Government Focuses on Factual Disputes in Drug Company’s Refund Suit

PERRIGO COMPANY AND SUBSIDIARIES,
Plaintiff,
v.
UNITED STATES OF AMERICA,
Defendant.

UNITED STATES DISTRICT COURT
WESTERN DISTRICT OF MICHIGAN
SOUTHERN DIVISION

The Hon. Robert J. Jonker

DEFENDANT'S RESPONSE TO PLAINTIFF'S MOTION FOR PARTIAL SUMMARY JUDGMENT

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Table of Contents

I. Introduction

II. Statement of Material Facts in Dispute

III. Legal Analysis

IV. Conclusion

Table of Authorities

Cases

Aldon Homes, Inc. v. Commissioner, 33 T.C. 582 (1959)

American Elec. Power Co. v. United States, 326 F.3d 737 (6th Cir. 2003)

Ballou v. United States, 370 F.2d 659 (6th Cir. 1966)

Barenholtz v. United States, 784 F.2d 375 (Fed. Cir. 1986)

Bass v. Commissioner, 50 T.C. 595 (1968)

Billy F. Hawk, Jr., GST Non-Exempt Marital Tr. v. Commissioner, 924 F.3d 821 (6th Cir. 2019)

Black & Decker Corp. v. United States, 436 F.3d 431 (4th Cir. 2006)

Bryant v. Commissioner, 928 F.2d 745 (6th Cir. 1991)

Commissioner v. Tower, 327 U.S. 280 (1946)

Consolidated Edison of N.Y. v. United States, 703 F.3d 1367 (Fed. Cir. 2013)

Continental Oil Co. v. Jones, 113 F.2d 557 (10th Cir. 1940)

Corliss v. Bowers, 281 U.S. 376 (1930)

Cottage Sav. Ass'n v. Commissioner, 499 U.S. 554 (1991)

Davis v. Commissioner, 585 F.2d 807 (6th Cir. 1978)

Decon Corp. v. Commissioner, 65 T.C. 829 (1976)

Dow Chemical Co. v. United States, 250 F.Supp.2d 748 (E.D. Mich. 2003)

Dow Chemical Co. v. United States, 435 F.3d 594 (6th Cir. 2006)

Easter v. Commissioner, T.C. Memo. 1964-58

Easter v. Commissioner, 338 F.2d 968 (4th Cir. 1964)

Fogelsong v. Commissioner T.C. Memo. 1976-294, 1976 WL 3474

Fogelsong v. Commissioner, 621 F.2d 865 (7th Cir. 1980)

Gerdau Macsteel, Inc. v. Commissioner, 139 T.C. 67 (2012)

Gregory v. Helvering, 293 U.S. 465 (1935)

HCA v. Commissioner, 81 T.C. 520 (1983)

Higgins v. Smith, 308 U.S. 473 (1940)

Illes v. Commissioner, 982 F.2d 163 (6th Cir. 1992)

In re CM Holdings, Inc., 301 F.3d 96 (3d Cir. 2002)

J&J Fernandez Ventures, L.P., 84 Fed. Cl. 369 (2007)

Keller v Commissioner 77 T.C. 1014 (1981)

Kerman v. Commissioner, 713 F.3d 849 (6th Cir. 2013)

Knetsch v. United States, 364 U.S. 361 (1960)

Mahoney v. Commissioner, 808 F.2d 1219 (6th Cir. 1987)

Malone & Hyde, Inc. v. Commissioner, 62 F.3d 835 (6th Cir. 1995)

Medieval Attractions, N.V. v. Commissioner, T.C. Memo. 1996-455, 1996 WL 58332

Milbrew, Inc. v. Commissioner, T.C. Memo. 1981-610

Milbrew, Inc. v. Commissioner 710 F.2d 1302 (7th Cir. 1983)

Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943)

National Carbide Corp. v. Commissioner, 336 U.S. 422 (1949)

National Lead Co. v. Commissioner, 336 F.2d 134 (2d Cir. 1964)

Northern Indiana Pub. Serv. Co. v. Commissioner, 115 F.3d 506 (7th Cir. 1997)

Pacific Mgmt. Grp. v. Commissioner, T.C. Memo. 2018-131, 2018 WL 4006591

Paymer v. Commissioner, 150 F.2d 334 (2d Cir. 1945)

Richardson v. Commissioner, 509 F.3d 736 (6th Cir. 2007)

Rink v. Commissioner, 47 F.3d 168 (6th Cir. 1995)

Roberto v. United States, 518 F.2d 1109 (2d Cir. 1975)

Rose v. Commissioner, 868 F.2d 851 (6th Cir. 1989)

Rubin v. Commissioner 51 T.C. 251 (1968)

Rubin v. Commissioner, 429 F.2d 650 (2d Cir. 1970)

Schering-Plough Corp. v. United States, 651 F.Supp.2d 219 (D.N.J. 2009)

Stearns-Roger Corp. v. United States, 774 F.2d 414 (10th Cir. 1985)

Summa Holdings v. Commissioner, 848 F.3d 779 (6th Cir. 2017)

United Parcel Serv. of Am. v. Commissioner, 1999 WL 592696 (Tax Court)

United Parcel Serv. of Am. v. Commissioner, 254 F.3d 1014 (11th Cir. 2001)

Statutes

26 U.S.C. § 482

26 U.S.C. § 951

26 U.S.C. § 6501

Rules

Fed. R. Civ. P. 56(c)(1)

Regulations

26 C.F.R. § 1.482-1

26 C.F.R. § 1.482-4(b)(4)

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I. Introduction

During the tax years at issue, Plaintiff earned over $298 million from sales of omeprazole tablets in the United States. Plaintiff packaged the tablets at its plant in Allegan, Michigan, marketed and sold the tablets from its offices in the United States, and distributed the tablets across America to large U.S. retail chains, including Wal-Mart, Costco, and CVS. Notwithstanding this locus of activities in the United States, Plaintiff contends that its wholly-owned offshore affiliate LLC¹ “earned” most of the omeprazole income — over $212 million — and this income should therefore go untaxed.

The core question for this case is a simple one: How is it that LLC's $212 million of “earnings” should go untaxed? Stripping away legalese and accounting chicanery, the answer boils down to material facts, most certainly in dispute, surrounding LLC's purported purchase and instantaneous resale of omeprazole tablets somewhere over the eastern Mediterranean Sea.² Material facts show that the “assignment” of the Dexcel Contract and the return Subcontract were components of a tax-avoidance scheme that lacked any business purpose. Material facts show that omeprazole-related transactions between LLC and Perrigo-U.S. lacked practicable economic effects. And material facts reveal that LLC was a sham. It served but one circular and tax-motivated purpose: to accumulate offshore “earnings” from fictional resales, and justify those fictional resales on the strength of its capacity to accumulate “earnings.”

Plaintiff hopes to navigate around Defendant's economic substance and sham entity defenses and focus the Court's attention on transfer pricing issues under Section 482 of the Internal Revenue Code. But there is more to consider here than a lack of arm's-length pricing. There is the absence of a business purpose. There are irregularities in the execution of various agreements. There is Dexcel's insistence on a Performance Guaranty. There is LLC's lack of employees and physical infrastructure. Where, as here, transactions are “heavily freighted with tax motives,” it would be inappropriate and illogical to skip to a Section 482 pricing analysis. See Rubin v. Commissioner, 429 F.2d 650, 653-54 (2d Cir. 1970); Medieval Attractions, N.V. v. Commissioner, T.C. Memo. 1996-455, 1996 WL 583322 at *41-52. Plaintiff cannot divert attention from the sleight of hand at the heart of the scheme — that LLC somehow “earned” over $212 million through instantaneous purchase and resale activities somewhere over the Mediterranean Sea — simply by urging the Court to close its eyes to these hard truths.

The insertion of LLC into Plaintiff's omeprazole supply chain added no value, and it mitigated no risks. Setting aside tax savings, Plaintiff's intercompany transactions added nothing to Plaintiff's financial returns. To the contrary, LLC was a drain on Plaintiff that could not be justified but for tax savings. Plaintiff's U.S.-based finance and tax departments generated a monstrous tangle of internal accounting entries to create a paper trail of intercompany “purchases” and “sales” with LLC, as well as to document LLC “paying” for the services of Plaintiff's U.S.-based employees. Furthermore, Dexcel exacted a quarterly fee from Plaintiff for playing along with the charade of doing business with LLC, all the while dealing with Plaintiff's U.S.-based employees and shipping product directly to Plaintiff in Michigan. In fact, Dexcel refused to do business with LLC absent a Performance Guaranty from Plaintiff. As an entity, LLC was nothing more than a cash box, a conduit through which profits from omeprazole sales in the United States moved offshore and beyond the reach of the IRS. Nor did LLC borrow money from third parties or otherwise obtain discounts or savings by virtue of operating offshore.

Plaintiff's backstop argument, that the Court must respect the “assignment” of the Dexcel Contract (and presumably, the Subcontract) because its “effective” date precedes the tax years at issue, is flawed in two respects, both fatal to Plaintiff's contention. First, this “closed year” argument ignores case law. Although the IRS cannot assess tax on income earned during a closed year, nothing bars the IRS, or the Court, from re-characterizing, adjusting, re-computing, or even disregarding closed-year transactions in order to assess tax on income earned during an open year. See e.g., J&J Fernandez Ventures, L.P., 84 Fed. Cl. 369, 374 (2007) (accepted practice to determine or adjust items in a closed year in order to assess taxes in a more recent year); see also National Lead Co. v. Commissioner, 336 F.2d 134, 141 (2d Cir. 1964) (disregarding closed-year transfer in evaluating effect of a transaction in an open year). Here, the Court is free to examine the “assignment” of the Dexcel Contract. If it was a sham, then Perrigo-U.S., not LLC, earned the income attributable to omeprazole sales in the years at issue.³

Second, the “assignment” is inseparable from the Subcontract. The Subcontract, which carries a one-year renewable term, was not executed until January 2010, well within the tax periods at issue.⁴ Plaintiff's tax scheme was thus renewed each tax year. Nothing prevents the IRS, or precludes the Court, from disregarding the myriad instantaneous and meaningless “purchase” and “sale” transactions pursuant to the Subcontract during those years.

II. Statement of Material Facts in Dispute

A. E&Y's “TESCM” plan resulted in the creation of entities that engaged in sham transactions to shelter income earned through sales of drug products in the United States.

In 2005, following Plaintiff's acquisition of an Israeli drug company known as Agis, Plaintiff engaged E&Y to explore a potential restructuring of its international business entities. (See Exhibit AQ 57:8-59:3; Exhibit AR at 4). The pretextual goals of the E&Y project were to integrate Plaintiff's historical businesses with Agis; create synergies with Agis; ensure Plaintiff's intellectual property resided “where the greatest market opportunities” existed; and to “efficiently deploy offshore cash.” (See Exhibit AR at 4). The project's acronym, “TESCM,” revealed another purpose: “Tax Effective Supply Chain Management.” (Exhibit AS 183:17-184:14; Exhibit AE at 1 (prev. filed at PageID.2470)).

While exploring TESCM “planning opportunities,” Plaintiff asked E&Y to evaluate third-party contracts that Plaintiff was negotiating with potential suppliers. (Exhibit AE at 1 (prev. filed at PageID.2470)). Out of this universe, E&Y selected three: a contract for omeprazole with an Israeli supplier, Dexcel; a contract for coated nicotine gum with a Danish supplier, Fertin; and a contract for the active ingredient known as desloratadine (for the generic equivalent of Clarinex) with a supplier known as Plantex. (Exhibit AR at 6, items 15-19; see also Exhibit AT). The three contracts had a common denominator: all three had “potential tax savings opportunities.” (Exhibit AE at 1 (prev. filed at PageID.2470)).

Assigning the three contracts to offshore affiliates accomplished none of Plaintiff's pretextual goals. There would be no need for use of Plaintiff's “intellectual property” overseas because the products were to be sold in the United States. (See PageID.458 Ans. 11; see also Exhibit AU 47:1-13; 75:1-76:22). For these products, the United States was “where the greatest market opportunities” existed. Nor did the creation of offshore affiliates result in the integration of business lines with Agis or create synergies with Agis. To the contrary, the offshore affiliates Plaintiff created to hold the contracts⁵ were “one-off strategies.” (Exhibit AV 87:11-15; 89:1-91:9). Because Plaintiff planned to sell the three products in the United States, there was no need for a structure to “efficiently deploy offshore cash.”

Originally, it appears that Plaintiff contemplated the setup of a more centralized offshore entity with its own employees. Later, in February 2008, E&Y understood that the “TESCM project stalled, so no people [were] in place.” (Exhibit AW 10 at 1). Notwithstanding this, Plaintiff doubled down and charged ahead with a flawed TESCM strategy that, as implemented, became Plaintiff's empty box strategy. Neither LLC nor Perrigo Denmark went to the trouble of hiring employees, establishing operations, or enhancing Plaintiff's financial returns beyond the funneling of pretax income offshore.

Plaintiff did establish an entity known as UK Finco in 2005 to serve as an “offshore bank” and to “centralize pooled resources.” (Exhibit AX 142:13-25). But there was much less to UK Finco than Plaintiff implies. UK Finco had no employees. It was a corporate front for treasury operations conducted out of Allegan, Michigan. (Id. 202:7-22). Notably, UK Finco did not serve as a cash manager for Plaintiff's legitimate operations in the United Kingdom (Wrafton Laboratories), Israel (Agis), Mexico (Quifa), or elsewhere. (Id. at 143:22-154:3). For legitimate operations, cash management functions remained decentralized. (Id.) (Local “designated treasury persons” handled those responsibilities). UK Finco did, purportedly, serve as the ultimate storehouse for offshore cash, much of it generated through the improper funneling offshore of sales of omeprazole and nicotine gum in the United States.⁶ But any purported efficiencies that may have been generated through use of UK Finco as a centralized offshore “bank” (and it is unclear whether there were any efficiencies) are immaterial to whether the sham transactions generating pretax cashflow to a flowing offshore through LLC and Perrigo Denmark should be disregarded.

The focus of this case is on Plaintiff's sales of omeprazole and on LLC. But Plaintiff followed the same strategy with respect to its supply contract for coated nicotine gum as it did for omeprazole. Effective as of May 2006, Plaintiff purported to “assign” to its offshore affiliate Perrigo Denmark certain rights to sell coated nicotine gum products supplied by a Danish company, Fertin. (Exhibit AU 92:9-94:14). As with omeprazole, the assignment did not affect Plaintiff's business or commercial operations. (Id. at 93:17-23). Like LLC, Perrigo Denmark had no employees. (Williams Declaration ¶ 4 & Exhibit BT). Like LLC, it appears Perrigo Denmark did not “pay” an arm's-length price for the contract rights it purported to receive. (SeeExhibit AU 94:7-97:22). As with omeprazole, what Plaintiff brought to the table were “contacts, the distribution opportunities, [and] the selling and marketing resources to gain that distribution.” (Id. 76:14-22). These attributes resided with Perrigo-U.S., not with Perrigo Denmark. As with LLC, Perrigo Denmark added nothing of value to the supply chain process.⁷

As to desloratadine, the generic of Clarinex, Plaintiff purported to “assign” contract rights with supplier Plantex to LLC at the same time that Plaintiff purported to assign the Dexcel Contract to LLC. (See Exhibit AZ 29:19-34:7; Exhibit AK (prev. filed at PageID.2506)). As with omeprazole, the “consideration” for the assignment was nominal. (PageID.2262 at item 2). At the time, Plaintiff anticipated that the brand owner would switch to the over-the-counter market, at which time Plaintiff would seek to sell and market a generic store-brand version of Clarinex. (Exhibit AU 47:1-13). The brand owner, however, never switched Clarinex to OTC. Consequently, Plaintiff never marketed desloratadine commercially. (Id. at 52:12-18).

Finally, in 2010, Plaintiff sought to replicate its omeprazole tax avoidance scheme with fexofenadine, the generic for allergy medicine Allegra. This time, LLC purported to contract directly with a third-party supplier. Plaintiff had learned that the owner of Allegra was planning to switch to the over-the-counter market. (Id. 24:13-18). Plaintiff decided to partner with Teva Pharmaceuticals, a generic manufacturer in the prescription drug market that valued Plaintiff's distribution capability. (Id. at 25:4-19). As an added advantage, Teva had settled a patent lawsuit with the owner of Allegra, eliminating delays or costs that might be associated with potential Paragraph IV litigation. (Id. at 27:15-29:3). Because LLC purported to enter directly into an agreement with Teva, LLC did not need to go through the fiction of making a nominal payment to Perrigo-U.S. as “consideration” for an assignment. Under the LLC/Teva agreement, LLC would receive 40% of net profits; however, if a competitor entered the market, LLC's percentage would increase to 50%, on the theory that Perrigo's selling and marketing resources, and its customer relationships, would be increasingly important in maintaining business. (Id. at 33:24-35:25). As with omeprazole, the structure overlooked the reality that Perrigo-U.S., not LLC, possessed those sales and marketing resources and customer relationships — that is, the valuable assets and functions that Perrigo brought to the table.

There were other flaws in Plaintiff's structuring of its fexofenadine transactions. The agreement was signed by Jeff Needham on behalf of Plaintiff, but Mr. Needham was not an officer of LLC and does not appear to have had authority to act for LLC. (Id. 40:9-41:9). LLC and Perrigo-U.S. never bothered to enter into a written contract for sales, marketing, and distribution. (Exhibit AZ 138:17-139:17). Instead, Plaintiff's employees simply employed the same pricing formula for intercompany “resales” of fexofenadine that Plaintiff employed with respect to “resales” of omeprazole. (Id.). During his deposition, Mr. Needham could not even recall what LLC was, strongly suggesting that LLC's paper transactions served no commercial function. (Exhibit AU 40:9-41:9).

The IRS determined that LLC's inclusion in the Teva agreement for fexofenadine was a sham, resulting in an increase in Plaintiff's taxable income of over $15 million for the two years. (Silver Declaration ¶ 2 & Exhibit AY). Plaintiff paid that tax and has not sought a refund for it.

B. The purported “assignment” of the Dexcel Contract to LLC and the related Subcontract back to Perrigo-U.S. were sham transactions throughout the tax periods at issue.

1. LLC's “title” to omeprazole tablets was a fiction.

Following the launch of store-brand omeprazole in 2008, Plaintiff issued thousands of purchase orders to Dexcel. (See Exhibit BA 52:3-16). Under the original Dexcel Contract, Plaintiff was to take title to the tablets (and assume risk of loss) on receipt in Michigan. (PageID.2215 at ¶ 5.3). The purported insertion of LLC into the supply chain complicated matters. LLC could not acquire and resell the tablets in the United States without subjecting itself to U.S. tax. (Exhibit AZ 85:8-86:14; 188:25-189:21; see also Exhibit AV 89:14-19). Plaintiff therefore prevailed on Dexcel to amend the Dexcel Contract so that title (and risk of loss) would transfer “immediately after departure” from Israel. (Exhibit BB 328:6-24; Exhibit AI at ¶ 3 (prev. filed at PageID.2500)). Dexcel exacted a quarterly fee of at least $20,000 for amending the shipping clause in the Dexcel Contract (despite that the amendment modified shipping terms to Dexcel's benefit). (Exhibit AI at ¶ 3(ii) (prev. filed at PageID.2500)). Dexcel also demanded and obtained a Performance Guaranty from Plaintiff to go along with the charade of doing business with LLC. (Exhibit BB 314:23-319:16; Exhibit AC (prev. filed at PageID.2462) & Exhibit AD (prev. filed at PageID.2467)).

Thereafter, LLC appeared on paper invoices and shipping documents issued by Dexcel. Plaintiff's accountants went through the formalities of creating paper “purchase” documents from LLC to Dexcel, and “resale” documents from LLC to Perrigo-U.S. The physical tablets themselves, however, were shipped directly from Dexcel in Israel to Perrigo-U.S. facilities in Michigan. (Exhibit AZ 85:14-86:14). There was no stop along the route for a layover at a facility owned by LLC. Regardless, Plaintiff maintains the tablets were transferred from Dexcel to LLC to Perrigo-U.S.

Eventually, in January 2010, Perrigo-U.S. and LLC executed a Subcontract, purported to be “effective as of November 29, 2006,” that addressed the chain of title to the tablets. (PageID.2268 at ¶ 4.6). Pursuant to that paragraph, Perrigo-U.S. was to take title (and assume risk of loss) “promptly after [LLC] obtains title to the Product,” in or over international waters. (Id.) Thus, on paper, Perrigo-U.S. obtained title to the tablets (and assumed risk of loss) “promptly after” the moment “immediately after departure” of the tablets from Dexcel's possession. In the intervening microsecond of time, the cost of the tablets skyrocketed. The reason for this mysterious price jump — or absence of any such reason — cannot be resolved on motion and will have to be explored at trial.

2. Plaintiff designed the 2010 Subcontract to shift most of its omeprazole income offshore to LLC under the guise of a “purchase price” formula.

The 2010 Subcontract purports to be an agreement between LLC (the supplier) and Perrigo-U.S. (the distributor). (PageID.2265). The “purchase price” to be paid by Perrigo-U.S. to LLC for a supply of omeprazole tablets is set by the formula in Exhibit B of the Subcontract. (PageID.2275). Notably, LLC is not “paid” on a per-tablet or volume-based metric. Nor is LLC paid on the basis of a markup percentage over the purchase cost from Dexcel. Rather, LLC's “compensation” depends on the success of sales efforts by Perrigo-U.S. It appears that the concept underlying the formula is that Perrigo-U.S. was to be reimbursed for its expenses and costs, receive a “market” return on sales (construed by Plaintiff and E&Y to equal 4.31% of net sales), and receive a “kicker” of 10% of Plaintiff's profits. (Id.; see also Exhibit AZ 92:8-95:22) The balance, equaling the lion's share, was to be “paid” to LLC.

The terms in the formula, however, were undefined. As applied by Plaintiff, it appears the formula was recursive, at least in part. The formula for computing “purchase price” requires, as an input, “residual profit.”⁸ But Plaintiff computed “residual profit” by making subtractions from the “purchase price.” (See Exhibit AZ 169:2-8; see also id. 169:9-171:18).⁹ Further, Plaintiff has been unable to explain how it derived the “standard costs” that LLC charged to Perrigo-U.S. (See Exhibit BA 137:3-139:7; Exhibit BC 298:14-24). In short, Plaintiff's application of the pricing formula, through which it shifted over $212 million in profits offshore during the tax years at issue, is indecipherable. One may infer that this state of affairs arose out of the reality that the intercompany transactions mattered only for tax purposes.

Although the details of the purchase price formula cannot be worked out prior to trial (if ever), the magnitude of Plaintiff's tax avoidance scheme is clear. Taking Plaintiff's accounting expert's adjustments at face value, Plaintiff shifted offshore at least $212.4 million out of approximately $298.3 million it earned from sales of omeprazole during the years at issue. (LaRue Declaration, PageID.2629 ¶ 3).

3. The Subcontract is not a “closed year” item. It was signed during the tax years at issue and carried a term of one year.

The Subcontract was executed on January 20, 2010. (Exhibit AZ 98:10-100:10; see also PageID.2273). By that time, store-brand omeprazole was no longer simply the biggest opportunity in the history of the company; it was a proven success. (See LaRue Declaration, PageID.2629). It remained a blockbuster for Plaintiff throughout the years at issue, even after Dr. Reddy's launched a competing version of generic omeprazole into the market. (Exhibit BD 81:4-83:16; LaRue Declaration, PageID.2629).

The term of the Subcontract is one year. (Exhibit AZ 97:14-24; PageID.2270 at § 8.1). Accordingly, it was open for renegotiation and renewal throughout the years at issue. As noted above in connection with the Teva agreement, Perrigo-U.S.'s unique capabilities become ever more important to sales after competitors enter a market. Given Dr. Reddy's entry into the marketplace and changing circumstances, one could have expected some a renegotiation of terms. There was none.

Throughout the tax years at issue, as between Perrigo-U.S. and LLC, Perrigo-U.S. held all of the proverbial negotiating “cards.” Perrigo-U.S. had relationships with large customers; it had sales channels and expertise in the marketing of omeprazole to those customers; it was the owner of a unique mass customization process to package and distribute product to Perrigo's customers; it had ample working capital; it had physical facilities; it had employees; it had a dominant market share in the store-brand space. (See Exhibit B, (prev. filed) PageID.2347, 38:25-40:8; PageID.2348-2349, 45:25-46:19; PageID.2349-2350, 48:1-49:9, 49:14-52:15; see also Exhibit BF 43:21-44:11). LLC had none of this. (Exhibit AZ 84:3-87:4). Yet according to Plaintiff, LLC was “earning profits” — the bulk of Plaintiff's omeprazole income.

How was LLC “earning profits?” Plaintiff's brief does not answer that question. LLC could not perform its purported obligations under the Subcontract. For example, LLC could not provide Perrigo-U.S. with “sales promotion and technical information materials.” (PageID.2267 at ¶ 3.2; Exhibit AV 182:2-21). LLC could not supply Perrigo-U.S. with product samples. (Id.) LLC could not provide Perrigo-U.S. with “brochures and printed advertising or technical data.” (Id.) LLC could not “supply Distributor with Product quantities as properly ordered,” since LLC held no inventory and Dexcel shipped product directly to Plaintiff's U.S. facilities. (Exhibit AZ 85:8-86:14; 188:25-189:21; see also Exhibit AV 89:14-19). LLC did not “[p]erform any obligation required of Distributor or Supplier under the Dexcel Agreement upon request of Distributor.” (PageID.2268 at ¶ 3.2). LLC and Dexcel relied on Plaintiff's Performance Guaranty, Plaintiff's U.S.-based employees, and Plaintiff's physical facilities.

Plaintiff, it appears, simply assumes LLC “earned” profits by virtue of its purported rights under the Dexcel Contract and purported “assignment.”

4. Events during the tax years at issue confirm that the purported “assignment” of the Dexcel Contract was a sham.

Defendant has already offered substantial evidence as to why the purported assignment of the Dexcel Contract was a sham transaction through February 2008. Events during fiscal years 2009-2012 further reveal the sham nature of the “assignment” to LLC.

Joseph Papa was LLC's president. Mr. Papa, who also served as Plaintiff's CEO during this time, has no recollection as to what LLC did or why it existed.¹⁰ (Exhibit BB 339:2-343:15; Exhibit BG 24). When shown a copy of the Subcontract, Mr. Papa could not think of a reason associated with the success of omeprazole why the Subcontract had been signed. (Exhibit BB 337:6-339:18).

It appears that Perrigo-U.S., not LLC, ascertained and mitigated supply chain risks inherent in purchasing product from a sole supplier overseas. (See Exhibit BD 72:3-78:6; 102:23-108:25; 111:25-113:8; Exhibit BH; Exhibit BI). This entailed, among other things, inspecting Dexcel facilities. (See id.) It seems doubtful that the on-the-ground Perrigo employees managing supply risk issues even knew of LLC's existence or that LLC had any effect on Plaintiff's omeprazole operations. (See Exhibit BD 121:17-122:18). It also appears that Perrigo-U.S., not LLC, was handling the supply issues that arose. (Id. 78:23-80:22; Exhibit BJ). In short, LLC did not impact Plaintiff's supply-chain management for omeprazole. (See Exhibit BD 112:22-113:17).¹¹

In 2009, Perrigo-U.S., not LLC, executed a supplement to the original Dexcel Contract called a Quality Assurance Agreement. (Exhibit BE 205:18-208:11; Exhibit BK). The agreement sets out responsibilities for the parties with respect to “quality control of manufacturing, packaging and supply.” (See id.) These responsibilities are divided between Perrigo-U.S. and Dexcel. Perrigo-U.S., not LLC, was afforded inspection rights under the agreement.¹² Dexcel, not LLC, is Plaintiff's supplier, according to this agreement.

Setting aside the routine issuance of paper invoices and shipping documents referring to LLC, Dexcel appears to have continued to act as though LLC did not exist. For example, in late 2009, Dexcel sent its “standard costing” information directly to Perrigo-U.S. (Exhibit BD 132:16-134:24; Exhibit BL). The letter tells Perrigo that “[w]e shall amend the supply and distribution agreement to reflect the above [contents of the letter].” (Id.) There is no mention of LLC. In 2010, Dexcel executed an agreement with Perrigo-U.S., not LLC, addressing the tracking of product safety information. (Exhibit BE 209:17-210:14; Exhibit BM).

5. Intercompany “services” and “management” agreements were not signed until 2010.

Because LLC lacked employees, it purported to contract with Perrigo-U.S. entities. (DeGood Decl. ¶ 27, (PageID.2144)). These “contracts” were not executed until 2010. (See Exhibit AZ 191:25-196:14; Exhibit BN & Exhibit BO). Notably, the agreements do not have appeared to affected commercial operations in the least.

6. The “assignment” of the Dexcel Contract did not shift risks or aid in Plaintiff's “expansion” of international operations.

Plaintiff does not explain how the purported assignment of the Dexcel Contract furthered the “expansion” of Plaintiff's international operations. LLC's involvement with Dexcel appears to have never expanded beyond the selling of tablets into the United States market for generic drugs. Moreover, LLC was a “one-off” strategy undertaken by Plaintiff “before we had globalized.” (Exhibit AV 87:11-15). Plaintiff was apparently exploring a partnership with Dexcel in Europe, but there is no indication that LLC had anything to do with those plans. (Exhibit BD 108:8-15).

As to “risks” assumed by LLC, Defendant has already addressed purported risks of FDA approval risk and Paragraph IV litigation brought by AstraZeneca. (See PageID.2597-2612). Additional “purported risks” that Plaintiff has mentioned include the entry of competitors in the generic market space; risk of decreasing customer demand for the product; and general litigation (presumably product liability and recall) risks. The evaluation of these “risks” is a matter for trial. But it is worth noting that LLC brought nothing to the table to mitigate the risk of competition other than a hoard of cash that accumulated offshore through sham transfers from Perrigo-U.S. Moreover, Plaintiff, not LLC, carried insurance that covered product liability risks. (Exhibit BE 189:19-191:15; 212:20-214:8).

Plaintiff's failure to shift its internal omeprazole development program to LLC indicates that LLC was not created to manage risk. The purported assignment to LLC likely included rights to Plaintiff's internal efforts to develop an omeprazole-based tablet. (Exhibit AV 151:3-152:21). And yet Plaintiff apparently restarted internal efforts to develop an omeprazole-based tablet during the tax years at issue. (See Exhibit BD 54:5-25; 69:8-71:18; Exhibit BP (FDA application submitted in March of 2012 and approved in 2015)). Even though the development program cost the company millions of dollars and surely entailed greater risks than the Dexcel tablet (as Plaintiff did not have a partner to absorb any risk), Plaintiff did not attempt to shift these risks overseas to LLC. (Exhibit BD 227:4-230:13). This further supports that the purpose of the “assignment” of the Dexcel Contract was to avoid tax, not shift risk.

7. LLC's “loans” and “distributions” to UK Finco simply served to funnel money earned in the United States to an offshore location.

Plaintiff avers in conclusory fashion that LLC also engaged in activities of “making loans” to its second-tier parent-affiliate UK Finco and “distributing profits.” The interest rate on “loans” to UK Finco from LLC and on “loans” from UK Finco to LLC appear to have been a wash. (Exhibit AX 229:22-230:15). In any event, “interest” or other “income” earned by LLC would simply become part of purported “profits” either distributed back up through PITLP to UK Finco, or offset against “loans.” (Exhibit BQ at 5). There is no evidence that having the funds flow through LLC served any purpose other than tax avoidance. How Plaintiff's pooling of funds in UK Finco may have lowered its financial costs, if relevant at all, would be a matter for trial.

8. The Performance Guaranty and First Amendment to the Dexcel Contract reveal the sham nature of the purported “assignment” of the Dexcel Contract to LLC.

Dexcel refused to do business with the “paper company,” LLC. (Exhibit AC at 2 (prev. filed at PageID.2462)). It demanded, and obtained, a Performance Guaranty from Perrigo Company. (Exhibit AD (prev. filed at PageID.2467)). It apparently also demanded and obtained an ongoing quarterly payment for the insertion of LLC into the supply chain. (See Exhibit AI at 2 (prev. filed at PageID.2500)). These documents suggest that it was actually Plaintiff and not LLC that was responsible for performing under the Dexcel Contract, notwithstanding the “assignment” to LLC.

C. The purported “assignment” of the Dexcel Contract to LLC is inextricably linked to the purported Subcontract back to Perrigo-U.S.

The purported “assignment” of the Dexcel Contract was the first of two steps in the tax avoidance plan. Because LLC lacked employees and operational capabilities, E&Y contemplated from the outset that LLC would have to subcontract with Perrigo-U.S. to perform under the Dexcel Contract. (See Exhibit AE at 6 (prev. filed at PageID.2470)). Because Plaintiff selected an ultra-low, indeed nominal, price for the purported “assignment,” E&Y thought it important to “factor that in” for purposes of establishing a transfer price for the tablets under the Subcontract. (Exhibit AS 196:3-197:5). This was necessary to improve the optics of the scheme. (See Exhibit AE at 6 (prev. filed at PageID.2470)). Plaintiff did not execute the Subcontract until January 20, 2010, years after the purported assignment (and within the years at issue). (PageID.2273).

D. The IRS did not complete its examination of Plaintiff's omeprazole transactions before the close of Plaintiff's 2007-2008 audit cycle.

The IRS examination of Plaintiff's omeprazole business is irrelevant to this tax refund suit. That said, it should be clear from even the limited matters raised in the DeGood Declaration that the IRS did not “change its mind” between audit cycles. Rather, the IRS had not completed its review of Plaintiff's omeprazole scheme before the close of the 2007-2008 audit cycle. Indeed, the IRS made numerous follow-up inquiries during the 2009-2010 and 20011-20012 cycles. (See DeGood Declaration ¶¶ 38-40 (PageID.2145-46)).

Follow-up inquiries were needed in part because Plaintiff's audit responses during the 2007-2008 cycle were incomplete and, in some instances, less than forthcoming. For example, during the 2007-2008 audit cycle, Perrigo told the IRS:

Perrigo does not retain records of old projections or forecasts related to product opportunities. Forecasts are updated as needed when material facts change but otherwise are not updated periodically as the product moves toward approval.

(Williams Declaration Ex. BU).

Plaintiff later produced numerous omeprazole projections related to omeprazole product opportunities. (See Williams Declaration ¶ 8). In addition, Plaintiff did not produce key documents during the 2007-2008 audit cycle. For example, it was not until the next audit cycle that the IRS learned that the “assignment” agreement was executed in May or June of 2007, not on November 29, 2006. (Id. at ¶ 9; compare Exhibit AL (prev. filed at PageID.2508)). Plaintiff did not produce LLC's bank statements to the IRS in the 2007-2008 audit cycle. (Williams Declaration ¶ 5). Plaintiff appears to have never produced a copy of the February 2008 capitalization memorandum that Mr. DeGood attached to his declaration. (Id. at ¶ 10; compare Exhibit AO (prev. filed at PageID.2515)). Similarly, Plaintiff appears to have never produced to the IRS a copy of a key email chain describing assignments of the omeprazole and desloratadine contracts to LLC as “proposed transactions” as late as May 2007. (Williams Declaration ¶ 11; compare Exhibit AK (prev. filed at PageID.2506)). And even after the completion of the IRS examinations, it took Plaintiff's own accounting expert months and months of time to try and untangle an inscrutable web of internal “transactions” Plaintiff created to “document” its tax avoidance scheme.

III. Legal Analysis

Material facts are in dispute as to whether LLC was formed for the purpose of tax avoidance. Material facts are in dispute as to the lack of practicable economic effects arising out of the “assignment” of the Dexcel Contract and the Subcontract. And material facts are in dispute regarding the lack of a legitimate business purpose or business activity for Plaintiff's insertion of LLC into the omeprazole supply chain.

Notwithstanding these factual disputes, Plaintiff moves for summary judgment on Defendant's economic substance and sham entity defenses, arguing that trial should be limited to transfer pricing questions under Section 482. In support of its motion, Plaintiff collapses the sham entity and economic substance doctrines into a taxpayer-friendly ode to formalism that is contrary to controlling case precedent and overlooks disputes of material fact.

A. Under Sixth Circuit case precedent, “sham entity” and “sham transaction” doctrines are distinct and require separate legal analyses.

Plaintiff's criticism of the government for arguing that the Court can respect “the separate viability of corporate entities while at the same time disregarding the corporation's activities” (PageID.2571) essentially criticizes Sixth Circuit precedent. See Davis v. Commissioner, 585 F.2d 807, 812 n.8 (6th Cir. 1978); Malone & Hyde, Inc. v. Commissioner, 62 F.3d 835, 841-43 (6th Cir. 1995).

In Davis, the taxpayers owned corporations that financed and constructed apartment buildings. The properties would generate losses during the first years of operation. To obtain the tax benefits from those losses, the taxpayers purchased the buildings from their corporations, but the corporations were to manage the properties and remain liable for the mortgage financing. Davis, 585 F.2d at 810. The IRS disallowed the taxpayers' loss deductions.

In affirming the IRS's determination, the Sixth Circuit assumed that under the test articulated in Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943), “the corporations, while controlled by the taxpayers, could not be disregarded as separate entities under the tax laws . . . [because the] corporations did, after all, have business purposes.” Id. at 812 n.8. Nevertheless, the disallowance was proper because the “transfer and management agreements . . . could not have been intended to achieve an arm's-length business arrangement, but rather were executed to obtain an advantageous tax situation for taxpayers.” Id. at 812.

Malone & Hyde provides another example where the Sixth Circuit applied the economic substance doctrine to transactions between properly-formed affiliates. In that case, the taxpayer created a subsidiary to provide reinsurance. After incorporating the subsidiary, the taxpayer entered into financial arrangements with a third-party insurer that minimized the subsidiary's actual risk exposure. Malone & Hyde, 62 F.3d at 836.

The Sixth Circuit acknowledged that the subsidiary “established reserve accounts, paid claimed losses only after the validity of those claims had been established, and was profitable.” Id. at 843. Nevertheless, the court concluded that the insurance transactions were shams. Id. at 841, 843. In examining the transactions, the Sixth Circuit quoted the following from a Tenth Circuit case:

“The result we here reach is not inconsistent with the fact that the parent and the subsidiary are separate corporate entities. Moline Properties v. Commissioner, 319 U.S. 436 (1943). The separation is not ignored. . . . There is no question that the parent paid the subsidiary, but the consequence of the payments sought to be deducted nevertheless still left the parent with its losses. The parent did not for its money receive 'insurance.' Many intercorporate transfers of funds are recognized, but in the circumstances before us nothing was received by the parent company in return. No insurance resulted.”

Id. at 841-42 (quoting Stearns-Roger Corp. v. United States, 774 F.2d 414, 416 (10th Cir. 1985)).

Thus, in this circuit, whether LLC is a sham entity is one question; whether the transactions at issue lack substance is a separate question.

More generally, corporations, even large corporations, are not immune from anti-abuse doctrines, as Plaintiff implies. For example, in Consolidated Edison of N.Y. v. United States, 703 F.3d 1367, 1381 (Fed. Cir. 2013), the court addressed a utility company that engaged in a complex leasing transaction with a Dutch utility; the transaction generated significant tax benefits. The court held that the transaction lacked economic substance. Id.; see also Schering-Plough Corp. v. United States, 651 F.Supp.2d 219, 238-40 (D.N.J. 2009); Gerdau Macsteel, Inc. v. Commissioner, 139 T.C. 67, 172 (2012).

B. There is a genuine dispute of material fact as to whether LLC was a sham.

1. An entity is a sham if it does not serve a valid business purpose or engage in substantive business activity.

Federal taxes cannot be avoided by “the simple expedient of drawing up papers.” Commissioner v. Tower, 327 U.S. 280, 291 (1946); see also Ballou v. United States, 370 F.2d 659, 664 (6th Cir. 1966) (setting aside family partnership agreement and trust instruments). Indeed, “taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed-the actual benefit for which the tax is paid.” Corliss v. Bowers, 281 U.S. 376, 378 (1930). Courts typically respect corporate entities formed for a legitimate business purpose “so long as that purpose is the equivalent of business activity or is followed by the carrying on of business by the corporation.” Moline, 319 U.S. at 439. However, “the corporate form may be disregarded where it is a sham or unreal,” id. (citing Higgins v. Smith, 308 U.S. 473, 477 (1940)), or where recognizing the separate corporate entity would work fraud on the tax statute, id. (citing Continental Oil Co. v. Jones, 113 F.2d 557, 562 (10th Cir. 1940)). Higgins and Continental Oil embody a clear exception to the general rule of corporate recognition under Moline: a corporation will not be treated as a separate entity if its sole function is to further a flagrant tax avoidance scheme.

In Higgins, the Supreme Court disregarded the taxpayer's subsidiary and disallowed losses incurred on the sale of securities below cost to the subsidiary. Corporate registration of the subsidiary was not sufficient for it to be recognized for tax purposes where evidence indicated that it was not “something that existed separate and apart” from the taxpayer:

It is clear an actual corporation existed. Numerous transactions were carried on by it over a period of years. It paid taxes, state and national, franchise and income. But the existence of an actual corporation is only one incident necessary to complete an actual sale to it under the revenue act.

Higgins, 308 U.S. at 476-77. Years after Higgins and Moline were decided, the Supreme Court summarized Higgins as turning on two factors: the lack of arm's-length dealing and the taxpayer having “retained de facto ownership” of the benefits transferred to the entity. See Cottage Sav. Ass'n v. Commissioner, 499 U.S. 554, 568 (1991).

In Continental Oil, the Tenth Circuit held that “it is clear beyond doubt” that last-minute transfers by a parent corporation of its oil and gas inventories to two non-producing subsidiaries in advance of the imposition of an excise tax were tax-motivated and that the parent company was liable for the tax. 113 F.2d at 564. The facts of Continental Oil bear striking similarities to the facts of this case. There, as here, the parent transferred valuable property to subsidiaries that were not in the financial position to make such a purchase. There, product purportedly owned by one of the subsidiaries was sold and distributed through the parent, and that subsidiary never took physical possession of the inventory. The same occurred here. Moreover, as here, the officers of the parent and the other subsidiary were substantially the same. The books and records for both were kept in the same location, and were worked by the same employees. Id. at 562-63. Continental Oil found the parent corporation liable, notwithstanding the fact that the subsidiaries were duly incorporated business entities. The Court should reach the same conclusion here.

2. There is a genuine dispute as to whether LLC lacked a non-tax business purpose or failed to engage in substantive business activity.

The record, taken as a whole, demonstrates that there is a genuine dispute over whether Plaintiff established LLC to further a flagrant tax scheme rather than to engage in meaningful business activity. It is undisputed that, prior to LLC's formation, Perrigo-U.S. (1) owned the exclusive distribution rights under the Dexcel Contract and (2) possessed unique physical infrastructure, intangible assets, and know-how to mass customize the packaging and distribution of store-brand products in the United States. Insertion of LLC into the supply chain served no valid business purpose and cost the company money.

Plaintiff claims to have engaged in “purchasing,” “selling,” “earning profits,” “making loans,” and “distributing profits.” These paper transactions in the furtherance of Plaintiff's tax scheme do not equate to substantive business activity under the Moline test. “Escaping taxation is not a substantive business activity.” Aldon Homes, Inc. v. Commissioner, 33 T.C. 582, 597 (1959) (citing National Carbide Corp. v. Commissioner, 336 U.S. 422, 437 n.20 (1949)). Moreover, vague and unsupported factual allegations cannot support summary judgment. Fed. R. Civ. P. 56(c)(1). And a large volume of evidence submitted by Defendant contravenes Plaintiff's conclusory statements.

Finally, Plaintiff attempts to salvage its argument by contending that LLC ultimately, if not initially, engaged in business activities. (PageID.2566 (citing Paymer v. Commissioner, 150 F.2d 334 (2d Cir. 1945)). But the government is not arguing that LLC was a sham throughout the 2009 and 2012 tax years solely because LLC was a sham at its formation. Rather, the government has offered evidence suggesting that LLC's activities never constituted the quantum or type of activities to avoid the sham exception to Moline.

C. Plaintiff's intercompany omeprazole transactions lack economic substance.

Whether LLC was a sham is one issue. Whether Plaintiff's intercompany omeprazole transactions lack economic substance is a separate issue. Defendant has submitted substantial evidence showing that Plaintiff's intercompany omeprazole transactions were devoid of practicable economic effects and lacked a business purpose. This evidence defeats Plaintiff's motion.

Plaintiff's scheme attempts to transform domestic earnings into foreign earnings. Although Congress has permitted U.S. businesses with foreign operations to defer taxation on foreign income, see 26 U.S.C. § 951 et seq., Plaintiff's omeprazole transactions were entirely U.S.-based. Perrigo-U.S. employees purchased omeprazole, mass customized outer packaging at its U.S. facilities, tracked inventory stored in the United States, and applied their expertise in the store-brand market to sell omeprazole to U.S. retailers. From start to finish, Plaintiff conducted a domestic operation, but it has papered the transaction so as to shoehorn it into the rules that permit the deferral of foreign income. The economic substance doctrine targets exactly this type of abuse. See Summa Holdings v. Commissioner, 848 F.3d 779, 785 (6th Cir. 2017) (“What the taxpayer cannot do is claim that the label he affixes on the transaction precludes it from being “income” under the Code or prevents the courts from treating it as “income” under the Code.”); see also Billy F. Hawk, Jr., GST Non-Exempt Marital Tr. v. Commissioner, 924 F.3d 821, 825 (6th Cir. 2019) (“While taxpayers are free to arrange their affairs to minimize taxes, they must do so in real ways — ways that give a transaction economic teeth and do not merely place tax-avoiding labels on tax-owing transactions.”) (citations omitted). Plaintiff's attempts to avoid the application of the economic substance doctrine are without merit.

1. Sixth Circuit precedent holds that a transaction has economic substance only if it has nontax economic consequences and a business purpose.

The Sixth Circuit uses a two-factor test to determine whether a transaction should be set aside as a sham. The first factor is an objective test: whether there are “practicable economic effects other than the creation of income tax losses.” See Illes v. Commissioner, 982 F.2d 163, 165 (6th Cir. 1992) (citing Rose v. Commissioner, 868 F.2d 851, 853 (6th Cir. 1989) & Bryant v. Commissioner, 928 F.2d 745 (6th Cir. 1991); Mahoney v. Commissioner, 808 F.2d 1219, 1220 (6th Cir. 1987)). The second factor, which comes into play only if a taxpayer clears the first factor, is a subjective test: “whether the taxpayer was motivated primarily by profit.” Rink v. Commissioner, 47 F.3d 168, 172 (6th Cir. 1995). The test is conjunctive: a taxpayer must demonstrate its transaction has practicable economic effects and is motivated primarily by profit. See id.

To establish “practicable economic effects,” a taxpayer must answer the following question affirmatively: “if the tax benefits are put aside, do the expected benefits exceed the costs?” Kerman v. Commissioner, 713 F.3d 849, 864-66 (6th Cir. 2013) (setting aside sham transaction where taxpayer failed to “elaborate on how he earned a profit” from the transaction). Moreover, the net benefit of the transaction must be appreciable, not a “relative pittance.” See Knetsch v. United States, 364 U.S. 361, 365-66 (1960).

In analyzing this factor, the Court must consider the entire structure of a transaction, not just isolated steps or elements. See American Elec. Power Co. v. United States, 326 F.3d 737, 742-43 (6th Cir. 2003) (plan lacked substance in the whole despite risk shifting under individual policies); Rink, 47 F.3d at 172 (limiting analysis to individual lease agreement “simply not supported by this circuit's precedent”); accord In re CM Holdings, Inc., 301 F.3d 96, 104 (3d Cir. 2002) (“The appropriate examination is of the net financial effect to the taxpayer, be it short or long term.”). Moreover, the non-tax economic consequences must flow from the transaction itself, not earnings generated from the transaction. See Am. Elec. Power, 326 F.3d at 744 (“[M]oney generated by means of abusive tax deductions can always be applied to beneficial causes, but the eventual use of the money thus generated is not part of the economic-sham analysis.”)

If the “practicable economic effects” factor is satisfied, the taxpayer still must satisfy the second economic substance factor: “whether the taxpayer was motivated by profit to participate in the transaction.” Dow Chemical Co. v. United States, 435 F.3d 594, 599 (6th Cir. 2006). Thus, “if a transaction or entity has no valid, non-tax business purpose . . . the Commissioner has the authority to find that the transaction or entity lacks economic substance and disregard it for tax purposes.” Richardson v. Commissioner, 509 F.3d 736, 741 (6th Cir. 2007) (internal quotation marks and citations omitted).

2. Disputes of material fact as to whether the intercompany omeprazole transactions had practical economic consequences preclude summary judgment and must be resolved at trial.

As with Plaintiff's decision to create LLC in the first place, Plaintiff offers no evidence showing its intercompany omeprazole transactions had real economic consequences. In contrast, Defendant has marshalled substantial evidence to put material facts in dispute. Plaintiff cannot show “practicable economic effects” through conclusory statements or by narrowly focusing on how LLC “performed” individual components of the scheme (e.g., LLC's “purchases” from Dexcel). Am. Elec. Power, 326 F.3d at 742-43; Rink, 47 F.3d at 172. Rather, Plaintiff must demonstrate that, taken as a whole, Perrigo-U.S.'s assignment of the contract to LLC, LLC's subsequent Subcontract back to Perrigo-U.S., and the “resale” transactions under the Subcontract generated pretax profits. In reality, inserting LLC into the supply chain had the opposite effect. It was a drain on profits. In addition, the fact that Plaintiff may have used untaxed cash from the sale of omeprazole in order to carry on other business is irrelevant to the economic substance analysis required by the Sixth Circuit. Am. Elec. Power, 326 F.3d at 744.

The activity Plaintiff describes in its brief is not “robust.” Rather, it consists of fictional paper transactions. The Sixth Circuit recently rejected an attempt by a taxpayer to claim that an entity engaged in substantive economic activity by engaging in contrived paper transactions. See Billy F. Hawk, 924 F.3d at 829 (6th Cir. 2019) (“[O]ne point of the sham-transaction doctrine is to look at what happened in fact, not what happened on paper.”).

Plaintiff's reliance on Northern Indiana, Bass, and United Parcel Services is misplaced. To the extent those cases are not at odds with Sixth Circuit case precedent, they are factually inapposite. In Northern Indiana and UPS, there were at least some economic effects. See Northern Indiana Pub. Serv. Co. v. Commissioner, 115 F.3d 506, 511 (7th Cir. 1997) (“access the Eurobond market”); United Parcel Serv. of Am. v. Commissioner, 254 F.3d 1014, 1018 (11th Cir. 2001) (“real insurance policy” with a third party). Moreover, the expansive approach espoused in UPS is inconsistent with the need to find “real” economic consequences as required by the Sixth Circuit in cases like Kerman, Davis, Hawk, and Malone & Hyde. The Fourth Circuit is similarly not aligned with the analysis in UPS. See Black & Decker Corp. v. United States, 436 F.3d 431, 442 (4th Cir. 2006) (“There is no basis here for abandoning our standard by scrutinizing the transaction for its 'real economic effects,' despite Taxpayer's argument that we should do so based on the law of another circuit [UPS].”). In relying on Bass, Plaintiff conflates the sham entity doctrine and the economic substance doctrine. See Bass v. Commissioner, 50 T.C. 595, 596 (1968) (addressing sham entity issue and concluding offshore entity engaged in business activity).

In sum, there are genuine disputes of material fact as to whether Plaintiff's intercompany omeprazole transactions had “practicable economic effects.”

3. Disputes of material fact as to whether Plaintiff had a legitimate business purpose other than tax avoidance when entering into intercompany omeprazole transactions preclude summary judgment.

Plaintiff concedes — as it must — that a transaction can have practicable economic effects and still lack economic substance if the transaction lacks a subjective business purpose. (PageID.2568). Plaintiff, however, attempts to escape this prong of the doctrine first, by asserting, without support, that it had a valid business purpose for its intercompany omeprazole transactions and, second, by arguing in essence that this test has no application to business enterprises. The weight of the evidence contradicts these assertions.

Plaintiff contends it assigned the Dexcel Contract to LLC “to implement an efficient international operating structure.” (PageID.2572). The only identifiable efficiency, however, is the compounding of money on a pretax basis offshore. The Court will need to evaluate the credibility of Plaintiff's current and former employees as to how the scheme was to further Plaintiff's “ability to exploit and deploy its IP globally in order to achieve the full synergies of the combined operations.” (PageID.2557).

4. The business purpose requirement is not limited to tax shelters.

Plaintiff seeks to limit the application of the economic substance doctrine to “tax shelters,” which it narrowly defines as “pre-packaged, structured transactions or complicated artificial structures unrelated to the taxpayer's core business that purportedly produce[ ] a loss or deduction (i.e., a tax benefit) for U.S. tax purposes.” (PageID.2573). Plaintiff appears to argue that so long as a taxpayer was not involved in a “tax shelter,” the business purpose prong of the economic substance doctrine is always satisfied. (PageID.2574).

This argument is in direct conflict with the law of the Sixth Circuit outlined above.¹³ In addition, the evidence shows Plaintiff inserted LLC into the supply chain as a mere artifice to shelter income. The United States contends that the TESCM scheme is a tax shelter.

Participants in tax shelters rarely admit that their transactions are tax shelters. Rather, they generally assert that the transaction has a business purpose that it is in line with their core business. For example, in Dow Chemical Co., Dow alleged that its purpose for entering into a life-insurance transaction was to produce cash flow to fund retiree medical costs. Dow Chemical Co. v. United States, 250 F.Supp.2d 748, 802 (E.D. Mich. 2003). The Sixth Circuit nonetheless held that the transaction lacked economic substance. 435 F.3d at 605. At no time did Dow admit that it had entered into a tax shelter.

Every taxpayer can claim that a transaction is a bona fide business transaction in line with its core business with a valid purpose and a profit motive. Plaintiff appears to argue that so long as a taxpayer makes this initial assertion, the government must demonstrate that the transaction is a “tax shelter” before it is appropriate to ask whether the alleged business purpose — a factual assertion — is accurate. There is no basis for this in the law.

D. The Court may look to events in prior years in determining Plaintiff's tax liability for 2009-2012.

Plaintiff contends, without authority, that the government cannot “'sham' PITLP/LLC's existence” or “dispute the economic substance of its transactions in the tax years at issue based on retroactive considerations of transactions in tax years closed under the statute of limitations.” (PageID.2578). Plaintiff misunderstands the nature of the statute of limitations on the assessment of tax.

It is true that the IRS is barred from assessing tax in a year for which the statute of limitations has lapsed. 26 U.S.C. § 6501. As applied here, the IRS may not assess tax on income Plaintiff earned during its 2007 or 2008 fiscal year. It has not done so.

But the statute of limitations does not bar the IRS from otherwise using information from a closed year. J&J Fernandez Ventures, 84 Fed.Cl. at 374. Rather, the IRS may re-characterize, adjust, recompute, or even disregard transactions in closed years in order to properly assess tax on income earned during in an open year. See id.; see also Barenholtz v. United States, 784 F.2d 375, 380-81 (Fed. Cir. 1986) (“It is well settled that the IRS and the courts may recompute taxable income in a closed year in order to determine tax liability in an open year.”).

In National Lead Co. v. Commissioner, the court looked to fifteen-year-old transactions in determining taxability with respect to transactions in an open year. 336 F.2d 134, 135 (2d Cir. 1964). In the open year of 1952, the petitioner received repayment of a “debt” owed to it by a British subsidiary. Id. at 139-140. The debt dated to 1937, when petitioner “sold” shares of a company purportedly worth $1.29 million to the subsidiary. Id. at 139. The subsidiary could not repay the “debt,” and petitioner took a loss of over $389,000 on its 1937 tax return, a loss that the IRS did not challenge. Id.

By 1952, the British pound had devalued. The subsidiary sold the shares and paid off the “debt” in pounds. The parent, tracking its receivable in dollars, claimed a tax loss for the differential, about $569,000. Id. at 139-140. In evaluating the 1952 transactions, the IRS disregarded the 1937 sale and thus calculated the taxpayer's 1952 liability without regard to the 1937 sale. Id. at 140. The Tax Court and Second Circuit upheld this determination. See id. at 140-41. As National Lead shows, the IRS may adjust — and even disregard — transactions in an earlier year when assessing tax on income in an open year.

Other cases stand for the same proposition. See e.g., Decon Corp. v. Commissioner, 65 T.C. 829, 839-43 (1976) (earlier year transaction lacked substance); Milbrew, Inc. v. Commissioner, T.C. Memo. 1981-610 (purchase of building in earlier year was a sham), aff'd, 710 F.2d 1302, 1307-08 (7th Cir. 1983) (taxpayer had no cost basis to depreciate because “as a matter of federal tax law, it never acquired” the building); Easter v. Commissioner, T.C. Memo. 1964-58 (disallowing depreciation deductions for 1958 based on details of transaction in 1949-50), aff'd, 338 F.2d 968, 969-70 (4th Cir. 1964) (per curiam).

Here, the Court is free to examine the nature of the Dexcel Contract “assignment.” If it is a sham, then Perrigo-U.S., rather than LLC, earned the income attributable to omeprazole sales during the years at issue. Moreover, as discussed above, there is a separate and independent reason why it is appropriate to examine the “assignment” in tandem with the Subcontract: Both are steps in the same scheme, and the Subcontract, which carries a one-year term, was not executed until 2010.

Finally, the IRS is not foreclosed from evaluating the nature of the “assignment” as part of its audit of income earned by Plaintiff during 2009-2012 merely because it did not make an adjustment during the 2007-2008 audit cycle. It is well-settled that the IRS is not estopped from adjusting a taxpayer's income simply because it failed to do so in an earlier year. See Roberto v. United States, 518 F.2d 1109, 1112 (2d Cir. 1975); Easter, 338 F.2d at 969-70. Plaintiff's recitation of “facts” regarding the IRS audit is thus irrelevant.

E. The IRS's alternative assessments under Section 482 do not immunize Plaintiff's transactions from scrutiny under the economic substance doctrine.

The egregious nature of Plaintiff's scheme is much more than, as Plaintiff suggests, a matter of mispricing. Plaintiff's scheme lacked a business purpose. Injecting LLC into Plaintiff's supply chain not only drained Plaintiff financially, it was a sleight-of-hand trick whereby LLC “earned” instantaneous profits over the Mediterranean Sea. This kind of flagrant scheme, “heavily freighted with tax motives,” should be disregarded for tax purposes. See Rubin, 429 F.2d at 653-54.

Plaintiff's legal authority for skipping past the application of the economic substance doctrine consists of five inapposite cases. In each of those cases, the selection of Section 482 as the proper analytical tool follows a discussion of the particular facts of the case, as those facts were adduced through presentation of evidence at trial.¹⁴ With varying degrees of analysis, the five decisions conclude that the taxpayers and companies at issue did not cross the line into sham territory.

In a more recent case involving issues of economic substance, the assignment of income doctrine, and an alternative IRS allocation under Section 482, the Tax Court held that certain “factoring arrangements” lacked economic substance and further concluded, notwithstanding Moline, that an S corporation was a “paper entity” and the relevant employment documents “were not worth the paper they were printed on.” See Pacific Mgmt. Grp. v. Commissioner, T.C. Memo. 2018-131, 2018 WL 4006591 at *10, *16-17, *26-27. This approach dovetails with IRS regulations construing Section 482. See 26 C.F.R. § 1.482-1(f)(2)(ii) (IRS will “evaluate the results of a transaction as actually structured. . . unless its structure lacks economic substance”).¹⁵

There is another distinction to be drawn. Plaintiff's case authorities on this issue, with one exception,¹⁶ predate the addition of the “commensurate with income” standard to Section 482 in 1986:

In the case of any transfer (or license) of intangible property (within the meaning of section 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible.

This “commensurate with income” standard would apply here. Plaintiff's “assignment” of the Dexcel Contract to LLC purports to constitute a transfer of intangible property. See 26 U.S.C. § 482; see also 26 C.F.R. § 1.482-4(b)(4) (contracts are intangible property). The express language of the statute requires a “transfer” of intangible property.¹⁷ Logically, a court must ascertain whether a “transfer” occurred before attempting to apply Section 482. See Medieval Attractions, T.C. Memo. 1996-455, 1996 WL 583322 at *40-52.

In Medieval Attractions, the Tax Court rejected a position similar to Plaintiff's contention in this case. The taxpayer there argued that “the pivotal issue here is the value of the intellectual property that was transferred to the petitioners, not the nature of the transactions by which they preserved their rights to use it.” Id. at *40 (emphasis in original). The Tax Court disagreed, concluding that before engaging in a pricing analysis under Section 482, a “transfer” must first be identified. Id. at *42. The Tax Court opined:

Inherent in the definition of transfer is the concept that the transferor must control or own the rights or economic benefits that the transferor desires to transfer to the transferee. To establish that a transfer has occurred, we must identify who owns the rights and economic benefits of the property that is the subject of the transfer.

Id.

Applying this framework, the Tax Court concluded that the “structure supporting the payment of royalties or franchise fees [in that case] was a sham.” Id. at *47. It also disallowed guarantee fees flowing from the sham structure. Id. at 48-52 (analyzing the economic substance of the transactions). This approach also dovetails with the more general principle that courts first determine the economic reality or substance of what actually occurred, regardless of the labels chosen by a taxpayer, and then proceed to apply the relevant provisions of the Internal Revenue Code. See Gregory v. Helvering, 293 U.S. 465 (1935).

In sum, the Court should first examine Plaintiff's tax scheme to determine what truly occurred. Only if the Court determines that the omeprazole transactions were not sham transactions would it then be appropriate to analyze those transactions under Section 482.

IV. Conclusion

Plaintiff's motion should be denied.

Dated: June 28, 2019

THE UNITED STATES OF AMERICA

DAVID A. HUBBERT
Deputy Assistant Attorney General

JAMES E. WEAVER
Senior Litigation Counsel
ARIE M. RUBENSTEIN
STEVEN M. DEAN
RICHARD J. HAGERMAN
Trial Attorneys
Tax Division, Department of Justice
P.O. Box 55
Washington, D.C. 20044
Telephone: (202) 305-4929
Facsimile: (202) 514-5238
James.E.Weaver@usdoj.gov

Local Counsel:

ANDREW B. BIRGE
United States Attorney

RYAN D. COBB
Assistant United States Attorney
Western District of Michigan
330 Ionia Avenue, N.W.
Suite 501
Grand Rapids, Michigan 49503
Telephone: (616) 456-2404
Facsimile: (616) 456-2510
Ryan.Cobb@usdoj.gov