In conducting a comparability analysis, it may be important to consider the stage of development of particular intangibles. It is often the case that an intangible is transferred in a controlled transaction at a point in time before it has been fully demonstrated that the intangible will support commercially viable products. A common example arises in the pharmaceutical industry, where chemical compounds may be patented, and the patents (or rights to use the patents) transferred in controlled transactions, well in advance of the time when further research, development and testing demonstrates that the compound constitutes a safe and effective treatment for a particular medical condition ...

For example, a pharmaceutical product will often have associated with it three or more types of intangibles. The active pharmaceutical ingredient may be protected by one or more patents. The product will also have been through a testing process and a government regulatory authority may have issued an approval to market the product in a given geographic market and for specific approved indications based on that testing. The product may be marketed under a particular trademark. In combination these intangibles may be extremely valuable. In isolation, one or more of them may have much less value. For example, the trademark without the patent and regulatory marketing approval may have limited value since the product could not be sold without the marketing approval and generic competitors could not be excluded from the market without the patent. Similarly, the value of the patent may be much greater once regulatory marketing approval has been obtained than would be the case in the absence of the marketing approval. The interactions between each of these classes of intangibles, as well as which parties performed functions, bore the risks and incurred the costs associated with securing the intangibles, are therefore very important in performing a transfer pricing analysis with regard to a transfer of the intangibles. It is important to consider the relative contribution to value creation where different associated enterprises hold rights in the intangibles used ...

Amgen, in a note to its financial statement for the quarterly period ended June 30, 2021, disclosed that it has been issued tax assessments of approximately $3.6b plus interest for tax years 2010, 2011 and 2012 by the IRS. Proposed adjustments for FY 2013, 2014 and 2015 has also been issued.  The dispute relates to the allocation of profits between Amgen group entities in the United States and the U.S. territory of Puerto Rico. According to the note, Amgen has filed a petition in the U.S. Tax Court to contest the assessments. 4. Income taxes The effective tax rates for the three and six months ended June 30, 2021, were 16.8% and 12.6%, respectively, compared with 11.2% and 10.4%, respectively, for the corresponding periods of the prior year. The increase in our effective tax rate for the three and six months ended June 30, 2021, was primarily due to the non-deductible IPR&D expense arising from the acquisition of Five Prime. The effective tax rates differ from the federal statutory rate primarily as a result of foreign earnings from the Company’s operations conducted in Puerto Rico, a territory of the United States that is treated as a foreign jurisdiction for U.S. tax purposes, that are subject to a tax incentive grant through 2035. In addition, the Company’s operations conducted in Singapore are subject to a tax incentive grant through 2034. These earnings are also subject to U.S. tax at a reduced rate of 10.5%. The U.S. territory of Puerto Rico imposes an excise tax on the gross intercompany purchase price of goods and services from our manufacturer in Puerto Rico. The rate of 4% is effective through December 31, 2027. We account for the excise tax as a manufacturing cost that is capitalized in inventory and expensed in cost of sales when the related products are sold. For U.S. income tax purposes, the excise tax results in foreign tax credits that are generally recognized in our provision for income taxes when the excise tax is incurred. One or more of our legal entities file income tax returns in the U.S. federal jurisdiction, various U.S. state jurisdictions and certain foreign jurisdictions. Our income tax returns are routinely examined by tax authorities in those jurisdictions. Significant disputes may arise with tax authorities involving issues regarding the timing and amount of deductions, the use of tax credits and allocations of income and expenses among various tax jurisdictions because of differing interpretations of tax laws, regulations and relevant facts. In 2017, we received a Revenue Agent Report (RAR) and a modified RAR from the Internal Revenue Service (IRS) for the years 2010, 2011 and 2012 proposing significant adjustments that primarily relate to the allocation of profits between certain of our entities in the United States and the U.S. territory of Puerto Rico. We disagreed with the proposed adjustments and calculations and pursued a resolution with the IRS administrative appeals office. As previously reported, we were unable to reach resolution with the IRS appeals office. In July 2021, we filed a petition in the U.S. Tax Court to contest two duplicate Statutory Notices of Deficiency (Notices) for 2010, 2011 and 2012 that we received in May and July 2021. The duplicate Notices seek to increase our U.S. taxable income by an amount that would result in additional federal tax of approximately $3.6 billion, plus interest. Any additional tax that could be imposed would be reduced by up to approximately $900 million of repatriation tax previously accrued on our foreign earnings. In any event, we firmly believe that the IRS’s positions in the Notices are without merit and we will vigorously contest the Notices through the judicial process. In addition, in 2020, we received an RAR and a modified RAR from the IRS for the years 2013, 2014 and 2015 also proposing significant adjustments that primarily relate to the allocation of profits between certain of our entities in the United States and the U.S. territory of Puerto Rico, similar to those proposed for the years 2010, 2011 and 2012. We disagree with the proposed adjustments and calculations and are pursuing resolution with the IRS administrative appeals office. We are currently under examination by the IRS for the years 2016, 2017 and 2018. We are also currently under examination by a number of other state and foreign tax jurisdictions. Final resolution of these complex matters is not likely within the next 12 months. We believe our accrual for income tax liabilities is appropriate based on past experience, interpretations of tax law, application of the tax law to our facts and judgments about potential actions by tax authorities; however, due to the complexity of the provision for income taxes and uncertain resolution of these matters, the ultimate outcome of any tax matters may result in payments substantially greater than amounts accrued and could have a material adverse impact on our condensed consolidated financial statements. We are no longer subject to U.S. federal income tax examinations for the years ended on or before December 31, 2009. During the three and six months ended June 30, 2021, the gross amounts of our unrecognized tax benefits (UTBs) increased $50 million and $110 million, respectively, as a result of tax positions taken during the current year. Substantially all of the UTBs as of June 30, 2021, if recognized, would affect our effective tax rate ...

For example, a pharmaceutical product will often have associated with it three or more types of intangibles. The active pharmaceutical ingredient may be protected by one or more patents. The product will also have been through a testing process and a government regulatory authority may have issued an approval to market the product in a given geographic market and for specific approved indications based on that testing. The product may be marketed under a particular trademark. In combination these intangibles may be extremely valuable. In isolation, one or more of them may have much less value. For example, the trademark without the patent and regulatory marketing approval may have limited value since the product could not be sold without the marketing approval and generic competitors could not be excluded from the market without the patent. Similarly, the value of the patent may be much greater once regulatory marketing approval has been obtained than would be the case in the absence of the marketing approval. The interactions between each of these classes of intangibles, as well as which parties performed functions, bore the risks and incurred the costs associated with securing the intangibles, are therefore very important in performing a transfer pricing analysis with regard to a transfer of the intangibles. It is important to consider the relative contribution to value creation where different associated enterprises hold rights in the intangibles used ...

The Canadian Supreme Court ruled in the case of GlaxoSmithKline Inc. regarding the intercompany prices established in purchases of ranitidine, the active ingredient used in the anti-ulcer drug Zantac, from a related party during years 1990 through 1993. The Supreme Court partially reversed an earlier determination by the Tax Court, upholding a determination by the Federal Court of Appeals in its conclusion that if other transactions are relevant in determining whether transfer prices are reasonable, these transactions should be taken into account. However, the Supreme Court did not determine whether the transfer pricing method used by GlaxoSmithKline Inc. was reasonable, and instead remitted the matter back to the Tax Court ...

A Turkeys Pharma Company carried out drug production, import and sales operations, and had purchased different active ingredients from foreign group companies. Following an audit the tax office found that the prices paid by the Pharma Company for six ingredients had been above the market price resulting in a hidden distribution of profits. A price study was performed for similar active ingredients suggesting price deviations ranging from 167 – 975 % Table 2: Price deviation from market price Theophylline 167.26%ibuprofen 478.34%Fluoxetine 975.15%Hyoscine-N-Butilbrüm 150.13%Povidone Iodine 176.83%metamizolesodi 260.05% An assessment was issued where the cost of the ingredients – and thus taxable income of the Pharma company – was adjusted based on the price paid for similar active ingredients between unrelated parties. The Pharma Company disagreed with the assessment and brought the case before the tax court. The Tax Court issued a decision in favor of the Pharma company. In a study from the Turkish Pharmaceutical Association it was stated that active ingredients could have different prices due to reasons such as using original methods, impurities, crystal structure and polymorphism, mesh size, batch size, certificate differences etc. Based on this study the Tax Court found, that although it had been determined that the Pharma Company had purchased active ingredients at higher prices compared to other companies, there was no clear information about the characteristics of the active substance, production factors, or other factors that will cause price differentiation. This decision was appealed by the tax authorities. The Court of Appeal approved of the decision issued by the tax court and dismissed the appeal. Click here for translation ...

Fulford India Ltd. imported active pharmaceutical ingredients (APIs) from related group companies and sold them in India. The TNM method was used for determening transfer prices. The tax administration found the CUP method to be the most appropriate. Fulford India argued that the CUP method requires stringent comparability and any differences which could materially affect the price in the open market should be taken into consideration. In the pharmaceutical world, APIs whith similar properties may still be different in relation to quality, efficiancy, impurities etc. Therefore, the two products cannot be compared. In court, it was further explained that Fulford also performed secondary manufacturing functions, converting the APIs into formulations. Hence, Fulford could be descriped as a value added distributor. The Court concluded that the selection of the best method should be based on functional analysis and the characterisation of the transactions and the entities. The fact that Fulford had secondary manufacturing activities had not previously been explained to the tax authorities. Accordingly, the case was returned to tax administration for a revised assessment ...

A Korean pharma corporation produced and sold finished pharmaceuticals. Active ingredients were imported from foreign related parties in the United States and Ireland. The Korean pharma corporation produced and sold the original finished products by importing the five original patented raw materials that had expired from the patent period in each business period from December 1, 2001 to November 30. The tax authorities calculated the normal price of the original raw materials by a comparable third party pricing method. As for the specific methodology, the median price of imported generic raw materials for other domestic pharmaceutical companies was calculated by multiplying the ratio between the original product and the medical insurance price of the drug (generic finished product) produced by the domestic generic raw material by other domestic pharmaceutical companies. After calculating the normal price of the raw materials, the difference between the original price of the original raw materials and the difference between the original price and the normal price of the raw materials was included in the income. The tax authorities filed a law suit against the company for the disposition of a corporate tax levy, which had the following points:there are significant differences between generic drugs (or their raw materials) and original drugs (or their raw materials) in terms of customer loyalty,was not a market price reflecting the difference in quality but a government regulation price, which is an indicator of finished products, andwas not correlated with the import price of raw materials, so it was pointed out that it was inappropriate as an index to adjust for significant difference. Judgement of the Supreme Court “Generic raw materials in this case have the same composition and molecular structure as the original raw materials of the case and their efficacy, ie biological efficacy, do not seem to be much different, so the rest of the generic raw materials It would be possible to derive reasonable normal prices through such adjustments to the import prices of generic raw materials in this case. The medical insurance drug price does not include the consideration of the market value of the drug and its raw materials in the decision process, and furthermore, it is not considered whether the raw material of the drug is original or generic. And the upper limit is also determined by the number of items listed on the same ingredient formulation and the upper limit of the listed ingredients. Therefore, the price of the original finished product in the case of the health insurance drug price and the price of the generic drug It is hard to say that the adjustment method that utilizes the difference between drug prices can not be a way to rationally eliminate differences in consumer loyalty etc. that have a significant impact on the import price of generic raw materials in this case.” The Supreme Court concluded that if the original drug (or raw material) and generic drug (or raw material) are different in terms of customer loyalty, sales method and cost structure, and if the difference can be reasonably adjusted, it was possible to derive a reasonable normal price. The problem was whether rational adjustments could be applied to take into account the difference in price between the original drug and the generic drugThe Supreme Court held that such an adjustment could not be made, at that the assessment issued by the tax authorities was illegal. Click here for English translation ...

Smithkline is a manufacturer of pharmaceutical products. During the period relevant to this appeal, 1981 to 1986, Smithkline manufactured a drug named Tagamet, the active ingredient of which is cimetidine. During those years, Smithkline bought cimetidine from related corporations outside Canada. All of the assessments under appeal are based on the Crown’s allegation that the price paid by Smithkline for cimetidine during that period was $66,982,990 more than would have been reasonable in the circumstances if Smithkline and its suppliers had been dealing at arm’s length. Following an audit the tax authorities issued assessments increasing Smithkline’s taxable income for 1981 to 1986 by a total of $66,982,990, and also reflect consequential adjustments to the investment tax credits for 1986 and 1987 and non-capital losses for 1987 to 1990. The increased income resulted from application of the CUP method. Smithkline filed notices of objection against all of these assessments. The Tax court dismissed the objections and decided in favor of the tax authorities. Judgement of the Court of Appeal The Court upheld the decision of the Tax Court and dismissed the appeal filed by Smithkline. Excerpt “[32] In this regard, it must be recalled that the Crown, based on the OECD Guidelines, has chosen to employ the CUP method for determining an arm’s length price for cimetidine. However, the OECD Guidelines also describe alternative pricing methods that the Crown has chosen not to employ. The choice of method depends upon finding appropriate comparators, which in turn depends upon analysis of points of difference and similarity between the structure, operations and activities of Smithkline and the various candidates for comparison (in this case, potentially all other Canadian pharmaceutical manufacturers). That might, at least in theory, include such things as profit margins and profitability. [33] At the commencement of the pre-trial discovery process, Smithkline might have had a basis for attempting to discover information in the possession of the Crown that could lead to a train of inquiry that would explain why and how the CUP method was used in this case, or that would discredit either the use of the CUP method or the manner in which it was used, including the choice of comparator. In theory, such information might be subject to disclosure even if the Crown undertook not to use it at trial, because such an undertaking would not derogate from the fact that the information might have proven to be of assistance to Smithkline in strengthening its own case or weakening that of the Crown. [34] However, in this case, the examinations for discovery took quite a different course, with the result that it is not necessary to reach any conclusion as to whether information about the profitability or profit margins of other pharmaceutical manufacturers is discoverable in pre-trial proceedings on the basis of a liberal reading of the pleadings. Nor is it necessary to deal with the arguments of the Crown that the degree of relevance associated with the requested information is so marginal that it would not justify the extraordinary effort it would require for the Crown to assemble and present it, or that section 241 of the Income Tax Act obliges the Crown to keep the information confidential despite Smithkline’s entitlement to pre-trial discovery. [35] Prior to the commencement of the examination for discovery, Smithkline must have been aware of the theoretical connection between subsection 69(2) of the Income Tax Act and the many factual problems that may arise when trying to compare enterprises and their transactions. If information about the relative profit margins and profitability of potentially comparable pharmaceutical manufacturers was ever in the Crown’s possession (and there is a factual dispute on that question), the door to its discoverability closed on February 23, 1999 when counsel for Smithkline completed the examination for discovery of Mr. Truckle without asking for it. [36] The door could have been reopened in one of two ways. First, it could have been reopened with leave of the Tax Court in a motion under subsection 93(1) of the Tax Court of Canada Rules (General Procedure). The hurdle faced by Smithkline in a motion to reopen an examination for discovery is well illustrated by the following comments of Prothonotary Hargrave in McLeod Lake Indian Band v. Chingee (1998), 149 F.T.R. 113 (T.D.), dealing with a similar provision of the Federal Court Rules, 1998. He said this at paragraph 18 (emphasis added): To require Harry Chingee, whose discovery has been concluded, to answer further questions, the Plaintiffs must establish a special reason to do so. Here I have in mind Rule 235 which provides that “Except with the leave of the Court, a party may examine for discovery any adverse party only once.”. This rule is a watering down of what was, until about 1990, Rule 465(19) which required special reason in an exceptional case in order to obtain further discovery. The present form of the rule, however, ought not to be interpreted so as to easily allow further discovery, once an examination has been concluded, for discovery must, at some point, come to an end. In the present instance I would deny further discovery because the material on which counsel wishes to examine was available at the time of the discovery of Harry Chingee and, with diligence, might have been [put] to him at that time. [37] Second, the door could have been reopened in the context of a question arising out of information provided after February 23, 1999 to fulfil an undertaking, to correct or clarify a previous answer, to answer a question taken under advisement, or to answer a question to which an objection had been made. [38] Counsel for Smithkline argues that the Crown, in its various letters after February 23, 1999 culminating in the October 20, 2000 letter, opened the door by implicitly suggesting a comparison between the profit margins and profitability of Smithkline and other companies. I do not interpret the Crown’s comments in those letters as suggested by counsel for Smithkline. The Tax Court Judge ...

Cyanamid Philippines, INC was engaged in the marketing of various products in the areas of pharmaceutical, animal health and nutrition, and crop protection chemicals as well as medical devices. The tax authorities issued an assessment for deficiency income tax, arising from (a) overstatement of cost of goods due to transfer pricing of products, namely; aurofac and minocycline, which petitioner purchased from its parent company, American Cyanamid; and (b) unnecessary and unreasonable payment of royalties to the latter company for the supply of technical know-how. Judgement of the Tax Court The Court decided in favour of Cyanamid Philippines. According to the court, the tax authorities had acted in an arbitrary, unreasonable, and capricious manner. There were no apparent attempt to verify the comparability of the pharmaceutical products being compared under a comparable uncontrolled price (CUP) method analysis. “It can be gleaned readily from the facts that the physical property and circumstances in the processing and sale of petitioner’s products are not “identical” or “so nearly identical that any difference can either have no effect on price, or such difference can be reflected by a reasonable number of adjustments to the price” of Pfizer’s products.”  “We so hold, therefore, that respondent never had any valid justification to declare the cost of goods of petitioner’s products, aurofac and minocycline, as having been overstated in price when bought from its parent company, American Cyanamid. “ On the issue of Royalties the Court stated “The obligation to pay royalties is founded on a licensing agreement duly sanctioned by proper government agencies. Without the license to use know-how, petitioner cannot engage in the processing and selling of its products. Petitioner continues to exist as a legitimate domestic corporation solely by virtue of its licensing agreement and any attempt to deny it the use of know-how would simply result in the natural cessation of its business. The elements of necessity and reasonableness are easily appreciated in the use of know-how in petitioner’s business. “ “In sum, we uphold the validity and the legality of the payment of royalties for know-how made by petitioner to its parent company, American Cyanamid.”  The decision was later affirmed by the Court of Appeals in 1999 ...