On September 25, 2014, the IRS released Private Letter Ruling (PLR 201436001), addressing whether a corporation operating in the pharmaceutical field meets the Section 1202 / QSBS criteria of being a “Qualified Trade or Business”.
The company in question in this PLR:
- works with pharmaceutical clients to commercialize experimental drugs.
- performs research, development, manufacture, and commercialization activities.
- tests drug effectiveness, manages clinical testing, and manufactures drugs.
The company develops processes to achieve the above, and uses its own facilities as well as its own intellectual property.
Under 1202(e)(3), businesses in various service industries are excluded from identifying as a qualified trade or business. The law specifically excludes health services as well as consulting services when the expertise of one or more of its employees is the primary business asset. However, in this ruling the company in question was found not to fall under this classification.
The ruling notes:
Company is not in the business of offering service in the form of individual expertise. Instead, Company’s activities involve the deployment of specific manufacturing assets and intellectual property assets to create value for customers. Essentially, Company is a pharmaceutical industry analogue of a parts manufacturer in the automobile industry. Thus, although Company works primarily in the pharmaceutical industry, which is certainly a component of the health industry, Company does not perform services in the health industry within the meaning of § 1202(e)(3). Neither are Company’s business activities within any of the prohibited categories set forth in § 1202(e)(3).
In this instance, a company working with pharmaceutical clients helping to commercialize drugs by using its own clinical and manufacturing facilities was a qualified small trade or business. Although the work performed by the company includes services, the broader nature of its activities is considered drug testing and manufacturing rather than providing individual expertise. Additionally, the company is adjunctive to health services rather than classified as health services.
This ruling could have implications for other pharmaceutical services and “health services” companies. However, note that private letter rulings apply directly only to the taxpayer who requested the ruling and cannot serve as official precedent.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.