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Executive Summary

Federal tax writers should permit the orphan drug research or R&D tax credits to be transferred to another company by not-yet- profitable start-ups, CytRx President and CEO Jack Luchese recommended during testimony before the House Ways & Means Committee. The panel held hearings April 9-10 on expiring tax measures, including the orphan drug and research and development tax credits. Representing the Association of Biotechnology Companies, Luchese recommended "first and foremost" that the R&D credit be made permanent. In addition to extending both credits, the committee should also consider "developing creative ways for small, pre-commercial companies to utilize the R&D or orphan drug tax credits, perhaps by allowing small pharmaceutical development companies to pass on the tax credits to specific classes of investors." Luchese recounted for the committee CytRx's experience in developing RheothRx, an orphan drug for the treatment of sickle cell anemia, including the setback in its financing strategy when CytRx learned it could not pass on its orphan drug credit. Upon preparing to initiate Phase II trials in 1989, Luchese said the firm became "painfully aware" of the need for more financing. "We were approached by several consultants familiar with our technology and our financial situation. They suggested that we consider an R&D partnership for $ 10 mil. which would fund the sickle cell development program. We all thought that the orphan drug tax credit could be passed on to our investors as part of the incentive for this long-term, high-risk investment. Half way through the process, we discovered that we could not pass on the orphan drug tax credit as we were not 'engaged in the trade or business' by the tax law. We were in a 'Catch 22' since we could not raise money to develop our products because we were not selling products to qualify as being in the trade or business." Luchese said the Georgia-based company's efforts to make the partnership work included an attempt to "target a $ 3.3 mil. private placement of equity in CytRx" appealing to Black investors since the drug was being developed for sickle cell treatment and offering to have the Board of Directors "agree to put up $ 400,000 of their own money." He said: "We failed, as the offering did not raise even one dollar." Along the way, the firm ran up $ 125,000 in attorney and tax accountant fees, administrative costs and the like and, in November 1989, terminated the partnership effort "because we did not have enough cash to pay the attorneys to finish the job." Two months later, "we were successful in raising $ 1 mil. through a private placement of equity and were able to continue operating until we licensed our technology to the company that offered us the best licensing deal -- Burroughs Wellcome." Although small companies "are the source of much innovation in the biotechnology pharmaceutical industry," Luchese added, many in search of long- term capital face a choice between abandoning their efforts or being "absorbed by a large pharmaceutical company, possibly a foreign company." The White House Council on Competitiveness biotech working group also has commented on the hurdles small, not-yet-profitable firms face in taking advantage of the R&D and orphan credits. In its February "Report on Biotechnology Policy," the group said it plans to reexamine tax policies that disadvantage start-up firms ("The Pink Sheet" Feb. 25, p. 7). A House Ways & Means Committee staffer pointed out that while the pass-on idea may have some appeal, it would be difficult to target it only to the pharmaceutical or biotech industries, while broader eligibility for a pass-on would likely be seen by many legislators as too costly. CytRx's Luchese also urged the House panel to allow the orphan drug credit to be used for all direct costs associated with clinical studies and toxicology research. Current law allows only "in-house" costs to be counted, he noted, but many small firms do not have such research capabilities. The costs of contracting with outside organizations to conduct such studies currently may not be applied toward the credit.

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