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Transfer pricing: judgment of the Supreme Court of Canada in the GlaxoSmithKline case

23 October 2012   (0 Comments)
Posted by: SAIT Technical
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By Emil Brincker (DLA Cliffe Dekker Hofmeyr Tax Alert)

Executive summary (SAIT Technical)

Emil Brincker discusses the recent transfer pricing judgment of the Supreme Court of Canada in the matter between Glaxo Canada and the Canadian Revenue Authorities. Glaxo Canada had entered into a supply agreement that established the transfer prices of a certain pharmaceutical ingredient called ranitidine. The company also entered into a licence agreement. Since Glaxo Canada was paying for some of the rights and benefits under the licence agreement as part of the purchase prices for ranitidine, it was indicated that one should consider the combined effect of the licence and supply agreements to establish an appropriate transfer pricing relationship.

The relevant Canadian statute required a court to determine whether the relevant price paid by Glaxo Canada was greater than the amount that would have been reasonable in the circumstances had the parties been dealing at arm's length.The Court indicated that the starting point to determine whether the parties acted at arm's length is that one should have regard to the economically relevant characteristics of the arm's length and non-arm's length circumstances to ensure that they are sufficiently comparable.

The Court emphasised that transfer pricing is not an exact science and that it is 'highly unlikely' that comparisons will yield identical circumstances.

The approach of the Tax Court was not accepted by the Supreme Court of Canada and the mater was referred back to the Tax Court in order to determine an appropriate price.

Full article

The Supreme Court of Canada gave judgment on 18 October 2012 in the matter between GlaxoSmithKline (Glaxo Canada) and the Canadian Revenue Authorities dealing with the transfer pricing arrangement between Glaxo Canada and related non-resident companies.

By way of background, Glaxo Canada entered into a licence agreement that conferred rights and benefits onto it. In addition, it also entered into a supply agreement that established the transfer prices of ranitidine, an active pharmaceutical ingredient in the brand name anti-ulcer drug Zantac. Among others, it was indicated that one should consider the combined effect of the licence and supply agreements in order to establish an appropriate transfer pricing relationship. The reason for this conclusion was that Glaxo Canada was at least paying for some of the rights and benefits under the licence agreement as part of the purchase prices for ranitidine. One could therefore not ignore the existence of the licence agreement and the payments made thereunder.

In establishing an appropriate benchmark, the Court indicated that one should firstly have regard to the words and provisions of the statute. The relevant Canadian statute required a court to determine whether the relevant price paid by Glaxo Canada was greater than the amount that would have been reasonable in the circumstances had the parties been dealing at arm's length. It was indicated that the OECD Guidelines do not form part of the statute, even though they suggest a number of methods that can be used to determine whether the prices paid were consistent with parties dealing at arm's length.

The Court indicated that the starting point to determine whether the parties acted at arm's length is that one should have regard to the economically relevant characteristics of the arm's length and non-arm's length circumstances to ensure that they are sufficiently comparable. If there are no related transactions or where the related transactions do not impact on the reasonableness of the prices paid, one should adopt a transaction by transaction approach. Even in such instance, one may have to consider other transactions that may impact on the ultimate arm's length relationship. One should consider the relevant circumstances as opposed to merely using comparables that do not take into account the economic circumstances of the relationship between the parties. It was indicated that the circumstances will include agreements that may confer rights and benefits to the payor over and above the purchase of property in circumstances where those other agreements may be linked to the agreement in terms of which the goods may be acquired.

The Court emphasised that transfer pricing is not an exact science and that it is 'highly unlikely' that comparisons will yield identical circumstances. A court must thus exercise its best informed judgment in establishing an acceptable arm's length price. This issue is especially relevant in circumstances where SARS often approaches a transfer pricing matter as if it is an exact science and as if there is only one transfer price. The Court specifically rejected such an approach. It was indicated that some leeway must be allowed in the determination of a reasonable amount. As long as a transfer price falls within such range, the relevant requirements of transfer pricing would be satisfied. It is only if it is not within that range that a court could select a point within a range it considers reasonable in the circumstances based on an average, median, mode or other appropriate statistical measure.

The following additional guidelines were indicated in establishing an arm's length relationship:

  • One should consider the respective roles and functions of the parties and transfer pricing should not result in a misallocation of earnings that fails to take account of the relevant functions and resources and risks inherent in each role that is played.
  • Prices should be determined having regard to the independent interests of each party.
  • In the specific instance it was indicated that arm's length distributions have found it in their interests to acquire the ranitidine from a GlaxoSmithKline group supplier rather than from generic resources.

Even though the judgment of the Supreme Court of Canada can thus be welcomed from a taxpayer's perspective, the one important issue to be appreciated is the fact that the cross-appeal of Glaxo Canada was also dismissed. Even though the approach of the Tax Court was thus not accepted by the Supreme Court of Canada, it was found that Glaxo Canada could not on that basis alone argue that it has 'demolished' the assumptions of the Canadian Revenue Authorities. The fact that the approach of the Revenue Authorities was thus incorrect, did not imply that Glaxo Canada 'demolished' the approach concerned. An inappropriate comparator therefore does not save the day for the taxpayer. One should appreciate that the burden of proof is then still upon the taxpayer, which makes it very difficult for the taxpayer. In the circumstances concerned the matter was referred back to the Tax Court to determine an appropriate price. The parties will thus have to spar another round in the Tax Court in order to determine what is in fact an appropriate price even though the Court found that the comparators and approach of the Canadian Revenue Authorities was not appropriate.



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