Outlook: US Revenue in smash and grab raid on GSK's UK profits

Nissan euro threat
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The Independent Online

Jean-Pierre Garnier has had a veritable lorry load of troubles poured on him since he became chief executive of GlaxoSmithKline four years ago, but just to pile on the agony along comes the American Internal Revenue Service to claim a deficiency in the company's US tax payments of $2.7bn in respect of the years 1989 to 1996. Add in accumulated interest and the fact that similar tax issues remain open for 1997-2000, and the total unpaid tax liability might amount to some $7bn.

Even for a company of GSK's size, that's hardly, as one analyst called it yesterday, "a drop in the ocean". But for the fact that the tax dispute has been known about for some time, though not its size, the impact on the share price would have been much more severe. GSK has already provided heavily against the claim in its accounts. Furthermore, legal advice is that even if the courts find against GSK, they would be unlikely to require payment of the full amount.

All the same, the dispute seems quite worrying enough. GSK finds its fat profit margins under attack on all fronts - from generic competition, from parallel imports, from medicare providers, litigants and governments, and now from the IRS too. Just as significant, the IRS has only served its "statutory notice of deficiency" because arbitration with the Inland Revenue in Britain failed to resolve the issue. This is believed to be the first case of any significance where the two jurisdictions have reached such an impasse. With the US asserting its independence from multilateral arbitration across all manner of jurisdictional disputes, it may be a harbinger of much worse to come.

The row relates to that hardy old perennial when it comes to tax - transfer pricing. This has long been a bigger problem for pharmaceuticals than most other industries because so much of the profit made on a prescribed drug relates to intellectual property. Through transfer pricing, companies have the opportunity to recognise profits in territories where it is most tax advantageous.

International rules and conventions exist to govern the way in which profit is shared between the country where the product is discovered and developed, the place it is manufactured and the country in which it is sold, but they are difficult to apply in the pharmaceuticals industry because of the relative lack of independent comparators, and in this case they seem to have broken down entirely.

The nub of the IRS's case is that too much of the profit on Zantac and other GSK legacy products was kept in Britain, where the product was developed, and elsewhere in the world, including Singapore, where the product was manufactured. The way in which the case has been framed is a particularly insulting one. The IRS contends that Zantac was essentially a copy of an existing American anti-ulcer drug, Tagamet, and that its runaway success in the US market was therefore largely the result of highly effective marketing by Glaxo's US distribution business rather than genuine innovation. A much larger proportion of the profit on the drug should therefore have been allocated to the US.

The IRS's stance sets a dangerous precedent. GSK and several other large pharmaceutical companies still undertake much of their research and development in the UK, where they form a vital part of the country's science base. Yet most of their sales are in the US, the world's largest healthcare market. If the US sticks to the line that most of the profit on pharmaceutical sales should be allocated to distribution, then eventually it makes no sense to undertake the research and development elsewhere.

The hypocrisy of the IRS's position is evidenced in the fact that it has introduced special legislation to stop US companies from siphoning off profits on intellectual property into low tax jurisdictions by requiring that adequate royalties are paid for product discovery. Where similar issues have been raised by US companies selling overseas, for instance in Japan, the IRS has argued the other side of the case - that most of the profit lies in discovery and development, not in distribution, even though the closed nature of the Japanese market and its suspicion of all things foreign means that the marketing of a foreign innovation truly does have to be spectacular for the product to make headway.

By refusing to budge, the IRS positions itself in the vanguard of US economic imperialism and protectionism. Its attitude seems to be that if the product is discovered in the US, then any success it enjoys is down to the genius and superiority of American science, but if discovered elsewhere, then it must be the effect of America's skills at selling, never mind that it might be a product that improves people's health.

GSK's commitment to the US is huge, growing, and unreserved, not just in what it sells there but in the amount of R&D it locates there too. Why, the chief executive would even domicile the company in the US if the City would allow him. The American position is an outrage, equally as offensive as its protectionist imposition of tariffs on imported steel. If the special relationship means anything, it should surely be called into play in this case.

Nissan euro threat

Carlos Ghosn, the French-born chief executive of Nissan, has been banging on again about Britain's failure to join the euro, which he says might cause the Japanese car manufacturer to build the replacement for the Almera somewhere in France rather than Sunderland. Mr Ghosn made similar threats about the Micra two years ago, but was eventually persuaded to locate production in Sunderland after the Government stumped up £40m of aid. Presumably a similar game is to be played this time around. The Government would be well advised to ignore him completely. Let Mr Ghosn do his worst.

Nissan is these days controlled by the French car giant, Renault, which is how Mr Ghosn came to be chief executive. If he had been running the show at the time the decision was made, the Sunderland plant would never have been built in the first place, and instead located in France close to one of Renault's pre-existing production facilities.

But that was back when French automobile executives would routinely characterise Britain as a Japanese aircraft carrier with hostile content located off European shores. Things have moved on quite a bit since then and today Renault is so joined at the hip to its Japanese counterpart that they have become virtually inseparable. Common platforms are being developed for their next generation of cars and, in many respects, the two companies already act like a fully merged company.

Operationally, it would no doubt be more logical for the Almera replacement to be built in France. Many of these cars are destined for the Continental market, so in other respects too eurozone production might make more sense. But to use that awful cliché, we where we are, and Sunderland remains one of the most efficient car production plants in the world. Making the plant obsolete given how much has already been invested in the place simply because it is outside the eurozone makes no sense at all.

Other Japanese car manufacturers with a presence in Britain have adopted a maturer attitude to the euro. Toyota thinks it would be better for business if Britain were a part of the single currency, but says that plans to increase production at Burnaston, Derbyshire from 220,000 units a year to 270,000 will go ahead with or without the euro. As for new production facilities for the European market, all of them are being built in low cost regions outside the eurozone - Poland, the Czech Republic and Turkey.

The truth is that the euro has become almost completely irrelevant in determining the location of production. Most manufacturing would not be located in developed Europe at all if companies were starting with a clean slate. Mr Ghosn has proved himself highly effective in turning around Nissan's fortunes, but he protests too much about the euro. It's all a lot of hot air, designed to squeeze more money out of the British tax payer, and should be treated as such.

jeremy.warner@independent.co.uk

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