The Lexpert Guides to the Leading US/Canada Cross-Border Corporate and Litigation Lawyers in Canada profiles leading business lawyers and features articles for attorneys and in-house counsel in the US about business law issues in Canada.
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TRANSFER PRICING Adechsa charged Glaxo Canada between $1,512 and $1,651 per kilogram. During the same period, Apotex Inc. and Novopharm Ltd. paid their arm's-length suppliers between $194 and $304 a kilogram. The difference attracted Ottawa's attention. It assessed Glaxo Canada $51 million in unpaid taxes for the taxation years 1990–1993. The company beat back the assessment through the Federal Court of Appeal, and the government took its case to the Supreme Court. Glaxo argued the price made business sense, since it was dictated by a licensing agreement that gave its Canadian subsidiary access to all of its other drugs and the right to sell brand-name Zantac for a much higher price. The local subsidiary was still making, and declaring, a 60-percent profit margin, the company said. The Crown told the justices of Canada's top court that when the CRA is analyzing transfer pricing, auditors have to focus exclusively on the actual product being priced for sale between divisions. Al Meghji, a tax litigator at Osler, Hoskin & Harcourt LLP, who argued the Supreme Court case for Glaxo, reasoned that auditors actually have to look at much wider circumstances. He cites the example of a company that manufactures PepsiCola and sells it at Loblaws, a large Canadian supermarket chain, for $1.20 a can. For a company to manufacture and sell Pepsi in Canada, he says, it has to have the right to put the Pepsi label on a can, the trade-mark right, it has to buy the syrup from the US company Pepsi Cola and the patents for the technology used to make it. "Let's assume I'm buying my syrup for $10 a gallon and I start manufacturing Pepsi Cola," says Meghji. "Next to the can of Pepsi on the Loblaws shelf is a can of President's Choice cola [its generic house brand], which sells for 60¢. "A CRA auditor goes to the Loblaws, buys the can of President's Choice cola and finds out the person who's manufacturing it is paying only $3 a gallon for their syrup while I'm paying $10 a gallon. So they come to me and say I'm offside transfer-pricing rules, and they're going to adjust the transfer price of the syrup down to $3, which would result in more profit to tax in Canada." Meghji – who used this example in the Supreme Court – says that this type of analysis, which the CRA applied to Glaxo, is fundamentally commercially flawed. "If I can sell my can of Pepsi for $1.20 while the President's Choice people are only able to sell their can for 60 cents, I should be able to pay more for my syrup, I should be willing to pay more for my syrup. Why? Because the ultimate product I manufacture has a higher sale price. So a commercially normal person would be willing to pay more for his syrup versus the President's Choice one. "That's the argument that won the case in the Supreme Court." In handing down its decision, the court explicitly said factors such as licensing agreements should be considered when determining a reasonable arm's-length price. "It is doubtful that comparators will be identical in all material respects in almost any case," acknowledged Justice Marshall Rothstein, who wrote the unanimous decision for the court, "[t]herefore, 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 satisfied." Meghji says one of the key points to come out of the decision is that Canada's Supreme Court says you "have to take into PHOTOGRAPHY BY PHILIPPE LANDREVILLE "THE US LED THE CHARGE SEVERAL YEARS AGO BUT COUNTRIES LIKE CANADA BEEFED UP THEIR AUDIT RESOURCES IN THE TRANSFER PRICE AREA, AND THAT'S LED TO A LOT OF REASSESSING ACTIVITY WHICH HAS CAUSED A LOT OF ISSUES." account commercial common sense, who is bearing what risk in a transaction, and who is carrying out what activities. That is the overriding point. "Another big takeaway is that the Supreme Court of Canada explicitly said the OECD guidelines on transfer pricing are just guidelines, not the law. The law is the law of Canada. The guidelines are just an interpretive aid. That's a huge development." The implications of having the Supreme Court acknowledge in its first decision in this area that transfer pricing is not an exact science is also extremely significant, says Emma Purdy of PwC. "The court recognized transfer pricing is not black and white it's gray, which makes it very difficult to say the answer is a particular number. You usually have a range. So what Glaxo said – and there are other countries coming to this view – is that as long as you're within a range, tax authorities should not try to adjust you to the top or the bottom. That should give advisers and clients some comfort." Does Purdy, who worked at the CRA in the 1990s, expect fewer reassessments as a result? www.lexpert.ca | LEXPERT • June 2013 | 31 B-00-Features.indd 31 13-05-23 10:21 AM