The Tax Court of Canada delivered a long-awaited decision in Canada’s first major transfer pricing court case. The decision (which the taxpayer may appeal) illustrates the court's endorsement of the hierarchy of methods set out in the OECD guidelines, where transactional methods trump profit-based analysis. The Minister of National Revenue (MNR) reassessed GlaxoSmithKline’s (Glaxo Canada) 1990 to 1993 taxation years by increasing its income in each taxation year on the basis that Glaxo Canada overpaid its related party supplier for the purchase of ranitidine hydrochloride (Ranitidine).

Ranitidine is the active pharmaceutical ingredient in a drug that is used to relieve stomach ulcers and heartburn. The drug is sold by Glaxo Canada under the brand name Zantac. During the years under audit, it purchased Ranitidine from Adechsa, a related party based in Switzerland. The Ranitidine purchased by Glaxo Canada from Adechsa was manufactured by a related party manufacturer in Singapore. The GlaxoSmithKline Group’s (GSK Group) transfer pricing arrangements allowed the Singapore related party manufacturer to earn gross profits of approximately 90% on the sale of ranitidine to Adechsa. Adechsa was required to earn a minimum 4% profit (by agreement with the Swiss tax authorities), and Glaxo Canada earned gross profits of approximately 60% on the sale of Zantac.

Glaxo Canada had separate inter-company licence and supply agreements with respect to Zantac. Under the licence agreement, It paid a 6% royalty to a related party in the United Kingdom for the rights to certain intangibles and services. The supply agreement between Glaxo Canada and Adechsa granted the Canada business the right to purchase Ranitidine.

During the 1990 to 1993 taxation years, third party generic pharmaceutical producers sold generic versions of Zantac in Canada. The generic pharmaceutical producers purchased generic ranitidine from arm’s length manufacturers at lower prices than Glaxo Canada paid to Adechsa. The MNR’s position was that the price paid by the generic pharmaceutical producers for generic ranitidine represented a reasonable price that Glaxo Canada should have paid Adechsa. The price per kilogram of ranitidine paid by Glaxo Canada to Adechsa ranged from CA$1,512 to CA$1,651 during the years under audit. The generic pharmaceutical producers paid their suppliers a price per kilogram of Ranitidine that ranged between CA$194 to CA$304. On reassessment, the MNR disallowed the deduction of the amount of the purchase price paid to Adechsa that exceeded the highest price paid by the generic pharmaceutical producers.

The judge concluded that the comparable uncontrolled price (CUP) method is the preferred method and that the purchase price paid by the generic pharmaceutical producers is an appropriate CUP. Specifically, the judge indicated that the highest price paid by the generic pharmaceutical producers represents a reasonable price that Glaxo Canada could have paid Adechsa. The judge did allow an additional $25 per kilogram of Ranitidine in acknowledgement that the ranitidine purchased from the related party manufacturer in Singapore was granulated, whereas the ranitidine purchased by the generic pharmaceutical producers was not.

Evidence reviewed
The MNR’s Counsel offered the following evidence for consideration: