Canada's decision on Glaxo coming soon!

Prepare yourselves--the Supreme Court will soon release its decision in the Glaxo SmithKline case.  The case record is here.  But as a quick reminder, here are the basics of the dispute:

• Glaxo Group and Glaxo Canada entered into a License Agreement giving Glaxo Canada the right to market Zantac, the active ingredient of which is ranitidine
• The agreement required Glaxo Canada to buy its ranitidine from a member of the Glaxo Group, Adechsa, a nonresident company. 
• Under that supply agreement, Glaxo Canada paid about five times as much per kilo for its ranitidine supply as its generic brand competitors paid for theirs (Glaxo Canada paid between $1,512 and $1,652 per kilo, while two generic brand competitors paid non arms' length suppliers between $194 and $304 per kilo).  
• Even at the inflated price, Glaxo Canada stood to earn a 40% profit margin on the sales of Zantac.
• The Minister deemed Glaxo Canada's purchase price to be greater than that which "would have been reasonable in the circumstances if ... [Adechsa] and ... [Glaxo Canada] had been dealing at arm's length," and therefore reallocated Glaxo Canada's profits under ITA s. 69(2) using $300 as the appropriate price for ranitidine.
• Glaxo Canada argued that any reasonable business person would enter into the supply agreement with Adechsa in order to obtain the benefit of the license agreement with the Glaxo Group.
• The trial judge assessed the license agreement and the supply agreement separately, and upheld the Minister's assessment but allowed an adjustment of $25 per kilogram to reflect the price of processing the ranitidine, therefore setting the arm's length price at $325 per kilo.
• The Federal Court of Appeal decided that the license and supply agreements should have been assessed together and determined that Glaxo Canada’s business circumstances were not comparable with the generic brand competitors because the question at issue was “whether that arm’s length purchaser would be able to sell his Ranitidine under the Zantac trademark." The FCA therefore found that the Tax Court erred in not considering the license agreement as a circumstance, and sent the matter back to trial court to decide whether the price was reasonable under the circumstances (following Gabco).
• On appeal, the SCC is to determine (1) whether the Federal Court of Appeal erred by applying the reasonable business person test to the interpretation of subsection 69(2) of the Income Tax Act; and (2) whether the Federal Court of Appeal erred in interpreting subsection 69(2) by failing to apply the arm’s-length principle on a transaction-by-transaction basis and on the basis that members of the multinational group are operating as separate entities.

My own view is the Gabco reasonable business person test was wrongly applied, and the license and supply agreement must be viewed separately under any coherent transfer pricing assessment, otherwise the taxpayer is free to create any pool of agreements they want to and tie them all together to justify any price--in other words, there would never be any comparables and you might as well not have a transfer pricing regime at all.      But the case deals with repealed s. 69(2) and not the current standard (ITA 247), so even if the SCC rules against the government here and delivers Glaxo a big win by letting it hide royalty payments in its supply agreement, there is likely still a chance that Canada could have a coherent arms' length rule under current law.

Keep in mind that Glaxo settled a similar transfer pricing dispute in the US for $3.4 billion back in 2006 pending a trial that was to begin in 2007; the bulk of the issues in that dispute involved Zantac, but the issue was the deductibility of royalties connected to marketing intangibles rather than the price paid for ranitidine.  The IRS said that GSK conceded over 60% of the total amount at issue in that case.