GlaxoSmithKline Inc. v. The Queen Decision Reversed on Appeal

In a major reversal, the Canadian Federal Court of Appeal (FCA) has ruled that GlaxoSmithKline Inc. did not violate the Canadian Income Tax Act with its early 1990s transfer pricing practices for ranitidine, the active ingredient in anti-ulcer drug Zantac. This outcome gives credence to a view held by many taxpayers and advisors that the arm’s length price of individual transactions should be established by considering all relevant intercompany transactions within the related group.

The decision also brings to the table the idea that, when determining comparability to measure an arm’s length transfer price, one can, and should take into account market and business conditions (such as the use of intangibles), in addition to any product differences. In this case, the generic market price taken at face value was not determined to be comparable to a reasonable price in the ‘branded’ market in which GSK was operating.

The background: On May 30, 2008, the Tax Court of Canada (TCC) ruled in favor of the Canada Revenue Agency (CRA) against GlaxoSmithKline (GSK) on a decades-old transfer pricing dispute. The ruling resulted in a $51 million adjustment for GSK, which was based on increasing income in the years in question by the difference that they paid for ranitidine per kilogram and the “reasonable” market price, as determined by the court, plus $25 dollars per kilogram.

In order to determine the “reasonable” market rate for ranitidine, the CRA applied the Comparable Uncontrolled Price (CUP) method and used prices paid for a generic version of the same drug as the comparable price. Pivotal in the final verdict was the contention that the only transaction under review should be the price set under GSK’s supply agreement with their related supplier, and that no other intercompany transaction should be considered in determining the price paid for ranitidine.

The ruling: In making the ruling, the judge disregarded the License Agreement between GSK and Glaxo Group, its British parent company. The latter agreement not only mandated that GSK must buy all raw materials from a related supplier, but also highlighted additional intangible value that GSK received through its agreement, which presumably offset the higher cost of the raw material ranitidine.

Some of the benefits included in the agreement were, but not limited to:

  • Having access to the Zantac brand name and marketing for the drug
  • Research and development
  • Access to new drugs

The appeal: GSK appealed this decision in the Canadian Federal Court of Appeal (FCA), and on July 26, 2010, the FCA found that the TCC judge erred in his interpretation of the former 69(2) (now section 247) of the Canadian Income Tax Act. It said that the comparability test should have considered “all relevant circumstances which an arm’s length purchaser would have had to consider.”

The FCA deemed that GSK’s License Agreement with its U.K. parent was relevant, and sent the issue back to the TCC to redetermine a “reasonable price” for ranitidine considering all of the business circumstances involved.