On October 18th, the Supreme Court of Canada (SCC) ruled for the first time on the subject of transfer pricing, specifically related to the longstanding GlaxoSmithKline case, Her Majesty the Queen v. GlaxoSmithKline Inc. In the first ever hearing of a transfer pricing-related issue, the SCC rejected Canada Revenue Agency's (CRA) appeal for a rehearing of the case to take into consideration the relevance of additional licensing agreements in the determination of an appropriate arm's-length price.
In the original case, GlaxoSmithKline Inc. (Glaxo Canada) entered into an agreement with the Glaxo Group to manufacture, market, and sell the pharmaceutical drug Zantac, the well-recognized anti-ucler medication, in Canada. As part of the agreement, Glaxo Canada was required to purchase the active ingredient for Zantac (ranitidine) from a Glaxo Group approved supplier. Glaxo Canada also licensed the right to sell the drug under the Zantac name. CRA argued that due to the availability of generic forms of ranitidine in Canada, the most appropriate transfer pricing method should be the CUP method as prescribed by the OECD Guidelines. As the market price for generic ranitidine was significantly less than the branded-version available through Glaxo Canada's supplier, applying the CUP approach would suggest that Glaxo Canada overpaid for the drug and its taxable income was significantly misrepresented. In essence, CRA ignored the aspect of the agreement which gives also Glaxo Canada the right to use the Zantac name.
The SCC found that all economic facts and circumstances should be taken into account (i.e. the licensing agreement) in the transfer pricing analysis, also referencing the relevant sections of the OECD Transfer Pricing Guidelines. In the case, the SCC ruled that the intercompany price paid by Glaxo Canada for the active ingredient ranitidine in the pharmaceutical drug Zantac was not higher than a reasonable amount, given that the product purchase price also conveyed the rights to use the Zantac name.
The SCC confirmed that the added benefits obtained by Glaxo Canada in the Zantac license were represented in the intercompany price, and could potentially justify the higher price paid. The SCC stated that the matter should be remitted to the Tax Court who should consider the effects of the license agreement and determine whether or not compensation for those rights is justified.
Although the SCC did not definitively state whether the intercompany price paid in the Glaxo case was arm's-length, we believe the ruling itself is ultimately positive for corporate taxpayers. Most importantly, it recognizes both the importance of fully understanding the nature of the intercompany transaction and determining the true comparability of market transactions.
We feel that a superior approach to completing transfer pricing documentation would focus not only on justifying the transfer pricing method selected, but should also focus on rigorously defending against the viability of alternative methods. Too often taxpayers and their advisors summarily dismiss alternative approaches to pricing intercompany transactions, and don't use the opportunity to establish strong defenses against obvious alternative pricing approaches that - if applied by a motivated tax authority - can result in significant audit adjustments and costly disputes.
We also potentially see how transfer pricing issues may be treated in high non-U.S. courts in the future. The OECD Guidelines provide these courts a comprehensive framework for properly analyzing intercompany activity. The SCC relies upon the OECD Guidelines and performs a sophisticated assessment of a significant transfer pricing dispute.