Zocor and Mevacor have been used by millions of people to help lower their cholesterol. But Merck & Co., the manufacturer and seller of these drugs, also used the drugs to lower something else – its income tax bill. Thirteen years ago, Merck set up a subsidiary with an address in Bermuda, which is a tax-friendly haven for Corporate America, and has used this ploy to avoid paying taxes. A British bank was Merck’s partner in this deal. Merck quietly transferred patents underlying the blockbuster drugs to the new subsidiary, and then Merck paid the subsidiary for use of the patents.

The arrangement in effect allowed a portion of the profits to disappear and allowed Merck to cut $1.5 billion off its federal tax bills over roughly the next 10 years. Now, the complicated transaction — never publicly disclosed — has sparked one of the largest tax disputes ever involving a U.S. corporation. The Internal Revenue Service has challenged the tax benefits from the arrangement. Merck will most likely be ordered to pay the IRS over $2.3 billion in back taxes, interest and penalties. The Merck arrangement, according to federal tax authorities, wasn’t a real partnership with a foreign bank, but instead was just a well-disguised loan agreement, designed to avoid taxes by maneuvering between the tax laws of different countries, with no economic substance.

Merck is not the only corporation that is using this arrangement to dodge taxes. There are other partnerships involving Dow Chemical Co., General Electric, and others doing the very same thing that the IRS is challenging with Merck. The IRS is challenging what is often called “tax arbitrage.” The IRS has formed a team to consider crafting new international treaties, as well as performing tax audits that would simultaneously look at a company’s tax obligations in multiple countries. There are other ways that U.S. companies are avoiding paying their U.S. taxes. For example, technology and pharmaceutical companies are shifting intellectual property assets to countries with far lower tax rates, such as Singapore and Ireland. It’s pretty sad when you consider how ordinary citizens work hard, pay their taxes, and then read where companies like Merck and others dodge paying their taxes.

Source: Wall Street Journal