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Canada after gsk - elusive valuations of bundled transaction

Reproduced with permission from Transfer Pricing International Journal, null, 04/15/2011. Copyright ஽ 2011 by TheBureau of National Affairs, Inc. (800-372-1033) http://www.bna.com Canada after GSK –
elusive valuations of
bundled transaction
Dale Hill and Mark Kirkey,
Taxand Canada
GSK has expanded what must be considered when determining an Thetaskofmakingvaluationsfortransferpric- for members of multinational entities (‘‘MNEs’’) to ing involving bundled transactions has always erode the tax base by transferring profits to jurisdic- been a daunting one. Placing dollar figures on tions with lower tax rates, or to entities that have pre- exchanges between related companies for transac- tions incorporating a combination of goods, services, In an effort to combat these downward forces on and intangibles is a considerable challenge for even the tax base, Canada has established transfer pricing the most well-versed tax practitioners. In this article legislation that seeks to ensure transfer pricing is not we examine the effects of transfer pricing using a Gl- used as a mechanism for tax avoidance by MNEs.
axoSmithKline example, and contemplate the ramifi- Where the CRA determines that a company has priced cations to the transfer pricing process arising there in an inter-company transaction artificially low or high, an effort to define a standard of reasonableness.
it can reassess the transaction and in some instances Adding to the difficulty of making accurate assess- impose a penalty equal to 10 percent of the transfer ments of these transactions is the unavailability of ap- propriate comparators. Often, due to the uniqueness Difficulties for MNEs arise in making determina- and the exclusive nature of the combination being ex- tions of what price would prevail in the market in situ- changed between non-arm’s length companies (espe- ations where the goods, services, or assets being cially in the case of intellectual property rights), exchanged are not made available to independent finding the ‘‘fair market value’’ may be impossible to third parties. A further complication is that transfer pricing often involves ‘‘bundled transactions’’, sce- In a recent decision of Canada’s Federal Court of narios in which a number of transactions for an as- Appeal, GlaxoSmithKline Inc. v. The Queen, light was sortment of goods, services, and intangibles are shed on the standard of reasonableness to be applied to such transfer pricing cases. The Court acknowl- In GlaxoSmithKline Inc., the issue under appeal in- edged that determinations of what is ‘‘reasonable’’ volved the reasonableness of a transfer pricing ar- cannot be reduced to mechanised, formulaic assess- rangement for such a bundled transaction in the ments. The real-world business circumstances in context of the pharmaceutical industry. Specifically, which corporations operate should not be divorced the court had to determine the legal standard and de- from evaluations of whether or not the transfer prices lineate the factors that are properly included in an in- paid were reasonable. To allow otherwise would be to quiry into what was reasonable in the circumstances.
condone a specious appraisal of fair market value inlieu of a genuine acknowledgement of the conditions ll. Facts
under which multinational entities do business.
GlaxoSmithKline Inc. (‘‘Glaxo Canada’’) was a wholly- Dale Hill and Mark
owned subsidiary of Glaxo Group, which was itself a l. Background
Kirkey are both
wholly-owned subsidiary of Glaxo Holdings plc. Both partners based in
With increasing globalisation, the Canada Revenue parent companies were United Kingdom corpora- Gowlings’ Ottawa
Agency (the ‘‘CRA’’), along with taxing authorities in tions. Glaxo Holdings was ‘‘the ultimate parent of the other countries, has grown concerned by the potential Glaxo Group of companies (‘Glaxo World compa- nies’)’’, which ‘‘discovered, developed, manufactured failure to withhold tax on dividends deemed to be paid and distributed a number of branded pharmaceutical to a non-resident shareholder equal to the amount paid in excess of what was reasonable in the circum- Glaxo Canada sold Zantac, a patented and trade- marked drug prescribed to treat stomach ulcers, inCanada. The active ingredient in Zantac, ranitidine, as lV. Position of The Crown in the appeal
well as the Zantac trade-mark, were owned by GlaxoGroup, but were licensed to Glaxo Canada for their The Crown asserted that the only agreement that should be considered in evaluating the reasonableness The manufacturing of ranitidine was handled by of the transfer price was the Supply Agreement – the two foreign companies within the Glaxo World com- Licence Agreement, in its opinion, should be ignored.
panies and sold to Adechsa SA (‘‘Adechsa’’), a Swiss If accepted, this would effectively shut the door on any resident Glaxo World clearing company. The Swiss effort by Glaxo Canada to rely upon the goodwill value company in turn sold it to Glaxo Canada for an of the Zantac trademarks or the regulatory approval amount between $1512 and $1651 per kilogram. The and marketing assistance received from Glaxo World transfer price paid by Glaxo Canada was determined as justification for the price disparity between the according to the ‘‘resale-price method’’. Glaxo World amounts it paid for ranitidine versus the amount paid and its distributors agreed that a gross margin of 60 by the generic companies. This is so because all intan- percent would be retained by the distributors, and the gibles were dealt with in the Licence Agreement. If it ranitidine would be priced accordingly. The starting were excluded from an assessment of the reasonable- point for determining the price the distributor would ness of the transfer price, all benefits conferred pay was the in-market price for the finished ranitidine therein to Glaxo Canada would not be considered.
product. The lower court used a simplified example to The Crown further alleged that even if the Licence demonstrate this mechanism of price setting: ‘‘if the Agreement and the Supply Agreement were taken to- ranitidine product was sold for $10 in Italy, the trans- gether, Glaxo Canada failed to prove that a party fer price would be $4; if the ranitidine product was transacting at arm’s length would have paid the same sold for $20 in France, the transfer price would be $8’’.
amount for the right to sell Zantac in Canada.
Two Canadian generic pharmaceutical companies, Apotex Inc. and Novophram Ltd., purchased their ra- V. Position of Glaxo Canada
nitidine from arm’s length suppliers for an amount be- Glaxo Canada argued that the determination of what tween $194 and $304 per kilogram. These prices were, a reasonable business person, standing in Glaxo Cana- at minimum, $1208 per kilo lower than the ranitidine da’s shoes but dealing at arm’s length with Adechsa, bought by Glaxo Canada from Adechsa.
would have paid involved more than simply declaring At the crux of the appeal were two contractual any price above that of fair market value to be ‘‘unrea- agreements. The first was a Supply Agreement be- sonable’’. It demands an analysis of the business cir- tween Glaxo Canada and Adechsa for the purchase of cumstances surrounding the transaction.
ranitidine. The second was a Licence Agreement be- As Glaxo Canada asserted, and the Court ultimately tween Glaxo Canada and the Glaxo Group, pursuant agreed, to ignore the Licence Agreement would be to to which Glaxo Canada paid a six percent royalty on create ‘ a fictitious business world where a purchaser its net sales of Zantac and other drugs in exchange for is able to purchase ranitidine at a price which does not take into account the circumstances which make it s the right to manufacture, use and sell products possible for that purchaser to obtain the rights to s the right to the use of the trademarks owned by make and sell Zantac’’. As no arm’s length party could sell Zantac-branded products without the existence of s the right to receive technical assistance for its sec- a Licence Agreement, it would be improper to exclude it from an analysis of what was ‘‘reasonable in the cir- s the use of the registration materials prepared by Glaxo Group, to be adapted to the Canadian envi-ronment and submitted to the Health Protection Vl. Decision of the Court
s access to new products, including line extensions The Federal Court of Appeal unanimously rejected the contention that the Licence Agreement should be ig-nored. It decided that a determination of whether or s the right to have a Glaxo World company sell [it] not the purchase price of the ranitidine was reason-able would need to factor in all relevant circum- stances which an arm’s length purchaser would have The Court emphasised that the test mandated by the Canadian transfer pricing legislation does not operate lll. The reassessment
regardless of the real business world in which the par- The CRA reassessed Glaxo Canada on the basis that it ties to the transaction participate. The Court outlined had overpaid Adechsa for the purchase of the drug, in- a number of crucial circumstances that would have creasing Glaxo Canada’s income by the difference be- existed regardless of the parties’ relation to each other.
tween the price paid by the generic companies for These circumstances arose from the market power at- their ranitidine and that paid by Glaxo Canada for its taching to Glaxo Group’s ownership of the intellectual ranitidine. Further, Glaxo Canada was assessed for its property associated with ranitidine, the Zantac trade- mark, and the other products covered by its Licence In the case of Glaxo Canada, it obtained the active Agreement with Glaxo Canada. Any arm’s length party ingredient ranitidine in conjunction with a licence for would have consequently had to consider the contents various rights to Glaxo products including the right to of the Licence Agreement in deciding whether or not sell Zantac branded products. In the Court’s view, the to pay the price asked for by Adechsa for the sale of value of the licence should not be considered sepa- rately from the cost of the ranitidine. The Court ac-knowledged that significant brand power existed inthe trademarked drug and, as a result, could afford Vll. Conclusion
the Glaxo Group a great deal of latitude in its transfer The considerations for the valuation of an appropriate pricing demands. The favourable bargaining position transfer price have been expanded by this case to in- of the Glaxo Group existed because of its ownership of clude all relevant circumstances that may be consid- the intangibles contained under the Licence Agree- ered by an arm’s length purchaser.
ment. This was so regardless of whether it was trans-acting with a subsidiary or an arm’s length party.
The Federal Court of Appeal accepted that there is Gowlings is a member of Taxand. The authors may be contacted no magic formula in determining whether or not a transfer price paid between related entities is reason- able. The totality of circumstances that would factor into any purchaser’s decision must be carefully anal- ysed before a conclusion can be drawn; to accept less The GSK case has, since this article was prepared, been accepted would be to turn a blind eye to the real-world circum- by the Supreme Court of Canada. The authors will provide a stances in which such contracts are made.
further article analysing the decision later in the year. Copyright ஽ 2011 by The Bureau of National Affairs, Inc. TPIJ ISSN 2042-8154

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