12 minute read 7 Jun 2022
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How to navigate global transfer pricing controversy in life sciences

12 minute read 7 Jun 2022

Life sciences companies face growing tax authority scrutiny of their transfer pricing practices and must prepare for escalating controversy.

In brief
  • Life sciences companies are subject to intensifying tax controversy risk in jurisdictions worldwide.
  • Observed trends in select markets highlights the prevalence of increasingly contentious and complicated transfer pricing disputes with tax authorities.
  • Life sciences companies should assess their transfer pricing practices and tax controversy management systems, plans and capabilities.

Transfer pricing (TP) plays a critical role in the allocation of income across jurisdictions and is a key focus of policymakers, tax authorities, public interest groups and global organizations, such as the Organisation for Economic Co-operation and Development (OECD) and the United Nations. As such, it is unsurprising that multinational enterprises (MNEs) face heightened and escalating scrutiny of their TP practices. In the 2021 EY International Tax and Transfer Pricing survey, TP was viewed as the number one tax risk, with 65% of the survey respondents expecting the number of TP audits to increase in the next three years. 

Certain characteristics of the macroeconomic environment, the tax regulatory environment and the life sciences (LS) industry place LS MNEs at an increased risk to TP challenges from tax authorities. These include significant fiscal needs for greater tax revenues and LS industry attributes, including potentially higher profitability, the significance of intangible property (IP), and the long R&D cycle. In this article, we review key TP controversy themes and issues observed in select markets, where LS controversy is particularly prevalent, and highlight some of the leading practices for LS companies to consider. 

Landmark transfer pricing cases highlight greater uncertainty

Tax courts are routinely upturning historical settlements and advanced rulings. In the past, TP cases were often decided in a manner where both the taxpayer and the tax administration had their technical positions recognized. More recently, tax cases are being resolved either wholly in favor of the taxpayer or the tax administration, with little compromise between the parties’ positions. This new approach to case resolution clearly raises the stakes for taxpayers.

Daniel Sosna and Marla McClure of Ernst & Young LLP (US) advise that taxpayers need to have a process in place to evaluate the continued relevance of legacy TP positions and settlements. For LS MNEs, this means reviewing and ensuring alignment with legal agreements, substance and comparable benchmarks. In addition, a robust best or most appropriate method selection is critical in LS transactions and controversy challenges. Sosna and McClure recommend validating whether the method selected is in fact the best or the most appropriate method given the MNE’s specific facts and data availability.

A continually evolving regulatory landscape poses new challenges

Recent years have seen an abundance of regulatory changes. Some of these changes are directly applicable to TP and the application of the arm’s-length principle — i.e., the updates to the OECD Transfer Pricing Guidelines and the new cost-sharing rules under US Treasury Regulations § 1.482-7. Others, including unilateral measures (e.g., base erosion and anti-abuse tax (BEAT) in the US; diverted profits tax (DPT) and the offshore receipts in respect of intangible property (ORIP) in the UK; DPT and multinational anti-avoidance law (MAAL) in Australia), regional developments (e.g., Anti-Tax Avoidance Directive (ATAD) in the EU), and global developments arising from Base Erosion and Profit Shifting (BEPS) 1.0 and 2.0, while not having a direct impact on the application of the arm’s-length principle, can have a profound impact on how taxpayers manage their TP.

Joel Cooper, EY Global ITTS Controversy Leader, advises that  it is no longer enough for taxpayers to focus on recent court cases and TP-related developments when determining TP positions, but that the potential application of these new rules also requires careful consideration. While these new rules all require individual consideration, one common thread is a focus on substance. In the LS sector, this will typically require alignment of key functions such as R&D, manufacturing and other commercial activities — depending on the operating model and structure — with the ownership of valuable IP and the recognition of profits. As there are differences in how companies drive value and therefore how they view and evaluate substance, it is important to have a methodical way to review and separate value drivers, such as early- and late-stage R&D, as well as manufacturing and commercial management of risks (e.g., plant scale-up and launch), to successfully support and defend the structure.

Taxpayers face new tax authority positions and arguments

Most notably in this category are the BEPS 2.0 initiatives originating from a perceived need for reform allowing for taxation of digital companies. The outcome of the reform is a global minimum tax and increased taxation for many of the largest LS companies. Other alternative means to tax intercompany transactions are withholding taxes, customs duties and restrictions on deductibility of certain payments.

Oliver Wehnert of Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft notes that German authorities are of the opinion that royalties or capital gains realized in an IP transaction between two nonresident parties are subject to German withholding tax or corporate income tax to the extent the underlying IP is registered in the German Patent and Trademark Office. The underlying provision being relied upon by the German authorities is almost 100 years old, but its application only came to prominence during 2020.

Wehnert further notes that as the license or IP transfer agreements potentially subject to this provision typically involve the license or transfer of a bundle of German and non-German, as well as registered and unregistered IP, numerous adjustments are to be made to the gross payments to determine the amounts potentially taxable in Germany. In that respect, TP principles together with medical law principles and IP protection possibilities in the pharmaceutical industry should be applied. Wehnert strongly advises that the analysis be anchored by a deep understanding of the pharmaceutical industry and corresponding operating models.

Franck Berger and Patrice Jan of Ernst & Young Société d'Avocats SELAS also highlight that the TP audits by the French tax authorities often involve interactions between the French TP rules and other incentive regimes; for example, the impact of French R&D tax incentives on the amount charged by French R&D service providers to affiliated service recipients. LS companies typically invoice contract R&D costs as the net of French R&D tax incentives on the basis that the incentives are intended to partially offset the higher costs of operating in France, and to increase the competitiveness of French R&D service providers. The French tax authorities, on the other hand, takes the position that while the incentives are intended to foster the development of the French R&D sector, the incentives should not otherwise reduce the price charged by French R&D service providers. Although the tax authorities have not prevailed in the courts on this point, it continues to frequently challenge taxpayers on audit. Accordingly, Berger and Jan recommend that taxpayers should prepare and have readily available a robust economic analysis that clearly links their reporting position to how independent parties incorporate R&D tax incentives into pricing terms. 

Transfer pricing audits are increasingly burdensome affairs

Tax authorities globally are issuing more detailed and cumbersome requests for information instead of relying on taxpayer representations and documentation. This places an undue burden on the entire business organization, as the information requested often has to come from finance and business functions (commercial, R&D and manufacturing), and places strain on already scarce resources. Tax authorities expect detailed system profit calculations, legal entity calculations and detailed allocation exercises not necessarily produced for other reasons within the finance organization. In addition, the details requested that relate to the historical tax structure, substance and financial arrangement are unprecedented.

Anna Lucey of Ernst & Young Services Limited (UK) says that Her Majesty's Revenue and Customs (HMRC) audits heavily focus on source evidence and particularly functional interviews to support contractual arrangements. As an example, to test the characterization of an R&D entity, HMRC expects to understand the end-to-end R&D process, the progression of LS products through the R&D pipeline, the process and roles responsible for stage-gate decisions, and the interactions between UK and non-UK parties throughout the process — all of which are expected to be supported by internal documents, functional interviews or case studies. Another feature of HMRC audits is that the financial data requested are typically very granular and include transactional or segmented information to allow HMRC to understand the operational TP aspects (e.g., definition of pass-through costs, application of mark-ups to various cost components and treatment of share-based costs).

Authorities across the world apply OECD rules inconsistently

One of the stated goals of the BEPS Actions 8–10 report was to align tax authorities around the taxation of intercompany transactions. Specifically, Actions 8–10 report was intended to “provide[s] guidance to determine the transfer pricing outcomes in accordance with the actual conduct of related parties in the context of the contractual terms of the transaction.”1 Despite carefully drafted language regarding risk and control of risk, authorities around the globe continue to interpret the OECD rules as requiring profits to follow functions and not risks. Countries continue to assert that all IP-related profits should follow development, enhancement, maintenance, protection, and exploitation (DEMPE), when the rules clearly say otherwise.

In this regard, Mike McDonald of Ernst & Young LLP (US), who served as a US delegate to the OECD’s Working Party 6 during the BEPS project and the drafting of Actions 8–10, recently stated, “I would be distressed if [US] Treasury is significantly moving away from the foundational guidance in [US Treasury Regulations] §1.482-1(d)(3), which properly respects contractual allocations of risk that have substance and for which there is appropriate control over that risk. These foundational principles are also contained in the OECD TP guidelines, if only one would take the trouble to read what the guidance actually says.”2

Lucey notes that HMRC typically closely examines participation of UK employees in group governance bodies (e.g., R&D committees) and their roles in high-level regional or global positions within the organization. This often leads to HMRC arguing that such individuals are performing value-creating and risk-controlling activities warranting additional, and often profit-based, compensation.

Berger and Jan also point out that the FTA frequently scrutinizes the characterization and functional profile of French LS companies. This often results in a demand for greater remuneration, attributable to DEMPE functions and related value-creating and leadership activities, purportedly performed by local French companies. In support of its position, the FTA generally downplays the significance of the legal ownership of IP and instead focuses on, for example, the location of marketing operations and the personnel involved with marketing activities.

Finally, Jason Vella and Michael Jenkins of Ernst & Young (Australia) emphasize that the Australian Tax Authorities (ATO) also closely scrutinizes IP-related transactions, including any DEMPE contributions made by Australian entities in connection with what the ATO describes as the ‘‘economic substance’’ of an IP transfer, and the options realistically available to Australian entities in connection with outbound transfers of IP.

Tax authorities increasingly rely on realistic alternatives

As part of the Tax Cuts and Jobs Act, the US codified realistic alternatives (RA), a concept included in both the OECD and revised cost share regulations. The concept is not new to TP but now is being used more widely as an economic backstop to determine if the TP was appropriate. With endless alternatives available, it seems results have the potential to vary widely and that RA can be pushed to the point of economically overturning a company’s legal form.

Sosna and McClure point out that in the LS sector, the application of RA is often at odds with the characterization of the transaction, chosen best method and transactions observed between third parties. For example, if a license transaction is recharacterized as a sale, the recharacterization often ignores that there are many external transactions that support the notion that parties will often choose a license over an outright sale. Moreover, the preferred business form often dictates the chosen TP method, as the plethora of external licensing agreements in the industry provide sufficient external and internal comparables to price a licensing transaction. Similarly, in the LS industry, we often see a recharacterization of manufacturing principals into contract manufacturers. This recharacterization ignores the risks that a manufacturing principal often assumes and controls, including product liability risk, scale-up of capabilities and lead time required to set new production lines and processes, and management of technology transfers and scale-up. There are many examples within the LS industry where delays in manufacturing scale-up or manufacturing product liability have negatively impacted profits where the risks managed and assumed by manufacturing principals cannot be oversimplified.

There is decreasing ability for companies to absorb double taxation 

The “race to the middle” on global tax rates, reinforced by the new global minimum tax proposals, along with foreign tax credits becoming more difficult to utilize, increases the cost of unrelieved double taxation arising from TP adjustments. As a result, the possibility to resolve double taxation through the mutual agreement procedure (MAP) is of paramount importance. There have been some positive developments in this area as a result of BEPS Action 14 and the peer review process, the Dispute Resolution Directive in the EU and greater adoption of arbitration provisions; however, there is still room for improvement. In the current tax environment, it is critical for taxpayers involved in cross-border tax controversy to be cognizant of when and where MAP is available, how they can access it, and how they can best utilize it to achieve timely and favorable outcomes, says Cooper.


The observed trends in this article apply widely across jurisdictions and reflect worldwide trends aligned with or as a result of global tax administration coordination efforts. In summary, Ana Maria Romero and Helena Aten of Ernst & Young LLP (US) emphasize that LS MNEs should not underestimate the importance of having a globally consistent narrative that clearly articulates and supports the allocation of income across jurisdictions, including the MNE’s business operations, where and how value is generated, the MNE’s specific and unique strengths and advantages, the significant risks borne and controlled by different controlled parties, and the activities undertaken in local markets. This narrative should be supported with contemporaneous documentation and should align with the MNE’s specific facts and operating model — i.e., the formal legal structure as established in intercompany contracts and other legal agreements. In light of this environment, LS MNEs should undertake periodic reviews of their pricing methodologies, and consider the application of alternative pricing methods and constructs frequently used by tax authorities, considering emerging practices and any changes to the business.

In addition, to meet all the challenges posed by the increasing rise in transfer pricing controversy, MNEs should have a well-defined global controversy strategy that includes alignment of people, processes, technology and data. Developing and implementing a global strategy ensures consistency in communication with tax authorities across the globe and can help minimize efforts in responding to tax authority requests.


The 2021 EY International Tax and Transfer Pricing survey finds that transfer pricing is the most significant tax risk for companies today. Life sciences companies are especially susceptible to tax authority challenges to their transfer pricing practices and face growing uncertainty and elevated risk in jurisdictions worldwide. To prepare for increased controversy, life sciences companies should evaluate their transfer pricing positions and internal tax controversy management systems and processes.

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