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GlaxoSmithKline prevails at Federal Court of Appeal, but saga continues In a July 26, 2010, decision, Canada’s Federal Court of Appeal (FCA) found that the Tax Court of Canada (TCC) erred in its interpretation of former subsection 69(2) of the Canadian Income Tax Act (ITA), which involved an application of the comparable uncontrolled price (CUP) method. The FCA sent back to the TCC the issue of the determination of a “reasonable price” for the active ingredient of Zantac. The FCA decision reaffirms a view held by most taxpayers and advisors that the arm’s length price of individual transactions should be determined with due consideration of all the other relevant intercompany transactions within the related group. This also applies to the use of the CUP method, where comparability adjustments should not just capture product differences, but market and business circumstance (such as the use of intangibles) that parties would consider in arm’s length dealings. Background The TCC on May 30, 2008, ruled in favor of the Canada Revenue Agency (CRA) in a long-running dispute with GlaxoSmithKline Inc. (GSK), the Canadian distributor of the patented anti-ulcer drug Zantac. The dispute focused on the transfer price paid for ranitidine, the active ingredient in Zantac, during the 1990 to 1993 taxation years. The CRA’s adjustment increased GSK’s taxable income by $51 million. The decision was made under the transfer pricing rules of section 69 of the ITA, the predecessor to the current rules in section 247. Under the former section, the test was whether the price paid would have been “reasonable in the circumstances” if the nonresident person and the taxpayer had been dealing at arm’s length. The TCC found that the price paid for ranitidine to a related Swiss company was not reasonable in the circumstances, and that a reasonable price was the amount paid by a group of selected generic pharmaceutical companies for a chemically equivalent product, plus a minor adjustment for additional granulation. The decision hinged on the assertion by the TCC judge that only the transaction under review, and not any other intercompany transaction, should be considered in the determination of whether the price paid by GSK for ranitidine was “reasonable in the circumstances.” In particular, the TCC excluded from consideration the license agreement between GSK and its U.K. parent, which provided GSK with the right to use the Zantac brand and other intangibles in its distribution activities. The ability of GSK to use these intangibles contributed to the price premium of Zantac over competing generic drugs. The TCC judge’s position was supported by relying on the Supreme Court of Canada’s decision in Singleton v. Canada, [2001] 2 SCR 1046. Overview of FCA’s decision The FCA found that the TCC judge erred in two respects. First, the TCC judge concluded on the basis of Singleton that other intercompany transactions, namely the license agreement with GSK’s UK parent, were of no relevance in the determination of a reasonable price under subsection 69(2). However, the FCA found no link between the provision in the ITA that was the subject of Singleton (paragraph 20(1)(c)(i)) and the provision relevant to this case (subsection 69(2)). Second, and similar to the above, the FCA found that the TCC judge erred in his interpretation of the “reasonable” test under subsection 69(2). According to the FCA, the test should have considered “all relevant circumstances which an arm’s length purchaser would have had to consider,” particularly GSK’s license agreement with its U.K. parent. In supporting this finding, the FCA relied on the “reasonable business person” standard found in Gabco Limited v. Minister of National Revenue (1968), 68 D.T.C. 5210. As a result, and because of the TCC’s greater exposure to the case facts, the FCA sent the case back to the TCC to redetermine the reasonable price under the correct test. Copyright 2010, Deloitte Global Services Limited. Impact of the FCA’s decision Although the “reasonable in the circumstances” test has since been replaced, through section 247 of the ITA, with an “arm’s length” test, the decision by the FCA involves an issue common to both former subsection 69(2) and section 247 of the ITA. The FCA decision reaffirms a view held by most taxpayers and advisors that the arm’s length price of individual transactions should be determined with due consideration of all the other relevant intercompany transactions within the related group. This also applies to the use of the CUP method, where comparability adjustments should not only capture product differences, but market and business circumstance (such as the use of intangibles) that parties would consider in arm’s length dealings. It remains to be seen whether the CRA will appeal the decision to the Supreme Court of Canada, or if not, how the TCC judge will undertake the transfer pricing analysis under this revised test. Regardless, the next debate will undoubtedly have further significant implications on how transfer pricing methods should be applied. — Norma Kraay (Toronto) Hernan Allik (Toronto) Senior Manager Deloitte Canada [email protected] About Deloitte Deloitte refers to one or more of Deloitte Global Services Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Global Services Limited and its member firms. “Deloitte” is the brand under which tens of thousands of dedicated professionals in independent firms throughout the world collaborate to provide audit, consulting, financial advisory, risk management, and tax services to selected clients. These firms are members of Deloitte Touche Tohmatsu Limited (DTTL), a UK private company limited by guarantee. Each member firm provides services in a particular geographic area and is subject to the laws and professional regulations of the particular country or countries in which it operates. DTTL does not itself provide services to clients. DTTL and each DTTL member firm are separate and distinct legal entities, which cannot obligate each other. DTTL and each DTTL member firm are liable only for their own acts or omissions and not those of each other. Each DTTL member firm is structured differently in accordance with national laws, regulations, customary practice, and other factors, and may secure the provision of professional services in its territory through subsidiaries, affiliates, and/or other entities. Disclaimer This publication contains general information only, and none of Deloitte Global Services Limited, its member firms, or its and their affiliates are, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your finances or your business. Before making any decision or taking any action that may affect your finances or your business, you should consult a qualified professional adviser. None of Deloitte Global Services Limited, its member firms, or its and their respective affiliates shall be responsible for any loss whatsoever sustained by any person who relies on this publication. Arm’s Length Standard Copyright 2010, Deloitte Global Services Limited.

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