IRS Hopes GSK’s $3.4 Bil. Transfer Pricing Settlement Is Just The Beginning

The Internal Revenue Service's multi-billion dollar settlement with GlaxoSmithKline over transfer pricing is a milestone for the agency in its efforts to better regulate the practice.

GSK agreed to pay the IRS $3.4 bil. to resolve a tax dispute that began in the 1980s in a deal announced Sept. 11.

"Our decision to accept GSK's settlement offer reflects our commitment to resolve transfer pricing controversies without litigation, provided that our ultimate goal of compliance is not compromised," the IRS said.

The IRS has been seeking to crack down on the practice of manipulating prices of transactions between divisions of a single company; changing how income is allocated between related parties can allow companies to shift profits to lower-tax jurisdictions.

The IRS requires transactions within one company to be conducted at "arm's length" to ensure accurate reporting.

"We have consistently said that transfer pricing is one of the most significant challenges for us in the area of corporate tax administration," IRS Commissioner Mark Everson said in a statement.

"The settlement of this case is an important development and sends a strong message of our resolve to continue to deal with this issue going forward."

One analysis of the worldwide profits of nine large U.S. drug firms estimated that almost $10 bil. of profits reported overseas in 2005 should have been taxed in the U.S. (¹ (Also see "U.S. Drug Firms Under IRS Scrutiny For Offshore Income Shifting" - Pink Sheet, 14 Aug, 2006.), p. 7).

The GSK settlement covers tax years 1989 through 2005 and includes the resolution of disputes over taxes paid on heritage Glaxo Wellcome products, particularly the ulcer drug Zantac , the company's best-selling product in the early 1990s.

Other products at issue were Serevent , Zofran , Imitrex , Ventolin , Ceftin , Flovent , Flonase , and Advair .

Specifically, IRS asserts that the company underreported U.S. profits "after making intercompany payments that took into account product intangibles developed by and trademarks owned by its U.K. parent, and other activities outside the U.S., and the value of GSK's marketing and other contributions in the U.S."

The $3.4 bil. settlement "is the largest single payment made to the IRS to resolve a tax dispute," according to the agency. As part of the settlement, GSK is also dropping its claim for a refund of $1.8 bil. in overpaid income taxes.

"Under the settlement agreement, GSK has conceded over 60% of the total amount put in issue by the two parties for the years pending in Tax Court," the IRS notes. The case was set to go to court in February 2007.

In 2004, the IRS issued GSK a statutory notice of deficiency for $2.7 bil. in taxes and $2.5 bil. in interest and penalties for 1989-1996; a notice for $1.9 bil. in taxes covering 1997-2000 followed in 2005 (² 'The Pink Sheet' Jan. 31, 2005, In Brief).

GSK estimated its liability for the 1989-2000 period to be $8.3 bil.; projected forward to include the 2000-2005 period, GSK calculated its total liability exposure at $14 bil. to $15 bil.

"GSK had previously made provision for the dispute and this settlement will not have any significant impact on the company's reported earnings or tax rate," the company said.

"GSK was confident of its position, but in view of the size of the potential financial exposure, as well as the continued level of resource being applied to the case, GSK concluded that it was in the best interests of its shareholders to reach this settlement, thereby removing the costs and uncertainty of future litigation."

In the short term, the IRS is dedicating additional resources to examinations of transfer pricing issues.

The agency also issued proposed regulations in August 2005 that aim to crack down on the use of cost-sharing arrangements for inappropriate profit shifting, and it has established a cost-sharing "issue management team" to coordinate "the identification, development, and resolution of cost sharing issues."

- Brian Marson