On July 26, 2010, the Federal Court of Appeal issued its
decision in the case of GlaxoSmithKline v. R., reversing
the Tax Court of Canada's decision and sending the case back to
the Tax Court for reconsideration. In 2008, Assistant Chief Justice
Rip (as he then was) of the Tax Court had held that the taxpayer,
GlaxoSmithKline Inc. ("Glaxo Canada"), had paid in excess
of a reasonable amount for its purchases of a pharmaceutical
ingredient, ranitidine, from Adechsa S.A., a non arm's length
Glaxo Canada was a wholly-owned subsidiary of Glaxo Group Limited
("Glaxo Group"), a United Kingdom corporation. Beginning
in 1982, Glaxo Canada packaged and sold Zantac, a patented and
trade-marked drug, in Canada. The Zantac trade-mark and patents for
its active pharmaceutical ingredient, ranitidine, were owned by
Glaxo Group, which licensed them to Glaxo Canada for use in
Glaxo Canada had a Licensing Agreement in place with Glaxo Group
for access to, and use of, the latter's intellectual property
including trade-marks and technical expertise. In consideration,
Glaxo Canada paid Glaxo Group a 6% royalty on its net sales of
Zantac. The intellectual property contract also required Glaxo
Canada to purchase ranitidine from Adechsa S.A. Under a separate
Supply Agreement with Adechsa S.A., Glaxo Canada paid Adechsa S.A.
between $1,512 and $1,651 per kilogram for ranitidine.
The issue in this case was whether Glaxo Canada had paid Adechsa
S.A. a "reasonable price" for the ranitidine. According
to the evidence, in the years in question Canadian generic
companies were able to purchase ranitidine for $193 to $304 per
kilogram. The Tax Court of Canada held that these purchases made by
arm's length Canadian generic companies were comparable to
those made by Glaxo Canada. The Tax Court determined that the
Licence Agreement with Glaxo Group and the Supply Agreement with
Adechsa S.A. covered separate matters and must be considered
separately. Based on this conclusion, the Tax Court decided that
Glaxo Canada had paid in excess of a reasonable amount on its
purchases of ranitidine and allowed the CRA's assessment to
increase the taxpayer's income by the difference between the
price that Glaxo Canada had paid for the ranitidine and the highest
price paid by the generic companies.
The Federal Court of Appeal, however, was of the opinion that the
Tax Court judge had erred in his assessment of the reasonable price
for the ranitidine because he did not take into account the
"business reality" of Glaxo Canada and made his
determination in a "fictitious business world where a
purchaser is able to purchase ranitidine at a price which does not
take into account the circumstances which make it possible for that
purchaser to obtain the rights to make and sell Zantac".
Specifically, the Court of Appeal said that the Tax Court judge
failed to consider the impact of the Licensing Agreement on what an
arm's length party would have paid for the ranitidine. The
Court of Appeal noted that the Licensing Agreement was an essential
consideration in the determination of a reasonable transfer price
because Glaxo Canada was legally bound to purchase the active
ingredient from Adechsa S.A. in order to distribute Zantac in
Canada. The Licensing Agreement was also important since the Court
of Appeal concluded that Glaxo Canada could not have viably
penetrated the generic ranitidine market since entrance costs to
this market would have been prohibitive, and as such the price paid
by the generic companies was not comparable. Thus, the Court of
Appeal held that the assessment of Glaxo Canada's transfer
price for the active ingredient had to be undertaken in light of
the terms and conditions of the Licensing Agreement, and sent the
matter back to the Tax Court for reconsideration of a reasonable
transfer price taking the Licensing Agreement into account.
This decision suggests a broader approach to transfer pricing
analyses that is sensitive to surrounding business realities. In
other words, in making an assessment of a "transaction"
for transfer pricing purposes, this decision suggests that all
transactions and agreements which affect the price of a particular
good or service should be taken into account when determining the
price for that particular good or service. This is counter to the
position often taken by the Canada Revenue Agency that each
transaction should be reviewed in isolation from other transactions
and agreements even where these other transactions impact on the
terms or pricing of the first transaction. Taxpayers should consult
their tax advisors to determine what impact this case will have on
their current transfer pricing methodologies.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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