Drugmakers are in trouble again. Tax authorities in the small Baltic country Lithuania accuses them of tax evasion and demands that they pay up. A tax audit concluded that some of the pharmaceutical manufacturers, who claimed that they only did “marketing,” in Lithuania, are in fact engaged in “selling.” And if they sell something, Lithuania wants sales tax.
The companies involved were not named, but Eli Lilly, Pfizer and AstraZeneca have come forward and said that they would fight the demands that they pay their taxes. Hence, we assume that they are involved.
It appears that this dispute relates to the fact that drug companies have avoided paying sales tax in Lithuania by sending invoices to local wholesalers and pharmacies in Lithuania from their operations outside Lithuania, instead of sending the invoices from their Lithuanian affiliates. Full story in the Baltic Times.
This is not the first time the major drug makers are in tax trouble.
The biggest tax scam on earth has a very innocent sounding name. It is called “transfer prices.” Abuse of transfer prices is a key tool many multinational corporations use to fool the U.S. and other jurisdictions to think that they have virtually no profit; hence, they shouldn’t pay any taxes.
Last year U.K.-based GlaxoSmithKline (GSK), one of the largest pharmaceutical companies in the world, was forced to pay $3.4 billion to the IRS to settle a transfer pricing dispute dating back 17 years. The IRS alleged that GSK improperly shifted profits from their U.S. to the U.K. entity.
And Merck, the famous U.S. drug company, also settled with the IRS, paying them $2.3 billion. According to the IRS, one of the schemes Merck used to cheat American tax payers was by setting up a subsidiary in tax-friendly Bermuda. Merck then quietly transferred patents for several blockbuster drugs to the new subsidiary and then paid the subsidiary for use of the patents. The arrangement in effect allowed some of the profits to disappear into Merck’s own “Bermuda triangle.”
Merck also faces legal action in Canada for $1.8 billion dollars in back taxes and interest “related to certain inter-company pricing matters.”
For companies in certain businesses, such as pharmaceuticals, it is very easy to simply “invent” the price a company charges their U.S. business for buying the company’s product which they manufacture in another country. And if they charge enough, poof; all the profit vanishes from the US, or Canada, or any other regular jurisdiction and end up in a corporate tax-haven. And that means American, Canadian or Lithuanian tax payers don’t get their fair share.
Of course, no company should have to pay more tax than they are legally obligated to, and they are entitled to locate to any low-tax jurisdiction. The problem starts when they use fraudulent transfer pricing and other tricks to artificially shift their income to a tax-haven.
According to current OECD guidelines transfer prices should be based upon the arm’s length principle – that means the transfer price should be the same as if the two companies involved were indeed two independents, not part of the same corporate structure. Reality is that standard operating procedure for multinationals is to consistently bend this rule. And why shouldn’t they? After all, it takes 17 years for them to pay up, per the GSK example above, even when they get caught.
There is only one problem for U.S. companies with this strategy, and that is that if they repatriate this money to the U.S. they have to pay full corporate taxes. In fact, according to BusinessWeek, U.S. multinational corporations have built up profits of as much as $750 billion overseas, much of it in tax havens such as the Ireland, Bahamas, and Singapore to avoid the stiff 35% levy they'd face if they repatriated the funds back into the U.S.
To rectify this problem, Congress generously provided for a one-time provision in the corporate tax code, so that multinational corporations could repatriate profits earned before 2003, and held in foreign subsidiaries, at an effective 5.25% tax rate.
And so the game goes on.
The people left holding the bag are you and me.
- Peter Rost, M.D. is a former VP of Pfizer and the author of Killer Drug and The Whistleblower.