Distinguished Advisor: Broader interpretation of transfer pricing

A recent Supreme Court of Canada (SCC) decision Canada v. GlaxoSmithKline Inc., 2012 SCC 52, adopts a broad test for transfer pricing, which may provide multinational corporations a new strategy for mitigating taxes, namely, transferring funds to sister companies in lower-tax jurisdictions.

According to the SCC: “Transfer pricing issues arise when entities of multinational corporations resident in different jurisdictions transfer property or provide services to one another. These entities do not deal at arm’s length and, thus, transactions between these entities may not be subject to ordinary market forces.”

Section 69(2) of the Income Tax Act, which applies to taxation years prior to 1997, was the provision applicable to this case. The more recent provision, Subsection 247(2) of the Act, replaced 69(2) for taxation years after 1997.

Paragraph 44 of the judgment explains succinctly the reasons for the decision:
“Because s. 69(2) requires an inquiry into the price that would be reasonable in the circumstances had the non-resident supplier and the Canadian taxpayer been dealing at arm’s length, it necessarily involves consideration of all circumstances of the Canadian taxpayer relevant to the price paid to the non-resident supplier. Such circumstances will include agreements that may confer rights and benefits in addition to the purchase of property where those agreements are linked to the purchasing agreement. The objective is to determine what an arm’s length purchaser would pay for the property and the rights and benefits together where the rights and benefits are linked to the price paid for the property.

Justice Rothstein for the unanimous court stated: “As long as a transfer price is within what the court determines is a reasonable range, the requirements of the section [69(2)] should be satisfied.”

The new test, therefore, offers subsidiaries some discretion to exercise their business judgment in areas in which they may have been prohibited under the rubric of transfer pricing rules. It does require the transfer price to fall within a reasonable range of what parties dealing at arm’s length from one another might pay and, importantly, it considers whether the price was reasonable given all the business circumstances.

The Facts. GlaxoSmithKline Inc., a multinational corporation based in the United Kingdom, has been in a battle with the Canada Revenue Agency (CRA) for almost two decades. The crux of the issue pertains to transfer pricing and how much corporate subsidiaries of the same parent can charge each other for goods.

From 1990 to 1993, the years in issue, Glaxo Canada purchased ranitidine from a Swiss affiliate of the parent for the manufacture of Zantac, a stomach ulcer medicine. It paid the affiliate more than $1,500 a kilogram, even though the drug cost the parent company an average of $146 a kg to make. Competitors, Apotex Inc. and Novopharm Ltd., paid between $194 and $304 a kg for ranitidine for their ulcer medicines. The CRA reassessed Glaxo Canada filings for those years and the dispute made its way through Tax Court of Canada, the Federal Court of Appeal and, finally, the SCC.

In its decision, the SCC found that it was insufficient to compare the prices paid by the competitors with the prices paid by Glaxo Canada. Counsel for Glaxo Canada successfully argued that Glaxo Canada had signed a licensing agreement that required it to buy the ranitidine from the Swiss affiliate; if it hadn’t, Glaxo Canada would not have had the right to sell the profitable Zantac medicine.

The SCC has referred the case back to the Tax Court so it can assess Glaxo’s tax bill under the new policy.

The Organization for Economic Co-operation and Development (OECD) was founded in 1961 to stimulate economic progress and world trade and thus far consists of 34 countries, including Canada. The OECD Transfer Pricing Guidelines state that “Transfer prices are significant for both taxpayers and tax administrations because they determine in large part the income and expenses, and therefore taxable profits, of associated enterprises in different tax jurisdictions.”

The full significance of this judgment might not reveal itself immediately, but many believe that a new tax-mitigating avenue has been paved. As such, it would not be surprising to see a response from Parliament.

Greer Jacks is updating jurisprudence in the EverGreen Explanatory Notes, an online research library of assistance to tax and financial professionals in working with their clients.