IRS Notice Pushes Perrigo's Potential Tax Debt From Move To Ireland Close To $3bn

IRS tax assessment for 2013, the year Perrigo acquired Dublin-based Elan, adds another cloud to OTC private label giant's outlook as it prepares to present plans for accelerating growth for its long-slumping consumer health business in the US and Europe at a March 9 investor day conference. Perrigo shares dropped more than 9% in early trading after IRS notice became known to investors before inching upward and ending at $47.92, down 6.8% from the previous day's close.

Perrigo Co. PLC's potential tax debt linked to its move to become an Irish firm could reach nearly $3bn with the US Internal Revenue Service ordering a $843m payment on top of Ireland's recent $1.9bn assessment.

The IRS notice about Perrigo's tax assessment for 2013, the year it acquired Dublin-based Elan Corp. PLC, adds another cloud to the OTC private label giant's outlook as it prepares to present plans for accelerating growth for its long-slumping consumer health business in the US and Europe at a March 9 investor day conference. President and CEO Murray Kessler and other Perrigo executives also are expected to discuss potential divestment plans for the firm's Rx generics business at the conference in New York.

Perrigo shares, long trading substantially lower than prices around $200 in 2015 when the firm fought off a hostile takeover by Mylan NV, dropped more than 9% to $46.75 in early trading on April 30 after the IRS notice became known to investors. In trading at nearly four times the average, Perrigo's share price inched upward and ended the day at $47.92, down 6.8% from the previous day's close.

The firm, based in Dublin since 2013 while maintaining its primary operations in Allegan, Mich., stated in an April 26 Securities and Exchange Commission filing that it received from IRS a revised Notice of Proposed Adjustment auditing Elan subsidiary Athena Neurosciences Inc. for 2011 through 2013.

The NOPA, "based on the IRS’s construction of events in 1996" when Elan acquired Athena, proposes a payment of $843, including additional tax and a 40% penalty, Perrigo states. Consideration of offsetting tax attributes and potentially material interest were not factors in the IRS' calculation, the firm says.

A draft NOPA the IRS submitted to Perrigo in July 2018 stated that Elan owed Athena additional royalty income related to Athena's development of multiple sclerosis drug Tysabri (natalizumab) prior to Elan's acquisition. However, Perrigo said it provided the IRS "substantial additional documentation" and discussed the question with agency officials and had "received no other communications from the IRS until receipt of the revised NOPA."

Athena reported royalties based on documentation from external tax advisors, but the IRS contends in the NOPA that when Elan began funding Athena’s research and development in 1996, "it should have paid a substantially higher royalty rate for the right to exploit Athena’s" intellectual property, according to Perrigo's SEC filing.

The firm says IRS officials "developed a theoretical 24.7% license royalty rate" from financial data included in Elan's 1996 purchase price allocation and determined Perrigo's tax assessment by applying the royalty rate to Tysabri sales revenue.

Perrigo provided the IRS "substantial additional documentation" refuting a draft NOPA it received in July 2018 and discussed the question with agency officials, but "received no other communications from the IRS until receipt of the revised NOPA."

"Perrigo strongly disagrees with the IRS income position. Perrigo also believes that the original transfer pricing methodology was appropriate and that no penalty should apply," the firm says in the SEC filing.

It says it will pursue administrative and judicial remedies including "potentially those available under the U.S. - Ireland Income Tax Treaty to alleviate double taxation" because Elan and its subsidiaries already reported in Ireland the income the IRS is claiming.

Perrigo owned rights to a royalty stream for Tysabri through its acquisition of Elan, but the product and the royalties arrangement didn't fit well in its overall structure and it sold the rights in 2017. (Also see "Perrigo Trims Workforce, Ships Tysabri License, Stays European Course" - Pink Sheet, 1 Mar, 2017.)

Big M&A Moves Prove Tough Fits

Like the Tysabri piece, the entire Elan acquisition along with its 2015 move into the European consumer health market by acquiring Omega Pharma NV could prove ill-fit for Perrigo. Its revenue and net income growth historically were linked to its dominance in the OTC private label and store brand space, but adding Elan and Omega Pharma introduced drags in both areas as well as on its gross margins.

With Elan, Perrigo's spending on R&D and manufacturing for Rx products generics, primarily specialty topicals, jumped greatly while it and other nonprescription generics marketers have faced pressures for lower prices from pharmacy benefit providers and insurance firms.

And in December, another potential hit from acquiring Elan emerged. The Irish Office of the Revenue submitted a "Notice of Amended Assessment" for 20 years of taxes on sales of Tysabri. (Also see "Irish $1.9bn Tax Bill 'Out Of Nowhere' Perplexes Perrigo, Troubles Analysts" - Pink Sheet, 18 Jan, 2019.)

Like the IRS notice, Perrigo is appealing the Irish ruling. The firm stated in an SEC filing that Irish tax regulators in October provided findings from an audit asserting that Elan's intellectual property sales of Tysabri should have been treated as chargeable gains subject to an effective 33% tax rate, rather than the 12.5% tax rate applicable to trading income. The agency also claimed that all amounts Perrigo received from Tysabri sales transaction and from its sale of the royalty rights should be taxed in Elan's 2013 tax year.

With its 2018 full-year and fourth-quarter results in February, Perrigo announced that Ireland's High Court will review the assessment the Revenue Office imposed. It says the judicial review is based on a breach of Elan's expectations as a taxpayer and it is challenging Irish Revenue's authority to issue the assessment, not the merits of the notice. Its appeal on the merits of the assessment before the Tax Appeals Commission is stayed pending resolution of the judicial review. It expects a substantive hearing before the commission in late 2019. (Also see "Perrigo Lights Smoking Cessation For Growth With Turnaround Woes 'Fixable'" - HBW Insight, 28 Feb, 2019.)

Surprises Arrive With Omega

Omega Pharma's portfolio not only substantially expanded Perrigo's nutritional products lineup but also moved it into the branded OTC drug and dietary supplement market and exposed it to varying regulations for consumer health product sales across different European markets. Additionally, Omega Pharma's expenses linked to distribution and its sales in some markets didn't meet Perrigo's expectations.

Ongoing changes to restructure and right-size Omega Pharma slowed sales in 2018 by 5% to €988m ($1.1bn), according to results reported separately from Perrigo's in early April. Perrigo blamed the slide on the termination of “unprofitable” distribution contracts in Belgium and Portugal, the divestiture of its Russian business to Alvogen Inc., and offloading the T. Leclerc, Innoxa and Bergasol cosmetic brands. (Also see "Perrigo's Omega Pharma Struggles In 2018 As It Continues To Restructure And Divest" - HBW Insight, 16 Apr, 2019.)

With Omega Pharma's results, Perrigo said it spent €9.9m ($11.1m) restructuring on reorganizing programs in France, Luxembourg and Germany and made leadership changes in Germany, Czech Republic, Ukraine and Turkey. Evaluations of Omega’s South Africa and Argentina operations – initiated in 2016 – were nearing completion.

Omega Pharma's main growth driver in 2019 would be its top-20 brands, which "are supported by the main research and development investments of the company, as well as by high promotional spend to create brand awareness in the different European countries.”

Investor groups haven't been happy with Perrigo's Omega Pharma deal. Multiple groups have filed securities fraud litigation alleging the firm misled shareholders about the strategic benefits from acquiring the firm and about other aspects of its business to stave off Mylan's takeover bid. (Also see "Perrigo Haunted By Mylan Rejection As Securities Fraud Complaints Mount" - HBW Insight, 31 Oct, 2018.)

Additionally, while CEO Kessler acknowledges Perrigo "lives and dies by the performance of the core US business," its domestic results are by increased private label and store brand competition.

At SVBLeerink, market analyst Ami Fadia acknowledged the IRS notice as another potential obstacle to Perrigo's turnaround.

"While we acknowledge this matter will likely take years to resolve, this only further adds uncertainty on top of €1.6B in potential liability amount related to Tysabri tax treatment," said Fadia in an April 29 research note. "We remain cautious although open minded heading into the Investor Day."