On October 18, 2012, the Supreme Court of Canada (SCC) dismissed the appeal and cross-appeal in The Queen v. GlaxoSmithKline Inc. (2012 SCC 52) and affirmed the decision of the Federal Court of Appeal. The decision will send the matter back to the Tax Court of Canada (TCC) for a rehearing and redetermination. The case is a landmark decision in transfer pricing as it was the first transfer pricing case heard by the SCC regarding Income Tax Act § 69(2) (now ITA § 247). The decision affirms that the arm’s length principle must consider all “economically relevant characteristics” of a transaction when determining an arm’s length price. At issue was whether GlaxoSmithKline charged its Canadian subsidiary too high a price for pharmaceutical ingredients, which resulted in an understatement of the subsidiary’s taxable income in Canada.
By way of background, from 1990 to 1993, Glaxo Canada purchased ranitidine from Adechsa SA, a Swiss subsidiary of GlaxoSmithKline Inc. Ranitidine was the active ingredient used in the stomach ulcer drug, Zantac. Ranitidine was discovered by the GlaxoSmithKline Group in 1976. The price paid by Glaxo Canada for ranitidine during 1990 to 1993 was between $1,512 and $1,651 per kilogram. The Canadian Revenue Authority (CRA) believed that the price paid by Glaxo Canada to Adechsa SA for the purchase of ranitidine was too high as the generic version was available on the market for less than one-fifth of the price paid to Adechsa SA. Accordingly, the CRA assessed Glaxo Canada $51 million of additional taxable income.
Glaxo Canada appealed the CRA’s assessment to the Tax Court of Canada in May 2008, and a decision was rendered in favor of the Crown. However, Glaxo Canada appealed the TCC decision to the Federal Court of Appeal in July 2010, and a decision was rendered in favor of Glaxo Canada. The SCC heard the Crown’s appeal in January 2012 and rendered its decision largely in favor of Glaxo Canada on October 18, 2012.
GlaxoSmithKline argued that the intercompany price for ranitidine was appropriate as the license agreement between the parent and subsidiary provided Glaxo Canada access to GlaxoSmithKline’s other patented drug products and the right to sell ranitidine under the branded name, Zantac, in Canada. In contrast, the Crown argued that the prices charged by generic drug companies were comparable transactions and that such prices should be used as the primary basis for determining an arm’s length price in this case.
The SCC agreed with GlaxoSmithKline’s argument that it was reasonable for the Canadian subsidiary to pay more than a generic company because it was receiving other benefits from the GlaxoSmithKline Group that included (1) access to a range of GlaxoSmithKline’s patented drugs, (2) access to know-how related to the manufacture and sale of patented drugs, and (3) know-how related to the approval process for drug products.
The SCC did not accept the Crown’s comparability argument as the price paid by generic companies “[did] not reflect the economic and business reality of [the Canadian subsidiary] and, at least without adjustment, [did] not indicate the price that would be reasonable in the circumstances.”
Although the SCC disagreed with the Crown’s position, its decision is likely viewed by GlaxoSmithKline as a partial victory, as the SCC chose not to establish a “reasonable” price that should have been paid by Glaxo Canada to Adechsa SA, and referred the matter back to the TCC for redetermination of the intercompany price. The TCC must, however, give consideration to the business and economic relationship between the related parties. The SCC decision highlighted the following matters:
- The OECD Guidelines state that a proper application of the arm’s length principle requires that regard be had for the “economically relevant characteristics” of the arm’s length and non-arm’s length circumstances to ensure they are “sufficiently comparable.”
- The SCC concluded that the price paid by Glaxo Canada to Adechsa SA for branded ranitidine was in fact a payment for a bundle of transactions that included the rights and benefits received by Glaxo Canada under a License Agreement with GlaxoSmithKline and for products under a supply agreement with Adechsa SA.
- The evidence provided during trial indicates that arm’s length distributors purchased ranitidine from the GlaxoSmithKline Group at prices higher than generic sources. This “suggests that higher-than-generic prices are justifiable and are not necessarily greater than a reasonable amount under § 69(2).”
This case is of particular interest as there has been little judicial guidance in Canada on transfer pricing issues. As transfer pricing is a multinational issue, the SCC decision is relevant globally, not just in Canada. While the decision generally favors the taxpayer, the pricing must be addressed – again – by the Tax Court of Canada. In addition, other issues relating to withholding taxes on deemed royalties may yet end with a partial victory for the Crown.
The SCC decision can be found at http://scc.lexum.org/.
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This Alert was authored by Angeline Zioulas, CA, who is the national transfer pricing partner for the Praxity Canadian affiliate firm, MNP LLP. Angeline is located in MNP’s Vancouver, British Columbia, office where she provides transfer pricing services to clients across Canada. This Alert has been provided to North American member firms of Praxity as part of the group’s collaborative efforts and initiatives and illustrates how Praxity members share a common desire to deliver professional excellence and high service standards. Praxity, AISBL (www.praxity.com) is the largest global alliance of independent accounting firms and the world’s eighth largest association of accounting firms.