Last month the Supreme Court of Canada (SCC) rendered a unanimious decision in GlaxoSmith Kline, supra. The decision provides insights into the high court’s view that all relevant facts and circumstances must be taken into account in addition to the selection of the appropriate pricing model or method. While the Canadian version of our Section 482 has since be revised, Canadian commentators (lawyers) explain that the decision is expected to have “a major influence on the interpretation and application of Canada’s transfer pricing rules” involving non-arms-length parties. See Mirandola and Lindsay, “Canada's Glaxo Ruling Provides Transfer Pricing Guidance”, Tax Notes International, October 29, 2012 which provides a concise and thoughtful review of the case.
Factual Background of the GlaxoSmithKline Decision
Over a four year period commencing in 1990, Glaxo Canada purchased an active ingredient in its well-known, anti-ulcer drug Zantac, from a related non-Canadian company at a price between C $1,512 per kilogram and C $1,651 per kilogram. There was evidence that this price was excessive and did not reflect an arms length price. More specifically, during the same period generic phara companies manufacturing in Canada purchased the same ingredient, i.e. “rantidine”, from unrelated parties for use in generic anti-ulcer drugs at nearly 5-7 times lower, i.e., C $194 per kilogram and C $304 per kilogram. Glaxo Canada was reassessed under form ITA section 69(2) (present ITA section 247(2)).
There were two agreements that were directly relevant to the transfer pricing issue: (i) a Related Party Supply Agreement: Glaxo Canada purchased rantidine from Adechsa S.A., a related company located in Switzerland, under a supply agreement. Glaxo Canada acquired the ranitidine, which was in effect already manufactured, put it into a delivery mechanism, and then packaged and marketed it as Zantac, a patented and trademarked drug; and (ii) Related Party License Agreement: Glaxo Group Ltd. (Glaxo Group), another related company, owned the Zantac trademark and the patent for ranitidine. Glaxo Group granted rights under the patent and trademark to Glaxo Canada under a license agreement. The license agreement conferred other rights and benefits on Glaxo Canada, including: access to new products, the right to the supply of raw and bulk materials, marketing support, and technical support for setting up new product lines. Glaxo Canada argued that the determination of the appropriate transfer price for ranitidine should be influenced by the rights and benefits conferred by the license agreement because it was inextricably linked to the supply agreement. The MNR argued that the appropriate transfer price should be determined on a transaction-by-transaction basis (that is, on the basis of the supply agreement, without regard to the license agreement).
Decision of the Tax Court of Canada in Glaxo Canada
The Tax Court of Canada held that the license agreement and the supply agreement must be considered independently from one another and that the rights and benefits to Glaxo Canada under the licensing agreement, per se, was not to be taken in determining the arm's-length price for the supply of ranitidine. In going about its work, the Tax Court used the “comparable uncontrolled price method” as the preferred transfer pricing methodology and accepted the highest price paid by the several generic pharmaceutical companies to arm's-length suppliers as introduced into evidence by counsel for the government as the relevant CUP. Aside from allowing a minor increment of C $25 per kilogram, the TCC affirmed the reassessment based on the substantially greater prices paid by the Canadian generic drug companies. Again, the Tax Court of Canada held that the licensing agreement was not relevant.
The Canadian Federal Court of Appeals Decision in Glaxo Canada
The Federal Court of Appeal held that the Tax Court of Canada had erred in refusing to consider the license agreement as a factor in the transfer pricing dispute. In granting the taxpayer’s request, it remitted the matter back to the Tax Court for redetermination of the "reasonable amount" payable for Glaxo Canada's ranitidine transactions. The MNR argued before the Federal Court of Appeal that the trial court 's approval of the assessment dimade no error of law (or fact) in its analysis. Glaxo Canada cross appealed contending that the case should not have been remitted back to the trial court and that the underlying proposed assessments should be rejected.
Decision of the Canadian Supreme Court
The Supreme Court of Canada rejected the MNR’s appeal from the Federal Court of Appeal’s decision to remand by the Tax Court and further rejected Glaxo Canada’s cross-appeal to dismiss the assessment on the narrow thought that the Tax Court failure to consider the transfer pricing determination based on both the license and supply agreements meant its decision was flawed and was therefore “demolished”.
After reviewing the relevant statutory standards and the OECD transfer pricing guidelines for 1979 and 1995, which OECD guidelines the Court acknowledged were not binding on the Court but simploy were used as aides in its analysis, the Supreme Court first stated that there are a number of methods for resolving whether transfer prices are consistent with prices determined between parties dealing at arm's length. There needs to be consideration by the trial court of what it referred to as the "economically relevant characteristics" of the arm's length and non-arm's length circumstances to ensure they are "sufficiently comparable." Where no related transactions are present or are not relevant, the Court stated that a transaction-by-transaction approach may be appropriate. However, "economically relevant characteristics of the situations being compared" may make it necessary to consider other transactions that impact the transfer price under consideration. The Supreme Court acknowledged that “other transactions” will include agreements that may confer rights and benefits in addition to the purchase of property where those agreements are linked to the purchasing agreement.
Therefore, “the objective is to determine what an arm's length purchaser would pay for the property and the rights and benefits together where the rights and benefits are linked to the price paid for the property. However, transfer pricing is not an exact science and it is highly unlikely that any comparisons will yield identical circumstances and the court will be required to exercise its best informed judgment in establishing a satisfactory arm's length price.”
The Supreme Court viewed that Glaxo Canada was paying for certain rights and benefits under the License Agreement as part of the purchase prices for ranitidine from Adechsa. As such, the License Agreement was relevant and could not be discarded. Viewing both the license and the supply agreements as integrated both must be considered for transfer pricing purposes. In this respect the Supreme Court opined that the Tax Court of Canada focused too narrowly on just what the prices paid by the generic pharma companies in Canada for rantidine as relevant in a transfer pricing case. Instead, it is only after identifying the circumstances arising from the License Agreement that are linked to the Supply Agreement that arm's length comparisons under any of the OECD methods or other methods may be determined.
On the other hand, the Glaxo Canada cross appeal motion to eliminate the assessment was addressed and summarily rejected.
The Supreme Court therefore agreed with the Federal Court of Appeal, that the matter be remitted to the Tax Court of Canada, 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 Adechsa. Whether or not compensation for intellectual property rights is justified in this particular case, is a matter for determination by the Tax Court.
Remand Back to the Tax Court of Canada Affirmed
On remand, the Tax Court of Canada will have to take into account the royalty or licensing fees that Glaxo Canada under the License Agreement and its direct impact on the proper arms length standard assuming that the MNR and the taxpayer do not otherwise propose to settle the dispute without another trial. The Supreme Court noted that the separate agreements may have resulted in the effective conversion of a royalty. Subject to withholding, into a purchase price (no withholding required) and the consequential tax benefit that could affect the price an arm's-length party would pay.