical substance ethyl alcohol, which is currently the latest concept in the framework of tax legislation and according to which law enforcement practice has not yet been formed.

In accordance with the set goal, the following tasks are defined::

• study of the main parameters of the excise tax on the pharmaceutical substance of ethyl alcohol,
• identification of issues relevant to pharmaceutical companies producing medicines from the pharmaceutical substance ethyl alcohol,
• assessment of the overall impact of this excise tax on the pharmaceutical market,
• a proposal of possible ways to improve the mechanism of application of excise tax on pharmaceutical substances.

Research methods and materials

The achievement of the set goal and the solution of the designated tasks are possible provided that the following general scientific methods are used in the process of research and evaluation of its results:

• deduction and induction – the use of methods makes it possible to improve the quality of work by relying on general scientific principles of conducting research on the theoretical foundations, principles and methods of state financial support for the pharmaceutical industry and ensuring the logic of research;
• analysis and synthesis – the application of this methodology will ensure the construction of a holistic, scientifically based concept for analyzing factors that reduce the effect of applying a new measure of excise taxation of alcohol;
• analogy – this method allows you to transfer previously studied tasks from one area of research to another, while obtaining new results, in particular, it will help you evaluate the possibilities of using various conceptual approaches in the field of pharmaceutical support, justify the optimal combination of such support measures and choose the most appropriate option for Russian practice.

The scientific novelty of the study lies in the refinement of a new approach to state regulation of excise taxation, based on a detailed analysis of legislative norms and rules, as well as an assessment of the effects of their impact on the pharmaceutical industry.

Literature review

Research in the field of taxation of the pharmaceutical industry in most cases touches on general conceptual issues of the influence of tax factors on financial condition and pricing. According to the results of a study by Latin American scientists, the dependence of retail price growth on tax factors and distribution margins differs significantly between countries^[3].

Taking into account information about the margins of the distribution and delivery system, as well as taxes, it was found that, on average, both factors led to a 63% increase in prices on a free-of-charge basis. Let's compare these results with the international indicators of 35 non-Latin American countries obtained in a study conducted by the London School of Economics and Novartis^[4]. The model price increases at the manufacturing plant due to distributors' margins and taxes were 19% and 5%, respectively, for a total of 24% for both components; the similar component in this sample from Latin America was 2.16–4.40 times higher^[5]. Thus, the tax factor has a significant impact on the pricing of medicines, and, consequently, on their availability.

The second aspect studied in the literature is devoted to the study of the role of tax incentives in the production of medicines. The most interesting in this aspect is the study of the American experience^[6]. Since the 1970s, the U.S. government has provided tax breaks to American corporations doing business in Puerto Rico under Section 936 of the Internal Revenue Code (IRC). Firms in the pharmaceutical industry accounted for 50% of tax benefits and 20% of jobs. The tax relief program was abolished in 2006, which led to a natural experiment to study the impact of the abolition of corporate tax benefits on enterprises producing pharmaceuticals and medical equipment. An analysis of panel data on enterprises for 1990-2017 showed that the probability of "survival" of manufacturing enterprises decreased from 90% three years before the repeal of Section 936 of the US Tax Code to about 50% three years after. In pharmaceutical and medical device companies, the decline in production ranged from 3.5% to 6.2%.

Finally, the third aspect that is considered in scientific research is the relevance and expediency of differentiated taxation, of which excise taxes are an element. The methodological basis of the differentiated taxation method was the provisions of the theory of surplus value^[7]. The application of a differentiated approach ensures fairness in taxation^[8], and also takes into account the varying degrees of susceptibility of industries to tax instruments^[9]. An example of such a method of excise taxation is present in a number of countries in the field of collection of payments for the sale of antibiotics. To date, antibiotic taxation schemes have been implemented only in a limited number of countries. An example is the antibiotic tax introduced in Belgium in 2014, based on the amount of active ingredient sold. (https://www.afmps.be/fr/veterinaire/medicaments/medicaments/bon_usage/Antibiotiques_problematique_resistance/taxe_sur_les , date of application: 12/29/2024), as well as the tax on antibiotics for intensive care, introduced in Denmark (https://www.danmap.org/reports/2018 , accessed: 12/29/2024). Using mathematical modeling technologies, American researchers presented estimates of three taxation strategies, 1) taxation of all antibiotics (single tax, FT); 2) uniform taxes for antibiotics with high, medium and low resistance (ST); 3) differentiated taxation scheme (DT)^[10]. The principle of differentiated taxation is that taxation is calculated with a certain frequency or "circles" (every 3 years in the basic version), depending on the prevalence of resistance in the class of antibiotics subject to taxation. For example, if we assume that the prevalence of resistance to three classes of antibiotics is 0.8, 0.5 and 0.25, then the changes in the tax rate will be as follows: 1.6 for the first class (0.8/0.5), 1 for the second class (0.5/0.5) and 0.5 for the third class (0.25/0.5). The results of the study showed the highest regulatory potential of differentiated taxation.

There is no analysis of the literature on the application of excise taxes specifically on pharmaceutical substances. This is largely due to two circumstances: 1) this practice is new for Russia, 2) there is no such mechanism for taxing the pharmaceutical substance ethyl alcohol in foreign countries. (https://www.gov.uk/government/publications/excise-notice-47-duty-free-spirits-use-in-manufacture-or-for-medical-or-scientific-purposes/excise-notice-47-duty-free-spirits-use-in-manufacture-or-for-medical-or-scientific-purposes , accessed: 12/28/2024). The tax legislation of foreign countries suggests an approach that is irrelevant for the Russian tax system, when the pharmaceutical substance of ethyl alcohol is not subject to excise duty and is not considered an excisable product. This confirms the relevance and scientific novelty of the present study, since the approach to regulating the pharmaceutical substance of ethyl alcohol is innovative and requires detailed analysis. At the moment, there is also no work in the Russian segment related to the study of the excise tax on the pharmaceutical substance of ethyl alcohol, which also confirms the relevance of this study.

New rules for the taxation of excise tax on pharmaceutical substances of ethyl alcohol

In accordance with the Tax Code of the Russian Federation, one of the central concepts related to the excise tax on the pharmaceutical substance of ethyl alcohol is the list of pharmaceutical products. This list includes medicines that cannot be used for the production of alcoholic beverages. In accordance with the Tax Code of the Russian Federation, in any case, this list includes medicines in which the proportion of ethyl alcohol is less than 20%. With regard to other medicinal products, by Decree of the Government of the Russian Federation dated 10/28/2024 No. 1437 "On Approval of the Rules for Approving the List of Medicines and (or) Medicinal Products Registered in accordance with the Law of the Eurasian Economic Union and (or) the Legislation of the Russian Federation, as raw materials for the production of which (in the production process of which) the pharmaceutical substance ethyl alcohol is used (ethanol)" ("RF PP No. 1437") introduced criteria. Thus, in accordance with the RF PP, the following medicines are included in the list of pharmaceutical products if:

• the composition of the drug contains more than 20% ethyl alcohol;
• the functional use of the medicinal product is not related to the ingestion of this medicinal product and (or) the characteristics of the alcohol-containing medicinal product specified in the regulatory documentation of the Ministry of Health of the Russian Federation exclude the possibility of using this medicinal product as a substitute for alcoholic beverages.

Currently, there are no lists of pharmaceutical products based on the selected criteria. As noted earlier, the availability of a medicinal product or a portfolio of medicinal products in the lists of pharmaceutical products depends on many features of the excise tax on the pharmaceutical substance ethyl alcohol and the further taxation of alcohol-containing medicinal products with excise tax. Additionally, we will use the diagram to reflect the logic of including medicines in the lists of pharmaceutical products (Figure 1).

Figure 1. Medicines included in the list of pharmaceutical products

Another important feature of this excise tax is the certificate for the manufacture of pharmaceutical products. According to clause 5 of Article 1 of Article 179.2 of the Tax Code of the Russian Federation, a certificate for the manufacture of pharmaceutical products is issued to companies that produce medicines provided for in the lists of pharmaceutical products, which use the pharmaceutical substance ethyl alcohol as raw materials. In other words, if a company has a portfolio of medicines in which there is at least one medicinal product included in the list of pharmaceutical products for the production of which ethyl alcohol is required, then such a pharmaceutical company must obtain a certificate for the manufacture of pharmaceutical products.

According to Article 181 of the Tax Code of the Russian Federation, excisable goods are not medicines that are included in the lists of pharmaceutical products. Thus, if a medicinal product is included in the list of pharmaceutical products, the company does not need to obtain an exemption when selling the medicinal product (this exemption will be discussed further).

In accordance with clause 20.2, clause 1 of the Tax Code of the Russian Federation, the object of taxation is the receipt or registration of a pharmaceutical substance, ethyl alcohol, if the company has a certificate for the manufacture of pharmaceutical products. Therefore, if a company does not have a certificate for the manufacture of pharmaceutical products, since this company does not produce any medicines from the list of pharmaceutical products, there is no object of taxation. However, in accordance with Clause 2.1, clause 1, Article 192 of the Tax Code of the Russian Federation, the sale of pharmaceutical substances of ethyl alcohol is taxed at a rate of 0 rubles per liter in the case of the sale of pharmaceutical substances of ethyl alcohol.:

1. pharmacy organizations;
2. medical organizations;
3. testing laboratories;
4. companies that have a certificate for the manufacture of pharmaceutical products.

In the case of the sale of a pharmaceutical substance of ethyl alcohol to other organizations, the supplier of this pharmaceutical substance must pay an excise tax at the general rates. Thus, if a pharmaceutical company does not have a taxable object when purchasing a pharmaceutical substance of ethyl alcohol due to the lack of a certificate for the manufacture of pharmaceutical products, the full-rate taxable object will arise from the supplier of the pharmaceutical substance (Figure 2).

Figure 2. Excise tax accrual in the presence/absence of a certificate for the manufacture of pharmaceutical products

In accordance with subclause 27, clause 1, Article 183 of the Tax Code of the Russian Federation, the sale of medicines in the territory of the Russian Federation by a company that has a certificate for the manufacture of pharmaceutical products and has calculated the amount of excise tax on the pharmaceutical substance of ethyl alcohol used for the production of alcohol-containing medicines is exempt from excise tax on the pharmaceutical substance of ethyl alcohol. Thus, if a company does not have a certificate for the manufacture of pharmaceutical products, it will purchase a pharmaceutical substance of ethyl alcohol with the excise tax already included without the possibility of deducting it, and it will sell a medicinal product with excise tax in accordance with the rates stipulated by the Tax Code of the Russian Federation for alcohol-containing products. For companies that have a certificate for the manufacture of pharmaceutical products, which, when purchasing a pharmaceutical substance of ethyl alcohol, are required to calculate the excise tax, the possibility of a full deduction of this excise tax is provided. Consider this deduction for companies that have a taxable object when purchasing a pharmaceutical substance of ethyl alcohol.

In accordance with Clause 11.1 of Article 200 of the Tax Code of the Russian Federation, excise tax amounts calculated by a company with a certificate for the manufacture of pharmaceutical products in respect of the pharmaceutical substance ethyl alcohol released into production are subject to deductions. For the purposes of obtaining a deduction, the volume of the purchased pharmaceutical substance, ethyl alcohol, is also important. If a pharmaceutical company purchases less than 500,000 thousand liters of pharmaceutical substance, in order to receive a deduction, the pharmaceutical company does not need to use the pharmaceutical substance of ethyl alcohol for the production of medicines from the list of pharmaceutical products, and there is no need to prepare additional documents. If a company purchases more than 500,000 liters of the pharmaceutical substance ethyl alcohol, for the purposes of deduction it is necessary to use the pharmaceutical substance ethyl alcohol for the production of medicines from the list of pharmaceutical products, as well as to prepare additional documentation. Additional documentation includes:

• register of invoices issued by sellers of pharmaceutical substances;
• the register of documents confirming the registration of a pharmaceutical substance;
• register of acts of decommissioning of pharmaceutical substances into production;
• the register of documents confirming the sale by the taxpayer of medicines produced by him, in the manufacture of which a pharmaceutical substance was used. (clause 11.1 of Art. 201 of the Tax Code of the Russian Federation).

At the moment, these registers, as well as the actual documents required for filling, have not been approved. Moreover, some forms have not yet been developed in the draft order of the Federal Tax Service (Draft Order of the Federal Tax Service of Russia "On Approval of formats, procedures for sending and procedure for submitting documents to the tax authorities provided for in paragraph 11.1 of Article 201 of the Tax Code of the Russian Federation").

According to the Ministry of Finance of the Russian Federation (https://pharmvestnik.ru/content/news/Farmsubstancii-dlya-proizvodstva-lekarstv-chastichno-vyvedut-iz-pod-akciza.html – date of issue: 12/29/2024), the volume of 500,000 thousand liters is sufficient for the production of medicines. Moreover, when manufacturing medicines from the list of pharmaceutical products, as well as when providing supporting documents, companies still have the opportunity to deduct excise tax. It is worth noting that the deadline for paying the excise tax, as well as submitting the declaration, is 9 months (in the case of a long production cycle, 15 months) after the tax period in which the pharmaceutical substance of ethyl alcohol was purchased. This rule applies specifically to the purchase of the pharmaceutical substance ethyl alcohol. These deadlines allow companies to release the pharmaceutical substance of ethyl alcohol into production and, consequently, to deduct the calculated excise tax and not pay the excise tax to the budget. The legislator provided for this provision in order to avoid the situation with the payment of excise tax to the budget for pharmaceutical companies.

Thus, for companies producing medicines from the list of pharmaceutical products, it is possible to produce and sell medicines without incurring an additional tax burden. However, if the portfolio of medicines consists of medicines that are not included in the list of pharmaceutical products, in this case the company faces a significant additional tax burden and a significant increase in selling prices. The new legislation makes the sale of alcoholic beverages under the guise of medical products economically unprofitable. However, if the pharmaceutical production portfolio is completely absent from the list of pharmaceutical products, this excise tax will significantly increase the selling price of medicines for consumers. At the same time, it should be noted that such a situation is unlikely and this circumstance will not affect the pharmaceutical market in general, since modern pharmaceutical companies have developed significant portfolios of medicines and, according to the author, at least several medicines will correspond to the list of pharmaceutical products with the possibility of obtaining a certificate for the manufacture of pharmaceutical products, as well as with further the opportunity to receive a deduction for the calculated excise tax.

Problems of calculating excise taxes on pharmaceutical substances and their solutions

Problem 1. The proposed mechanism for calculating excise taxes on pharmaceutical substances carries potential risks. In particular, the largest pharmaceutical companies, whose portfolio consists of alcohol-containing medicines, upon purchase of more than 500,000 thousand liters, will be required to pay an excise tax on the pharmaceutical substance of ethyl alcohol in respect of medicines that are not included in the list of pharmaceutical products. This situation will arise due to the lack of the possibility of accepting the accrued excise tax for deduction. In this case, the excise tax on the pharmaceutical substance of ethyl alcohol may affect the Russian market of medicines. For example, in the case of the production of a medicinal product that requires 0.25 liters of the pharmaceutical substance ethyl alcohol, the increase in price of the medicinal product in this case will amount to 185 rubles. Given the low cost of alcohol-containing medicines, this increase may be significant for consumers. However, due to the fact that the excise tax on pharmaceutical substances will come into effect on January 1, 2025, it is currently not possible to assess its impact on the Russian market of medicines.

Solution to the problem 1. According to the author, as part of the development directions, it is necessary to provide additional confirmation of the possibility of deducting excise tax on the sale of medicines not included in the pharmaceutical product lists for pharmaceutical companies that purchase more than 500,000 thousand liters of the pharmaceutical substance ethyl alcohol. This proposal will allow large pharmaceutical companies that have a certificate for the manufacture of pharmaceutical products, including those that produce medicines not from the pharmaceutical product lists, to apply a tax deduction and, therefore, not to increase the cost of manufactured medicines containing alcohol.

This proposal can be implemented in the form of an additional document confirming the following facts:

(1) The company is a large pharmaceutical company that manufactures medicines,

(2) a company does not sell medicinal products that are not on the pharmaceutical product list in respect of companies that do not have licenses for the wholesale and retail sale of medicinal products.

The category of "large pharmaceutical companies" should include pharmaceutical companies with an income of more than 2 billion rubles and an average registered number of more than 250 people in accordance with the criteria established by the Russian Federation for the definition of small, medium and large enterprises. A similar practice of preferential taxation applies to VAT when applying the declarative procedure for its reimbursement^[11][12] and will reduce the costs of the state for tax administration of alcohol producers^[13][14]. A significant part of such organizations use tax monitoring, and therefore are in close cooperation with tax authorities and do not use illegal tax optimization schemes^[15][16].

Problem 2. A significant problem for pharmaceutical companies producing alcohol-containing products will be the increased administrative burden (especially when purchasing more than 500,000 thousand liters of the pharmaceutical substance ethyl alcohol). In the new conditions, manufacturers must obtain certificates, submit declarations, and prepare new supporting documentation in order to be exempt from paying excise tax on the pharmaceutical substance of ethyl alcohol. In this context, it is important to note once again that this norm was introduced for the purpose of controlling the production of alcoholic beverages, increasing the cost and charging excise tax for misuse of the pharmaceutical substance ethyl alcohol. Thus, the additional administrative burden caused by the state's attempt to introduce additional control over the production of alcoholic beverages through the misuse of medical alcohol will also fall on bona fide taxpayers operating within the legal framework. It follows from this that, under the new legislation, pharmaceutical companies need to confirm the intended use of the pharmaceutical substance ethyl alcohol in order to avoid additional tax burden.

Solution option 2. It is important to note that it is difficult to propose any effective alternatives, as well as options for reducing the administrative burden under the mechanism used since 2025, and it is necessary to evaluate the results of its practical implementation. However, at the preliminary stage, the possibility of creating in the future a special register of bona fide pharmaceutical manufacturers, whose members will be endowed with administrative advantages, should be considered. For example, they will be subject to a simplified procedure for confirming the intended use of the pharmaceutical substance ethyl alcohol.

Conclusion

Thus, based on the analysis of the excise tax on the pharmaceutical substance of ethyl alcohol, it can be concluded that this tax is aimed at controlling the misuse of medical alcohol in the production of alcoholic beverages, imposing excise taxes on such production in order to equalize its value. As part of the implementation of the new mechanism, pharmaceutical companies face an additional administrative burden regarding the need to confirm the intended use of the pharmaceutical substance ethyl alcohol. It is worth noting that the legislative innovations are aimed at ensuring that pharmaceutical companies only have an additional administrative burden, but not a tax burden.

However, large pharmaceutical companies may have an additional tax burden if they purchase more than 500,000 thousand liters of pharmaceutical substance ethyl alcohol for the production of medicines that are not included in the lists of pharmaceutical products. The proposal presented in this article makes it possible to eliminate the emerging negative effect of increasing the tax burden in the pharmaceutical industry.