Demet Tepe and Stéphane Dupuis
Montreal, Transfer Pricing
Vancouver, Transfer Pricing
The Supreme Court of Canada (SCC) recently heard one of the most important
transfer pricing cases in Canada to date, The Queen v.
GlaxoSmithKline Inc. KPMG attended this hearing on January 13,
2012. Gord Denusik (Vancouver), Demet Tepe and Stéphane Dupuis (Montreal)
provide the following highlights of the SCC proceedings and their
impressions of the court's reactions.
This transfer pricing case involves the
determination of the price paid by a Canadian subsidiary (Glaxo Canada) of a
pharmaceutical company to a related non-resident company for ranitidine, the key
ingredient used in the manufacture of a brand-name prescription drug. Glaxo
Canada was paying a price more than five times higher to buy the ranitidine from
the Glaxo Group than it would have paid to buy the ranitidine from generic
A seven-member panel of the SCC heard this case. The SCC judges’ questions and
comments during the hearing are worth highlighting, as they may provide some
useful insights into the SCC’s views on transfer pricing.
It is difficult to predict which way the SCC will decide this case because the
judges asked difficult and probing questions to counsel representing both the
CRA and the taxpayer. When the SCC’s decision is rendered, we hope it will
provide helpful guidance on interpreting and applying Canada’s transfer pricing
To manufacture and sell the brand-name
drug Zantac in the Canadian market, Glaxo Canada paid a royalty to its U.K.
parent company under a license agreement (the License Agreement). Glaxo Canada’s
rights under this agreement included the right to:
Manufacture, use and sell various Glaxo
Group products (including Zantac)
Use other trademarks owned by the Glaxo
Access new Glaxo Group products
Receive technical support.
As well, under the License Agreement to
sell Zantac, Glaxo Canada was required to purchase ranitidine — the key
ingredient to Zantac — from a Glaxo Group approved source. Adechsa, a
non-resident company in Switzerland within the Glaxo Group, was one approved
During the years 1990 to 1993, Glaxo
Canada (a Canadian company) purchased ranitidine, an active pharmaceutical
ingredient, from Adechsa and used it to manufacture and sell Zantac in Canada.
The purchases were made under a Supply Agreement between Glaxo Canada and
The price Glaxo Canada paid Adechsa for
ranitidine during the relevant period ranged from $1,512 to $1,651 per kilogram.
This price was significantly higher than the amount Canadian generic
manufacturers were paying for their purchases of ranitidine from other suppliers
(i.e., $194 to $304 per kilogram).
The CRA reassessed Glaxo Canada by
increasing its income on the basis that the amount it had paid Adechsa for the
purchase of ranitidine was “not reasonable in the circumstances” within the
meaning of the transfer pricing rules in subsection 69(2) of the Income Tax Act
(the Act). According to the CRA, the amount Glaxo Canada paid did not reflect an
arm’s length price because it exceeded the amount generic drug companies paid
for ranitidine on the open market.
Glaxo Canada’s position was that the
price paid to Adechsa was reasonable in the circumstances when viewed in
consideration with the License Agreement and its business to sell Zantac (i.e.,
in order to market and sell Zantac, it was required to purchase ranitidine from
Adechsa; it could not have purchased ranitidine from the generic suppliers
without losing its rights to sell Zantac along with a host of other patented and
trademarked products belonging to the Glaxo Group).
Tax Court of Canada’s decision
Glaxo Canada appealed the CRA’s
reassessment to the Tax Court of Canada (TCC), which affirmed the CRA's
adjustment of the transfer price on the basis of the prices generic drug
companies were charged for ranitidine. The TCC supported the CRA’s position
that, in determining the reasonableness of the amount paid; the License
Agreement was an irrelevant consideration because “one must look at the
transaction in issue and not the surrounding circumstances, other transactions
or other realities”.
of Appeal’s decision
The Federal Court of Appeal (FCA)
rejected the premise of the reassessments and the TCC’s decision. The FCA
concluded that to determine the transfer price, it was necessary to interpret
the words “reasonable in the circumstances” in accordance with the reasonable
business person test articulated in GABCO
Limited v. Minister of National Revenue.
According to the FCA, the question
therefore was “whether an arm’s length Canadian distributor of Zantac would have
been willing, taking into account the relevant circumstances, to pay the price
paid by [Glaxo Canada] to Adechsa.” The relevant circumstances included the
business reality that an arm’s-length purchaser was bound to consider whether it
intended to sell ranitidine under the Zantac trademark.
The FCA identified the following five
circumstances related to the License Agreement that must be considered in
determining the transfer price of ranitidine:
Glaxo Group owned the Zantac trademark
and would own it even if Glaxo Canada was an arm’s length licensee.
Zantac commanded a premium over generic
Glaxo Group owned the ranitidine patent
and would have owned it even if Glaxo Canada had been in an arm’s-length
Without the License Agreement, Glaxo
Canada would not have been in a position to use the ranitidine patent and
the Zantac trademark. Consequently, in those circumstances, the only
possibility open to Glaxo Canada would have been to enter the generic market
where the cost of entry would likely have been high, considering that both
of the competitors (i.e., Apotex and Novopharm) were already well placed and
Without the license agreement, Glaxo
Canada would not have had access to the portfolio of other patented and
trademarked products to which it had access under the License Agreement.
However, instead of reversing the TCC
decision, the FCA mandated that the file be returned to the TCC for
redetermination of the transfer price in accordance with the circumstances
Supreme Court of Canada hearing
Issues before the SCC
The issues before the SCC were transfer pricing and a procedural issue
concerning whether the FCA erred in referring the matter to TCC for rehearing.
Concerning transfer pricing, the
issues before the SCC were whether:
Identification of a transaction that is the subject of a transfer price
analysis is limited by the bona fide legal arrangements of taxpayer
Transfer prices in independent transactions between a Canadian taxpayer and
different entities of a multinational group should be assessed separately or
conducting transfer pricing analysis in Canada, the arm’s length standard
has been displaced by a “reasonable business person” test (the
Transfer pricing issue — SCC’s challenge
to CRA’s position
The CRA appealed the FCA decision on the
basis that the
FCA interpreted paragraph 69(2) of the Act in a way that conflicts with the
words, context and purpose of the provision and is incompatible with the OECD
transfer pricing principles. The key question to be determined was whether
taxpayers are to factor in all circumstances in determining the arm’s length
price (i.e., circumstances a reasonable business person would consider).
The CRA’s position is that, in a transfer pricing exercise, the appropriate
analysis is simply what is the arm’s length price for ranitidine; other
circumstances are not to be considered. As such, it is not necessary to
determine whether an arm’s length Canadian distributor of Zantac would have been
willing to pay the price paid by Glaxo Canada to Adechsa, taking into account
the relevant circumstances ascertained based on the
GABCO reasonable business person test.
According to the CRA, it is not relevant whether the purchaser wants to acquire
the ranitidine for the generic drug market or the premium brand market, nor is
it relevant whether the purchaser is required to acquire the ranitidine only
from certain suppliers under a license agreement.
Further, the term “reasonable in the circumstances” does not require putting
arm’s length parties in Glaxo Canada’s shoes and asking whether they would have
agreed to pay a dictated price for ranitidine higher than the open market price
if they could sell the drug under the name Zantac at a premium price. The
correct way to do the analysis is to strip away all non-arm’s length
circumstances, in this case, the License Agreement and the possibility to sell
the drug at a premium price, and not ask whether the whole deal was reasonable.
SCC’s questions at the
The SCC’s questions to counsel representing the CRA focused on whether
determining the arm’s length price for the transaction required taking into
account that Glaxo Canada purchased the ranitidine so it could sell Zantac.
Underlying this question was whether it was appropriate to ignore the License
Agreement and keep it separate from the analysis of the arm’s length price of
The SCC asked the CRA what “reasonable in the circumstances” could mean if not
business realities. The CRA answered that business reality in this case could
only include economically relevant characteristics related to the purchase of
ranitidine and not the purchase of ranitidine to produce the Zantac drug.
Some of the SCC judges did not seem convinced that this interpretation was
correct, stating that if the meaning of “reasonable in the circumstances” was to
be as restrictive as the CRA argued, paragraph 69(2) of the Act would have
expressed it otherwise.
Further, some of the SCC judges noted the business reality that if Glaxo Canada
had purchased the ranitidine at a cheaper price as the generic companies did, it
would not have been able to sell the product under the Zantac name. The judges
asked whether the correct question was whether arm’s length parties in the same
situation as Glaxo Canada who wanted to sell Zantac would have paid the same
price for the ranitidine.
A few SCC judges also questioned whether the CRA had changed the circumstance
applicable to Glaxo Canada in its analysis when it considered what price Glaxo
Canada would have paid if it was a generic drug manufacturer and seller.
The questions from the SCC seemed to further suggest that there were two
Canadian markets for the purchase of the ranitidine, i.e., the market for
generic companies and the market for branded pharmaceutical companies. The CRA
disagreed and pointed out that there was only one Canadian market to purchase
the ranitidine. The SCC insisted and reiterated that maybe there was one market
but two different products, i.e., the Zantac drug and the generic drugs.
The SCC asked if, according to the CRA’s interpretation, it would not be
reasonable for a Porsche manufacturer to buy an expensive engine from a supplier
in order to meet Porsche standards when it could purchase cheap Chevy engines
instead. To this argument, the CRA replied that this was not an applicable
question to the Glaxo Canada case, and asked instead whether it would be
reasonable for the Porsche manufacturer to buy an engine that is the same as the
Chevy one but to pay the supplier a higher price for it.
The SCC also asked the CRA if it would have been as reluctant to accept
additional charges bundled in the goods’ purchase price if they had been, for
example, quality control test charges [i.e., accompanying services] instead of
intangible property. The CRA said that quality control test charges would be
easier to accept because they can be considered economically relevant
Transfer pricing issue — SCC’s challenge
to Glaxo Canada’s position
Glaxo Canada’s position
In the oral argument, counsel representing Glaxo Canada stated that the case
simply requires answering to the following thought experiment question: Imagine
the meeting of the two CEOs of Glaxo Group and Glaxo Canada. The CEO of Glaxo
Group proposes at time of contract formation a deal to the CEO of Glaxo Canada
that goes more or less like this: “You are going to pay a royalty of 6% of sales
for the use of the patent (during patent life) and for the use of trademark and
other intangibles for the whole time you distribute the trademarked product
Zantac, and you will also pay $1,500 per kilogram for the physical product
ranitidine. We will organize the transaction with a view that you will realize a
gross margin of 60%” (the gross margin referred to during the hearings).
Glaxo Canada stated that the relevant question of the case was: When proposed
that deal, would a reasonable business person standing in the shoes of the CEO
of Glaxo Canada accept it?
SCC’s questions at the
The SCC did not appear to oppose this way of putting the problem of the arm’s
length price determination. However, some of the judges did not appear to be
convinced that Glaxo Canada has demonstrated or defended any of the existing
evidence that the price it paid for ranitidine was arm’s length.
In particular, the SCC asked whether Glaxo Canada thought that the “resale
minus” transfer pricing method was the appropriate method instead of the
comparable uncontrolled price method the CRA used. Further, the SCC asked
whether the European comparables provided the appropriate evidence of the arm’s
length nature of Glaxo Canada’s intercompany pricing.
In reply, Glaxo Canada made the point that, although it thought the resale minus
method was correct, that discussion was irrelevant at this stage because the
trial judge had rejected that position and accepted the CRA’s position that the
price of the generics must be the basis of comparability.
SCC’s reaction to
Based on the line of questioning from the SCC, some of the judges appeared to
insist that the term “reasonable in the circumstances”, comparability standards
and the OECD transfer pricing guidelines mean that the court had to consider the
price on the basis that Glaxo Canada was buying the ranitidine for the purposes
of selling Zantac and that the court cannot therefore look just at the price of
generics (i.e., the court must stand in the shoes of the taxpayer; the court
must consider all economically relevant characteristics). However, it remains to
be seen whether the SCC’s decision will agree with this argument.
Procedural issue — Should the FCA have
referred the case back to the TCC?
In its decision, the FCA referred the case back to the TCC, asking the TCC to
reassess the matter based on all the relevant factors as set out by the FCA.
Glaxo Canada appealed the FCA decision to refer the case back to the TCC,
arguing that given the FCA’s conclusions, Glaxo Canada had discharged its onus
and thus the reassessments must be set aside.
Glaxo Canada argued that in contesting an assessment, the onus on the taxpayer
is to establish the existence of facts or laws showing an error in relation to
the taxation imposed by the reassessments. Specifically, to satisfy its onus,
the taxpayer need only:
Disprove the allegations and certain assumptions of facts that the CRA made
in raising the reassessments
Adduce evidence to demonstrate that the factual assumptions were incorrect,
Establish by argument that, even if the assumed facts were correct, they did
not justify the assessment as a matter of law.
Glaxo Canada’s position was that it met the third requirement because the FCA
concluded that the TCC (and therefore the CRA in raising the reassessments) had
failed to apply the proper legal test in determining the amount that would have
been reasonable in the circumstances (i.e., the CRA did not apply the reasonable
business person test).
At the SCC hearing, Glaxo Canada reiterated this position by arguing that its
burden of proof was to demolish the basis of the CRA’s argument and basis of the
reassessments and that, on that account, its onus had been met.
When the SCC judges raised the issue of whether Glaxo Canada should not have
produced evidence demonstrating that $1,500 was the right arm’s length price
when taking into account all the relevant factors, Glaxo Canada argued that this
would require adducing evidence that was not shown at the TCC, amounting to a
The CRA’s reassessments (and the TCC decision) were based on the approach that
would ignore the License Agreement and other factors a reasonable business
person selling Zantac would have considered. Glaxo Canada argued that, because
the reassessments are based on treating these other considerations as
irrelevant, and because the FCA ruled that one cannot ignore these other
considerations, there is now no law or basis to support the CRA’s contention
that the pricing was not reasonable.
As argued by Glaxo Canada, in order for the CRA to now argue that the pricing
was not reasonable, it must come up with new arguments — effectively, it must
assess again. Glaxo Canada pointed out that the statute of limitation for
assessment has expired.
the end of the appeal, when asked by an SCC judge what the CRA would do if the
matter is referred back to the TCC, the CRA stated it would stick to its theory
and that its only basis for assessment was the price of generics. Though
presumably the CRA would have to change its argument if the SCC sent the case
back to the TCC for a new hearing, perhaps it is not surprising that the CRA
would not admit its approach could be wrong at this stage in the process.
KPMG observations — Other transfer pricing matters of note
In the course of the hearing, a few other interesting items for transfer pricing
Reasonable business person test
In the line of SCC questioning concerning the factors to consider in determining
arm’s length pricing, it seemed clear that at least a few judges subscribed to a
broad inclusion of the various factors and circumstances, i.e., standing in the
shoes of the taxpayer and applying the reasonable business person test. In this
case, that would mean considering the price on the basis that Glaxo Canada was
buying the ranitidine for the purposes of selling Zantac. This position is
advanced in the decisions in Alberta
Pricing and GE Capital and in some
other international decisions.
Transfer pricing case
Although technically the provision at issue in this case was subsection 69(2) of
the Act, which has since been replaced by new transfer pricing rules in section
247, this is a transfer pricing case because all parties (the CRA, Glaxo Canada
and even the SCC judges) referred to, quoted and sourced the OECD transfer
Arm’s length price
As discussed above, some of the questions the SCC directed to Glaxo Canada
focused on whether the $1,500 per kilogram it paid was an arm’s length price.
Unless this case is referred back to the TCC, the question of whether this was
an arm’s length price once the License Agreement and other circumstances were
factored in will not be answered. The take-away here is that, based on the line
of questioning by the SCC, it appears that any taxpayer in similar situations
will still have to demonstrate that the pricing for each separate transaction is
Other questions the SCC directed to Glaxo Canada focused on withholding tax, and
whether a taxpayer could set up a similar structure to reduce the amount of
withholding tax required to be remitted (i.e., pay a low royalty that is subject
to withholding tax but a higher product purchase price that is not subject to
withholding tax). The SCC acknowledged this was not an issue before the courts
here. Nevertheless, they wanted commentary from Glaxo Canada.
Glaxo Canada response was that it is a common practice in Canada for companies
to acquire goods that clearly have an intangible property component. Glaxo
Canada pointed out that no withholding tax is remitted when Nike products or
Porsche cars are acquired and imported into Canada, even though their price is
largely attributable to the Nike or the Porsche intellectual property as opposed
to the actual product. Glaxo Canada stated that, as unrelated parties are not
required to unbundle intangible property payments from tangible goods or service
payments (for Nike or Porsche products), then Adechsa and Glaxo Canada are not
SCC decision reserved
The decision for the case has been reserved. We do not know at this time when to
expect the SCC to render its judgment.
For more information, contact your KPMG adviser.