Case study:

ISSUES IN ACCOUNTING EDUCATION

Vol. 22, No. 4 November 2007 pp. 749759

GlaxoSmithKline Plc.: International Transfer Pricing and Taxation

Mahendra R. Gujarathi

Please reference the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations and the 1.482-4 Treasury Regulations documents to answer the following question: What are the available methods per the U.S. regulations to determine transfer prices for intangible property? Which method in your opinion is the most appropriate in GSK's case? What are the difficulties, if any, in the application of your chosen method? Compare:

o Comparable Uncontrolled Price

o Comparable Profits Method

o Profit Split Method.

Assume that in April 199X, GSK (U.K.) transfers Zantac tablets costing $5 million to GSK (U.S.) for distribution and marketing in the U.S. GSK (U.S.), which has the exclusive right to use the brand name and GSK's trademarks in the U.S., sells the products for $100 million. Uncontrolled publicly traded U.S. companies engaged in the distribution of pharmaceutical products have earned an average of 25 percent operating profit on sales for the past three years. Total sales of GSK (U.S.) in 1999 were $10 billion, and operating expenses other than cost of sales were $4 billion. Operating expenses on the sale of individual products can be approximated by the ratio of their sales to total sales. Compute the transfer price under the ''Comparable Profits Method,'' and incomes for GSK (U.K.) and GSK (U.S.) in April 199X for the Zantac sales.

Assume that in April 199X, GSK (U.K.) transfers Zantac tablets costing $5 million to GSK (U.S.) for distribution and marketing in the U.S. GSK (U.S.) has the exclusive right to use the brand name and GSK's trademark in the U.S. GSK (U.S.) sells the products for $100 million. Independent companies comparable to GSK (U.K.) that perform routine (contract) R&D and production functions for other pharmaceuticals charge a royalty of 13 percent of net sales. Similarly, companies similar to GSK (U.S.) that manage the routine marketing and distribution functions for other companies charge commissions of 24 percent of sales. While contribution to the joint intangible asset (created by the R&D and marketing efforts) cannot be precisely computed, it is estimated to be even. Compute the transfer price under the ''Residual Profit Split Method,'' and incomes for GSK (U.K.) and GSK (U.S.) in April 199X for the Zantac sales.

Consider the results in Requirements 3(b) and 3(c). Now assume that the sales involved in the transaction are $30 billion over the years 19891999 for Zantac and other products. A penalty of 40 percent also applies for the gross valuation misstatement. In addition, assume that compounded interest (8 percent per annum) is assessed by the IRS on unpaid taxes from the end of 1999 through the settlement date (approximately, seven years later). If GSK (U.S.) has paid taxes at the rate of 35 percent (using the Comparable Profits Method), and if the IRS decides that the Residual Profit Split Method is more appropriate, compute the amount that GSK (U.S.) would owe to the IRS including back taxes, penalty, and interest. What can you conclude in terms of the $8.3 billion claim by the IRS and the fear of GSK that the tax bill would go up to $15 billions?