Global Tax Adviser
January 24, 2012

GlaxoSmithKline Inc. Transfer Pricing Case — Exclusive Highlights of Supreme Court Hearing

Demet Tepe and Stéphane Dupuis
Montreal, Transfer Pricing

Gordon Denusik
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 manufacturers.

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 law.


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 Group

  • 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 supplier.

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 Adechsa.

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”.   

Federal Court 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 ranitidine drugs.

  • Glaxo Group owned the ranitidine patent and would have owned it even if Glaxo Canada had been in an arm’s-length relationship.

  • 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 positioned.

  • 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 listed above.

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 bundled together

  •  When conducting transfer pricing analysis in Canada, the arm’s length standard has been displaced by a “reasonable business person” test (the GABCO test). 

Transfer pricing issue — SCC’s challenge to CRA’s position

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 hearing
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 ranitidine.

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 characteristics.

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 hearing
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 taxpayer’s argument
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, or

  • 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 second trial.

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.

At 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 were discussed:

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 pricing guidelines.

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 arm’s length. 

Withholding tax
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 either.

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.


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