Judgment of GlaxoSmithKline Inc. v. Her Majesty the Queen
Court: Federal Court of Appeal ("FCA") of
Brief: This is a significant judgment which emphasises the comparability standards required for the application of the CUP method and signifies the relevance of 'business considerations' while determining the arm's length price. Whereas the original judgement indicated the Tax Court's unwillingness to look at the overall business relationship within the group, the FCA has taken a much broader view, recognising what a reasonable business person dealing at arm's length would consider (such as the use of intangibles). The FCA's reference to "business reality" is a breath of fresh air for taxpayers.
Citation: GlaxoSmithKline Inc. v. Her Majesty the Queen
Judgement:
Background
On 26 July, 2010, the Federal Court of Appeal ("FCA") of
Whereas the Tax Court had found that the price of the active ingredient could be established by prices in the generic market, ignoring the fact that the taxpayer's transaction took place in the branded pharmaceutical market; the FCA found that business realities such as the use of the brand name, and the higher prices that result, should be taken into account, and bring into question the comparability of those generic CUPs.
Although the FCA set aside the original decision, it did not make the ultimate determination of an appropriate arm's length price and returned the matter to the Tax Court Judge for reconsideration.
In Indian transfer pricing ("TP") audits, the Revenue authorities have been seeking to compare the import price of original researched (branded) active ingredients imported by Indian affiliates of global pharmaceutical companies, with the prices of generic versions available in the Indian market. Therefore, the above ruling is of immense relevance to the Indian pharmaceutical players.
Facts:- rom 1990 to 1993, GSK Canada had acquired the active ingredient for Zantac from a related company, Adechsa, under a "Supply Agreement" at prices ranging from $1,512 to $1,652 per kilogram. Under a second agreement ("License Agreement"), GSK Canada obtained the rights from the Glaxo Group to use the trademark "Zantac", amongst other benefits, for a royalty of 6%. The Tax Court Judge rejected the taxpayer's arguments that the agreements should be considered together in establishing whether the price paid for the active ingredient was "reasonable in the circumstances", (the arm's length standard at the time as required by section 69 of Canada's Income Tax Act). Instead, the Tax Court Judge restricted its analysis to the Supply Agreement only, which it deemed comparable to supply agreements between generic producers and distributors.
Ruling
The FCA took the opposite view, recognising that the Licence Agreement is relevant to determining the price that would have been reasonable in the circumstances.
Specifically, Glaxo Group's ownership of the Zantac trademark, the premium that Zantac commanded over generic ranitidine drugs in the market, the inability of the taxpayer to compete in the generic market without the Zantac trademark, and, the portfolio of other products to which the taxpayer had access under the Licence Agreement, were all relevant factors in the view of the FCA.
The FCA's reasons for Judgement specifically note:
"Clearly, in the circumstances in the case, the Judge's approach was mistaken. In a real business world, presumably an arm's length purchaser could always buy ranitidine at market prices from a willing seller. However the question is whether that arm's length purchaser would be able to sell his ranitidine under the Zantac trademark. In my view, as a result of the approach which he took, the Judge failed to consider the business reality which an arm's length purchaser was bound to consider if he intended to sell Zantac."
In addition: 'The Judge made his determination in a fictitious business world where a purchaser is able to purchase ranitidine at a price which does not take into account the circumstances which make it possible for that purchaser to obtain rights to make and sell Zantac."
The FCA's decision recognises that the high profitability associated with Zantac (which under the Tax Court decision remained with GSK Canada) did not belong to GSK Canada, but was a function of the market power that Glaxo Group contributed under the Licence Agreement. The FCA referenced the case of "Roche Product Pty. Limited and Commissioner of Taxation" [2008] AATA (July 22, 2008) as follows:
"The intellectual property came from very substantial expenditure on research and development much of which would have produced no results. The profits from the exploitation of the intellectual property rights was something to which (the parent company which invented the product] had a special claim even though the profit would be collected for Australian sales by the Australian subsidiary."
The FCA concluded that the Judge erred in law, failing to apply the proper test in determining the amount that would have been "reasonable in the circumstances". However, the FCA returned the matter to the Tax Court Judge for rehearing and reconsideration of what a reasonable amount would be, giving proper consideration to all the relevant facts.
This is a significant judgment which emphasises the comparability standards required for the application of the CUP method and signifies the relevance of 'business considerations' while determining the arm's length price. Whereas the original judgement indicated the Tax Court's unwillingness to look at the overall business relationship within the group, the FCA has taken a much broader view, recognising what a reasonable business person dealing at arm's length would consider (such as the use of intangibles). The FCA's reference to "business reality" is a breath of fresh air for taxpayers.
In the Indian context, the judgment of the FCA is broadly in line with the ruling of the Income-tax Appellate Tribunal ("Tribunal") in the case of UCB India Private Limited v. ACIT [2009-TIOL-184-ITAT-MUM] (Mumbai Tribunal) wherein the Tribunal had ruled on the issue of comparison of the price of branded active ingredients with that of generics. In its ruling, the Tribunal had emphasised that though CUP is a direct method, it cannot be applied in all situations. A scientific basis should be adopted to compare the active ingredients in terms of their purity, potency and characteristics. Though the Indian law relating to drugs and cosmetics prescribes minimum standards of quality, efficacy and safety of pharmaceutical products, active ingredients produced and supplied by the originator cannot always be compared with those supplied by duplicator.
The FCA's ruling once again reminds taxpayers to undertake an in-depth FAR analysis, in particular, an evaluation of critical economic / commercial considerations, while conducting the TP analysis so as to ensure smoother audits and greater acceptability of the TP documentation by the Revenue authorities.
