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Merck to pay $2.3 billion in tax fight

The pharmaceutical giant settles a dispute with the IRS, which had sought $3.8 billion.

February 15, 2007|Kathy M. Kristof | Times Staff Writer

And you thought your tax bill was bad.

Pharmaceutical giant Merck & Co. agreed Wednesday to pay $2.3 billion to settle a long-standing tax dispute with the Internal Revenue Service over a series of partnerships the company used in the 1990s to cut its income taxes. The deal was the second-largest reported tax settlement after a $3.4-billion deal reached in September with British pharmaceutical company GlaxoSmithKline.

Still, the settlement was significantly less than the $3.8 billion that the IRS claimed was due from Merck.

"The company concluded that given the theoretical amount in disagreement, it was in the company's best interest to reach this settlement so as to remove the uncertainty and cost of potential litigation," Whitehouse Station, N.J.-based Merck said in a statement.

Merck, which reported 2006 sales of $22.6 billion, said it had already set aside reserves against the possible settlement and did not expect 2007 earnings to be affected by it. Its shares rose 11 cents to $44.06.

The IRS said that "reaching an agreement of this magnitude was the result of cooperation by both parties."

Neither Merck nor the IRS would provide details of the tax dispute. However, a Merck spokesman confirmed that the dispute revolved around a 1993 transaction in which Merck set up a partnership in tax-friendly Bermuda to help finance its purchase of Medco. The acquisition gave this Bermuda-based subsidiary patents to two cholesterol drugs, Zocor and Mevacor. Merck then paid the partnership that it set up royalties from sales of these drugs, deducting the royalties as business expenses on its U.S. income tax bill.

By setting up the subsidiary, the company could deduct money it essentially paid itself.

The IRS got wind of the deal in 2004 and notified Merck that it was disputing the deductions the company claimed for paying these royalties.

Although the IRS has been criticized for negotiating away billions in tax liabilities through so-called fast-track settlements like this one, industry experts maintain that the deal probably was wise, given the time and uncertainty of taking complex tax issues to court.

"Generally, a settlement is safer for both sides than rolling the dice," said Martin G. Laffer, a certified public accountant who frequently testifies in tax fraud cases. "There is a lot at stake and this is a bird in the hand."

Beverly Hills tax attorney Elliot Kajan said the shelter Merck had employed was not considered an abusive one and had some legitimate business benefits. Had the IRS taken this to court, it could have jeopardized the entire amount and spent years -- and millions of dollars -- litigating the issue.

"You are dealing with a very complicated factual pattern that was analyzed by some of the most respected tax minds in the country, who gave it their seal of approval," Kajan said. "Yes, the IRS gave up something to settle this without going to the mat. But I see both sides as winners on something like this."

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