October 18, 2012
Canadian taxpayers who conduct cross-border transactions with related parties have been eagerly awaiting today’s decision by the Supreme Court of Canada (SCC) in the transfer pricing case The Queen v. GlaxoSmithKline Inc. The SCC did not decide the final outcome of the transfer pricing dispute but did confirm that, in determining transfer prices, significant factors that arm’s length parties would likely consider, such as the licence agreement in this case, must be taken into account. The CRA’s more narrow “transaction-by-transaction” approach was rejected.
The SCC referred the case back to the Tax Court of Canada for retrial, with each party allowed to provide new evidence. As a result, it’s not known how long it will take for this transfer pricing dispute of almost 20 years to finally be resolved. Though the SCC provided some further guidance on the factors that should be considered in determining a transfer price, this additional guidance is more limited than many had hoped. As such, this decision does not resolve the long-standing uncertainty for taxpayers in this area.
The GlaxoSmithKline case involves the determination of the price paid by a Canadian subsidiary (Glaxo Canada) of a pharmaceutical company (Glaxo UK) to a related non-resident Swiss company Adechsa S.A. (Swissco) for ranitidine, the key raw ingredient used in the manufacture of the brand name drug Zantac.
Glaxo Canada, which had the license to sell Zantac in Canada, was buying the ranitidine from Swissco in accordance with the licence agreement at a price that was more than five times higher than that paid by generic manufacturers.
The CRA reassessed Glaxo Canada by increasing its income on the basis that the price Glaxo Canada paid to Swissco was not reasonable in the circumstances had they been dealing at arm’s length; rather the CRA asserted that the price paid should have reflected the price for ranitidine on the open market.
Glaxo Canada’s position in its appeal to the Tax Court of Canada (TCC) was that the price paid to Swissco was reasonable in light of all economically relevant factors, in particular the related license agreement and its business of selling branded drugs as opposed to generic drugs.
To market and sell Zantac, Glaxo Canada was required under the license agreement to purchase ranitidine only from approved suppliers, such as Swissco. Glaxo Canada could not have purchased ranitidine from generic suppliers without violating the license agreement and losing its rights to sell not only Zantac but also a host of other patented and trademarked products belonging to the Glaxo corporate group.
In its original decision in 2010, the TCC upheld the CRA reassessments. The TCC ruled that the license agreement was an irrelevant consideration in the determination of the price charged for ranitidine because “one must look at the transaction in issue and not the surrounding circumstances, other transactions or other realities.”
However, 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 take into account factors such as the license agreement and to apply the "reasonable business person" test. The FCA remitted the matter back to the TCC for redetermination of the “reasonable amount” payable for Glaxo Canada’s ranitidine transactions.
The case was then appealed to the SCC for resolution.
The SCC upheld the FCA’s decision that the matter should be remitted to the TCC to be redetermined, having regard to the effect of the licence agreement on the prices paid by Glaxo Canada for the supply of ranitidine from Swissco.
The SCC noted that the generic comparators the CRA put forth in its original assessment and that the TCC used do not reflect the economic and business reality of Glaxo Canada and, at least without adjustment, do not indicate the price that would be reasonable in the circumstances, had Glaxo Canada and Swissco been dealing at arm’s length.
According to the SCC, arm’s length comparisons under any of the OECD transfer pricing methods or other methods may be determined only after identifying the circumstances arising from the licence agreement that are linked to the supply agreement (which set the transfer prices of ranitidine).
The SCC noted that the court is required to determine whether the transfer price was greater than the amount that would have been reasonable in the circumstances, had the parties been dealing at arm’s length. If transactions other than the transaction being reviewed are relevant in determining this question, they must not be ignored.
The SCC provided some guidance on the factors that the TCC should consider in redetermining the transfer price in this case. The SCC noted the reality that “transfer pricing is not an exact science”. It is doubtful that comparators will be identical in all material respects in almost any case. Therefore, some leeway must be allowed in the determination of the reasonable amount. As long as a transfer price is within what the court determines to be a reasonable range, the requirements of the law should be satisfied. If not, the court might select a point within a range it considers reasonable in the circumstances based on an average, median, mode or other appropriate statistical measure, having regard to the evidence that the court found to be relevant.
Second, the SCC stated that the respective roles and functions of Glaxo Canada and its parent company Glaxo Group should be kept in mind. Glaxo Canada engaged in the secondary manufacturing and marketing of Zantac. Glaxo Group owns the intellectual property and provided other rights and benefits to Glaxo Canada. According to the SCC, transfer pricing should not result in a misallocation of earnings that fails to take account of these different functions and the resources and risks inherent in each. Whether compensation for intellectual property rights is justified in this case is a matter for the TCC to determine.
The SCC noted that any compensation for intellectual property rights may be subject to withholding tax and that the TCC may address this issue at the retrial.
The contribution of intellectual property to profits is at the forefront of transfer pricing today, and is a significant focus of the OECD. Taxpayers are well advised to devote sufficient resources to identifying and pricing their value-driving intellectual properties.
Third, the SCC noted that prices between parties dealing at arm’s length will be established having regard to the independent interests of each party to the transaction. That means the interests of Glaxo Group and Glaxo Canada must both be considered. An appropriate determination under the arm’s length test should reflect these realities.
Fourth, the SCC pointed out that some evidence in this case indicates that arm’s length distributors have found it in their interest to acquire ranitidine from a Glaxo Group supplier, rather than from generic sources. This suggests that higher-than-generic transfer prices are justified and are not necessarily greater than a reasonable amount under Canada’s transfer pricing law.
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