Tax Break Used by Drug Makers Failed to Add Jobs
By ALEX BERENSON
Published: July 24, 2007
Two years ago, when companies received a big tax break to bring home their offshore profits, the president and Congress justified it as a one-time tax amnesty that would create American jobs.
Drug makers were the biggest beneficiaries of the amnesty program, repatriating about $100 billion in foreign profits and paying only minimal taxes. But the companies did not create many jobs in return. Instead, since 2005 the American drug industry has laid off tens of thousands of workers in this country.
And now drug companies are once again using complex strategies, many of them demonstrably legal, to shelter billions of dollars in profits in international tax havens, according to their financial statements and independent tax experts.
In one popular accounting move, companies declare their foreign markets as far more profitable than their American businesses — even though drug prices are typically higher in the United States than anywhere else in the world.
Drug makers are not the only American multinationals using tax loopholes to declare large portions of their income beyond the reach of the Internal Revenue Service. The Brookings Institution estimates that multinational companies are using overseas tax shelters to lower their payments to the Treasury by about $50 billion a year.
But the drug industry accounts for one of the biggest portions of that shortfall, according to the I.R.S. and independent tax experts. And the nature of their business gives drug makers techniques, like sheltering valuable pharmaceutical patents in tax-friendly havens like Ireland, that many other industries cannot use.
Moreover, the sheer heft of the American drug industry, which had about $60 billion in pretax profits last year, can give disproportionate weight to the economic impact of its tax sheltering techniques.
Even though the tax amnesty legislation has expired, its passage encouraged companies to be even more aggressive about sheltering money, expecting another holiday in the future, said H. David Rosenbloom, director of the international tax program at New York University. Democrats and Republicans supported the legislation, which passed with sizable majorities in October 2004.
“Congress can swear on two stacks of Bibles that it’ll never do it again,” Mr. Rosenbloom said, “but they’ve lost their virginity.”
With a few narrow exceptions, the drug companies are supposed to be paying as much as 35 percent of their worldwide profits in United States federal taxes. In reality they pay much less.
Last year, for example Eli Lilly, the sixth-largest American drug maker, paid less than 6 percent of its profits of $3.4 billion to the United States government, according to its financial statement.
Amgen, the American biotechnology giant, which reported last year that 80 percent of its $14.3 billion in sales occurred in this country, paid about 22 percent in United States federal tax on its $4 billion in profits.
The discrepancy was possible because Amgen claimed a profit margin of almost 100 percent on its foreign sales, but only 15 percent on its American sales.
The I.R.S. has recently increased the number of examiners trying to find hidden profits overseas. It has even had some victories, as in February when the drug maker Merck agreed to pay $2.3 billion to the government to settle a claim it had hidden profits in a Bermuda partnership.
“This is really a priority for the service right now — there’s a lot of focus on cross-border transactions,” said Frank Y. Ng, the I.R.S. deputy commissioner for international tax matters. But even after adding resources, the I.R.S. has only about 500 examiners to review international returns.
Lilly said in a statement that it complied with the law in taking advantage of the 2005 tax amnesty, which enabled the company to avoid more than $2.3 billion in American taxes. Lilly said it believed that the 2005 tax break had encouraged investment in the United States, noting that the company, which is based in Indianapolis, has invested $1.3 billion in the state of Indiana alone.
Still, since the beginning of 2005, Lilly has cut its United States work force by more than 8 percent, reducing it to 22,000 jobs by last January.
Lilly also noted that its overall reported worldwide tax rate for 2006 — which includes taxes paid to other countries and taxes that it has deferred but will theoretically pay at some future date — was about 20 percent in 2006.
Pfizer, Merck and Amgen declined requests for comment.
Tax experts like Michael J. McIntyre, a law professor at Wayne State University in Detroit, say the drug makers are taking advantage of antiquated rules that work better for manufactured products like steel and automobiles.
Under this system, when companies transfer products between divisions in different countries, they must account for the sales internally through “transfer pricing.” But they have significant discretion in how they set prices for these transactions.