Question

In the last decade, there was a proliferation of multinational enterprises (MNEs) throughout the world. These MNEs restructured their business model by having branches, affiliates, and other related parties in several countries. This restructuring was primarily for the purposes of tax planning so that MNEs would reduce their global tax rate.

Please review the opening case and attempt the questions that follow.

Opening Case

GLAXOSMITHKLINE INC. V HER MAJESTY THE QUEEN: A BAD CASE OF HEARTBURN The Tax Court of Canada delivered a long-awaited decision on May 30, 2008, 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 Inc.’s (“GSK Canada”) 1990 to 1993 taxation years (or “years under audit”) by increasing its income in each taxation year on the basis that GSK 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 GSK Canada under the brand name Zantac. During the years under audit, GSK Canada purchased ranitidine from Adechsa S.A. (“Adechsa”), a related party based in Switzerland. The ranitidine purchased by GSK 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 GSK Canada earned gross profits of approximately 60% on the sale of Zantac.

GSK Canada had separate intercompany licence and supply agreements with respect to Zantac. Under the licence agreement, GSK Canada paid a 6% royalty to a related party in the United Kingdom for the rights to certain intangibles and services. The supply agreement between GSK Canada and Adechsa granted GSK Canada 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 GSK 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 GSK Canada should have paid Adechsa. The price per kilogram of ranitidine paid by GSK Canada to Adechsa ranged from CA$1,512 to CA$1,651 during the years under audit. The generic pharmaceutical producers 211 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 GSK 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.

Adapted from www.pwcglobal.com (19 June 2008)

1. Why is transfer pricing such a contentious issue?

2. Why do you think the judge favoured the “CUP” method?

3 What other method would have been appropriate?

Answer 1

The transfer price applicable when there is a transaction between 2 related parties one which is other than home country. The transaction should be done at arm length price. There is contention that the transaction has been done at arm length price but in reality it is not. The transaction is done with the motive to avoid tax.

The judge favour the CUP method because it is the most favorable method because the transaction can be easily compare with the unrelated party.

Cost plus method can be other alternative based on the situation.