SUPREME COURT OF CANADA

CITATION: Canada v. GlaxoSmithKline Inc., 2012 SCC 52, [2012] 3 DATE: 20121018
S.C.R. 3 DOCKET: 33874

BETWEEN:
Her Majesty The Queen
Appellant/Respondent on cross-appeal
and
GlaxoSmithKline Inc.
Respondent/Appellant on cross-appeal

CORAM: McLachlin C.J. and Deschamps, Abella, Rothstein, Cromwell, Moldaver

and Karakatsanis JJ.

REASONS FOR JUDGMENT: Rothstein J. (McLachlin C.J. and Deschamps, Abella,

(paras. 1 to 77) Cromwell, Moldaver and Karakatsanis JJ. concurring)
 -2-

Canada v. GlaxoSmithKline Inc., 2012 SCC 52, [2012] 3 S.C.R. 3

Her Majesty The Queen Appellant/Respondent on cross-appeal

v.

GlaxoSmithKline Inc. Respondent/Appellant on cross-appeal

Indexed as: Canada v. GlaxoSmithKline Inc.

2012 SCC 52

File No.: 33874.

2012: January 13; 2012: October 18.

Present: McLachlin C.J. and Deschamps, Abella, Rothstein, Cromwell, Moldaver and
Karakatsanis JJ.

ON APPEAL FROM THE FEDERAL COURT OF APPEAL

Taxation Income Tax Transfer Pricing Taxpayer manufacturing

and marketing patented and trademarked drug pursuant to Licence Agreement

 -3-

Taxpayer purchasing active pharmaceutical ingredient pursuant to separate Supply

Agreement with related non-resident company Minister of National Revenue

reassessing taxpayer by increasing its income on basis that taxpayer had overpaid

non-arms length supplier for purchase of drug ingredient Minister not

considering effect of Licence Agreement on reasonableness of price paid for

ingredient under Supply Agreement What circumstances are to be taken into

account in determining reasonable arms length price against which to compare non-

arms length transfer price? Whether Licence Agreement is a circumstance to be

taken into account Whether Federal Court of Appeal erred in remitting matter to

Tax Court for rehearing and reconsideration Income Tax Act, R.S.C. 1985, c. 1

(5th Supp.), s. 69(2).

Between 1990 and 1993, the respondent, GlaxoSmithKline Inc. (Glaxo

Canada), purchased ranitidine, the active pharmaceutical ingredient in the brand

name anti-ulcer drug Zantac, from Adechsa S.A., a related non-resident company, for

between $1,512 and $1,651 per kilogram. During the same period, two Canadian

generic pharmaceutical companies, Apotex Inc. and Novopharm Ltd., purchased

ranitidine from other sources for use in their generic anti-ulcer drugs for between

$194 and $304 per kilogram from arms length suppliers.

A Licence Agreement conferred rights and benefits on Glaxo Canada and

a Supply Agreement set the transfer prices of ranitidine. The combined effect of the

Licence and Supply agreements enabled Glaxo Canada, among other things, to
 -4-

purchase ranitidine, put it in a delivery mechanism, and market it under the trademark

Zantac.

The appellant, the Minister of National Revenue, reassessed Glaxo

Canada for the taxation years 1990, 1991, 1992, and 1993, pursuant to the then

applicable s. 69(2) of the Act (now s. 247(2)) on the basis that the prices it paid for

ranitidine were greater than an amount that would have been reasonable in the

circumstances had they been dealing at arms length. Glaxo Canada appealed to the

Tax Court of Canada, where, with one minor revision, the reassessment was upheld

on the basis that the Licence and Supply agreements were to be considered

independently. The Federal Court of Appeal allowed the appeal and remitted the

matter back to the Tax Court for redetermination of the reasonable amount payable

for Glaxo Canadas ranitidine transactions.

Held: The appeal and cross-appeal should be dismissed.

Section 69(2) requires the court to determine whether the transfer price

was greater than the amount that would have been reasonable in the circumstances,

had the parties been dealing at arms length. If transactions other than the purchasing

transaction are relevant in determining this question, they must not be ignored.

Section 69(2) does not, itself, offer guidance as to how to determine the reasonable

amount that would have been payable had the parties been dealing at arms length.

The OECDs 1979 Guidelines and the OECDs 1995 Guidelines are not controlling as

if they were a Canadian statute. However, they suggest a number of methods for
 -5-

determining whether transfer prices are consistent with prices determined between

parties dealing at arms length.

A proper application of the arms length principle requires that regard be

had for the economically relevant characteristics of the arms length and non-arms

length circumstances to ensure they are sufficiently comparable. Where there are

no related transactions or where related transactions are not relevant to the

determination of the reasonableness of the price in issue, a transaction-by-transaction

approach may be appropriate. However, economically relevant characteristics of the

situations being compared may make it necessary to consider other transactions that

impact the transfer price under consideration. In each case, it is necessary to address

this question by considering the relevant circumstances and, if required, transactions

other than the purchasing transactions must be taken into account.

Such circumstances will include agreements that may confer rights and

benefits in addition to the purchase of property where those agreements are linked to

the purchasing agreement. The objective is to determine what an arms length

purchaser would pay for the property and the rights and benefits together where the

rights and benefits are linked to the price paid for the property. However, transfer

pricing is not an exact science and it is highly unlikely that any comparisons will

yield identical circumstances and the court will be required to exercise its best

informed judgment in establishing a satisfactory arms length price.

 -6-

In this case, Glaxo Canada was paying for at least some of the rights and

benefits under the Licence Agreement as part of the purchase prices for ranitidine

from Adechsa. As such, the Licence Agreement could not be ignored in determining

the reasonable amount paid to Adechsa under s. 69(2), which applies not only to

payment for goods but also to payment for services. Considering the Licence and

Supply Agreements together offers a realistic picture of the profits of Glaxo Canada.

The prices paid by Glaxo Canada to Adechsa were a payment for a bundle of at least

some rights and benefits under the Licence Agreement and product under the Supply

Agreement. The generic comparators used by the Tax Court 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 arms length. It is only after identifying the

circumstances arising from the Licence Agreement that are linked to the Supply

Agreement that arms length comparisons under any of the OECD methods or other

methods may be determined.

The assumption that the prices paid by Glaxo Canada for ranitidine were

greater than the amount that would have been reasonable in the circumstances had

Glaxo Canada and Adechsa been dealing at arms length has not been demolished.

As found by the Federal Court of Appeal, the matter should be remitted to the Tax

Court to be redetermined, having regard to the effect of the Licence Agreement on the

prices paid by Glaxo Canada for the supply of ranitidine from Adechsa. Whether or
 -7-

not compensation for intellectual property rights is justified in this particular case is a

matter for determination by the Tax Court.

Cases Cited

Distinguished: Singleton v. Canada, 2001 SCC 61, [2001] 2 S.C.R.

1046; Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622; referred to: Gabco Ltd. v.

Minister of National Revenue (1968), 68 D.T.C. 5210; Hickman Motors Ltd. v.

Canada, [1997] 2 S.C.R. 336.

Statutes and Regulations Cited

Act to amend the Income Tax Act and to make certain provisions and alterations in
the statute law related to or consequential upon the amendments to that Act,
S.C. 1970-71-72, c. 63, s. 1.

Act to amend the Income War Tax Act, S.C. 1939, c. 46, s. 13.

Income Tax Act, R.S.C. 1952, c. 148, ss. 17(3) [rep. 1970-71-72, c. 63, s. 1], 69(2)
[ad. idem].

Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), ss. 20(1)(c)(i), 69(2) [rep. 1998, c. 19,
s. 107], 212(1)(d), 215(1), 247(2) [ad. idem, s. 238].

Income Tax Act, S.C. 1948, c. 52, s. 17(3).

Income Tax Amendments Act, 1997, S.C. 1998, c. 19, ss. 107, 238.

Income War Tax Act, R.S.C. 1927, c. 97, s. 23B [ad. 1939, c. 46, s. 13].

Patent Act Amendment Act, 1992, S.C. 1993, c. 2, s. 11(1).

 -8-

Authors Cited

Organisation for Economic Co-operation and Development. Transfer Pricing and

Multinational Enterprises: Report of the OECD Committee on Fiscal Affairs.
Paris: The Organisation, 1979.

Organisation for Economic Co-operation and Development. Transfer Pricing

Guidelines for Multinational Enterprises and Tax Administrations. Paris: The
Organisation, 1995.

APPEAL and CROSS-APPEAL from a judgment of the Federal Court of

Appeal (Nadon, Layden-Stevenson and Stratas JJ.A.), 2010 FCA 201, 405 N.R. 307,

2010 D.T.C. 5124, [2010] 6 C.T.C. 220, [2010] F.C.J. No. 953 (QL), 2010

CarswellNat 2409, setting aside a decision of Rip A.C.J., 2008 TCC 324, 2008 D.T.C.

3957, [2008] T.C.J. No. 249 (QL), 2008 CarswellNat 1666. Appeal and cross-appeal

dismissed.

Wendy Burnham, Eric Noble and Karen Janke-Curliss, for the

appellant/respondent on cross-appeal.

Al Meghji, Joseph M. Steiner, Amanda Heale and Pooja Samtani, for the

respondent/appellant on cross-appeal.

The judgment of the Court was delivered by

ROTHSTEIN J.
 -9-

I. Introduction

[1] Transfer pricing issues arise when entities of multinational corporations

resident in different jurisdictions transfer property or provide services to one another.

These entities do not deal at arms length and, thus, transactions between these

entities may not be subject to ordinary market forces. Their absence may result in

prices being set so as to divert profits from the appropriate tax jurisdiction. Since

1939, the Income Tax Act has included provisions under which a Canadian taxpayer

may be reassessed to include, in Canadian profits, the difference between the prices

for property paid to a non-resident with which it does not deal at arms length and

what those prices would have been had they been dealing at arms length.

[2] The Minister of National Revenue reassessed GlaxoSmithKline Inc.

(Glaxo Canada) for the taxation years 1990, 1991, 1992, and 1993, pursuant to the

then-applicable s. 69(2) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the

Act), on the basis that the prices Glaxo Canada paid to a supplier with which it did

not deal at arms length, for ranitidine, the active ingredient in the anti-ulcer drug

Zantac, were greater than an amount that would have been reasonable in the

circumstances had they been dealing at arms length. (Section 69(2) of the Act was

repealed in 1998 (S.C. 1998, c. 19, s. 107) and has been replaced by s. 247(2) of the

Act (ad. idem, s. 238)). The reassessment increased Glaxo Canadas income by the

difference between the highest price paid by generic pharmaceutical companies and

that paid by Glaxo Canada for ranitidine. Glaxo Canada appealed to the Tax Court of
 - 10 -

Canada, where Rip A.C.J. (as he then was) upheld, with one minor revision, the

reassessment. On Glaxo Canadas further appeal, the Federal Court of Appeal

allowed the appeal and remitted the matter to the Tax Court for reconsideration. The

Minister has appealed that decision to this Court.

[3] The issue on appeal is the correct application of s. 69(2): in particular,

what circumstances are to be taken into account in determining the reasonable arms

length price against which to compare the non-arms length transfer price. Glaxo

Canada cross-appeals the decision of the Federal Court of Appeal to remit the matter

to the Tax Court for rehearing and reconsideration. If this Court denies the Ministers

appeal, Glaxo Canada argues that the matter should not be remitted because it has

successfully demolished the Ministers assumptions, thus fully discharging the

taxpayers burden in appealing the reassessment. For the reasons that follow, I would

dismiss both the appeal and the cross-appeal.

II. Facts

[4] Between 1990 and 1993, the respondent, Glaxo Canada, purchased

ranitidine, the active pharmaceutical ingredient in the brand-name anti-ulcer drug

Zantac, from Adechsa S.A., a related non-resident company, for between $1,512 and

$1,651 per kilogram. During the same period, two Canadian generic pharmaceutical

companies, Apotex Inc. and Novopharm Ltd., purchased ranitidine from other sources

for use in their generic anti-ulcer drugs for between $194 and $304 per kilogram.
 - 11 -

[5] At the relevant time Glaxo Canada was a wholly owned subsidiary of

Glaxo Group Ltd., which itself was a wholly owned subsidiary of Glaxo Holdings

plc, a United Kingdom corporation. In addition to its ownership of Glaxo Canada,

Glaxo Group was the parent of other companies, which discovered, developed,

manufactured and marketed branded pharmaceutical products. These products were

then placed in a delivery mechanism such as a tablet, liquid or gel and marketed and

sold throughout the world through subsidiaries such as Glaxo Canada or independent

arms length distributors.

[6] During the taxation years in issue, Glaxo Canada acted as a secondary

manufacturer and marketer which meant that it acquired the active pharmaceutical

ingredient, ranitidine, and put it into a delivery mechanism and packaged and

marketed Zantac, a patented and trademarked drug used to treat stomach ulcers.

Glaxo Group owned the Zantac trademark and the patent for its active ingredient,

ranitidine, and granted rights under the patent and trademark to Glaxo Canada under a

Licence Agreement. Glaxo Canada purchased ranitidine from Adechsa, a Glaxo

Group clearing company located in Switzerland, under a Supply Agreement.

[7] At the heart of this appeal are these two agreements. The Licence

Agreement conferred the following rights and benefits on Glaxo Canada:

1. the right under the patents to manufacture, use and sell Glaxo Group

products (s. 3(1)(a));

 - 12 -

2. the exclusive right to the use of the trademarks owned by Glaxo Group,

including Zantac (s. 3(1)(b));

3. the right to receive technical assistance for its secondary manufacturing

requirements (s. 3(4));

4. the use of the registration materials prepared by Glaxo Group, to be

adapted to the Canadian environment and submitted to the Health

Protection Branch (s. 4(2));

5. access to new products, including line extensions (s. 4(1));

6. access to any inventions or improvement in regard to existing drugs (s.

6(1));

7. the right to have a Glaxo World Group company sell to the appellant any

raw materials or materials in bulk form (s. 7(1));

8. marketing support in the form of promotional material, medical papers

and literature, market research data, and any other information that may

be useful in the marketing of products (s. 10(1));

9. indemnification against damages arising from patent or trademark

infringement actions (s. 13(2));

 - 13 -

10. technical assistance for setting up new product lines at Glaxo Canadas

manufacturing facilities (s. 4(3));

11. if the original trademark for a new product cannot be registered or if

additional trademarks are necessary, Glaxo Group to take the necessary

steps (s. 4(4));

12. Glaxo Canada to have an opportunity to sub-license any new third party

product obtained by Glaxo Group (s. 5(1));

13. in regard to third party products, Glaxo Group to provide any information

pertinent to the approval of the product by the Canada Health Protection

Branch (s. 5(2));

14. Glaxo Group to arrange that technical information in regard to third party

products will be granted to Glaxo Canada (s. 5(4)).

[8] Under the Supply Agreement, Glaxo Group set the transfer prices of the

active ingredient, ranitidine, using the resale-price method as described by Rip A.C.J.:

Glaxo World used what is referred to as a resale-price method to

determine the transfer price of the API [active pharmaceutical ingredient].
Glaxo World and its distributors agreed that a gross margin of 60 percent
would be retained by the distributors and the ranitidine was priced
accordingly. To use a very simple example, if the ranitidine product was
sold for $10 in Italy, the transfer price would be $4; if the ranitidine
 - 14 -

product was sold for $20 in France, the transfer price would be $8.
Appellants counsel described the process as follows:

the starting point for determining the price to the distributor was the
in-market price for the finished ranitidine product;

from that in-market price the parties agreed, assuming specified

conditions were satisfied, a gross profit margin [to] be retained by
the distributor (approximately 60%); and

the remainder would be remitted back to Glaxo Group in the form of

transfer price, royalties, [or both]. Where the distributor was to pay
both transfer prices and royalties, they would be considered together
to determine the distributors gross profit margin after payment of
the royalty. [para. 47]

(2008 TCC 325, 2008 D.T.C. 3957)

This method resulted in prices of over $1,500 per kilogram for ranitidine paid by

Glaxo Canada to Adechsa. The combined effect of the Licence and Supply

agreements enabled Glaxo Canada, among other things, to purchase the active

ingredient ranitidine, put it in a delivery mechanism, and market it under the

trademark Zantac.

[9] During the taxation years in issue, two Canadian generic pharmaceutical

companies, Apotex and Novopharm, sold generic anti-ulcer pharmaceutical products

in Canada. These companies purchased ranitidine at lower prices than Glaxo Canada,

between $194 and $304 per kilogram, from arms length suppliers. There was no

evidence that the supply contracts of Apotex or Novopharm conferred anything

beyond the supply of ranitidine.

 - 15 -

[10] These generic companies were able to market generic versions of drugs

whose patent was still in effect by reason of the compulsory licensing scheme that

existed for pharmaceutical products in Canada up to February 1993 (Patent Act

Amendment Act, 1992, S.C. 1993, c. 2). This scheme allowed generic versions of

patented pharmaceutical products to be marketed and sold in Canada in exchange for

a royalty payment to the patent owner. The licences granted to Apotex and

Novopharm predated December 20, 1991, and therefore continued to subsist,

notwithstanding repeal of the compulsory licensing scheme in February 1993 (ad.

idem, s. 11(1)).

[11] The Minister reassessed Glaxo Canada for its 1990, 1991, 1992, and 1993

taxation years, increasing its income by some $51 million under s. 69(2) of the Act on

the basis that it had paid Adechsa more than a reasonable amount for the purchase of

ranitidine.

III. Tax Court of Canada, 2008 TCC 324, 2008 D.T.C. 3957 (Rip A.C.J.)

[12] Rip A.C.J. affirmed the Ministers reassessment. He found that Singleton

v. Canada, 2001 SCC 61, [2001] 2 S.C.R. 1046, required the Licence and Supply

agreements to be considered independently. As a result, he did not consider whether

the rights and benefits under the Licence Agreement were a relevant circumstance in

determining the appropriate arms length price for the supply of ranitidine.
 - 16 -

[13] Rip A.C.J. employed the comparable uncontrolled price (CUP) method,

referred to in the Organisation for Economic Co-operation and Development

(OECD) Transfer Pricing and Multinational Enterprises: Report of the OECD

Committee on Fiscal Affairs (1979) (the 1979 Guidelines) and the OECDs revised

1995 Transfer Pricing Guidelines for Multinational Enterprises and Tax

Administrations (1995) (the 1995 Guidelines), to test the reasonableness of Glaxo

Canadas ranitidine transactions. He found that the appropriate comparator

transaction was the highest price paid by the generic pharmaceutical companies for

ranitidine from arms length suppliers. Under this approach, he found the prices

Glaxo Canada paid to Adechsa for ranitidine were greater than the reasonable amount

had they been dealing at arms length. Aside from allowing a $25 per kilogram

increment for granulation, he upheld the reassessment of the Minister.

IV. Federal Court of Appeal, 2010 FCA 201, 405 N.R. 307 (Nadon, Layden-
Stevenson and Stratas JJ.A.)

[14] Nadon J.A., writing for a unanimous panel, found that the Tax Court had

erred in not considering the Licence Agreement when determining whether the prices

paid by Glaxo Canada for ranitidine were reasonable under s. 69(2). He said that

Singleton was not relevant and that the test of reasonable in the circumstances

included all circumstances that an arms length purchaser would have to consider.

Based on Gabco Ltd. v. Minister of National Revenue (1968), 68 D.T.C. 5210 (Ex.

Ct.), Nadon J.A. adopted the reasonable business person test, which required an

inquiry into the circumstances that an arms length purchaser would consider relevant
 - 17 -

when deciding what price to pay (para. 69). He found that Rip A.C.J. had erred when

he assessed the fair market value of ranitidine based on the amounts paid by the

generic pharmaceutical companies to arms length suppliers.

[15] Having determined that Singleton did not preclude looking at both the

Supply and Licence agreements and applying the reasonable business person test,

Justice Nadon found that the Licence Agreement was central to Glaxo Canadas

business reality, and that it would be so even if the relationship with Adechsa was at

arms length. Therefore, it was a circumstance that had to be taken into account

when determining whether the prices paid by Glaxo Canada for ranitidine were

reasonable. In his view, the Tax Court erred in using the purchase prices of ranitidine

of the generic pharmaceutical companies to determine whether the Glaxo Canada

prices were reasonable, as the Licence Agreement created fundamentally different

circumstances for Glaxo Canadas transactions.

[16] However, Nadon J.A. found that the burden on the taxpayer had not been

fully discharged as the reasonable amount remained to be determined for Glaxo

Canadas ranitidine transactions. He remitted the matter to the Tax Court for

redetermination.

V. Analysis

A. Transfer Pricing in the Income Tax Act

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[17] The first transfer pricing provision in the Canadian Income Tax Act was

enacted as s. 23B of the Income War Tax Act, R.S.C. 1927, c. 97, by An Act to amend

the Income War Tax Act, S.C. 1939, c. 46, s. 13. The provision was re-enacted as s.

17(3) of The Income Tax Act, S.C. 1948, c. 52, and again as s. 17(3) of the Income

Tax Act, R.S.C. 1952, c. 148. Section 17(3) of the 1952 Act is almost identical to s.

69(2) first enacted in 1971 (S.C. 1970-71-72, c. 63, s. 1), with immaterial

modifications in 1985 (R.S.C. 1985, c. 1 (5th Supp.)).

[18] The 1985 version of s. 69(2) applicable to the years 1990-1993 reads:

(2) Where a taxpayer has paid or agreed to pay to a non-resident

person with whom the taxpayer was not dealing at arms length as price,
rental, royalty or other payment for or for the use or reproduction of any
property, or as consideration for the carriage of goods or passengers or
for other services, an amount greater than the amount (in this subsection
referred to as the reasonable amount) that would have been reasonable
in the circumstances if the non-resident person and the taxpayer had been
dealing at arms length, the reasonable amount shall, for the purpose of
computing the taxpayers income under this Part, be deemed to have been
the amount that was paid or is payable therefor.

[19] On the facts of this case, the section asks whether the prices Glaxo

Canada paid Adechsa for ranitidine were greater than what would have been

reasonable if Adechsa and Glaxo Canada had been dealing at arms length. The

challenge is to find an arms length proxy that replicates the circumstances of Glaxo

Canada as closely as possible in respect of its acquisition of ranitidine.

B. The OECD Methods of Determining Reasonable Transfer Prices

 - 19 -

[20] In the courts below and in this Court, there has been reference to the 1979

Guidelines and the 1995 Guidelines (the Guidelines). The Guidelines contain

commentary and methodology pertaining to the issue of transfer pricing. However,

the Guidelines are not controlling as if they were a Canadian statute and the test of

any set of transactions or prices ultimately must be determined according to s. 69(2)

rather than any particular methodology or commentary set out in the Guidelines.

[21] Section 69(2) does not, itself, offer guidance as to how to determine the

reasonable amount that would have been payable had the parties been dealing at

arms length. However, the Guidelines suggest a number of methods for determining

whether transfer prices are consistent with prices determined between parties dealing

at arms length.

[22] In the Tax Court, the parties relied on four methods from the Guidelines

to assess the reasonableness of the prices Glaxo Canada paid Adechsa. The Minister

relied on the CUP method and the cost plus method (see 1979 Guidelines, at paras. 48

and 63). The CUP method compares the prices in comparable transactions between

parties dealing at arms length with the transfer prices paid by the taxpayer being

reassessed. The Guidelines say this is the most direct way of determining the arms

length price. This is the method under which the Minister compared the Glaxo

Canada transfer prices with the prices paid by Apotex and Novopharm.
 - 20 -

[23] However, the 1995 Guidelines also say that the arms length transactions

must be carefully considered for comparability with the transfer price transactions.

Transactions are only comparable if:

1. None of the differences (if any) between the transactions being compared or

between the enterprises undertaking those transactions could materially affect

the price in the open market; or

2. Reasonably accurate adjustments can be made to eliminate the material effects

of such differences. (See 1995 Guidelines, at para. 1.15.)

[24] The cost plus method is based upon the foreign suppliers costs, plus an

appropriate mark-up. However, the 1979 Guidelines say that the method raise[d]

problems both as regards assessing costs . . . and the appropriate mark-up for profit

(para. 63). They suggest its usefulness may be as a means of verifying prices after

other methods have been applied. The Minister used the cost plus method to verify

the arms length prices he determined under the CUP method.

[25] Glaxo Canada relied on the resale price, the transactional net margin and

the CUP methods, using a set of European comparators. As described above, the

resale-price method starts with the price charged by the reseller (Glaxo Canada) in the

market for the product (Zantac). The price is then reduced by the proportion

representing the resellers cost and appropriate profit, i.e. the resellers gross profit

margin. The balance is the transfer price for the product purchased from the related
 - 21 -

non-resident supplier (Adechsa). This gross profit margin is then compared to the

gross profit margin earned by independent arms length resellers. The 1979

Guidelines observe that this method is the most useful when applied to marketing

operations. Glaxo Canada compared its gross profit margin with those of independent

European distributors of Zantac.

[26] The transactional net margin method looks at the net profit relative to a

base such as costs, sales or assets in a controlled transaction as compared to the net

profit ratio earned by the same taxpayer in comparable uncontrolled transactions. If

this is not possible, consideration may be given to the net profit relative to costs, sales

or assets of an independent enterprise, provided the circumstances are comparable

and adjustments may be made to obtain reliable results.

[27] Glaxo Canadas CUP approach utilized the prices paid by European

independent distributors of Zantac which Glaxo Canada submitted approximated the

prices paid by Glaxo Canada to Adechsa.

C. The Transactional Approach Adopted by the Tax Court

[28] Rip A.C.J. rejected Glaxo Canadas evidence and submissions. Utilizing

the CUP method, Rip A.C.J. compared the prices paid by Glaxo Canada with those

paid by the Canadian generic companies for ranitidine and found that the highest

generic prices paid were in the range of $300 per kilogram, while Glaxo Canada was

paying over $1,500 per kilogram.

 - 22 -

[29] Glaxo Canada had argued that the comparison with generic companies

was inappropriate. It said that the Licence Agreement must be taken into account, as

it conferred certain rights and benefits related to the purpose for which its ranitidine

was purchased.

[30] However, Rip A.C.J. found that Singleton precluded him from

considering the Licence Agreement. Absent the Licence Agreement, the prices paid

under the Supply Agreement had to be considered as being only for ranitidine. There

could thus be no compensation for other rights or benefits under the Supply

Agreement. Because the prices paid by Glaxo Canada and the generic companies

were both solely for ranitidine, there were no differences between the transactions

that might justify higher transfer prices than the prices paid by Apotex and

Novopharm (aside from a $25 per kilogram charge for granulation that Glaxo Canada

was allowed).

[31] The question before Rip A.C.J. was the determination of the reasonable

price under s. 69(2). Critical to that determination was whether the Licence

Agreement was a circumstance to be taken into account.

[32] The Minister argues that this Courts decisions in Singleton and Shell

Canada Ltd. v. Canada, [1999] 3 S.C.R. 622, along with the Guidelines, require a

transactional, sometimes called a transaction-by-transaction, approach when

determining the reasonable transfer price under s. 69(2). In the Tax Court, the

Minister explained that the transaction-by-transaction approach is one in which the

 - 23 -

transaction in issue must be considered independently from surrounding

circumstances, other transactions, or other realities. In this Court, the Minister

submitted that each transfer is to be treated as a separate transaction (A.F.,

at para. 46). Accordingly, the Licence Agreement would be irrelevant.

(1) Singleton

[33] The Minister submits that Singleton and Shell, decided under s. 20(1)(c)

(i) of the Act, are authority for the proposition that a transaction-by-transaction

approach must be followed under s. 69(2). Singleton involved the deductibility from

income of interest paid and payable on borrowed money under s. 20(1)(c)(i), of the

Income Tax Act. In Singleton, the taxpayer used funds from his capital account at his

law firm to assist in financing the purchase of a home. He then used borrowed funds

to replace the funds he was withdrawing from his capital account. The sole issue was

whether borrowed money was used for the purpose of earning income. This Court

found that the borrowed funds were used to invest in the law firm for the purpose of

earning income and, therefore, the interest payable thereon was deductible for income

tax purposes. The fact that the borrowing occurred because the taxpayer wanted to

use his equity in the firm to buy a house was irrelevant for determining the use of the

borrowed funds. For purposes of s. 20(1)(c)(i), it would be wrong to collapse the

transaction withdrawing funds from the firm to purchase the house and the borrowing

transaction to replenish the capital account at the firm. It was the requirement to treat
 - 24 -

the two transactions separately that caused Rip A.C.J., at para. 78, to say that s. 69(2)

required the Supply and Licence agreements to be treated separately.

[34] With respect, the approach of the Tax Court judge and the argument of

the Minister ignore the difference between s. 20(1)(c)(i) and s. 69(2). Nothing in s.

20(1)(c)(i) entitles a court to search for anything other than the use to which the

borrowed funds are put. The factual determination is simply whether the use of

borrowed funds was for the purpose of earning income.

[35] Section 20(1)(c)(i) does not ask whether it is unreasonable to claim the

interest deduction; nor does it require a comparison of transactions to determine if the

deduction is reasonable. By contrast, s. 69(2) requires the court to determine whether

the transfer price was greater than the amount that would have been reasonable in the

circumstances, had the parties been dealing at arms length. If transactions other than

the purchasing transaction are relevant in determining this question, they must not be

ignored.

(2) Shell

[36] The issue in Shell similarly involved s. 20(1)(c)(i). Again the issue

involved whether borrowed funds were used for the purpose of earning income. In

Shell, the taxpayer had entered into an agreement to borrow $150 million in New

Zealand currency at an interest rate of 15.4 percent. The taxpayer converted these

funds into U.S. currency, which was then used for business purposes. Through a
 - 25 -

series of foreign currency transactions relating to the devaluation of the New Zealand

currency over the course of the loan, Shell was able to reduce its effective rate of

interest to 9.1 percent, while still claiming an income tax deduction based on the 15.4

percent interest rate on the initial transaction.

[37] The issue in Shell, as in Singleton, turned on whether the borrowed funds,

once converted into U.S. currency, could properly be considered to be used for the

purpose of earning income. The Court found that it was irrelevant that the funds had

been converted into U.S. currency as part of a sophisticated tax scheme. The Minister

was not entitled to re-characterize the taxpayers bona fide legal relationships.

[38] This differs significantly from s. 69(2). The requirement of s. 69(2) is

that the price established in a non-arms length transfer pricing transaction is to be

redetermined as if it were between parties dealing at arms length. If the

circumstances require, transactions other than the purchasing transactions must be

taken into account to determine whether the actual price was or was not greater than

the amount that would have been reasonable had the parties been dealing at arms

length. Shell is therefore also inapplicable to a determination under s. 69(2).

(3) Guidelines Do Not Require a Transaction-by-Transaction

Approach

[39] The Minister also relied on para. 1.42 of the 1995 Guidelines to justify

the transaction-by-transaction requirement. Paragraph 1.42 provides:

 - 26 -

Ideally, in order to arrive at the most precise approximation of fair

market value, the arms length principle should be applied on a
transaction-by-transaction basis.

The Minister submits that para. 1.42 requires the court to focus only on the particular

transaction at issue and, thus, does not permit the Licence Agreement to inform the

determination of the reasonableness of the prices paid for ranitidine under the Supply

Agreement.

[40] However, para. 1.42 is not as restrictive as the Minister submits. It also

provides:

. . . there are often situations where separate transactions are so closely

linked or continuous that they cannot be evaluated adequately on a
separate basis.

Thus, while a transaction-by-transaction approach may be ideal, the 1995 Guidelines

themselves recognize that it is not appropriate in all cases.

[41] Further, the general statement in the 1995 Guidelines regarding the arms

length principle at para. 1.15 also provides guidance as to when related transactions

should be taken into account:

Application of the arms length principle is generally based on a

comparison of the conditions in a controlled transaction with the
conditions in transactions between independent enterprises. In order for
such comparisons to be useful, the economically relevant characteristics
of the situations being compared must be sufficiently comparable. To be
comparable means that none of the differences (if any) between the
 - 27 -

situations being compared could materially affect the condition being

examined in the methodology (e.g. price or margin), or that reasonably
accurate adjustments can be made to eliminate the effect of any such
differences. [Emphasis added.]

[42] Thus, according to the 1995 Guidelines, a proper application of the arms

length principle requires that regard be had for the economically relevant

characteristics of the arms length and non-arms length circumstances to ensure they

are sufficiently comparable. Where there are no related transactions or where

related transactions are not relevant to the determination of the reasonableness of the

price in issue, a transaction-by-transaction approach may be appropriate. However,

economically relevant characteristics of the situations being compared may make it

necessary to consider other transactions that impact the transfer price under

consideration. In each case, it is necessary to address this question by considering the

relevant circumstances.

D. The Licence Agreement Is Relevant in the Circumstances

[43] For the above reasons, in my respectful opinion, Rip A.C.J. was in error

when he found that he was precluded from considering the Licence Agreement.

Nonetheless, while consideration of the Licence Agreement was not precluded, the

question still remains as to whether he should have considered it.

[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
 - 28 -

taxpayer been dealing at arms length, it necessarily involves consideration of all the

circumstances of the Canadian taxpayer relevant to the price paid to the non-resident

supplier. Such circumstances will include agreements that may confer rights and

benefits in addition to the purchase of property where those agreements are linked to

the purchasing agreement. The objective is to determine what an arms length

purchaser would pay for the property and the rights and benefits together where the

rights and benefits are linked to the price paid for the property.

[45] The business of Glaxo Canada was the secondary manufacturing and

marketing of brand-name pharmaceuticals, including Zantac. Glaxo Canada also

engaged in research and development although there is no indication that its research

and development work pertained to Zantac. Glaxo Canadas purchase of ranitidine

must be understood, having regard to this business reality.

[46] Rip A.C.J. found, at para. 86, that 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.

[47] There were only two approved sources, one of which was Adechsa. Thus,

in order to avail itself of the benefits of the Licence Agreement, Glaxo Canada was

required to purchase the active ingredient from one of these sources. This

requirement was not the product of the non-arms length relationship between Glaxo

Canada and Glaxo Group or Adechsa. Rather, it arose because Glaxo Group

controlled the trademark and patent of the brand-name pharmaceutical product Glaxo
 - 29 -

Canada wished to market. An arms length distributor wishing to market Zantac might

well be faced with the same requirement.

[48] The effect of the link between the Licence and Supply agreements was

that an entity that wished to market Zantac was subject to contractual terms affecting

the price of ranitidine that generic marketers of ranitidine products were not.

[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. The result of the price paid was to allocate to Glaxo

Canada what Glaxo Group considered to be appropriate compensation for its

secondary manufacturing and marketing function in respect of ranitidine and Zantac.

[50] Rip A.C.J. appears to have been concerned that a multinational

organization, by requiring a Canadian subsidiary to acquire a product from a specified

supplier, would escape the requirement to have its prices measured against arms

length prices (para. 89). However, whatever price was determined by Glaxo Group

would be subject to s. 69(2) and the requirement that the transfer pricing transactions

be measured against transactions between parties dealing with each other at arms

length.

[51] Thus, it appears that Glaxo Canada was paying for at least some of the

rights and benefits under the Licence Agreement as part of the purchase prices for

ranitidine from Adechsa. Because the prices paid to Adechsa were set, in part, as
 - 30 -

compensation to Glaxo Group for the rights and benefits conferred on Glaxo Canada

under the Licence Agreement, the Licence Agreement could not be ignored in

determining the reasonable amount paid to Adechsa under s. 69(2), which applies not

only to payment for goods but also to payment for services.

[52] Considering the Licence and Supply agreements together offers a realistic

picture of the profits of Glaxo Canada. It cannot be irrelevant that Glaxo Canadas

function was primarily as a secondary manufacturer and marketer. It did not originate

new products and the intellectual property rights associated with them. Nor did it

undertake the investment and risk involved with originating new products. Nor did it

have the other risks and investment costs which Glaxo Group undertook under the

Licence Agreement. The prices paid by Glaxo Canada to Adechsa were a payment

for a bundle of at least some rights and benefits under the Licence Agreement and

product under the Supply Agreement.

[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 arms length.

 - 31 -

[54] I agree with Justice Nadon that the amount that would have been

reasonable in the circumstances if Glaxo Canada and Adechsa had been dealing at

arms length has yet to be determined (para. 79). This will require a close

examination of the terms of the Licence Agreement and the rights and benefits

granted to Glaxo Canada under that Agreement.

[55] However, with respect to royalties, I would observe that the Licence

Agreement expressly provides under clause 11(1)(b):

(ii) in the event that GLAXO CANADA purchases raw materials or

bulk or finished Product from GROUP or an Associate it is the
parties express intention that no royalties be payable by GLAXO
CANADA on the importation of such raw materials or bulk or
finished Product but only on GLAXO CANADAs Net Sales of
Product in the Territory;

(iii) GLAXO CANADA shall not be required to pay any royalty or

license fee as a condition of the sale by GROUP or its Associates
to GLAXO CANADA of merchandise for export to the Territory
and such merchandise shall be priced in accordance with a separate
agreement between the parties without regard to royalties payable
hereunder [as contemplated in sub-clause 7(1) hereof]

(iv) no royalty shall be payable by GLAXO CANADA on its

manufacture or use of the Products but only on its sales of the
Products; [Text in brackets in original.]

[56] Glaxo Canadas pleadings in the Tax Court did not rely on s. 212(1)(d) or

s. 215(1) of the Act, which provide for tax payable by non-residents on royalties or

similar payments for the right to use any patent or trademark in Canada and for

withholding tax on behalf of the non-resident. There is no evidence that Glaxo

 - 32 -

Canada withheld any amounts of the prices it paid to Adechsa in respect of royalties

for the use or the right to use the ranitidine patent or Zantac trademark.

[57] Although I said above that the purchase price appeared to be linked to

some of the rights and benefits conferred under the Licence Agreement, I make no

determination in these reasons as to whether the rights under the ranitidine patent

granted to Glaxo Canada to manufacture and sell Zantac and the exclusive right to use

the Zantac trademark are linked to the purchase price paid by Glaxo Canada to

Adechsa. However, arguably, if the purchase price includes compensation for

intellectual property rights granted to Glaxo Canada, there would have to be

consistency between that and Glaxo Canadas position with respect to Part XIII

withholding tax. This issue was not specifically argued in this Court and may be

addressed by the parties in the Tax Court and considered by the Tax Court judge when

considering whether any specific rights and benefits conferred on Glaxo Canada

under the Licence Agreement are linked to the price for ranitidine paid to Adechsa.

[58] In any event, there are rights and benefits under the Licence Agreement

referred to in para. 7 above, other than the patent and trademark rights granted to

Glaxo Canada. For example, guaranteed access to new products, the right to the

supply of raw materials and materials in bulk, marketing support, and technical

assistance for setting up new product lines all appear to have some value.

[59] In addition, while, as Rip A.C.J. found, Glaxo Canadas ranitidine and

generic ranitidine are chemically equivalent and bio-equivalent, he also found that
 - 33 -

there was value in the fact that Adechsas ranitidine manufactured under Glaxo

Groups good manufacturing practices may confer a certain degree of comfort that

the good has minimal impurities and is manufactured in a responsible manner

(para. 118). Zantac is priced higher than the generic products, presumably, at least in

part, because of that degree of comfort that Rip A.C.J. acknowledged.

[60] These are all features of the Licence Agreement and the requirement to

purchase from a Glaxo-approved source that add value to the ranitidine that Glaxo

Canada purchased from Adechsa over and above the value of generic ranitidine

without these rights and benefits. They should justify some recognition in

determining what an arms length purchaser would be prepared to pay for the same

rights and benefits conveyed with ranitidine purchased from a Glaxo Group source. It

is only after identifying the circumstances arising from the Licence Agreement that

are linked to the Supply Agreement that arms length comparisons under any of the

OECD methods or other methods may be determined.

[61] I would offer the following additional guidance with respect to the

redetermination. First, s. 69(2) uses the term reasonable amount. This reflects the

fact that, to use the words of the 1995 Guidelines, transfer pricing is not an exact

science (para. 1.45). It is doubtful that comparators will be identical in all material

respects in almost any case. Therefore, some leeway must be allowed in the

determination of the reasonable amount. As long as a transfer price is within what the

court determines is a reasonable range, the requirements of the section should be

 - 34 -

satisfied. If it is not, the court might select a point within a range it considers

reasonable in the circumstances based on an average, median, mode, or other

appropriate statistical measure, having regard to the evidence that the court found to

be relevant. I repeat for emphasis that it is highly unlikely that any comparisons will

yield identical circumstances and the Tax Court judge will be required to exercise his

best informed judgment in establishing a satisfactory arms length price.

[62] Second, while assessment of the evidence is a matter for the trial judge, I

would observe that the respective roles and functions of Glaxo Canada and the Glaxo

Group should be kept in mind. Glaxo Canada engaged in the secondary

manufacturing and marketing of Zantac. Glaxo Group is the owner of the intellectual

property and provided other rights and benefits to Glaxo Canada. 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. As discussed above,

whether or not compensation for intellectual property rights is justified in this

particular case is a matter for determination by the Tax Court judge.

[63] Third, prices between parties dealing at arms length will be established

having regard to the independent interests of each party to the transaction. That

means that the interests of Glaxo Group and Glaxo Canada must both be considered.

An appropriate determination under the arms length test of s. 69(2) should reflect

these realities.
 - 35 -

[64] Fourth, in this case, there is some evidence that indicates that arms

length distributors have found it in their interest to acquire ranitidine from a Glaxo

Group supplier, rather than from generic sources. This suggests that higher-than-

generic transfer prices are justified and are not necessarily greater than a reasonable

amount under s. 69(2).

[65] I would dismiss the appeal, and for the reasons below, dismiss the cross-

appeal and remit the matter to Rip A.C.J. (now Chief Justice) for redetermination.

VI. Cross-Appeal

[66] Glaxo Canada cross-appeals, arguing that the decision of the Federal

Court of Appeal to remit the matter to the Tax Court for redetermination should be

overturned. It asks this Court to set aside the reassessment on the basis that it has

satisfied its burden as a taxpayer because it has demolished the assumptions of the

Minister.

[67] The Federal Court of Appeal remitted the matter to the Tax Court on the

basis that Glaxo Canada had not discharged its burden of demonstrating that the

prices it paid Adechsa for ranitidine were reasonable under s. 69(2):

As a result, I conclude that the Judge erred in law in failing to apply

the proper test in determining the amount that would have been
reasonable in the circumstances if the appellant and Adechsa had been
dealing at arms length. Counsel for the appellant argued that in the event
that we agreed with him that the Judge erred in not considering the
 - 36 -

License Agreement, we should then determine the reasonable amount.

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. [para. 82]

The Federal Court of Appeal declined to make such a determination on the basis that

it could not properly assess the adequacy of the record on this point and remitted the

matter to the Tax Court judge to consider whether a decision can be made on the basis

of the existing record or whether additional evidence is necessary.

[68] Glaxo Canada argues that the choice of the generic comparator

transactions by the Minister constitutes the basis of the Ministers assessment.

Therefore, the burden on Glaxo Canada was only to demonstrate that the transactions

of the generic pharmaceutical companies were not the proper comparator. In Glaxo

Canadas view, such a finding would demolish the basis of the assessment, thus,

discharging its burden.

[69] The Minister argues that the basis of the assessment was the

determination that the prices Glaxo Canada paid for ranitidine were not reasonable.

The selection of the generic comparators was only a means which the Minister had

chosen to demonstrate the unreasonableness.

[70] The basis of the assessment is found in the assumptions in the Ministers

Amended Reply to Glaxo Canadas Amended Notice of Appeal. Assumptions 14p)

and r.A) provide:

 - 37 -

p) the Appellant paid Adechsa, with whom it was not dealing at arms
length, a price for ranitidine which was greater than the amount
that would have been reasonable in the circumstances if the
Appellant and Adechsa had been dealing at arms length;

r.A) any amounts paid by the appellant to Adechsa over and above the
prices paid by other Canadian pharmaceutical companies (as
detailed in Schedule A attached) were not for the supply of
ranitidine;

[71] Glaxo Canada argues, in effect, that only assumption 14r.A) constitutes

the basis of the assessment and that it has demolished that assumption. The Minister

argues that the basis of the assessment is assumption 14p). The text of the

assumptions supports the position of the Minister. Here assumption 14p) sets out the

statutory basis for the reassessment, placing the reassessment squarely under s. 69(2).

The taxpayers liability is governed by the Act and the Ministers authority to reassess

arises from invoking a particular provision or provisions of the Act.

[72] In Hickman Motors Ltd. v. Canada, [1997] 2 S.C.R. 336, Justice

LHeureux-Dub states that the taxpayers burden is to demolish the exact

assumptions made by the Minister but no more (para. 92 (emphasis deleted)). Here,

it is safe to say that assumption 14r.A) by the Minister of the prices paid by Apotex

and Novopharm as CUP transactions, without adjustments, was indeed demolished.

However, assumption 14p) was not.

[73] Indeed, at the Tax Court, Glaxo Canada sought to establish the

reasonableness of the prices it paid, though its evidence and argument were not

accepted by the Tax Court judge. In other words, it accepted the burden of
 - 38 -

demonstrating that the prices it paid were reasonable within the meaning of s. 69(2).

Had it been successful in establishing that the prices it paid were reasonable,

assumption 14p) as well as 14r.A), would have been demolished.

[74] As it stands, the assumption that the prices paid by Glaxo Canada for

ranitidine were greater than the amount that would have been reasonable in the

circumstances, had Glaxo Canada and Adechsa been dealing at arms length, has not

been demolished. Therefore, assumption 14p) remains standing.

[75] At the Federal Court of Appeal, Glaxo Canada argued that that court

could determine the reasonable amount. If the Federal Court of Appeal could

determine the reasonable amount, I cannot see why it could not remit the matter to the

Tax Court for that very determination.

[76] Like the Federal Court of Appeal, I would remit the matter to the Tax

Court to be redetermined, having regard to the effect of the Licence Agreement on the

prices paid by Glaxo Canada for the supply of ranitidine from Adechsa. The Tax

Court judge should consider any new evidence the parties seek to adduce and that he

may choose to allow.

VII. Conclusion
 - 39 -

[77] I would dismiss the appeal with costs throughout; dismiss the cross-

appeal with costs in this Court and remit the matter to the Tax Court for

redetermination.

Appeal and cross-appeal dismissed with costs.

Solicitor for the appellant/respondent on cross- appeal: Attorney

General of Canada, Ottawa.

Solicitors for the respondent/appellant on cross-appeal: Osler, Hoskin &

Harcourt, Toronto.