The Glaxo Canada tax case: a better pill.

• Author: Bernier, Jacques
• Position: Transfer pricing

On July 26, 2010, the Canadian Federal Court of Appeal unanimously reversed the Tax Court of Canada in the transfer pricing case between GlaxoSmithKline Inc. (Glaxo Canada) and the Canada Revenue Agency (CRA). This recent decision is the first pronouncement from an appellate court in Canada on a transfer pricing matter. Thankfully, the decision is helpful to taxpayers, though not conclusive in all respects. As more litigation will follow the Court of Appeal's decision, this commentary will be brief. (1)

Facts

The case involved the transfer price paid by Glaxo Canada for an active pharmaceutical ingredient known as ranitidine. Glaxo Canada paid between $1,512 and $1,651 for each kilogram it purchased from its trading/clearing affiliate. The CRA raised substantial reassessments using prices paid by generic pharmaceutical companies ranging between $194 and $304 per kilogram of generic ranitidine which were used as a Comparable Uncontrolled Price (CUP). Glaxo Canada used its ranitidine to sell Zantac under a license agreement with its parent, which also owned the valuable intangibles of the Glaxo Group. The license agreement provided those intangibles to Glaxo Canada, along with related services in exchange for a six-percent royalty on net sales of all products, including Zantac. Glaxo Canada was remarkably profitable and defended the CRA's reassessments by advancing internal CUPs, the Resale Price Method (with a median of 62 percent) and the Transactional Net Margin Method.

The Tax Court of Canada Decision

The Tax Court held in favor of the CRA principally because it was of the view that the applicable provision, former subsection 69(2) of the Income Tax Act, mandated only the consideration of the purchase and sale of active ingredients between Glaxo Canada and its affiliate supplier under the supply agreement. Under this approach, the bundle of intangibles received by Glaxo Canada under its license agreement with its parent, the owner of the intangibles, was simply irrelevant. In the end, the Tax Court allowed only for a nominal price adjustment of $25 per kilogram to factor in some product differences.

The Court of Appeal Decision

On appeal, the Court of Appeal determined that the Tax Court erred in law in its interpretation of the applicable legal test. In particular, the Court of Appeal found that the Tax Court's heavy reliance on a Supreme Court of Canada decision on interest deductibility (2) could not be of any help to the disposition...