Put together this blawg with Jonathan Crangle, our articling student. … OK, so he wrote it, I edited it … creatively.

Today, the Supreme Court of Canada (“SCC”) released their decision in Canada v GlaxoSmithKline Inc. (see link) (2012 SCC 52). Transfer pricing laws require business groups transferring property between different jurisdictions to pay a reasonable amount; effectively, what an arm’s length party would pay. The determination of this price is referred to as transfer pricing. This case centers on the transfer pricing of ranitidine, an anti-ulcer drug.


GlaxoSmithKline Inc. (“Glaxo Canada”) was the Canadian distributor of the anti-ulcer drug ranitidine, which they sold under the brand name Zantac. Glaxo Canada purchased the ranitidine from the Swiss company, Adechsa SA (“Adechsa”). Both Glaxo Canada and Adechsa were subsidiaries of the UK company, Glaxo Group Ltd. (“Glaxo Group”).
Glaxo Canada had two agreements in place that allowed them to sell ranitidine in Canada under the brand name Zantac:

1. A “Licence Agreement” with Glaxo Group

Glaxo Group owned the ranitidine patent and the Zantac trademark. Glaxo Canada agreed to pay 6% of their net sales as a royalty to Glaxo Group for distributing rights for Zantac in Canada. Glaxo Group would also provide marketing support, access to future products and other forms of assistance. Importantly, the Licence Agreement included a commitment by Glaxo Canada to only purchase ranitidine from approved suppliers. Adechsa was one of two approved suppliers.

2. A “Supply Agreement” with Adechsa

Glaxo Canada purchased ranitidine from Adechsa. Between 1990 and 1993, Glaxo Canada paid between $1512 and $1651 per kilogram for ranitidine. This transfer price was ultimately set by Glaxo Group.

While Glaxo Canada was paying between $1512 and $1651 per kilogram for ranitidine, Canadian generic pharmaceutical companies were paying between $194 and $304 per kilogram for the exact same product. At the time, the generic pharmaceutical companies could sell patented drugs under Canada’s Compulsory Licencing scheme as long as they paid the patent holder 4% of net sales as a royalty.

The Minister of National Revenue (the “Minister”) reassessed Glaxo Canada for the taxation years 1990 through 1993 pursuant to the former subsection 69(2) of the Income Tax Act (now replaced by section 247 (see link). The Minister increased Glaxo Canada’s income on the basis that transfer price Glaxo Canada paid for ranitidine was unreasonably high.

Subsection 69(2), as it applied at the time, read:

(2) Where a taxpayer has paid or agreed to pay to a non-resident person with whom the taxpayer was not dealing at arm’s length as price, rental, royalty or other payment for or for the use or reproduction of any property, or as consideration for the carriage of goods or passengers or for other services, an amount greater than the amount (in this subsection referred to as “the reasonable amount”) that would have been reasonable in the circumstances if the non-resident person and the taxpayer had been dealing at arm’s length, the reasonable amount shall, for the purpose of computing the taxpayer’s income under this Part, be deemed to have been the amount that was paid or is payable therefor.

Judicial History

At the Tax Court of Canada (see link), Rip A.C.J. (as he was then) upheld the Minister’s assessment. He analyzed the Supply Agreement between Glaxo Canada and Adechsa, and determined that the generic pharmaceutical companies were appropriate comparators using the comparable uncontrolled price (“CUP”) method provided by the Organisation for Economic Co-operation and Development (“OECD”) transfer pricing guidelines http://www.oecd.org/ctp/tp/guidelines. He determined that Glaxo Canada paid an unreasonably high amount for ranitidine and therefore did not make a reasonable profit in Canada. Chief Justice Rip also noted that Glaxo Group invested enormous amounts worldwide on marketing Zantac. He wrote of the marketing effort in Canada at paragraph 32:

“The local sales representatives would visit local doctors and communicate to them the various marketing information about Zantac. The appellant’s goal was to convince doctors to prescribe Zantac over other ulcer-relief products.”

The Federal Court of Appeal (see link) determined that the Supply Agreement could not be analyzed in isolation from the Licence Agreement because the Licence Agreement was central to Glaxo Canada’s business reality. The appropriate test was to determine whether an arm’s length party having the same business considerations as Glaxo Canada would pay the same price for ranitidine. The Federal Court of Appeal remitted the case back to the Tax Court for this redetermination.

Supreme Court of Canada

Justice Rothstein, writing for a unanimous SCC, upheld the Federal Court of Appeal’s decision. To determine if Glaxo Canada paid Adechsa a reasonable amount for ranitidine, an arm’s length proxy needs to be identified that replicates Glaxo Canada’s circumstances as closely as possible. The OECD transfer pricing guidelines are not controlling like a statute. The test of any set of transactions or prices needs to be determined according to subsection 69(2). However, since subsection 69(2) did not provide a definition for “reasonable amount”, the OECD transfer pricing guidelines could be used to provide methods to determine this transfer price. Like the lower courts, the SCC relied on the 1979 and 1995 versions of the guidelines.

The OECD transfer pricing guidelines provide several methods for determining the “reasonable amount”. The goal is to find a comparator that most accurately resembles the transaction at hand. The “economically relevant characteristics” of the parties must be sufficiently comparable to an arm’s length party for the arm’s length principle to be satisfied.

The SCC agreed with the Federal Court of Appeal that the Licence Agreement was relevant to the circumstances that an arm’s length party would need to consider when determining a transfer price under the Supply Agreement. The rights and benefits under the Licence Agreement were contingent on Glaxo Canada entering into a Supply Agreement with an approved manufacturer. Glaxo Canada was paying for at least some of the rights and benefits under the Licence Agreement as part of the Supply Agreement. The Licence Agreement could not be ignored in the transfer pricing analysis. Any entity that wanted to market Zantac would be subject to contractual terms in the Licence Agreement. The generic pharmaceutical companies were not subject to these terms. The generic pharmaceutical companies were therefore inappropriate comparators under the CUP analysis since not all economically relevant characteristics were comparable.

The amount that would have been reasonable in the circumstances has yet to be determined. The matter was remitted back to the Tax Court for redetermination regarding whether there was any misallocation of earnings.

The SCC provided some important guidance with respect to redetermination:

• Transfer pricing is not an exact science—some leeway must be allowed in the determination of the reasonable amount. “As long as a transfer price is within what the court determines is a reasonable range, the requirements of the section should be satisfied. If it is not, the court might select a point within a range it considers reasonable in the circumstances based on an average, median, mode, or other appropriate statistical measure, having regard to the evidence that the court found to be relevant” (at para 61).

• The respective roles and functions of the parties must be kept in mind.

• Prices between parties dealing at arm’s length will be established having regard to the independent interests of each party to the transaction.

• Arm’s length parties might find it in their interest to acquire product from a trusted source. This suggests a higher transfer price is justified.

Editorial Comment

The Minister’s assessment was based on the transfer price under the Supply Agreement, without regard to whether the terms of the Licence Agreement were also reasonable in the circumstances. The Crown’s argument was thus limited to pleadings about how much ranitidine should cost. If the Crown’s assertion was that Glaxo Canada underpaid for intellectual property and overpaid for ranitidine, both agreements needed to be challenged and the agreements would need to be “unbundled”. Had the Crown challenged both the supply and licence agreements, the result of this case might have been different.
The SCC determined that the Supply Agreement and Licence Agreement are linked. The Licence Agreement would be economically relevant to an arm’s length party looking to sign a Supply Agreement with Adechsa. The additional rights and benefits (not including the patent and trademark rights) provided under the Licence Agreement would increase the value of the Supply Agreement, and a proper comparator would need to reflect this fact.

This case centered on transfer pricing under subsection 69(2). The OECD transfer pricing guidelines that were examined were the 1979 and 1995 versions. The SCC did not provide any analysis or guidance regarding the new transfer pricing provision, section 247. The SCC also did not provide any analysis or guidance regarding the newest OECD transfer pricing guidelines that focus on choosing the most appropriate transfer pricing method and explain in more detail the comparability analysis and intellectual property transfer pricing. The tax planning value of this decision with regard to the new provision, section 247, and the 2010 OECD guidelines is therefore somewhat limited.

However, the SCC did make several comments that are significant to transfer pricing professionals. Firstly, the SCC affirmed that an appropriate comparator must resemble the parties to the transaction as closely and accurately as possible. Secondly, the SCC stated that a reasonable transfer price should fall within a range of arm’s length prices. This is highly significant to transfer pricing professionals as it appears to be contrary to the Canada Revenue Agency’s (“CRA”) long-standing policy:

… that the use of statistical measures, such as an inter-quartile range, does not necessarily enhance the reliability of the comparable data considered in producing a range because they do not relate to comparability.

(Canada Revenue Agency, Income Tax Liaison Meeting (December 6, 2011), response to question 12c).

The SCC therefore appears to have approved statistical methods other than an unweighted yearly average of comparators’ pricing which has been, with occasional exceptions, CRA policy. However, the SCC’s position is consistent with the 2010 OECD transfer pricing guidelines and puts Canada back in line with other jurisdictions. This is good news for Canadian transfer pricing professionals—this suggests we can now feel more comfortable using the same transfer pricing methods with respect to Canadian companies that are in common use worldwide.