Why Big Pharma's $15B International Tax Dodge Is Coming To an End

AstraZeneca (AZN) reached a $783 million settlement with British authorities that covers 15 years of taxes it never paid. The deal exposes the way Big Pharma juggles its money to avoid taxes, often by parking figleaf assets in foreign countries better known for their vacation resorts than research facilities.

It also illustrates why this kind of behavior is coming to an end as governments, strapped for cash in the recession, wake up to the $15.5 billion they're missing out on thanks to international tax dodging.

Here's how it works. One of AZ's biggest selling drugs is Crestor, the anti-cholesterol medicine. AZ makes $4.5 billion a year selling this drug. It's well known that the drug was discovered in Japan and then licensed to AZ, which is based in the U.K. The biggest market for Crestor is in the U.S.

So why were the legal rights to Crestor registered in Puerto Rico way back in 1999? It's not because of the nice weather. The migraine drug Zomig and the cancer treatment Faslodex are registered there. Unsurprisingly, it's because there are tax advantages to pretending that the greatest drug AZ ever brought to market comes from the land of Bacardi.

These tax dodges tend to be complicated in practice but are simple to understand in principle: A company leaves its cash or assets in a low-tax jurisdiction and then sets up a scheme to repatriate the cash to the U.S. or U.K., where it's actually being spent, without paying taxes on it.

Under U.S. law, cash from foreign subsidiaries is taxed for the obvious reason that if it wasn't, all companies would park their money offshore and nobody would pay any tax. Which is what several large companies have recently tried to do:

Transfer pricing This explains why, for instance, Bayer pays about 29.3 percent of its revenues in tax whereas Novartis pays only 14 percent, even though they're in the same business and sell in similar markets.

Companies barely even pretend they're not doing it. Pricewaterhouse Coopers has an entire practice dedicated to finagling foreign tax laws for drug companies. It publishes news letters with titles such as, "Generating cash from Irish R&D activities" and "Revised OECD transfer pricing guidelines respond to business concerns on key issue."

Governments are finally waking up. The IRS has made it clear that it is going after as many drug tax vacation deals as it can find. The FT reports that as much as $15.5 billion of corporate money goes untaxed via transfer pricing every year.

Next on the agenda: Pfizer (PFE), whose books for 2006 through 2008 are currently being audited. I wonder what the tax auditors will find?