GlaxoSmithKline in the SCC

On January 13, 2011, the SCC heard its first transfer-pricing case--the government's appeal of the FCA's decision in GlaxoSmithKline Inc. v. Canada (2010 FCA 201). The decision in this case could clarify important elements in Canada's transfer-pricing regime.

The facts were as follows. GSK had a licence agreement that granted it the right to manufacture and sell at a premium price the drug known as Zantac in Canada. Under another interrelated agreement, GSK was required to purchase the active ingredient from an affiliate company of the group for a price considerably higher than both the actual production cost and the price paid by generic-drug companies. The minister partly disallowed the deduction for the active ingredient, relying on subsection 69(2) to conclude that the deduction should be limited to the amount that was "reasonable in the circumstances"--the price paid by the generic-drug companies. GSK argued that the transactions were not comparable and that the licence agreement had to be taken into account in the transfer-pricing analysis.

In the GSK appeal, there are three key issues that might be addressed by the SCC:

  1. The FCA's decision interpreted subsection 69(2) according to the view that all relevant circumstances have to be considered--that is, it applied the "reasonable business person" test (Gabco Ltd. v. MNR, 68 DTC 5210 (Ex. Ct.)). Will the SCC follow this inherently subjective test in deciding whether an arm's-length Canadian distributor of Zantac would pay the price that GSK did?

  2. It is possible that an arm's-length Zantac distributor would have agreed to pay a premium on the active ingredient in order to realize a higher margin on the sale of the branded drug. By choosing whether or not to consider the licence agreement in its analysis, the SCC will provide guidance on the degree to which the business context surrounding intercompany transactions should be considered.

  3. Canadian transfer-pricing jurisprudence has accepted that elements resulting from a non-arm's-length situation are to be considered in the interpretation and application of the arm's-length standard (for example, the implicit support given by a parent corporation to its subsidiary, as in Canada v. General Electric Capital Canada Inc. (2010 FCA 344)). Following this decision, will the price imposed under GSK's licence agreement be regarded as an element that can be considered in the analysis?

At the January 13 hearing, the SCC showed considerable interest in the question of GSK's business reality in the analysis. Some judges noted that the subsection 69(2) "reasonable in the circumstances" wording was broad enough to include the consideration of business reality.

By addressing the points described above, the SCC can provide much-needed guidance on the application of transfer-pricing legislation and further refine the concept of "reasonable in the circumstances" when applying and interpreting the arm's-length standard from a Canadian perspective.

Nathalie Perron
Deloitte & Touche LLP, Montreal

Canadian Tax Focus
Volume 2, Number 1, February 2012
©2012, Canadian Tax Foundation