October 18, 2012
GlaxoSmithKline Inc. — Supreme Court Sends Transfer Pricing Dispute Back to Square One
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 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.
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.
We can help
Your KPMG adviser can help you review your company’s transfer pricing policies and help you verify, support and document the existence of arm’s length intercompany charges for transactions within your corporate group. For details, please contact your KPMG adviser.
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