The transfer pricing dispute between the Internal Revenue Service (IRS) and Glaxo SmithKline (Americas) Inc. & Subsidiaries (GSK), representing the largest tax dispute in IRS’ history, has been successfully resolved. In order to conclude the dispute, which is still pending in the U.S. Tax Court, GSK will pay the IRS an estimated $3.4 billion, the largest single payment made to the IRS to resolve a tax dispute and abandon its claim seeking a refund of $1.8 billion in overpaid income taxes.

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“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 W. Everson said in a statement announcing the settlement of the dispute. “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.”

The agreement concludes a dispute dating back to the 1980s.

“The treaty-based negotiation process between the U.S. and UK failed to resolve this matter before it went to court in the U.S. This is, frankly, astonishing, given the history of amicable resolution of such matters between these two governments. All multi nationals do business in the
UK and U.S., and tax allocation matters are ever-present,” said Cym H. Lowell,international tax lawyer and author of International Taxes Weekly, when asked about the significance of the settlement.

The Tax Court case concerns “transfer pricing,” an accounting method requiring that related parties engage in transactions at arm’s length to ensure proper reporting of taxable income. The Tax Court dispute for years 1989-2000 involves intercompany transactions between GSK and certain of it foreign affiliates relating to various GSK “heritage” pharmaceutical products. Specifically at issue is the level of U.S. profits reported by GSK after making intercompany payments that took into account product intangibles developed by and trademarks owned by its United Kingdom parent, and other activities outside the U.S. and the value of GSK’s marketing and other contributions in the U.S. Under the settlement agreement, GSK has conceded over 60 percent of the total amount put in issue by the two parties for the years pending in Tax Court.

GSK and the IRS have also reached agreement for tax years 2001 through 2005, with respect to the transfer pricing issues in those years.

IRS Chief Counsel Donald Korb praised the extraordinary efforts of the Manhattan-based trial team handling the case in bringing about such an outstanding result for the government. “I am often asked the question,” Korb said, “whether the Chief Counsel lawyers are being constantly outgunned by the large law firms they face in the big dollar cases in the Tax Court. During my tenure as Chief Counsel it has become quite evident to me that our lawyers can go up against the best firms the private tax bar has to offer in the Tax Court and achieve quite successful results.”

This settlement exemplifies the IRS’s continuing commitment to resolve transfer pricing disputes through responsible and innovative agreements that embody the arm’s length standard for related-party transactions – or through litigation when necessary. “Transfer pricing that allocated an appropriate return to the U.S. affiliates of multinational groups is a key focus for the IRS,” said Mr. Korb. “We are pleased that GSK has chosen to put this controversy behind it. Our decision to accept GSK’s settlement offer reflects our commitment to resolving transfer pricing controversies without litigation, provided that our ultimate goal of compliance is not compromised.”

“The exposure to double taxation, which seems apparent in the settlement and failure of the treaty negotiation process, is a serious threat to the reported earnings of any CFO’s company," Lowell added. "Effective tax rate is a pivotal issue for multinationals, as well as a career-defining element for tax executives. Under the principles of Sarbanes-Oxley Section 404, as well as the pertinent financial accounting standards (FASB 109 and the new FIN 48), the current and potential treatment of
uncertain tax matters is a potential nightmare for any CFO.”

The resolution of the Glaxo case will likely encourage the IRS to assert similar theories against other mutlinationals, according to Lowell, thus ensuring that transfer pricing issues will remain the single biggest tax issue for most multinational companies.