GlaxoSmithKline transfer pricing case settled
The landmark transfer pricing case involving GlaxoSmithKline has settled on the eve of the second Tax Court of Canada trial in the matter, scheduled to commence on January 12, 2015.
“Counsel for Glaxo confirmed the settlement but the details remain confidential,” writes William Innes of Rueter Scargall Bennett in Bill Innes on Current Tax Cases.
The need for a second trial originated with the Supreme Court of Canada’s landmark 2012 ruling in the case, which was the first time the high court had dealt with transfer pricing issues.
To ensure that revenues and expenses are allocated fairly in cross-border intra-corporate transactions, tax authorities in an increasing number of countries require taxpayers within the same group to ensure that any transfer of goods, services, intangibles or financing arrangements between them occurs on the same terms as the terms that independent parties would negotiate. This is known as the “arm’s length principle.”
But implementing the arm’s length principle is easier said than done. This is particularly true in Canada, where the statutory guidance found in s. 247(2) of the Income Tax Act (ITA) is sketchy and the interpretive jurisprudence is embryonic despite the fact that the section and its similar predecessor, s. 69(2), have been in force since 1998.
GlaxoSmithKline (GSK) arose when GlaxoSmithKline Inc. (Glaxo), the Canadian subsidiary of Glaxo Group plc, a U.K. corporation, agreed to purchase ranitidine, the prime ingredient in the best-selling drug Zantac, from Adechsa, an affiliated company that was the Swiss subsidiary of the Glaxo Group, for between C$1512 and C$1651 per kilogram. Glaxo Group owned the intellectual property associated with Zantac.
At the time, generic manufacturers were marketing a generic alternative to Zantac. They managed to purchase ranitidine in the market at significantly lower prices, between C$194 and C$304 per kilogram.
The Canada Revenue Agency (CRA) challenged the deductibility of Glaxo’s payments to Adechsa, arguing that the expense was not “reasonable in the circumstances” as required by the ITA. A reasonable amount, the CRA argued, was the amount paid by the generics.
But Glaxo responded that a consideration of reasonableness should take into account a license agreement between the Glaxo Group and Glaxo. The agreement allowed Glaxo to use the parent’s trademarks and brand, including Zantac, and provided access to other drugs. Glaxo paid Glaxo Group a 6 per cent royalty on sales of drugs covered by the license agreement.
The trial judge at the first trial in the Tax Court of Canada refused to consider the license agreement, reasoning that the two agreements covered separate matters. He ruled that the reasonable price for Glaxo to pay was the highest price paid by the generics subject to a small adjustment.
But the Federal Court of Appeal overturned the Tax Court’s decision and decided that the license agreement was relevant. In its view, the trial judge had erred by equating the “fair market price” paid by the generics with what was “reasonable in the circumstances.” As the court saw it, what was “reasonable in the circumstances” required “an inquiry into those circumstances which an arm’s length purchaser, standing in the shoes of [Glaxo’s] would consider relevant” in determining what it was willing to pay for ranitidine.
Here, the relevant circumstances were that Glaxo Group owned the Zantac intellectual property and would have owned it even if Glaxo was arm’s length; Zantac commanded a premium over generic drugs; and without the license agreement, Glaxo could not have used the Zantac trademark nor would it have had access to Glaxo Group’s other products.
Although the FCA sent the case back to the trial judge to determine the appropriate transfer price in light of its guidelines and the Supreme Court of Canada upheld that decision, observers still consider GlaxoSmithKline a victory for taxpayers.
“What is important is the Supreme Court’s acknowledgement that transfer pricing decisions don’t exist in a vacuum and don’t operate outside business realities,” said Claire Kennedy, a tax partner in Bennett Jones LLP’s Toronto office. “Here, the circumstances did not arise out of the non-arm’s length relationship between Glaxo and the Glaxo group but from the business realities imposed by the market power of the product.”
More particularly, the SCC ruled that all “economically relevant characteristics” of the transaction, including the involvement of related companies and related transactions, merited consideration. Finally, the Court recognized that transfer pricing was not an exact science and that some leeway was necessary in determining whether an allocation was reasonable.
