What pharma needs to know about transfer pricing

Transfer pricing analysis helps companies to manage tax risks as well as identify business opportunities

Some of the most notable tax disputes in U.S. Tax Court have been in the pharma industry – and have been about transfer pricing. It’s an area the IRS continues to focus on. Pharmaceutical manufacturing and biotech companies should be proactive about managing transfer pricing to mitigate tax compliance risk as well as to surface opportunities for the business.

Transfer pricing is the price of transactions between related (or controlled) parties. A transfer pricing study or analysis helps companies decide how to price transactions between related parties in different tax jurisdictions.

Typical related-party transactions in the pharmaceutical manufacturing sector include:

  • sales of drugs to related parties for distribution
  • licensing / transfer of intangibles such as manufacturing and regulatory know-how, patent and exclusivity of drugs and active compounds
  • provision of services such contract manufacturing
  • intercompany loans

Understanding transfer pricing analysis

Transfer pricing analysis involves the determination of “arm’s-length” pricing – the prices that would have been charged on comparable transactions between two unrelated parties. Non-arm’s-length prices may imply income and profits shifting by taxpayers from a high-tax jurisdiction to a low-tax jurisdiction.

Transfer pricing analysis helps taxpayers to manage tax risks related to the following question: Did the taxpayer report results from an intercompany transaction consistent with the results that would have been realized if unrelated parties had engaged in the same transaction under the same circumstances?

IRS looking closely at transfer pricing

Transfer pricing continues to be a high priority area for the IRS.

In an ongoing campaign, the IRS is sending letters to a significant number of U.S.-based subsidiaries of foreign-owned manufacturers and distributors inquiring about their intercompany transaction pricing. These letters are in direct response to information reported in tax filings by those companies. The IRS letters indicated that the companies’ intercompany transaction pricing may not comply with U.S. transfer pricing regulations.

Additionally, transfer pricing has been the subject of some of the most notable U.S. Tax Court cases.

For example, in 2006, the IRS settled with GlaxoSmithKline for $3.4 billion in additional tax, penalties and interest in a transfer pricing dispute – the largest single payment made to-date to resolve a tax dispute.

Another example is an ongoing case in U.S. tax court alleging that Amgen underreported its U.S. taxes from 2010 to 2015, primarily in attributing what should have been U.S. taxable income to its Puerto Rican manufacturing subsidiary, which produces many of its drugs. Amgen disclosed that it may owe the Internal Revenue Service $10.7 billion in taxes and penalties, which are not deductible for U.S. tax purposes, due to this transfer pricing dispute.

While these two examples are very large companies, transfer pricing disputes are not limited to the largest taxpayers. The dollar amounts at issue with smaller organizations may not be as large, but the potential transfer pricing adjustments and penalties resulting from a transfer pricing dispute can be significant in proportion to the companies’ revenues.

Managing tax risks

When the taxpayer prepares a well-documented report to support their transfer prices, tax authorities can rely on that analysis of functions, risks, intangibles, value drivers, etc., to determine the reasonableness of prices. This can help support the taxpayer in avoiding further examination scrutiny related to transfer pricing.

As of January 2024, more than 75 countries have implemented a transfer pricing documentation requirement. Even in jurisdictions where it is not mandatory to prepare documentation in advance, taxpayers may be required to produce a report that supports their transfer prices upon request by tax authorities – typically within 10 to 30 days of a request. In addition, over 100 tax jurisdictions impose penalties related to transfer pricing adjustments, ranging from fines to imprisonment.

Supporting strategic business decisions

In addition to helping with risk mitigation, transfer pricing analysis also enables companies to identify and create opportunities that increase shareholder value.

Consider a company operating in multiple tax jurisdictions that needs to make strategic decisions about which of its controlled entities are to:

  • carry out what business activities (e.g., R&D, manufacturing, distribution, etc.),
  • assume the corresponding risks
  • own which assets, both tangible and intangible

These decisions impact the company’s allocation of costs and profits, potentially with business and tax implications. A transfer pricing analysis can support management in making informed decisions, taking into account the company’s value chain, risk allocation and tax consequences.

For example, a pharmaceutical company that was in a Phase-3 clinical trial for the FDA’s New Drug Application, planned to set up a manufacturing entity in Ireland in anticipation of commencing sales in the U.S. Management wanted to assess the tax costs and benefits of the company’s characterization as an entrepreneurial principal as compared with as a limited-risk distributor. Using 15-year sales/expense projections and contemporaneous market data, a transfer pricing analysis was performed to structure the drug purchase price payable by the U.S. company to its related Irish manufacturer and the royalty rate for embedded IP under various business scenarios.

Management used results from the transfer pricing analysis to make strategic decisions regarding allocation of people, functions, risks and IP between the U.S. company and its related Irish manufacturer. The resulting intercompany purchase price and the royalty rate were consistent with each other, reflected the arm’s-length returns to the aforementioned allocations, and enabled the U.S. company to minimize its consolidated world-wide tax leakages.

Related-party transactions like this are prevalent in the pharmaceutical manufacturing and biotech sector. Companies should consider engaging a qualified tax professional to perform a transfer pricing analysis that can help them mitigate tax compliance risk and identify opportunities to increase shareholder value.

Justen Ghwee is a director of International Tax services at Kaufman Rossin, the largest independent CPA and advisory firm in Florida and one of the top 100 firms in the United States. You can reach him at jghwee@kaufmanrossin.com.

Peter Stratos is a principal of International Tax services at Kaufman Rossin, the largest independent CPA and advisory firm in Florida and one of the top 100 firms in the United States. You can reach him at pstratos@kaufmanrossin.com.

Read the full article on Pharma Manufacturing.


Justen Ghwee is a International Tax Director at Kaufman Rossin, one of the Top 100 CPA and advisory firms in the U.S.

Peter Stratos, MST, CPA, is a International Tax Principal at Kaufman Rossin, one of the Top 100 CPA and advisory firms in the U.S.