Merck Adds U.S., Canada Tax Disputes to Woes [WSJ]
Liabilities in Four Cases Could Total $5.58 Billion As Vioxx Suits Continue
By JOHN CARREYROU and JESSE DRUCKER
November 8, 2006; Page A3
Merck & Co. disclosed four separate tax disputes in the U.S. and Canada with potential liabilities totaling $5.58 billion, adding to the financial pressures weighing on the drug maker as it continues to battle tens of thousands of lawsuits related to its withdrawn painkiller Vioxx.
The newly disclosed liabilities, which Merck says it is fighting, signal a crackdown by tax authorities in the U.S. and Canada on some of the maneuvers pharmaceutical companies employ to maximize profits on their drugs. In September, drug giant GlaxoSmithKline PLC agreed to pay the U.S. government $3.4 billion to settle a dispute over how to tax dealings between the British company and its American subsidiary.
The fact that Merck is in four sizable tax disputes at once is unusual and the liabilities involved are big, but Merck likely can afford to pay them. As of Sept. 30, it had $15.22 billion in current assets, including $6.22 billion in cash. But an unfavorable resolution to the disputes would hurt the company's operations and cash flow in the quarter it made the payment. At least one of the transactions in dispute also provided an income statement benefit, which could potentially be reversed depending on the outcome. In the third quarter, Merck earned $940.6 million on $5.41 billion in sales.
Moreover, Merck is facing liabilities that could reach tens of billions of dollars related to Vioxx, the painkiller it withdrew from the market in September 2004 after evidence emerged that it increased the risk of heart attacks and strokes. Merck has been fighting the cases one by one. So far, it has won five cases and lost four.
In a recent interview, Merck's chief executive officer, Richard Clark, said the company was "very conservative" in its tax practices. He also said the potential liabilities weren't a concern, given Merck's financial wherewithal. "I don't lose any sleep over that," he said.
A Merck spokesman said the company believed the transactions are in "full compliance with IRS rules" and that it plans to contest the matter.
Among the new disclosures Merck made in a filing with the Securities and Exchange Commission, the company for the first time put a dollar figure on a previously disclosed dispute with the Canada Revenue Agency. According to Merck's filing, the Canada Revenue Agency issued the Whitehouse Station, N.J., company a notice on Oct. 10 for $1.76 billion in back taxes and interest "related to certain intercompany pricing matters."
The dispute involves revenues Merck had in 1998 to 2004 on its blockbuster asthma and allergy drug Singulair, according to someone familiar with the matter. Singulair was originally developed by Merck's Canadian subsidiary in Montreal, entitling the Canadian government to tax revenue on the drug, the person said.
U.S. Patent & Trademark Office records show that, in December 1998, Merck transferred patents associated with Singulair to a Barbados subsidiary called Tradewinds Manufacturing SRL. At the time, Barbados was considered a tax haven because of a variety of favorable tax provisions it offered.
In such "transfer pricing" disputes, tax authorities argue either that too much revenue is being reported in a low-tax jurisdiction, or that too many expenses are being reported in connection with a high-tax jurisdiction, thus lowering taxable income there.
In its SEC filing, Merck said it disagrees with the position taken by the Canadian tax authorities, but said it could be "required to post a deposit of up to one-half the tax and interest assessed which could have a material adverse effect on the Company's cash flows in the quarter in which the deposit is made." Merck said it will contest the assessments.
Large transfer pricing disputes are increasingly common. GlaxoSmithKline's settlement with the IRS came after the agency alleged Glaxo's American unit overpaid its British parent for drugs, largely for antiulcer drug Zantac. Those overpayments had the effect of reducing the company's U.S. profit, and also its U.S. tax bill. The IRS said the settlement was the largest ever.
Software maker Symantec Corp. and telecom equipment manufacturer Motorola Inc. have also disclosed sizable transfer pricing disputes with the IRS. Symantec and Motorola disagree with the IRS's position. Symantec is suing the IRS over the proposed adjustments and Motorola says it is planning to dispute the finding.
Of the $5.58 billion in potential liabilities disclosed yesterday, Merck had previously disclosed $2.3 billion related to a partnership deal dating back to 1993. That deal was the subject of a page-one article in The Wall Street Journal in September, which disclosed the complex transaction allowed Merck to shift taxable income to a subsidiary of a United Kingdom bank, Abbey National PLC, but avoid the financial loss of shifting comparable book income. The disputed $2.3 billion in taxes cover the years 1993 to 2001. The total liability could be higher if the IRS assesses additional penalties.
Merck said the two other disputes, which are with the IRS, stem from "minority equity financing" deals. But the details of those deals are unclear.
Dow Chemical Co. is also in a dispute with the IRS and Justice Department that is very similar to the deal that Merck struck with Abbey. Dow has called that deal a "minority equity financing" as well.
Dow is suing the government over the IRS's proposed adjustments.
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