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Home > English > Communiqués > Charitable donations of drugs by corporations Charitable donations of drugs by corporations February 11, 2000
Tax-Driven Practices and Consequences
Personal message by Scott Hillstrom (click here for his message on the e-drug mailing list) dated January 22, 2000:
For a
long time I have been investigating what is causing donations of drugs by US pharmaceutical companies that do not comply with the guidelines . This has led to in-depth discussions with the essential drug experts, NGOs,
Congressional staff, drug company executives, and others. Simply put, the tax scheme in the US creates perverse incentives for donors and the NGOs who receive and forward donated drugs. I have proposed a way to correct
them.The findings and recommendations
resulting from this work are attached. Please take the time to read and comment. To his credit, Cong. Dogget is concerned about this issue and may be in a position to obtain reforms in the law that would tend to reduce
harmful donations. Please address your comments as well to him via Melissa Mueller atmelissa.mueller@mail.house.gov.
We are also in contact with a member of the
press who is interested in the issue. Please be in touch if you have factual information that might bear on the problem.
If we speak forcefully to the issue at this time, there is a possibility of meaningful change.
Thanks for your interest.
Scott Hillstrom
President, Cry for the World Foundation
e-mail: scott.hillstrom@analyticorp.co.nz
Complete text of the results of the investigation with the courtesy of Scott Hillstrom:
1. The Problem
1.1 The Internal Revenue Code in the U.S.1 entitles donors of goods-in-kind to deduct from their taxable income:
The cost of producing the donated drug; plus 50% of the difference between that cost and the wholesale price of the drug; but Not more than twice the cost basis of the goods donated.
Donors receive tax deductions and
are spared the cost of disposing of drugs they can't sell.2 Therefore, U.S. pharmaceutical companies are incensed to donate drugs. Indeed, this is the intention of Congress in allowing the deduction; but sometimes the
incentives produce perverse, unintended consequences leading to needless suffering and even death in the developing world. For example:
Seriously ill people may be treated with inappropriate or impotent drugs that don't work, while they might otherwise have obtained effective drugs that do; Drugs are unusable or misused because they are not labeled in a language used in the locality to which they are sent;
Developed world valuations are
used when drugs are shipped into countries resulting in high duties and shipping costs, draining resources from some of the world's poorest communities;
Some 'dumped' drugs
are improperly disposed of and may find their way to patients through black-market channels resulting in ineffective treatment, illness and death;
Precious resources in
the developing world are consumed sorting out and destroying drugs that are worthless or worse; and Multilateral agencies and national government are impaired in their
efforts to rationalize drug use in developing countries. 3
1.2 The World Health Organization
(the "WHO") has promulgatedGuidelines for Drug Donations (the "Guidelines") to deter noncompliant donations. The Guidelines are generally supported by multilateral agencies, national governments, and others who do not have a direct or indirect economic stake in the U.S. tax benefits of donations. Relief organizations, some pharmaceutical companies, and others who would lose economic benefits generally oppose them. Some who 'officially' support the Guidelines do not, in fact, comply with them. While there is room for honest difference concerning the content and application of the Guidelines in particular circumstances, it is undisputed that the problems they are designed to ameliorate are real and serious; even life threatening to some of the world's poorest people.
1.3 Several U.S. based relief agencies are in the business of providing their tax-exempt organization's services to forward drug donations for corporations seeking to donate drugs. Typically, these charities
distribute the drugs to other relief agencies and governments in the U.S. or in the developing world. Often, they refer to this as "placing a gift", reflecting the fact a donor needs a tax-exempt organization
through whom to make the gift to qualify for the deduction. The livelihood of these charities revolves around accepting whatever gifts that donors have available to give and they aggressively compete to obtain them.
Rejecting donations that may be inappropriate, outdated, or improperly labeled is often contrary to their economic interests. Their revenue is usually linked, directly or indirectly, to the volume of drug donations that
they accept. Thus, like donors, recipient charities have powerful incentives to accept whatever drugs the donor seeks to "place". Following are some examples of practices followed by some of these charitable
agencies.
1.4 Examples of the practices that can be observed in this industry include:
a. Reselling Drugs. A tax-exempt organization accepts a tax-deductible gift and resells it to another relief agency or
a health care provider. Since reselling of donated drugs threatens the deductibility of the gift, the money paid to the reselling agency may be characterized as a "handling fee" or cost reimbursement. Where it
is based on the cost of handling, this is a fair characterization. But where the amount varies based on the type or value of the donated drugs (which are unrelated to the cost of handling), or where handling fees
collected do not reflect the true cost of handling, the money paid is arguably a price received for the sale of the drug. And where the 'gift' by the reseller is conditioned on a quid-pro-quo from the recipient, it is
more likely a sale.
b. Inflated Revenue Reporting. Nonprofit, tax-exempt organizations strive to keep their operating expenses as small a percentage of their revenues as possible. Drugs donated by a U.S. company
to a U.S. charity create an opportunity for the charity to mislead financial donors. Charitable recipients tend to report in-kind drug donations received as revenue based on the wholesale list price of the donated drug.
In fact, drugs are most often donated because they are not commercially marketable are, therefore, not worth the wholesale list price. Moreover, generic equivalents are often available at a small fraction (e.g. 10%) of
the list price of 'branded' drugs. By using the much higher U.S. wholesale list price 4, the charity appears to have dramatically higher revenues making its operating costs, as a percentage of revenue, appear to be much
smaller than they would if the true value of the donated drug were reported. This low percentage is used as evidence to financial donors (who give money rather than drugs) that the charity is a worthy object of their
cash donations. Of course, reporting the wholesale list price may also generate a larger tax deduction for the donor company.
c. Double Counting Revenues. As described above, a tax-exempt organization to whom a
donor company makes a donation may include the inflated wholesale list price of the gift in its revenue. Then, when that organization passes this donation on to another similar organization, that organization may also
include the same donation as its revenue. With two agencies (and maybe more) reporting the same gift as revenue, it appears to the public that twice as much has been donated to charity.
d. Diversion of Funds from
Good Medicine to Bad. Sometimes an agency pays more to obtain a donation from another agency than they could have paid for the generic equivalent. They do this because the 'donation' can be recorded as inflated revenue
while the purchase of a generic must be reported as an expense. The generic equivalent that they do not buy would be appropriate, fresh and properly labeled while the 'donation' that they do buy often is not. The
inferior drug is deliberately accepted in lieu of the generic drug because the charity's benefit from inflating its revenue rather than reporting expense is deemed to be worth the difference. 5
e. Acceptance of
Inappropriate, Short-dated, and Poorly Labeled Drugs. The U.S. drug market is focused on U.S. needs while the developing world's needs are entirely different. 6 Therefore, many donations of drugs are not appropriate to
the needs of the place to which they are sent. Donations often consist of drugs that are being donated because they will expire before they can be legally sold in the U.S. with the result that they are expired by the
time they reach a patient in the developing world. They may, therefore, be ineffective or worse, while their administration drains scarce resources. Even when appropriate and fresh, they are almost always labeled
exclusively in English and are, therefore, not useable in some of the countries where they are sent where English is not spoken.
f. Lack of Regulation. Pharmaceutical drugs need to be regulated in the developing
world for same reasons we regulate them for our own health and safety-they can make people sick and interfere with effective treatment and they can kill. Typically, donors and tax-exempt organizations do not exercise
control over the drugs they distribute, but simply fulfill requests or purchase orders received from relief agencies seeking drugs. In most cases, agencies maintain few records indicating what ultimately becomes of the
drugs they gift-on to agencies in the field. Multilateral organizations and governments have extensively documented the problems created by inappropriate, outdated and poorly labeled drugs. Indeed, the Guidelines were
promulgated to stop them.
2. The Solution.
2.1 Present Law. Since the system is driven by tax benefits to donors, the solution may lie in adjusting the rules to assure that the intent of
Congress is fulfilled when donor companies are allowed tax deductions. IRC Sec. 170(e)(3)(A) already requires substantiation of tax deductions claimed for drug donations (Exhibit A). Congress intended that donors
substantiate donations by showing that:
a. The donation was used for the donee organization's exempt purpose; and
b. It was used solely for the care of the ill, the needy, or infants; and
c. It was not transferred by the donee in exchange for money.
If this intent were put into effect, the problems described above would be substantially solved.
2.2 New Rules. Donors should be required, at a minimum, to document that drug donations were:
a. Appropriate where, when, and as used;
b. Properly labeled so that the packaging could be read by health providers in the location where they were used;
c. Within reasonable time from expiry so that they were safe and effective; and
d. Generally in substantial compliance with WHO's Drug Donation Guidelines.
2.3 Documentation. To minimize uncertainty and furnish a way that donors can be assured that proper donations are rewarded with
deductions:
a. Documentation should be considered reasonable if it is supported by the best good-faith estimates of compliance, and valuations should be limited to reasonable market value rather than
manufacturers' wholesale list prices. Explanations of the rules (as are customarily supplied in the case of many other tax rules) can supply whatever guidelines and examples are necessary to minimize uncertainty; and
b. A 'safe-harbor' should be created so that donors who comply with it will not be at risk that their deduction might be subsequently denied.
2.4 If such a rule is adopted as law, donor companies will require
support documentation from tax-exempt organizations to whom they make contributions. The requirement to produce this will in turn force the organizations to make sure that only proper donations are accepted and that
they are properly handled. This will supply the critical, but presently absent, 'regulatory' effect necessary to the safe distribution of pharmaceutical drugs.
EXHIBIT A
Internal Revenue Code
Sec. 170 IRC
(a) Allowance of deduction
(1) General rule
There shall be allowed as a deduction any charitable contribution (as defined in subsection (c)) payment of which is made within
the taxable year. A charitable contribution shall be allowable as a deduction only if verified under regulations prescribed by the Secretary . . .
(c) Charitable contribution defined
For
purposes of this section, the term ''charitable contribution'' means a contribution or gift to or for the use of . . .
(2) A corporation, trust, or community chest, fund, or foundation . . .
(B) organized and operated exclusively7 for religious, charitable, scientific, literary, or educational purposes, . . .
(e) Certain contributions of ordinary income and capital gain property . . .
(3) Special rule for certain contributions of inventory and other
property (A) Qualified contributions
For purposes of this paragraph, a qualified contribution shall mean a charitable contribution of property described in paragraph (1) or (2) of section 12218,
by a corporation . . . to an organization which is described in section 501(c)(3) and is exempt under section 501(a) . . . but only if 9
(i) the use of the property by the donee is related to the purpose or
function constituting the basis for its exemption under section 501 and the property is to be used by the donee solely for the care of the ill, the needy, or infants;
(ii) the property is not transferred by the donee in exchange for money, other property, or services; [and]
(iii) the taxpayer receives from the donee a written statement representing that its use and
disposition of the property will be in accordance with the provisions of clauses (i) and (ii); . . .
(8) Substantiation requirement for certain contributions
(A) General rule
No
deduction shall be allowed under subsection (a) for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgment of the contribution by the donee
organization that meets the requirements of subparagraph (B).
(B) Content of acknowledgment
An acknowledgment meets the requirements of this subparagraph if it includes the following information:
(i) The amount of cash and a description (but not value) of any property other than cash contributed.
(ii) Whether the donee organization provided any goods or services in consideration, in whole or in
part, for any property described in clause (i).
(iii) A description and good faith estimate of the value10 of any goods or services referred to in clause (ii)
. . .
1 IRC Sec. 170
2 Health regulations require expensive procedures for the disposal of biohazards including many drugs.
3 Guidelines for Drug Donations, Revised 1999, World Health Organization
4 A generic equivalent might be
available for 10% of the branded list price, in which case, the branded price would overstate the true value of the gift by 1000%
5 A World Vision official has reported purchasing donated medicine from MAP
International at a higher price than more appropriate, fresher, better labeled drugs could be bought generically in Europe.
6 Leading causes of death in the developing world include Malaria, dysentery, respiratory infections, etc.
7 Where the primary purpose is to 'dump' inappropriate, outdated, or badly labeled products to save the donor
the cost of disposal the donation is not made "exclusively" for charitable purposes.
8 stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the
taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;
9 Donor companies must produce documents that show the following:
a. the donation was used for the donee organization's exempt purpose; and
b. it was used solely for the care of the ill, the needy, or infants; and
c. it was not transferred by the donee in exchange for money (e.g. handling fees); and
d. the foregoing are substantiated in writing.
10 Current practices uses manufacturers' wholesale list prices what are
patently NOT a good faith estimate since most donations are made for the very reason that the drugs donated cannot be sold.
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