Canada v GlaxoSmithKline Inc is the first ruling of the Supreme Court of Canada that deals with issues involving transfer pricing and how they are treated under the Income Tax Act of Canada ("ITA").
Background
In 1976, a predecessor of GlaxoSmithKline Inc. ("GSK") discovered the drug ranitidine, which was approved for sale in Canada in 1981 and marketed as Zantac. Ranitidine's primary manufacture was conducted by related companies located in the United Kingdom and Singapore, and it was subsequently sold to Adechsa SA, another related company located in Switzerland, for further sale to other group companies and unrelated distributors at prices dictated by the parent company.Appellant's factum at SCC, par. 911
In addition, the following intercompany agreements were entered into by Glaxo Canada:
in 1972, a Consultancy Agreement with Glaxo Group Limited covering services and intangibles provided to Glaxo Canada in exchange for a 5% royaltyAppellant's factum at SCC, par. 8 in 1983, a Supply Agreement with Adechsa for the purchase of ranitidineAppellant's factum at SCC, par. 12 an amendment to the 1972 agreement, to cover services and intangibles relating to ZantacAppellant's factum at SCC, par. 14 in 1988, a Licence Agreement with Glaxo Group Limited that replaced the 1972 agreement, and which covered various services and intangibles, in exchange for a 6% royalty on the net sales of drugsAppellant's factum at SCC, par. 15
During its taxation years from 1990 to 1993, Glaxo deducted and remitted withholding tax with respect to royalty payments it made to Glaxo Group Limited under the 1988 agreement, but not with respect to payments to Adechsa under the 1983 agreement, which were considered fully deductible as cost of goods sold.Appellant's factum at SCC, par. 17
By 1990, generic drug manufacturers such as Apotex and Novopharm were able to acquire ranitidine on the open market at prices significantly less than Glaxo Canada was paying under its 1983 agreement.Appellant's factum at SCC, para 19 The Minister of National Revenue subsequently reassessed Glaxo Canada's 19901993 taxation years under:
s. 69(2),replaced in 1998 by the current ITA s. 247(2)(a) and (c) which applied where a taxpayer is not dealing at arm's length with a non-resident and pays an amount greater than the amount "that would have been reasonable in the circumstances if the non-resident person and the taxpayer had been dealing at arm's length". In such a case, the transfer price is deemed to be the reasonable amount determined on an arm's length basis.Appellant's factum at SCC, par. 20 s. 56(2),ITA s. 56(2) which resulted in a deemed dividend to Adechsa, and its assessment for withholding tax under Part XIII of the ITA.
Glaxo Canada subsequently appealed the reassessments to the Tax Court of Canada (TCC).
The courts below
Tax Court of Canada On 30 May 2008, the TCC allowed the appeals, ordering the s. 69(2) and Part XIII assessments to be returned to the Minister for reassessment with respect to a minor pricing adjustment. Otherwise, the approach used in arriving at the assessments was considered to be correct. Rip ACJ (as he then was) identified the key issues in the case as:GlaxoSmithKline (TCC), par. 70
whether the Supply Agreement and the Licence Agreement should be considered together to determine a reasonable transfer price the meaning of the phrase "reasonable in the circumstances" in s. 69(2) the impact of the differences in Glaxo's good manufacturing practices and health, safety and environmental standards on the comparability of the ranitidine purchased by the appellant with that purchased by the generic companies
He ruled that the comparable uncontrolled price method was the preferred approach to use to establish the arm's length transfer price, subject to adjustment for the issues in dispute.GlaxoSmithKline (TCC), par. 71 He also ruled that the Part XIII assessments for withholding tax were essentially correct, but subject to a minor pricing adjustment with respect to the drug's granulation.GlaxoSmithKline (TCC), par. 176
Federal Court of Appeal The TCC ruling was set aside by the Federal Court of Appeal on 26 July 2010. In his ruling, Nadon JA stated the trial judge had erred in the following respects:
concluding that the Licence Agreement and Supply Agreement were to be considered independently of one another within the context of Singleton v. CanadaSingleton v. Canada, 2001 SCC 61, 2 SCR 1046 GlaxoSmithKline (FCA), par. 65 misunderstanding the s. 69(2) test of what is "reasonable in the circumstances"GlaxoSmithKline (FCA), par. 69
The Singleton test applied to a different part of the Act under different circumstances,GlaxoSmithKline (FCA), para 6668 and the consideration of what is reasonable must be governed by the standard noted in Gabco Ltd v Minister of National Revenue,Gabco Ltd v Minister of National Revenue, 68 DTC 5210 (Ex Cr), as endorsed by the FCA in where Cattanach J stated:
Nadon JA subsequently listed the following "circumstances" of what could be considered as reasonable in the case at bar:GlaxoSmithKline (FCA), par. 79
Glaxo Group owned the Zantac trademark and would own it even if the appellant 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 the appellant had been in an arm's length relationship. Without the License Agreement, the appellant 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 the appellant would have been to enter the generic market where the cost of entry into that market would likely have been high, considering that both Apotex and Novopharm were already well placed and positioned. Without the License Agreement, the appellant would not have had access to the portfolio of other patented and trademarked products to which it had access under the License Agreement.
The appeal was allowed with costs, setting aside the Tax Court's decision, and the matter was returned to the trial judge for rehearing and reconsideration of the matter in the light of the FCA's reasons.
An appeal by the Crown on the reversal, and cross-appeal by GSK with respect to the case being returned to the TCC for rehearing, were subsequently made to the Supreme Court of Canada, which heard the case on 13 January 2012.
Arguments before the SCC
Appeal
The Crown argued that applying a "reasonable in the circumstances" test, as the FCA did, does not fulfil the conditions of section 69(2), as a price that may be reasonable is not necessarily an arm's-length price.Appellant's factum at SCC, par. 3034 According to the Crown, only those circumstances that would be relevant to parties bargaining at arm‟s length for a particular good should be considered in the analysis,Appellant's factum at SCC, par. 3549 which it asserted was supported by the SCC's rulings in Singleton and Shell Canada Ltd. v. Canada.Shell Canada Ltd. v. Canada, 3 SCR 622, 1999 CanLII 647 (SCC) In its view, other circumstances, such as Glaxo Canada‟s status as a distributor of Zantac, were irrelevant to the consideration of the price paid for ranitidine.Appellant's factum at SCC, par. 5092
In response to questions from the Justices about the meaning of "reasonable circumstances" in s. 69(2), the Crown submitted that:
the phrase was intended to consider only the "economically relevant circumstances" pertaining to the specific transaction in question, in accordance with the OECD Transfer Pricing Guidelinesfor current version, see s. 69(2) did not allow consideration of "the whole deal"
As to questions as to whether a hypothetical independent licensee entering into a similar arrangement with Glaxo could be reassessed in the same manner, the Crown responded that such a licensee could be reassessed as not "dealing at arm‟s length" if it was tied into a set price and had no ability to bargain.
In its submission, GSK concurred with the FCA ruling with respect to the inclusion of the License Agreement in determining reasonable circumstances.Respondent's factum at SCC, par. 4144 S. 69(2) should therefore be presumed to situate the parties at arm's length, ultimately asking, "Would they do the deal?"Respondent's factum at SCC, par. 4560 As to questions posed on whether the price paid for ranitidine was a bundled price for tangible and intangible propertythus potentially triggering liability for withholding taxGSK contended that the situation was analogous to luxury brands such as Rolex and Porsche. While there are undoubtedly components of intellectual property embedded in the price of the tangible good, it is not Canadian law or practice to segregate and separately tax the discrete elements.
As to the applicability of the OECD guidelines, GSK stated that there was no dispute between the parties that the issue in question is solely the price of the tangible good rather than its characterization.Respondent's factum at SCC, par. 9099
Cross-appeal
In its cross-appeal, GSK submitted that it had demolished the Minister's reassessment by demonstrating that the theory at the heart of the liability determined by the Minister was wrong, and therefore the reassessment must be set aside.Respondent's factum at SCC, par. 100125 To a question posed as to whether the onus was still on the taxpayer to prove that it did not overpay for ranitidine (as the lower courts had not yet addressed the issue), GSK responded that, once it had demolished the Crown's basis for reassessment, the onus shifted to the Crown to show that Glaxo had paid too much.
In reply, the Crown contended that GSK did not demolish the reassessment, and therefore it remained valid and open for reconsideration by the TCC.Appellant's factum at SCC, par. 100109 To the question of whether, if the case were to be sent back to the TCC, any other issue could be argued, the Crown stated that the argument would remain essentially the same, as the generic comparable prices comprised the only available information to support arm's-length prices for ranitidine.
Decision by the SCC
In a unanimous decision by Rothstein J, the appeal and cross-appeal were dismissed.
Appeal
While s. 69(2) does not state what is a "reasonable amount", the OECD guidelines do provide commentary and methodology pertaining to the issue of transfer pricing. However, the test of any set of transactions or prices ultimately must be determined according to s. 69(2).GlaxoSmithKline (SCC), par. 20
The trial judge erred in relying on Singleton and Shell Canada for requiring a transaction-by-transaction approach, but s. 69(2) only requires that the price established in a non-arm’s length transfer pricing transaction is to be redetermined as if it were between parties dealing at arm’s length. If the circumstances require, transactions other than the purchasing transactions must be taken into account to determine whether the actual price was or was not greater than the amount that would have been reasonable had the parties been dealing at arm’s length.GlaxoSmithKline (SCC), par. 38 The OECD Guidelines state that a proper application of the arm’s length principle requires that regard be had for the "economically relevant characteristics" of the arm’s length and non-arm’s length circumstances to ensure they are "sufficiently comparable".GlaxoSmithKline (SCC), par. 42