On September 25, 2025, the U.S. District Court for the Western District of Michigan issued its long-awaited opinion in Perrigo Co. v. United States. Perrigo is a global manufacturer and distributor of over-the-counter (OTC) drug products. Perrigo's expansion beyond the U.S. began in the late 1990s. It identified Prilosec, then a prescription drug with omeprazole as the active ingredient, as an attractive opportunity for a generic OTC competitor once Prilosec switched to the OTC market. While Perrigo tried to develop a generic omeprazole product in-house, its efforts initially were unsuccessful, and Perrigo concurrently looked to unrelated drug manufacturers as potential partners to bring the product to market. In 2004, Perrigo identified an unrelated Israeli company, Dexcel, that was developing a generic OTC omeprazole product. Perrigo, through U.S. affiliate L. Perrigo Company (LPC), entered a supply and distribution contract with Dexcel in 2005 where, if Dexcel's omeprazole product was successfully launched, LPC would distribute the product in the U.S. and the companies would split the resulting profits. Later, LPC assigned its rights to the Dexcel contract to Perrigo LLC (LLC), a new disregarded entity wholly owned by Perrigo Israel Trading Limited Partnership, a new Israeli affiliate, both of which were formed in November 2006. LLC then subcontracted the U.S. distribution obligations back to LPC. The assignment of the Dexcel contract from LPC to LLC was documented in a written agreement signed at the end of Perrigo's 2007 fiscal year and was effective as of November 2006. The distribution arrangement between LPC and LLC was memorialized in a written intercompany agreement signed in January 2010, with an effective date of November 2006. The omeprazole product developed by Dexcel launched in 2008 and was wildly successful. 

The IRS audited Perrigo's 2009-2012 tax years and reallocated LLC's income from the Dexcel contract to LPC based on two alternative grounds: (1) the assignment of contract rights from LPC to LLC lacked economic substance and therefore should not be given effect for tax purposes under various judicial doctrines, and (2) virtually all of the income from the contract was rightly earned by LPC under section 482. Perrigo paid the asserted taxes, penalties, and interest and sued for a refund in federal district court. 

The court agreed with Perrigo that the intercompany assignment of contract rights did not violate the economic substance doctrine or other related sham doctrines. In support of its position, the government pointed to the retroactive execution of the intercompany agreements (perhaps, according to the government, after Dexcel's generic omeprazole product's success was a sure thing), LLC's lack of employees and functions, and the inadequate capitalization of LLC until years after the assignment. Thus, the government argued, LLC could not have satisfied its obligations or borne the risk that was inherent in the Dexcel contract. The court made factual findings contrary to the government's position. The court found that the assignment of the Dexcel contract to LLC was part of the company's overall globalization initiative and therefore furthered a genuine business purpose. Perrigo sought expert advice from an accounting firm to structure its expanding international operations in an efficient manner. Furthermore, the court found that formal execution of the intercompany agreements with an earlier effective date within the same fiscal year was not uncommon for large corporations and other evidence supported that the assignment actually occurred in 2006. While tax minimization was a strong driver of the arrangement, the court concluded as a matter of fact that it was not the only driver, which was sufficient to defeat the government's sham theories.

The court also rejected as arbitrary and capricious the government's alternative reallocation of income under section 482 using a discounted cash flow (DCF) analysis, in particular rejecting the use by the government of ex-post data. The court held that the arm's length price must be determined based on the information that was known or should have been known at the time of the transaction (i.e., the ex-ante approach). Perrigo's DCF analysis used financial projections prepared for non-tax purposes as of the date of the assignment (November 2006) to determine a net present value (NPV) of the Dexcel contract rights. The court found that this approach, with modifications, was the most reliable method to determine the arm's length price. Those modifications included a rejection of the use of fully loaded distribution costs actually incurred by LPC (again rejecting ex-post data) and of differential discount rates to convert the lump-sum NPV to a royalty rate. Following these modifications, and based on a submission from the government's expert, the approach endorsed by the court appeared to result in an effective royalty of 11.12 percent (pending computations). This is roughly double the effective royalty advanced by the taxpayer in litigation (5.25 percent), but it is still closer to the taxpayer's position than the government's position (a 21.5 percent royalty).

We expect that the district court's ruling in Perrigo will be appealed and taxpayers should watch the case for further developments. The court's opinion is nevertheless noteworthy for its discussion of the common law economic substance and related judicial doctrines as an alternative tool to reallocate income between affiliates of a multinational enterprise. The Internal Revenue Service (IRS) has increasingly used the economic substance doctrine in recent years and the Perrigo opinion is unlikely to change that trend. The case addressed the common law economic substance doctrine and not the codified doctrine in section 7701(o), enacted in 2010. The opinion is also noteworthy for its discussion of the permissibility under the arm's length standard of using ex-post data in the context of pricing transfers of intangible property. The discussion is particularly interesting given the IRS's recent clarification of its position regarding the application of the regulatory periodic adjustment rules, which rely on ex-post data. 

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