Canada: Canadian Tax @ Gowlings: October 7, 2010

Last Updated: October 13 2010

Edited by Laura Monteith


  • Federal Court of Appeal "Gets it Right" and Overturns Tax Court's Glaxo Ruling
  • TD Securities Case: Tax Refunds for U.S. LLCs?
  • Taxand - access Taxand's Take for the latest tax issues affecting multinationals worldwide as well as Taxand's latest range of publications.

Federal Court of Appeal "Gets it Right" and Overturns Tax Court's Glaxo Ruling
By Pierre Alary, Dale Hill, Mark Kirkey and Jamal Hejazi, Ph.D.


On July 26, 2010, the Federal Court of Appeal ("FCA") overturned one of the most significant transfer pricing decisions in Canadian history in the case of GlaxoSmithKline Inc. v. The Queen1(the "Glaxo case"). When examined from all avenues, the case yields important conclusions that both practitioners and multinational corporations alike should note when dealing with contentious transfer pricing issues.  Specifically, the court held that a comprehensive examination of all relevant facts as well as the entirety of GlaxoSmithKline Inc.'s ("GSK") business model must be undertaken in order to determine a reliable transfer price.

The adoption of such an approach is important on many levels. The real-world business circumstances in which related parties operate on a daily basis are far different from those of unrelated parties, making it difficult to find a true transfer price attributable to related party transactions.  Nevertheless, when allocating profits within a related party setting, one must proceed with the assumption that related parties can indeed operate independently of one another, which creates a fictitious event.  In such an environment, any transfer pricing conclusion can be subject to scrutiny and, as the many governments begin to understand the complexities of transfer pricing, we will continue to see increased  audit controversy related to the arm's length standard and increased efforts by companies to avoid double taxation.  The Court's ruling that all factors, including the use of intangibles by related parties, be considered when determining the appropriate transfer price was correct and should serve as a useful precedent for future disputes. 


Transfer pricing can be defined as the price that a member of a multinational group charges a foreign related party for goods, services and/or intangibles2. A tax dispute will arise when the tax authority is of the view that the parties set the transfer price too high or too low in order to transfer profits from a high tax jurisdiction to a low tax jurisdiction3. GSK, a Canadian company, is a wholly-owned subsidiary of Glaxo Group, which in turn is a wholly-owned subsidiary of Glaxo Holdings plc. The FCA described Glaxo Holdings as "the ultimate parent of the Glaxo Group of companies," which "discovered, developed, manufactured and distributed a number of branded pharmaceutical products.4" Glaxo Holdings and Glaxo Group are both United Kingdom corporations. The Glaxo case involved the reassessment of GSK's income tax returns for the years 1990 to 1993. GSK is the Canadian distributor of Adechsa S.A. ("Adechsa"), a related Swiss company.

Contentious Issues

i) Purchase Price of Ranitidine

The dispute focused on the price that GSK paid to Adechsa for ranitidine, an active ingredient found in Zantac, a popular drug used to treat and prevent stomach ulcers. The Minister of National Revenue ("MNR") believed that GSK had paid an excessive amount ($1,600 per kilogram) for this active ingredient pursuant to subsection 69(2) of the Income Tax Act  ("ITA"). MNR based its argument on the price that generic drug companies, such as Apotex Inc. and Novopharm Ltd., were paying third party manufacturers for the same product, which ranged from $200 to $300 per kilogram. MNR originally increased the income of GSK for the years in question by approximately $51 million, which represents the difference between the prices paid by the generic companies and GSK for their ranitidine. Further, MNR assessed GSK under Part XIII of the ITA with respect to GSK's failure to withhold tax on dividends deemed to be paid to a non-resident shareholder.

GSK's position was that the generics were not an appropriate comparator for two reasons, namely:

  1. GSK's actual business circumstances were wholly different from those of Apotex and Novopharm, such that the transactions were not comparable within the meaning of subsection 69(2) of the ITA and the CUP method;
  2. The ranitidine that GSK purchased from Adechsa was manufactured under Glaxo World's standards of good manufacturing practices, granulated to Glaxo World standards, and produced in accordance with Glaxo World's health, safety, and environmental standards.

GSK submitted that independent third party licensees in Europe, which purchased the same ranitidine under the same set of business circumstances as GSK, were the best comparators.

ii) Contractual Agreements

The Glaxo case was centered around two contractual agreements: i) a Supply Agreement between GSK and Adechsa for the purchase of ranitidine; and ii) a License Agreement between GSK and the Glaxo Group. Under the License Agreement, GSK paid a 6% royalty to the Glaxo Group for the rights to certain intangibles and services. These intangibles included trademarks as well as marketing support, technical assistance and registration materials. Access to such intangibles and services were required to assist GSK in selling its drug in the Canadian market at a "premium".

GSK argued that both the Supply Agreement with Adechsa and the License Agreement with Glaxo Group should therefore be considered, and a failure to do so would not reflect the economic realities of GSK. Conversely, MNR argued that the two agreements were to be looked at separately, and that the only transactions relevant to the case were those with Adechsa.

The Tax Court Decision

The Tax Court of Canada ("TCC") has often stated that the comparable uncontrolled price ("CUP") method offers the most direct way to determining an arm's length price. The transfer price is set by reference to comparable transactions between a buyer and a seller who are not associated enterprises. The TCC concluded that the CUP method was the preferred method and  that the price paid to Adechsa was not reasonable. Rather, it determined that Apotex and Novopharm were the appropriate comparator and that the "reasonable" price for ranitidine was the highest price paid by the generic drug companies with a $25 adjustment to account for the fact that GSK was buying granulated ranitidine, while the generic drug companies were not.

The TCC also ruled that the License Agreement should not be considered when determining 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 because the Supply Agreement and the License Agreement covered separate matters.

The Federal Court of Appeal Decision

A ruling on the Part XIII5 assessment hinged heavily on the findings regarding the subsection 69(2)6 assessment, namely, whether the prices paid by GSK to Adechsa for ranitidine would have been reasonable in the circumstances if GSK and Adechsa had been dealing at arm's length. Thus, if the Court were to find that the TCC correctly ruled on the subsection 69(2) issue, the TCC's ruling with respect to Part XIII would also be upheld.

The FCA unanimously held that the TCC erred in failing to consider the License Agreement between GSK and the Glaxo Group. It decided that a determination of whether or not the purchase price of the ranitidine was reasonable would need to factor in all relevant circumstances which an arm's length purchaser would have had to consider5. In coming to this conclusion, the Court relied on the test enunciated in Gabco Limited v. Minister of National Revenue6:

It is not a question of the Minister or this Court substituting its judgment for what is a reasonable amount to pay, but rather a case of the Minister or the Court coming to the conclusion that no reasonable business man would have contracted to pay such an amount having only the business considerations of the appellant in mind.

In the Court's opinion, the Gabco test requires an inquiry into those circumstances which an arm's length purchaser, standing in the shoes of GSK, would consider relevant in deciding whether it should pay the price paid by GSK to Adechsa for its ranitidine. Hence, the test mandated by subsection 69(2) does not operate regardless of the real business world in which the parties to a transaction participate.7

The Court identified a number of "circumstances" which supports the contention that the License Agreement was a crucial consideration in determining the amount that would have been reasonable in the circumstances if the parties had been dealing at arm's length.  These circumstances "arose from the market power attaching to Glaxo Group's ownership of the intellectual property associated with ranitidine, the Zantac trademark, and the other products covered by its License Agreement with GSK."8 In light of these circumstances, any arm's length party would have had to consider the contents of the License Agreement in deciding whether or not to pay the price set by Adechsa for the sale of Zantac ranitidine9.


The FCA set aside the TCC's decision and returned the matter to the TCC for rehearing and reconsideration of the matter in light of the FCA's reasons. The FCA's decision illustrates the complexities involved when determining whether or not a transfer price paid between related entities is reasonable. Such a determination must take into account all relevant circumstances that would factor into any purchaser's decision in order to reflect the real-world circumstances in which such contracts are made. In the case of GSK, the active ingredient ranitidine was purchased by GSK in conjunction with a License Agreement affording GSK the right to use and sell several Glaxo products, including Zantac products. The FCA held that the License Agreement should be considered conjointly with the cost of the ranitidine. Thus, the Court acknowledged that the significant brand power associated to the drug affords the Glaxo Group a great deal of bargaining power when negotiating transfer pricing transactions, regardless of whether they are dealing with a related or arm's length party. While the adoption of an approach factoring real-world business circumstances was a necessary one, this less mechanical method of calculation makes it less likely that multinational corporations and governments will arrive at the same outcome.  The intricacy of a case by case factual analysis along with the Government's complete disregard for the value of intangibles ensures that similar transfer pricing disputes will arise.


GlaxoSmithKline Inc. v. Canada 2010 FCA 201.

2 Dale Hill & Mark Kirkey, "Recent Developments in Transfer Pricing" (2005) Gowlings Knowledge Centre at 1.

3 Pierre Alary, "Pass the Zantac: The Glaxo Ruling and its Effects on Transfer Pricing in Canada" (September 25 2008), Taxation Law @ Gowlings.

Supra note 1 at para. 7.

5 Part XIII, Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.)

6 Subsection 69(2), Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.)

Supra note 1 at para. 69.

Gabco Limited v. Minister of National Revenue (1968), 68 D.T.C. 5210 (Ex.Cr.) at 5216.

Supra note 1 at para. 73-74.

10 Supra note 1 at para. 80.

11 Supra note 1 at para. 81.

TD Securities Case: Tax Refunds for U.S. LLCs?
By Dalia Hamdy

It has been a long standing administrative policy of the Canada Revenue Agency ("CRA") that United States ("US") limited liability companies ("US LLCs") are not entitled to benefits under the Canada-US Income Tax Convention (the "Treaty").  This policy is based on the view that disregarded US LLCs are classified for Canadian tax purposes as corporations that are not US residents under the Treaty, since the US LLCs are not themselves liable to pay income tax under US law.  Prior to changes to the Treaty on ratification of the Fifth Protocol in December, 2008 the CRA was not prepared to treat a US LLC as fiscally transparent and look through the US LLC in the same way as the CRA looks through a partnership, to the residence of the members of the US LLC. 

The practical effect of this policy was that US LLCs could not benefit from relief under the Treaty that was available to US residents operating or investing in Canada.  One such form of relief is the reduced branch tax rate (5% instead of 25%) permitted under the Treaty on business income earned through a permanent establishment in Canada.

However, on April 8, 2010, the Tax Court of Canada ("TCC") upheld the taxpayer's appeal in TD Securities (USA) LLC v. The Queen ("TD Securities") on the basis that, despite its flow-through status, TD Securities (USA) LLC ("TD LLC") was a resident of the US and could, therefore, benefit from the reduced branch tax rate under the Treaty.  The changes to the Treaty under the Fifth Protocol have resolved this situation for US LLCs with the same fact situation as TD Securities for 2009 and subsequent years by looking through the US LLC to the residence of the members.  However, the years under appeal in TD Securities pre-dated the ratification of the Fifth Protocol.  This judgment supports claims for benefits under the Treaty to US LLCs for years prior to the implementation of the Fifth Protocol.

The CRA has decided not to file an appeal.  Therefore, the TCC's judgement in TD Securities is now final.  However, the CRA released a statement on July 7, 2010,1 in which it took the position that, notwithstanding the TCC's decision in TD Securities, the CRA continues to be of the view that a US LLC that is treated as fiscally transparent for US tax purposes is not a US resident for purposes of the Treaty.  Nevertheless, in light of the decision, the CRA may provide relief under the Treaty to a US LLC for years prior to 2009 in certain circumstances.  Where the CRA determines that relief is available, the CRA expects that there will be corresponding adjustments to any foreign tax credits claimed in the US that relate to the refunded Canadian taxes.


Subject to relief under a tax treaty, non-residents of Canada that carry on business in Canada are subject to Canadian income tax under Part I of the Income Tax Act (Canada) (the "ITA") on the income from their Canadian business activity. Part XIV of the ITA provides that a non-resident carrying on business in Canada will be liable for an additional "branch" tax of 25% of its Canadian net after-tax income, which may be reduced under a tax treaty.  This tax is a proxy for the non-resident withholding tax on dividends that would have been payable if the non-resident had used a Canadian subsidiary to carry on business, rather than a branch, and the subsidiary paid a dividend to the non-resident.


TD LLC is a New York based US registered broker dealer organized under the laws of the State of Delaware. As a US LLC, it had elected to have any income it received flow tax-free through to its sole member TD Holdings II Inc. ("Holdings II"), at which level it was taxed on a consolidated basis with the income of the ultimate parent company, Toronto Dominion Holdings (USA) Inc. ("TD USA")2.  TD USA is a wholly-owned direct subsidiary of The Toronto-Dominion Bank.

TD LLC maintains a permanent establishment in the form of a branch office in Canada to service its US clients ("TD Canada Branch").  TD Canada Branch's profits for 2005 and 2006 were reported by it in its Canadian tax returns.  The Treaty expressly provides that the rate of Canadian Part XIV tax for Canadian branches of US residents is reduced from 25% to 5%.  TD LLC claimed the reduced rate of Canadian branch tax of 5% under the Treaty in respect of the 2005 and 2006 income of TD Canada Branch.

The CRA assessed TD LLC to deny it the benefit of the 5% US Treaty branch tax rate.  This assessment was based on the determination that TD LLC, as a fiscally transparent entity, was not a "resident" of the United States, as it is required to be to benefit from the Treaty.  This meant that TD USA was unable to claim a full foreign tax credit on its consolidated US return under the US Internal Revenue Code (the "Code").

TD LLC appealed the CRA's decision to the TCC.


Whether TD LLC is a "resident" of the US for purposes of the Treaty?

CRA's position

The CRA argued three main points:

  1. The meaning of the phrase "resident of a contracting state" used in the Treaty is clear and unambiguous.  The meaning of the language chosen by Canada and the US to define to whom the Treaty applies cannot be interpreted in an expansive or purposive way to entitle TD LLC to Treaty benefits.
  2. TD LLC could not be a "resident" of the US because it was not itself subject to tax in the US.  This is because the Code's "check-the-box" regulations permit US LLCs to elect between corporate and pass-through treatment.  TD LLC did not file an election under the "check-the-box" regulations.  Accordingly, under the Code, it is a disregarded entity and was not itself subject to tax on its income.  Instead, all of its income was required to be included in the income of its sole member, Holdings II, as if the activities of TD LLC were carried on directly by Holdings II.  The 2005 and 2006 income of TD LLC's Canadian branch was included in the income of Holdings II in this manner under the Code.
  3. Even if TD LLC is considered to be liable to tax in the US by virtue of its income being taxed to Holdings II, that tax is not "by reason of [TD LLC's] domicile, residence, place of management, citizenship, place of incorporation or any other criterion of a similar nature" as required by Article IV of the Treaty.

TD LLC's position

TD LLC took the position that the phrase liable to tax was not a defined term in the Treaty and therefore, must be defined in accordance with Canadian law.  TD LLC submitted that whether an entity is liable to tax does not necessarily mean that the entity is required to pay tax directly on its income under the Code.  Tax was paid in the US on TD USA's income not by TD USA directly but on a consolidated basis with its parent company, as permitted under the Code.  The Court should, therefore, conclude that TD USA was liable to tax in the US and hence was a resident of the US.

TD LLC's alternative argument was that, consistent with the commentaries to the relevant provisions of the Model Tax Convention on Income and on Capital of the Organization for Economic Co-operation and Development (the "OECD" and the "OECD Model Treaty"), a liberal interpretation to, and application of, the Treaty must be adopted in order to allow the Treaty to achieve its purpose.  Therefore, the phrase "resident of a Contracting State", must be interpreted in an expansive way to include a US LLC such as TD LLC.


The TCC ruled in favour of the taxpayer, TD LLC. The TCC held that the income of TD LLC should enjoy the benefits of the Treaty.  TD LLC was a resident of the US and was "liable to tax" in the US on a comprehensive basis.

The TCC relied on the OECD Partnership Report and OECD Model Treaty Commentary, as well as case law on treaty interpretation.  Justice Boyle took a purposive approach and held that TD LLC was entitled to treaty benefits on the basis that its income was subject to full and comprehensive US tax at the member level and, as such, it was liable to tax in, and therefore a "resident" of, the US for purposes of the Treaty. 

The TCC emphasized that its decision,

"stands for no more than the proposition that, properly interpreted and applied in context in a manner to achieve its intended object and purpose, the US Treaty's favourable tax rate reductions apply for years prior to the Fifth Protocol Amendments to the Canadian-sourced income of a US LLC if all of that income is fully and comprehensively taxed by the US to the members of the LLC resident in the US on the same basis as had the income been earned directly by those members."

Justice Boyle reviewed the CRA positions regarding US LLCs and noted that, with the exception of US LLCs, CRA had been consistent in its interpretation of Article IV in determining treaty residence.  He concluded that the treatment of partnership and US LLCs should be analogous.  He also noted that the Treaty intended that the entitlement to treaty benefits for income earned by a fiscally transparent entity, such as a partnership or US LLC, be determined at the member level using a look-through approach.

He concluded that TD LLC must be considered a resident of the US for purposes of the Treaty, it must be considered to be liable to tax in the US by virtue of all of its income being taxed at the member level and it must be considered to be subject to full and comprehensive tax under the Code.


The TCC's decision in the TD Securities case is important because it overturns the long-standing CRA position that a fiscally transparent US LLC is not a US resident for purposes of the Treaty.  It also highlights the importance of the Fifth Protocol Amendments when interpreting the context and purpose of Treaty provisions.  This decision could have implications for US LLCs that may have been denied or did not seek Treaty benefits for years prior to 2009.  US LLCs with US resident members who were denied Treaty benefits due to the CRA's US LLC policy may apply for refunds for overpaid tax, subject to the limitation periods in the ITA.  

How then should a US LLC secure such benefits and recover potentially overpaid branch tax or withholding tax for periods prior to 2009 (pre-Fifth Protocol)?  The CRA has adopted a restrictive view of the TD Securities case.  It has indicated that it will provide the relief contemplated by this decision in very limited circumstances.  The CRA has stated:

"Treaty benefits claimed by an LLC with respect to an amount of income, profit or gain will be recognized by the CRA only if the amount is considered to be derived, pursuant to Article IV(6) of the Treaty, by a person who is a resident of the United States and that person is a 'qualifying person' or is entitled, with respect to the amount, to the benefits of the Treaty pursuant to paragraph 3, 4 or 6 of Article XXIX A."3

US LLCs should consult with a tax advisor to determine whether the TCC's decision in TD Securities could be applicable to their situation and if so, how to best proceed to recover any excess taxes paid or withheld.

Please contact any member of the Gowlings Tax Group to discuss the implications of TD Securities and to determine whether a refund may be available to a particular US LLC.


1 CRA Document No. 2010-0369271C6, Canada-US Tax Convention – Treatment of LLCs (June 16, 2010).

2 An LLC is a company that is recognized as a distinct legal entity separate from its members under Delaware and US law.  The parties agreed that a US LLC is similarly recognized as a distinct legal entity separate from its members under Canadian law.

3 Supra note 1.


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