Legislators and judiciaries alike have lent a hand in 2012 to modify aspects of the transfer pricing landscape, which is in constant evolution, leading to various interpretations by multinationals and the governing tax authorities. Confusion around transfer pricing is understandable considering that related parties must assume they are independent of one another when determining intercompany prices, thus creating a fictitious event. Recent legal developments in Canada will require the Canada Revenue Agency to consider all relevant intercompany transactions, not only a singular transaction that may be taken out of context. As well arbitration provisions, added to the Canada-US Income Tax Treaty, will help to ensure that double tax cases are not only resolved but resolved in a more timely manner.
l. Supreme Court Upholds Federal Court of Appeal's Glaxo Decision
A. Case Overview
In 2008, The Tax Court of Canada (''TCC'') delivered a controversial decision against GlaxoSmithKline Inc. (''GSK'') upholding a reassessment by the Canada Revenue Agency (''CRA'') over the price that GSK paid Adechsa, a related party, for the active ingredient ranitidine, found in Zantac. The case also involved a licence agreement between GSK and its parent Glaxo Group for services and intangibles owned by Glaxo Group. The TCC's (and MNR's) position was that the licence agreement should be ignored when determining the arm's length price of the ranitidine. The Federal Court of Appeal ruled in favour of GSK in its July 2010 decision, when it held that the TCC erred in failing to consider the licence agreement between GSK and the Glaxo Group. It decided that it was necessary to take into account all relevant factors that an arm's length purchaser would have to consider, including the market power attaching to the Zantac trademark. While an approach that factors in real-world business circumstances is welcomed, this less mechanical method of valuation makes it less likely that multinational corporations and governments will arrive at the same outcome.
A seven member panel of the Supreme Court of Canada (''SCC'') heard the Minister's appeal on January 13, 2012. The SCC unanimously agreed with the FCA that Rip A.C.J. erred in refusing to take account of the Licence Agreement. Rothstein J. also agreed with Justice Nadon that ''the amount that would have been reasonable in the circumstances'' if GSK and Adechsa had been dealing at arm's length has yet to be determined, which will require a close examination by the TCC of the terms of the Licence Agreement and the rights and benefits granted to GSK under that agreement.
The SCC considered the Organisation for Economic Co-operation and Development's (''OECD'') guidelines in finding that, while a transaction-by-transaction approach may be ideal, such an approach is not appropriate in all cases. Thus, if transactions other than the purchasing transaction are relevant in determining whether the transfer price was greater than the amount that would have been reasonable in the circumstances, these transactions must not be ignored.
B. SCC Decision and Rationale
The SCC held that in determining what an arm's length purchaser would be prepared to pay for the same rights and benefits conveyed from a Glaxo Group source, one must recognise the various features of the Licence Agreement. ''It is only after identifying the circumstances arising from the Licence 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.''
In the present case, the SCC recognised that GSK could only purchase ranitidine from two approved sources, one of which was Adechsa, if it wanted to take advantage of the benefits offered by the Licence Agreement. This requirement was a product of Glaxo Group's control of the trademark and patent of Zantac, rather than the non-arm's length relationship between the relevant parties. Thus, this same requirement would likely apply to an arm's length distributor wishing to market Zantac.
ll. Mandatory Arbitration
Multinational companies are facing increased scrutiny of their international transactions involving related parties which is leading to assessments that result in the taxation of the same income in two jurisdictions. In some cases achieving a negotiated settlement, between the two countries, over which country should tax the income is not possible. In those cases where a settlement cannot be reached there is now a provision included in the Fifth Protocol to the Canada-US Tax Treaty that deals with arbitration of such disputes.
Arbitration under the Canada-US treaty is a new option available to taxpayers who have been assessed by either the US or Canadian tax authorities on certain income including transfer pricing adjustments and where such assessments result in double tax that the two countries cannot resolve within a 24 month period. Previously, negotiations in competent authority could go on endlessly, sometimes for five or more years. Now, after a taxpayer submits all the relevant documents that the competent authorities need to negotiate the file they will only have 24 months to reach a resolution. After this time expires the taxpayer has the right to request arbitration. The arbitration provision in the Canada-US treaty contemplates that the decision be made by three arbitrators, one assigned by each country and one selected by the arbitrators. The final decision will be made using ''baseball'' arbitration wherein the arbitrators must select one of the two proposals submitted by the two governments with no changes.
The arbitration provisions in the Canada-US Treaty will motivate competent authority analysts to reach a principled decision and will hopefully reduce the number of extreme positions put forward by each country. Neither country will want the decision making process handed off to arbitrators, except in the rarest of cases, and as such will force the analysts of each country to work diligently towards a conclusion.
The CRA's most recent MAP report reflects a significant increase in the number of cases closed. We believe this is a direct result of the arbitration provisions and the lack of desire by either the CRA or the IRS to go to arbitration. The CRA and IRS do not publish any statistics on arbitration, however it is our understanding that since the arbitration provision have been in place there have been three cases heard and that all have gone in favour of the IRS. Details of the cases are not available. What we can interpret from the number of cases closed by CRA in their last fiscal year is that the governments appear motivated to avoid going to arbitration in all but rare cases. The provisions have had the intended effect of getting both the US and Canadian competent authorities to settle cases more quickly.
III. CRA Aggressively Pursues Transfer Pricing Adjustments
The CRA continues to aggressively audit international transactions, looking for taxpayers who stray too far from the ''norm''. This in fact no different than other close trading partners with Canada, see comments by President Obama in the US and recent headlines in the UK about Starbucks, Google and Amazon.com. The CRA auditors, supported by economists and senior analysts have certain benchmarks in mind when they look at an intercompany transaction. When the margins reported fall short of what is expected, a more detailed audit will be conducted and in a number of cases an adjustment will be proposed often with what looks like a ''shoot first, ask questions later'' attitude. This aggressive stance by the CRA (along with other governments around the world) is expected to continue into the foreseeable future and increases the need for business to take a balanced approach to transfer pricing and prepare detailed documentation in support of their intercompany transactions.
This article was originally published in the January 2013 issue of Transfer Pricing International Journal.
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