The Internal Revenue Service and GlaxoSmithKline (“GSK”), a U.K.-based pharmaceutical company, announced the settlement of a long-standing transfer pricing dispute, resolving all issues in the case. Under the settlement agreement, GSK will pay the IRS approximately $3.4 billion of tax and interest to resolve the dispute for the 1989-2005 tax years. According to the IRS, this is the largest single payment ever made to resolve a U.S. tax dispute.

The IRS proposed approximately $4.5 billion in tax deficiencies for the 1989-2000 tax years. For the same period, GSK sought a refund of $1.8 billion. The 1989-2000 tax years were docketed in the U.S. Tax Court (GSK filed the initial protest in April 2004) and scheduled to go to trial in February 2007. If carried forward, the IRS’s theories would have resulted in substantial proposed deficiencies for the 2001-2005 tax years.

Issues in Dispute

The dispute between GSK and the IRS involved intercompany transactions between GSK’s U.S. affiliate and its foreign affiliates, including the U.K. parent company, relating to various GSK pharmaceutical products. Specifically at issue was the level of profits reported by GSK’s U.S. affiliate after making intercompany payments that took into account product and marketing intangibles.

The IRS and GSK disagreed about how much of the residual return from the product and marketing intangibles belonged in the United States. GSK took the position that its U.S. affiliate was a mere distributor tasked with routine marketing and selling functions in the United States. To the extent that valuable intangibles contributed to the profits from the U.S. sale of products, those intangibles were owned and/or developed outside the United States. The IRS argued that GSK’s U.S. affiliate was a licensee and not a mere distributor, and that it was the owner for tax purposes of valuable product and marketing intangibles associated with the licensed products.

The parties also settled GSK’s APA discrimination claim. GSK asserted that the IRS discriminated against GSK because the IRS would not agree to an APA with GSK on terms similar to APAs that the IRS struck with similarly situated U.S.-based pharmaceutical companies. Specifically, GSK alleged that the IRS denied to U.K.-based GSK the transfer pricing treatment afforded by the APA Program to U.S.-based SmithKline Beecham Corp., which merged with Glaxo in 2000.

Ramifications

The size of this settlement is unprecedented and may have significant ramifications on how the IRS pursues transfer pricing cases. The IRS was successful in extracting significant additional tax and interest without risking an adverse decision or additional disclosures relating to the APA program. The IRS was willing to give up a substantial percentage of its proposed adjustments over a 16-year period to achieve that result. The IRS’s historical track record in transfer pricing litigation is mixed at best, and the IRS has come under Congressional and media scrutiny in recent years based on perceptions that it is not enforcing the transfer pricing rules with sufficient vigor. The substantial settlement in this case serves as a powerful counterpoint to those perceptions. IRS Commissioner Everson has stated repeatedly that transfer pricing enforcement is a high priority for the IRS. This settlement may further embolden IRS examiners to aggressively pursue transfer pricing issues, particularly in the context of inbound taxpayers.

For more information, please contact any of the following lawyers:

Rocco Femia, rfemia@milchev.com, 202-626-5823

Kevin Kenworthy, kkenworthy@milchev.com, 202-626-5848

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