Judgment summary
This case concerns the application of section 69(2) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), to transfer pricing transactions between GlaxoSmithKline Inc. (Glaxo Canada) and Adechsa S.A., a related non-resident supplier. Between 1990 and 1993, Glaxo Canada purchased ranitidine, the active ingredient in Zantac, from Adechsa at prices between $1,512 and $1,651 per kilogram, while generic companies Apotex Inc. and Novopharm Ltd. paid between $194 and $304 per kilogram for ranitidine from arm's length suppliers (paras. 4, 9).
The Minister of National Revenue reassessed Glaxo Canada, increasing its income by approximately $51 million, on the basis that the prices paid to Adechsa were greater than a reasonable amount had the parties been dealing at arm's length (para. 11). The Tax Court upheld the reassessment, finding that a separate Licence Agreement conferring patent, trademark, and other rights on Glaxo Canada could not be considered together with the Supply Agreement, relying on Singleton v. Canada (paras. 12, 30).
The Federal Court of Appeal disagreed, holding that the Licence Agreement was a relevant circumstance and that Singleton did not preclude its consideration. It remitted the matter to the Tax Court for redetermination of the reasonable amount (paras. 14-16).
The Supreme Court of Canada dismissed both the Minister's appeal and Glaxo Canada's cross-appeal. It held that section 69(2) requires consideration of all relevant circumstances, including linked agreements such as the Licence Agreement, when determining the reasonable arm's length price. The matter was remitted to the Tax Court for redetermination, having regard to the effect of the Licence Agreement on the prices paid for ranitidine (paras. 60, 76).
Background
Glaxo Canada, a wholly owned subsidiary within the Glaxo Group, acted as a secondary manufacturer and marketer of the brand-name anti-ulcer drug Zantac. It purchased the active ingredient ranitidine from Adechsa S.A., a related Swiss clearing company, under a Supply Agreement, while a separate Licence Agreement granted Glaxo Canada patent and trademark rights, technical assistance, marketing support, and other benefits (paras. 5-8).
The transfer price for ranitidine was set using a resale-price method under which distributors retained a gross margin of approximately 60 percent, with the remainder remitted to Glaxo Group as transfer price, royalties, or both (para. 8). This resulted in Glaxo Canada paying over $1,500 per kilogram, compared to $194 to $304 per kilogram paid by generic companies Apotex and Novopharm to arm's length suppliers (paras. 4, 9).
The generic companies were able to sell competing ranitidine products under a compulsory licensing scheme for pharmaceuticals that existed in Canada until February 1993 (para. 10). The Minister reassessed Glaxo Canada under section 69(2) of the Income Tax Act, increasing its income by the difference between the highest generic price and the price Glaxo Canada paid (paras. 2, 11).
Core dispute
The central issue was what circumstances should be taken into account in determining the reasonable arm's length price against which to compare the non-arm's length transfer price paid by Glaxo Canada for ranitidine, and specifically whether the Licence Agreement, which conferred patent, trademark and other rights, was a relevant circumstance (para. 3).
The Minister argued that a transaction-by-transaction approach was required, relying on Singleton v. Canada and Shell Canada Ltd. v. Canada, such that the Supply Agreement should be assessed independently of the Licence Agreement, making generic company prices for ranitidine alone the appropriate comparator (paras. 12, 32).
Glaxo Canada argued that the Licence Agreement was linked to the Supply Agreement and had to be considered together, as it conferred rights and benefits that generic companies did not receive, making the generic comparators inappropriate (para. 29).
On cross-appeal, Glaxo Canada argued that it had already discharged its burden of demolishing the Minister's assumptions by showing the generic comparators were flawed, and that the matter should not be remitted to the Tax Court but resolved in its favour (paras. 66, 68).
Court findings
The Court held that section 69(2) requires determination of 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, and that if other transactions are relevant to this question they must not be ignored (para. 35).
The Court found that Singleton and Shell were decided under section 20(1)(c)(i), which addresses a different question, namely the use of borrowed funds, and do not require a transaction-by-transaction approach under section 69(2) (paras. 34-38).
The 1995 Guidelines were found not to require strict transaction-by-transaction analysis in all cases; where economically relevant characteristics make other transactions relevant, they must be considered for comparability (paras. 40-42).
The Court held that the Licence Agreement was a circumstance that could not be ignored, since Glaxo Canada was required by the Licence Agreement to purchase ranitidine from Glaxo-approved sources, and the prices paid to Adechsa reflected, at least in part, compensation for rights and benefits under the Licence Agreement (paras. 46-51).
The generic comparators used by the Tax Court did not reflect the economic and business reality of Glaxo Canada and, without adjustment, did not indicate a reasonable arm's length price (para. 53). The Court set out additional guidance for redetermination, including that transfer pricing is not an exact science, that a reasonable range of prices may be acceptable, and that the respective functions, resources and risks of Glaxo Canada and Glaxo Group should be considered (paras. 61-64).
On the cross-appeal, the Court held that the taxpayer's burden was to demolish the Minister's exact assumptions, and that while the assumption regarding the generic comparators (assumption 14r.A)) had been demolished, the core assumption that the price paid was greater than a reasonable amount (assumption 14p)) had not been demolished (paras. 70-74).
Outcome
The Supreme Court of Canada dismissed the Minister's appeal and dismissed Glaxo Canada's cross-appeal, with costs throughout and costs in this Court on the cross-appeal (para. 77).
The matter was remitted to the Tax Court of Canada, to Rip A.C.J. (by then Chief Justice), for redetermination of the reasonable amount payable for Glaxo Canada's ranitidine transactions, having regard to the effect of the Licence Agreement on the prices paid to Adechsa. The Tax Court judge was directed to consider any new evidence the parties might seek to adduce (paras. 65, 76).
Tp method highlighted
The judgment discusses several transfer pricing methods drawn from the OECD's 1979 Guidelines and 1995 Guidelines. The Minister relied on the comparable uncontrolled price (CUP) method, comparing Glaxo Canada's transfer prices with prices paid by generic companies Apotex and Novopharm, and used the cost plus method to verify results (paras. 22-24).
Glaxo Canada relied on the resale price method, the transactional net margin method, and its own CUP approach using European distributor comparators (paras. 25-27).
The Tax Court applied the CUP method using the generic company prices as comparators, without adjustment for the Licence Agreement, and upheld the reassessment subject to a minor $25 per kilogram increment for granulation (paras. 13, 28).
The Supreme Court held that no single OECD method is mandated by section 69(2) and that the Guidelines are not controlling as if they were a Canadian statute, but they assist in assessing whether transfer prices are consistent with arm's length prices (paras. 20-21). It held that comparability requires that economically relevant characteristics of the compared transactions be sufficiently similar, or that reasonably accurate adjustments be made, and that it is only after identifying which circumstances under the Licence Agreement are linked to the Supply Agreement that any OECD method or other method may properly be applied (paras. 41, 60).
Major issues / areas of contention
- Whether the Licence Agreement conferring patent, trademark and other rights on Glaxo Canada was a relevant circumstance in determining the reasonable arm's length price for ranitidine under section 69(2).
- Whether Singleton v. Canada and Shell Canada Ltd. v. Canada required a transaction-by-transaction approach under section 69(2), precluding consideration of the Licence Agreement together with the Supply Agreement.
- Whether the prices paid by generic pharmaceutical companies Apotex and Novopharm for ranitidine were appropriate comparators under the comparable uncontrolled price method.
- Whether the OECD Guidelines of 1979 and 1995 are controlling in determining a reasonable arm's length price under section 69(2).
- Whether the Federal Court of Appeal erred in remitting the matter to the Tax Court for rehearing and reconsideration rather than determining the reasonable amount itself.
- Whether Glaxo Canada had discharged its burden of demolishing the Minister's assumptions underlying the reassessment.