August 5, 2010
No. 2010-29

 

GlaxoSmithKline Inc. — Taxpayer Wins But at What Price?

 

The Federal Court of Appeal (FCA) has reversed the Tax Court of Canada (TCC) decision in GlaxoSmithKline Inc. v. The Queen. This case involves the price paid by a Canadian subsidiary of a pharmaceutical company to a related non-resident company for an active ingredient used in the manufacture of a blockbuster prescription drug. Previously, the TCC essentially upheld the CRA's proposed adjustment to income for the 1990-1993 taxation years for almost $51.5 million.

 

Facts

 

During the years 1990 to 1993, a Canadian company (Glaxo) purchased the active ingredient (ranitidine) of one of its drug products (Zantac) from a non-resident affiliate in Switzerland (Swissco). Glaxo paid a royalty of 6% to its U.K. parent company (UK Parent) pursuant to a license agreement. The price Glaxo paid for ranitidine during the relevant period ranged from $1,512 to $1,651 per kilogram, whereas Canadian generic manufacturers were purchasing ranitidine for $194 to $304 per kilogram.

 

The TCC allowed the CRA's bid to apply the comparable uncontrolled price (CUP) method and adjust the transfer price on the basis that the Canadian subsidiary paid a higher price to the non-arm’s-length vendor for the active ingredient than would have been reasonable if the companies were dealing at arm’s length. The CRA also succeeded in arguing that the amounts paid in excess of the reasonable amount to the related third party constituted a benefit to that party, and therefore non-resident withholding tax should apply to the excess.

 

FCA's decision


 

In its reversal of the TCC's decision, the FCA made a key determination regarding the license agreement between UK Parent and Glaxo, which gave Glaxo access to UK Parent's intellectual property, including the right to use intellectual property relating to Zantac. The FCA said that the license agreement should be considered in determining the transfer price of the ranitidine. The FCA stated that the TCC erred in concluding that the license agreement was irrelevant, on the basis of Singleton.

 

The FCA further stated that the TCC misunderstood the test that applies in the interpretation of transfer pricing rules. To determine whether the price paid by Glaxo for its ranitidine have been "reasonable in the circumstances", the TCC should have  inquired into the circumstances which an arm’s-length purchaser would consider relevant in deciding whether it should pay the price paid by Glaxo to Swissco for its ranitidine, as determined in GABCO.

 

As a result, the FCA said that the TCC failed to consider the business reality that an arm’s-length purchaser was bound to consider if he or she intended to sell ranitidine under the Zantac trademark.

 

The FCA identified the following five circumstances related to the license agreement were required in determining the transfer price of ranitidine:

  1. UK Parent owned the Zantac trademark and would own it even if Glaxo was an arm’s-length licensee.
  2. Zantac commanded a premium over generic ranitidine drugs.
  3. UK Parent owned the ranitidine patent and would have owned it even if Glaxo had been in an arm’s-length relationship.
  4. Without the license agreement, Glaxo would not have been able to use the ranitidine patent and the Zantac trademark. Consequently, in those circumstances, the only possibility open to Glaxo would have been to enter the generic market where the cost of entry would likely have been high, considering that both of the competitors were already well placed and positioned.
  5. Without the license agreement, Glaxo would not have had access to the portfolio of other patented and trademarked products.

 

The FCA then mandated that the file be returned to the TCC for redetermination of the transfer price in accordance with the circumstances listed above.

KPMG observation

The first four circumstances listed by the FCA suggest that Glaxo had two options for the purchase of ranitidine. Glaxo could either purchase ranitidine at a high price from a UK Parent-approved supplier (i.e., Swissco) and earn high profit margins in selling Zantac, or it could purchase ranitidine from another source and pay a license fee under Canada’s then-compulsory licensing regime. As the third or fourth generic supplier for a given product, Glaxo would get a lower price for its product and presumably lower profit margins.

It appears that the FCA's position is that, in reality, it would not be unreasonable for a corporation to have picked the first option over the second, even if it meant paying a higher price for ranitidine.

The fifth circumstance may be the most important. As a licensee, Glaxo had not only access to the intellectual property relating to Zantac but also access to UK Parent's entire portfolio of products. This important consideration is often overlooked in transfer pricing audits of pharmaceutical companies in Canada. The Canadian affiliate generally obtains an entire portfolio of products, some of which are blockbusters and others that are more routine. In these cases, it is important to analyze the business decisions and the resulting transfer prices with a view to the entire portfolio.

Although the FCA sent the file back to the TCC for redetermination, the decision's clear dispatch of the Singleton decision and mandatory reference to the five circumstances are a welcome turn of events.

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.
 

           

 

Information current to August 4, 2010. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500.

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