GlaxoSmithKline: Something for Everyone

On October 18, 2012, the Supreme Court of Canada (SCC) released its long awaited decision in Canada v. GlaxoSmithKline Inc. (GlaxoSmithKline), the first transfer pricing appeal heard by the SCC.

In dismissing the Canada Revenue Agency’s (CRA) appeal, the unanimous decision by Justice Rothstein not only provided a strong win for taxpayers, but the Court also provided considerable guidance on transfer pricing principles generally. While Glaxo won the case, the SCC sent the appeal back to the Tax Court for further consideration of the transfer pricing and added to the issues to be considered the question whether additional withholding tax should have been paid.


Zantac is an incredibly successful premium priced anti-ulcer drug which for many years was the world’s bestselling drug.

The key ingredient in Zantac was ranitidine. Ranitidine was developed and patented by the Glaxo Group. The well-known Zantac brand was also owned, and the marketing campaign developed, by the Glaxo Group.

In Canada, Zantac was sold by Glaxo Canada under license from the Glaxo Group. As authorized by the license, Glaxo Canada acted as a secondary manufacturer and marketer of Zantac in Canada for which it paid a royalty of 6% of net sales. As required by the license, Glaxo Canada purchased ranitidine from an approved member of the Glaxo Group – Adechsa of Switzerland. Under a separate supply agreement Adechsa charged Glaxo Canada between $1,512 and $1,651 per kg for the Glaxo ranitidine. The amounts paid for the royalty and the ranitidine were priced so as to allow Glaxo Canada a 60% gross margin on the sale of Zantac in Canada.

Under Canada’s then compulsory licensing system, competing drug companies could produce and sell generic versions of successful drugs such as Zantac. The generic drug companies were able to purchase generic ranitidine at $194 to $304 per kg for use in unbranded anti-ulcer drugs.

The CRA took the position that, under then subsection 69(2) of the Income Tax Act (Tax Act), the evaluation of the price paid by Glaxo Canada for the Glaxo ranitidine must be determined in isolation with no consideration given to the Zantac license. On that basis, the CRA concluded that Glaxo Canada drastically overpaid Adechsa for the Glaxo ranitidine and applied subsection 69(2) of the Tax Act to reassess on the basis that it should have paid the same amount for the Glaxo ranitidine as the generic drug companies paid for the generic ranitidine. This resulted in a substantial increase in Glaxo Canada’s income for the taxation years in dispute.

Those reassessments were the subject of the appeal.

The Tax Court of Canada1

The key issue was whether subsection 69(2) required the Court to consider the license and supply agreement together or the supply agreement in isolation as reassessed by the CRA.

In upholding the CRA’s reassessments, Chief Justice Rip interpreted the previous SCC decisions in Singleton v. Canada (Singleton) and Shell Canada Ltd. v. Canada (Shell) for the proposition that those decisions required that the reasonable price for the Glaxo ranitidine be determined in isolation from the license.

In considering the transfer price for the Glaxo ranitidine under the supply agreement in insolation, without consideration of the license, the Chief Justice used the comparable uncontrolled price method from the OECD Guidelines to determine that the price paid by the generic companies for ranitidine was the proper comparable resulting in a substantial downward adjustment to the transfer prices under the supply agreement.

Notably, Chief Justice Rip intentionally made no finding as to the reasonableness of the combined license and supply agreement payments made by Glaxo Canada to the Glaxo Group, observing that "it may very well be that a 40 percent total profit to Glaxo Group is reasonable; however, the issue before me is whether the purchase price of the ranitidine was reasonable. One cannot combine the two transactions and ignore the distinct tax treatments that follow from each."

As a result, the Tax Court decision effectively upheld the CRA transfer pricing adjustments in full, which at the time was considered a major victory for CRA.

Federal Court of Appeal

At the Federal Court of Appeal (FCA),2 the Court focused on the legal test adopted by the Tax Court in respect of the application of subsection 69(2) of the Tax Act. Specifically, in determining the reasonable price for ranitidine, was the Court required to consider the license and supply agreement together or just the supply agreement for ranitidine in isolation. Justice Nadon for the FCA concluded that the Tax Court judge made an error in law by misinterpreting subsection 69(2) of the Tax Act and held that, under that provision, the license granting the right to sell Zantac in Canada must be taken into account when considering the reasonable price for ranitidine under the supply agreement, holding:

[74] Consequently, it is my view that the Judge was bound to consider those circumstances which an arm's length purchaser would necessarily have had to consider. In other words, the test mandated by subsection 69(2) does not operate regardless of the real business world in which the parties to a transaction participate …

[76] Clearly, in the circumstances of this case, the Judge's approach was mistaken. In a real business world, presumably an arm's length purchaser could always buy ranitidine at market prices from a willing seller. However, the question is whether that arm's length purchaser would be able to sell his ranitidine under the Zantac trademark. In my view, as a result of the approach which he took, the Judge failed to consider the business reality which an arm's length purchaser was bound to consider if he intended to sell Zantac …

[78] Because it was central to the appellant's business reality, and would be so if it were dealing at arm's length with Adechsa, the license agreement with Glaxo Group was "a circumstance" which had to be taken into account by the Judge ...

Despite the clear finding that the Tax Court Judge made an error in considering the supply agreement in isolation, the FCA was unwilling to allow the appeal in full or to make its own determination as to the reasonable price for ranitidine. Instead, the Court decided to send the appeal back to the Tax Court Judge for reconsideration using the proper test, stating:

… In my view, that determination ought to be made by the Judge, who heard the parties for well over forty days, and not by this Court.

[83] Whether the consideration of the license agreement as a circumstance relevant to the determination of "the reasonable amount" will lead the Judge to the conclusion sought by the appellant is not for us to say…. Whether the present record is sufficient to allow the Judge to perform that task, I cannot say. The Judge may be satisfied that the record is sufficient or he may request the parties to adduce additional evidence and submissions as a result of this Court's decision.


The CRA appealed to the SCC seeking to reinstate the Tax Court decision. Glaxo cross-appealed the decision to remit the matter to the Tax Court for rehearing and reconsideration on the basis that, as a procedural matter, because at trial it had demolished the assumptions underlying CRA’s reassessment, its appeal should have been allowed in full without remittance back to the Tax Court.

The SCC decision upheld the FCA decision and dismissed both the appeal and cross-appeal.

In so confirming that the Tax Court Judge made an error in law in considering the supply agreement in isolation, Justice Rothstein distinguished Singleton and Shell on the basis that the language of subsection 69(2) at issue in the Glaxo appeal was very different from subparagraph 20(1)(c)(i), the provision at issue in Singleton and Shell. As to the application of subsection 69(2) in this case, the Court concluded that the supply agreement and license must be considered together noting:

[43]… in my respectful opinion, Rip A.C.J. was in error when he found that he was precluded from considering the Licence Agreement.

[44] 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 …

[46] Rip A.C.J. found at para. 86, "it was by virtue of the Licence Agreement that the appellant was required to purchase its ranitidine from Glaxo approved sources". The parties have not disputed this finding.

[49] As such, the rights and benefits of the Licence Agreement were contingent on Glaxo Canada entering into a Supply Agreement with suppliers to be designated by Glaxo Group …

[52] Considering the Licence and Supply agreements together offers a realistic picture of the profits of Glaxo Canada …

[53] I agree with the Federal Court of Appeal that Rip A.C.J. erred in refusing to take account of the Licence Agreement. It was that refusal which led him to find that the prices the generic pharmaceutical companies paid for ranitidine were comparable under the CUP method. However, the generic comparators do not reflect the economic and business reality of Glaxo Canada and, at least without adjustment, do not indicate the price that would be reasonable in the circumstances, had Glaxo Canada and Adechsa been dealing at arm’s length.

In the cross appeal, Glaxo Canada argued that because it had been established that the generic price was not the proper comparator for its purchase of the Glaxo ranitidine, it had demolished the basis for the CRA’s assessment. As a result, on the basis of the SCC’s decision in Hickman Motors Ltd. v. Canada (Hickman Motors), the Tax Court should have allowed the appeal in full.

In dismissing the cross-appeal, Justice Rothstein noted that in fact Glaxo had not demolished all of the CRA’s assumptions. In particular, the CRA had also assumed that the price paid by Glaxo for ranitidine "was greater than the amount that would have been reasonable in the circumstances"3 and the SCC noted that the assumption had not been demolished.

So while the taxpayer had not completely demolished the CRA’s assumptions, those assumptions were not complete nor had the trial judge made a transfer pricing determination supportable in law because of his failure to consider the full circumstances of the transaction. Thus the only recourse was to send the matter back to the trial judge because the reasonable price "has yet to be determined."4 In sending the matter back to the trial judge, the SCC directed that "the Tax Court judge should consider any new evidence the parties seek to adduce and that he may choose to allow."5

Given that Glaxo Canada sought to justify the amount paid for the Glaxo ranitidine by reference to the licencing agreement and the benefits received thereunder, including the right to resell under the Zantac brand, it is hardly surprising that the question of withholding tax surfaced. What is somewhat surprising is that in referring the transfer pricing issue back to the Tax Court, the SCC appears to have authorized the parties to address the issue for consideration by the Tax Court Judge even though such tax formed no part of any assessment that was before the Tax Court.

In the final result, Glaxo was successful in maintaining that the generic price for ranitidine was not the proper comparator for the price it had paid for the Glaxo ranitidine. However, the extent to which it was entitled to deduct the full amount paid remains to be determined and furthermore consideration is to be given whether some portion of that amount should have also been subject to withholding tax.

Additional Observations

The decision is a big win for Glaxo. Although its transfer pricing dispute is not over, and it now faces an additional issue re the potential application of withholding tax on a portion of the amount payable for the ranitidine, Glaxo has successfully avoided the initial one-sided CRA victory.

For taxpayers, the decision is an even bigger win, as the decision provides clear and helpful guidance from the SCC on the application of transfer pricing principles going forward. Notably, Justice Rothstein made the following additional points that will assist taxpayers.

OECD Guidelines Not Law

Justice Rothstein forcefully held that the OECD Guidelines are not a Canadian statute and that the test for transfer pricing must be determined under Canadian law. Throughout the judgment there are several references to the determination of an appropriate transfer price that is to be made by the Court exercising its informed judgment. This is a direct reminder that, as found by the SCC in Canderel Ltd. v. Canada and Toronto College Park Ltd. v. Canada, the ultimate determination of, profit under section 9 of the Tax Act is a question of law with economic, accounting and business principles being interpretative aids subservient to applicable legal principles.

Use of Ranges in Determining Transfer Prices

Justice Rothstein at paragraph 61 reiterates that transfer pricing "is not an exact science," such that flexibility must be provided in the selection of comparators and that leeway must be provided in determining a transfer price. As a result it was held that "as long as a transfer price is within what the court determines is a reasonable range…" no adjustment should be made. Thus, so long as related taxpayers set their prices within a defensible range, no adjustment by CRA would be warranted.

Profit Only Where Profit Is Due

Transfer pricing must result in an allocation of earnings consistent with the functions and the resources performed. In this instance, had the SCC upheld the CRA’s transfer pricing adjustments, then Glaxo Canada would have been allocated profits significantly greater than warranted for its limited functions as a secondary manufacturer and marketer.

In paragraphs 52 and 62, Justice Rothstein emphasized that the functions performed by the respective parties must be fully appreciated in order to ensure their profits are commensurate with the relative contributions of each party to the transaction. In this regard, the Court specifically stated that "transfer pricing should not result in a misallocation of earnings that fails to take account of these different functions and the resources and risks inherent in each."

Singleton and Shell Reaffirmed

In distinguishing its decisions in Singleton and Shell, the SCC specifically reviewed the two decisions and reaffirmed the principles established therein with respect to the deductibility of interest under subparagraph 20(1)(c)(i). As reaffirmed by the SCC, the test for interest is a simple factual determination "whether the use of borrowed funds was for the purpose of earning income"6 and no more. It is irrelevant whether the funds had been borrowed as part of a "sophisticated tax scheme" nor is the Minister entitled to "collapse"7 transactions or to "re-characterize the taxpayer’s bona fide legal relationships."8 This reaffirmation is reassuring because the composition of the SCC has changed substantially since Singleton and Shell were decided.

Procedural Matters

While the cross appeal brought by Glaxo was ultimately unsuccessful, it was not because the procedural argument was flawed or invalid, but rather because of the factual circumstance that Glaxo had failed to demolish all of the key assumptions made by the CRA at trial. In another case, where the taxpayer has refuted all of the key assumptions, we expect the principle from Hickman Motors to apply. This decision is a reminder that at trial taxpayers must be vigilant in successfully challenging all disputed ministerial assumptions.

In Conclusion

The SCC’s first transfer pricing decision is a big win for taxpayers providing much needed guidance for transfer pricing cases going forward. At the same time, the CRA also benefitted from the decision in that the Glaxo pricing remains an open issue with the possibility of additional withholding tax.

1 GlaxoSmithKline Inc. v. The Queen
2 GlaxoSmithKline Inc. v. Canada
3 GlaxoSmithKline at paragraph 70
4 GlaxoSmithKline at paragraph 54
5 GlaxoSmithKline at paragraph 55
6 GlaxoSmithKline at paragraph 34
7 GlaxoSmithKline at paragraph 33
8 GlaxoSmithKline at paragraph 37