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McKesson: Taxpayer Seeks to Raise Additional Issue on Appeal

“Judges are expected to decide cases as framed by the parties, then step back and allow the appellate process to unfold. In this case, the trial judge did neither.”
- Taxpayer’s Supplemental Memorandum of Fact and Law

The transfer pricing case of McKesson v. The Queen has raised procedural issues that are without precedent in Canadian tax cases. This week, those procedural issues became a central part of the matters that will be considered by the Federal Court of Appeal.

In a Notice of Motion (and other materials) filed this week, the taxpayer has asked for a new trial before the Tax Court.

Background

McKesson is a case involving transfer pricing adjustments under section 247 of the Income Tax Act (Canada) in respect of the factoring of accounts receivable as well as the limitation period in Article 9(3) of the Canada-Luxembourg Tax Convention. The Tax Court dismissed the taxpayer’s appeal.

After the taxpayer had commenced an appeal in the Federal Court of Appeal, Tax Court Justice Patrick Boyle recused himself (2014 TCC 266) from the two remaining issues before the lower court (i.e., costs and the content of the Tax Court’s public file) on the basis that the taxpayer had, in its materials filed in the Court of Appeal, accused of him of bias (see our previous post here).

Notice of Motion

On November 3, the taxpayer filed a Notice of Motion in the Federal Court of Appeal for leave to file (i) an Amended Notice of Appeal, and (ii) a Supplementary Memorandum of Fact and Law. In its Motion, the taxpayer states that Justice Boyle’s reasons for recusal raise a further ground of appeal in addition to those already set out in the original Notice of Appeal. The proposed Amended Notice of Appeal and Supplementary Memorandum of Fact and Law address the following additional ground of appeal:

Do the trial judge’s Recusal Reasons compromise the appearance and reality of a fair process in this case such that a new trial is necessary?

Specifically, the proposed Amended Notice of Appeal states,

8. The Trial Judge’s Reasons for Recusal dated September 4, 2014 interfere with the fairness of the appellate process and compromise the appearance and reality fairness of both the trial and appeal.

The taxpayer has also hired additional counsel in respect of the motion, namely Henein Hutchison LLP, a Toronto-based litigation law firm.

Taxpayer’s Arguments

The taxpayer’s Written Representations in support of its Motion argue that the recusal reasons were directed at the Court of Appeal and have compromised the fairness of the case. The taxpayer argues that this “improper intervention” has compromised the integrity of the appeal process.

The taxpayer’s Supplementary Memorandum of Fact and Law states that the trial judge’s “intervention in this appeal was ill-advised and improper”. The taxpayer argues that the trial judge should have remained “above the fray” and should not have “put himself into the appellate arena”.

The taxpayer characterizes the recusal reasons as a “post-hoc attempt to justify to an appellate court a decision given many months earlier” [emphasis in original]. The taxpayer states that the “Recusal Reasons are nothing less than an explicit attempt by the trial judge to insert himself into the appellate process as an advocate against the Appellant and its lawyers.”

The taxpayer argues that the recusal reasons must be considered part of the record in the case before the Federal Court of Appeal. A new trial would, in the taxpayer’s view, give it “an opportunity to make its case at trial, free of the unfairness that has now tainted this proceeding.”

The taxpayer also argued that the recusal reasons have undermined the solicitor-client relationship, and retrospectively reveal the trial judge’s disposition against the taxpayer.

The taxpayer has requested that the appeal be allowed and the matter remitted to the Tax Court for a new trial before a different judge.

*     *     *

The Crown has not yet filed its response to the taxpayer’s Notice of Motion.

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McKesson: Taxpayer Seeks to Raise Additional Issue on Appeal

McKesson: Trial Judge Recuses Self From Two Remaining Issues in Transfer Pricing Case

In McKesson v. The Queen (2014 TCC 266), Justice Patrick Boyle recused himself from the two remaining issues with which he was seized in the transfer pricing case – costs and the content of the court’s public file (i.e., the determination of whether certain information may be confidential).

This unusual decision arises as a result of the content of the Appellant’s factum filed in the Federal Court of Appeal in the appeal of Justice Boyle’s trial decision in McKesson (see our posts on the Tax Court case here and the Federal Court of Appeal proceeding here and here).

In his recusal reasons, Justice Boyle wrote:

[4]        As detailed below, I have, of my own motion, decided that I am compelled to consider whether I need to recuse myself from the two remaining issues before this Court. A consideration of this issue is required because I became aware that the Appellant and Appellant’s counsel, together with its co-counsel in the Federal Court of Appeal in respect of the appeal of the trial decision, had made certain public written statements about me in its factum in the Federal Court of Appeal (the “Factum”) which, upon reflection, appear to me to clearly include:

(i)         allegations that I was untruthful and deceitful in my Reasons;

(ii)         clear untruths about me, what I said and heard in the course of the trial, as well as the existence of evidentiary foundations supporting what I wrote in my Reasons; and

(iii)        allegations of impartiality on my part.

[5]        This requires me to consider whether:

(i)         I believe that a reasonable person reading the Factum, my Reasons, and the relevant portions of the transcript would believe that the trial judge so strongly complained of by McKesson Canada might not be able to remain impartial in his consideration of costs and confidential information;

(ii)         I believe I can impartially consider, weigh and decide the costs and confidential information issues before me; and

(iii)        whether the public challenge of my impartiality expressed by McKesson Canada and its co-counsel in the Factum is itself sufficient to warrant recusing myself at this stage.

 …

[133]     I view these as public allegations by a party to the costs and confidential information matters remaining before this Court that, regardless of the merits of their reasoning or their thoughts, I am unable to decide the remaining matters impartially. I believe that a reasonable person reading only these phrases from the Factum, without reviewing my Reasons or the trial Transcript, would believe that such strong complaints by McKesson Canada and its counsel may give rise to a serious doubt that I will be seen to be able to dispose of the two remaining issues and discharge my duties on an impartial basis.

[136]     For the Reasons identified above, I have decided I have to recuse myself from the remaining costs and confidential information issues in McKesson Canada’s proceeding in this Court.

[137]     It may be that some of the perceived untruths about the trial judge described above under heading II might individually not warrant recusal, and may be within an appellate advocate’s licence to overstate through the use of absolutes like ‘never’, ‘only’ and ‘any’.

[138]     However, I am satisfied that a reasonable fair-minded Canadian, informed and aware of all the issues addressed above, would entertain doubt that I could remain able to reach impartial decisions. I believe that such a reasonable fair-minded and informed person, viewing this realistically and practically would, after appropriate reflection, be left with a reasoned suspicion or apprehension of bias, actual or perceived. Canadians should rightly expect their trial judges to have broad shoulders and thick skins when a losing party appeals their decision, but I do not believe Canadians think that should extend to accusations of dishonesty by the judge, nor to untruths about the judge. Trial judges should not have to defend their honour and integrity from such inappropriate attacks. English is a very rich language; the Appellant and its counsel could have forcefully advanced their chosen grounds for appeal without the use of unqualified extreme statements which attack the personal or professional integrity of the trial judge.

[139]     For these reasons, I will be advising my Chief Justice that I am recusing myself from completing the McKesson Canada proceeding in the Tax Court. This extends to the consideration and disposition of the costs submissions of the parties in this case, as well as to the 2010 confidential information order of Justice Hogan in this case and its proper final implementation by the Tax Court and its Registry.

No date has been set for the hearing of the main matter by the Federal Court of Appeal.

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McKesson: Trial Judge Recuses Self From Two Remaining Issues in Transfer Pricing Case

McKesson: Respondent’s Factum Filed

Earlier this year, McKesson Canada Corporation appealed the decision of the Tax Court of Canada in McKesson Canada Corporation v. The Queen (2013 TCC 404) (see Federal Court of Appeal File Nos. A-48-14 and A-49-14).

At issue was the appropriate discount rate paid under a receivables sales agreement between McKesson Canada and its parent company, MIH, under section 247 of the Income Tax Act (Canada). A secondary issue was the assessment of withholding tax on a deemed dividend that arose as a result of the lower discount rate. For our earlier blog post on the Tax Court decision see here.

In the Federal Court of Appeal, the Appellant’s Memorandum of Fact and Law was filed on June 11, 2014. For our earlier post summarizing the appellant’s memorandum see here.

The Respondent’s Memorandum of Fact and Law was recently filed on August 11, 2014.

In its Memorandum, the Respondent states that the trial judge’s “carefully reasoned decision” and findings were “amply supported” by the evidence at trial and no palpable and overriding error can be found in the trial judge’s conclusions.

The Respondent summarizes its points at issue at paragraph 56 of its Memorandum:

  • The trial judge applied the correct test. His decision was based on what arm’s-length persons would agree to pay for the rights and benefits obtained and not on findings of tax avoidance, lack of need for funds, or group control.
  • Ample evidence supports the trial judge’s determination of the arm’s-length discount rate. Since no palpable and overriding error was committed, his decision should not be disturbed.
  • The trial judge did not commit an error of law in concluding that the five-year limitation period in Article 9(3) of the Canada-Luxembourg Tax Treaty does not apply to the Part XIII tax reassessment at issue.

No hearing date has yet been set for the hearing in the Federal Court of Appeal.

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McKesson: Respondent’s Factum Filed

McKesson: Appellant’s Factum Filed‏

On January 10, 2014, McKesson Canada Corporation appealed the decision of the Tax Court of Canada in McKesson Canada Corporation v. The Queen (2013 TCC 404) (see Federal Court of Appeal File Nos. A-48-14 and A-49-14).

In McKesson, the Tax Court upheld the CRA’s transfer price adjustments (made pursuant to section 247 of the Income Tax Act (Canada)) that had reduced the discount rate paid under a receivables sales agreement between McKesson Canada and its parent company, MIH, from 2.206% to 1.013%. The Tax Court also upheld the assessment of withholding tax on a deemed dividend that arose in a secondary adjustment resulting from the lower discount rate.

The Appellant’s Memorandum of fact and law was filed on June 11, 2014.

In its Memorandum, the Appellant states that the Trial Judge made a “fundamental error of law” and requests that the appeal be allowed with costs and the matter be remitted to the Tax Court for a new trial before a different judge. The Appellant describes the issues on the appeal as follows:

Did the Trial Judge err in law by stepping outside the pleadings and the case put forward and as developed by the parties over the course of the trial to find against McKesson Canada, thereby depriving McKesson Canada of its right to know the case it had to meet and its right to a fair opportunity to meet that case?

Did the Trial Judge err in law when he misconstrued the arm’s-length principle by holding that, in determining what terms and conditions arm’s length parties would have made or imposed, he was to assume that one party (purchaser) controls the other (seller)?

As a result of stepping outside of the pleadings and the case put forward and as developed by the parties over the course of the trial and committing an error of law, did the Trial Judge calculate the discount rate in a manner that ignored the assumption of risk by MIH, contrary to the terms of the Agreement and resulted in a discount rate that is commercially absurd?

Did the Trial Judge err in permitting the Minister to assess non-resident withholding tax after the expiry of the applicable limitation period and in contravention of Canada’s obligations under a bilateral tax treaty?

See our previous commentary on the Tax Court’s McKesson decision here.

 

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McKesson: Appellant’s Factum Filed‏

Marzen: Tax Court Upholds Transfer Pricing Adjustments

The decision of the Tax Court of Canada in Marzen Artistic Aluminum Ltd. v. The Queen (2014 TCC 194) is the latest addition to a growing body of Canadian judgments on the application of the transfer pricing rules in section 247 of the Income Tax Act (Canada) (the “Act”).

In a lengthy set of reasons, the Tax Court upheld all but a fraction of the CRA’s reassessment of the taxpayer, such reassessments having disallowed the deduction of approximately $7.1M of fees paid by the Canadian taxpayer to its Barbados subsidiary. The Court also upheld the imposition of a penalty under subsection 247(3) of the Act.

The taxpayer was in the business of designing, manufacturing and selling aluminum and vinyl windows. Beginning in 1999, the taxpayer implemented what the Court referred to as the “Barbados Structure”. Under this structure, the taxpayer entered into a “Marketing and Sales Services Agreement” (“MSSA”) pursuant to which the taxpayer’s Barbados subsidiary (“SII”) would provide certain marketing and other sales-related services to the taxpayer in respect of certain jurisdictions, notably the U.S. The fee was calculated as the greater of $100,000 or 25% of sales originated by SII. In total, amounts paid by the taxpayer to SII under the MSSA and related agreements was $4.1M for 2000 and $7.8M for 2001. These amounts were deducted by the taxpayer in computing its Canadian income. SII paid nominal income tax in Barbados on this income. SII then declared dividends to the taxpayer, which were generally received tax-free as dividends out of exempt surplus, pursuant to the deduction in section 113 of the Act.

The Canada Revenue Agency reassessed under section 247 of the Act to disallow a portion of the deduction and imposed a penalty.

In considering the transfer pricing rules in section 247, the Court stated the issues were as follows: (i) whether the terms and conditions imposed in respect of the MSSA differed from what would have been agreed to by persons dealing at arm’s-length, (ii) if so, what adjustments should be made to the quantum of the fees paid under the MSSA so that it was equivalent to the price that would have been paid had the parties been at arm’s-length, and (iii) whether the taxpayer was liable to penalty under subsection 247(3) for the 2001 tax year.

The Court determined that the terms and conditions of the arrangement were not consistent with what arm’s-length parties would have agreed to. In the Court’s view, SII provided few or no marketing and sales services (such services having been subcontracted to another of the taxpayer’s foreign subsidiaries). Further, the Barbados Structure was purely tax-motivated, allowing deductible fees to be repatriated as tax-free exempt surplus dividends. These “attractive advantages” in the Court’s view, would not be available to arm’s-length parties. In the Court’s opinion, applying the “comparable uncontrolled price” method of determining the transfer price, as argued by the Crown, provided the most accurate arm’s-length price.

In this case, the taxpayer was entitled to deduct certain of the fees paid to SII plus $32,500 in each year for corporate and directorship services provided to SII by its director. In the result, the vast majority of the fees paid by the taxpayer to SII were denied and added back into the taxpayer’s income. The Court also found that the transfer pricing penalty was applicable, as the taxpayer failed to make reasonable efforts to determine and use arm’s-length transfer prices in 2001 (the 2000 adjustment did not meet the $5 million threshold for imposing a penalty under subsection 247(3) of the Act).

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Marzen: Tax Court Upholds Transfer Pricing Adjustments

International and Transfer Pricing Audits: Toronto Centre Canada Revenue Agency & Professionals Breakfast Seminar

International and Transfer Pricing Audits

At the Toronto Centre Canada Revenue Agency & Professionals Breakfast Seminar on February 18, 2014, the CRA provided an update on international and transfer pricing audits. The slides can be found here. The discussion was led by Paul Stesco, Manager of the International Advisory Services Section, International and Large Business Directorate, Compliance Programs Branch of the CRA and Cliff Rand, National Managing Partner of Deloitte Tax Law LLP.  Here is a brief overview of some of the highlights from the presentation on how such audits are performed:

  • Research and Analysis Stage: the CRA uses the internet extensively for research (e.g. industry analysis, competitor analysis, etc.) as well as prior audit reports, tax returns and annual reports of taxapyers to identify transactions and the appropriate transfer pricing methods applicable to those transactions.
  • Mandatory Referrals to Headquarters: mandatory referrals by the field auditor to the International Tax Division (“ITD”) are required in several situations including: cost contribution arrangements, reassessments that could be issued after the tax treaty deadlines, transfer pricing penalties under subsection 247(3), recharacterization under paragraphs 247(2)(b) and (d), the application of subsection 95(6) and downward pricing adjustments under subsection 247(2) and (10). Situations which involve the use of “secret comparables” to reassess the taxpayer (i.e. comparables used by the CRA that cannot be found in a public database) will automatically be forwarded to the ITD; the CRA will not forward audit issues to the ITD if the “secret comparables” were used only for risk analysis.
  • Access to Taxpayers: during an audit, the CRA may request access to certain individuals involved in the taxpayer’s business. The CRA does not necessarily require physical access to non-resident taxpayers; a telephone interview may suffice. An interview with operational personnel is likely to streamline the audit and, as such, is in the best interests of the taxpayer. Taxpayers are permitted to record such interviews (even including the use of a court reporter to produce a transcript).
  • Currency of Auditsinstead of proceeding on a year by year basis, audits will now generally begin with the most current risk-assessed taxation year (and one back year) and may then move back to other open years in respect of the same issue.  Having said that, there are still “legacy files” within the CRA’s system.
  • Concerns/Complaints: a taxpayer who wishes to express concerns about a transfer pricing audit should follow the appropriate local chain of command: first contact the auditor, then the Team Leader and the relevant Section Manager at the local TSO. Taxpayers should refrain from directly contacting Head Office. The CRA stressed the importance of communicating with the audit team on a regular basis.
  • Contemporaneous Documentation Requirement in subsection 247(4): the CRA acknowledged that transfer pricing studies have been accepted even if they were prepared after the period to which they relate.
  • Transfer Pricing Review Committee (TPRC): two types of referrals proceed to the TPRC: (1) penalty referrals under subsection 247(3) which involve transfer pricing adjustments in excess of 10% of gross revenue or greater than $5,000,000; and (2) referrals of recharacterization as an assessing position under paragraph 247(2)(b).
    • As of October 31, 2013, penalty referrals made up 86.5% of all referrals while recharacterization referrals accounted for 13.5% of all referrals.
    • The taxpayer does not have direct access to the TPRC to make submissions. However, minutes of committee meetings may be obtained by making an Access to Information request.

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International and Transfer Pricing Audits: Toronto Centre Canada Revenue Agency & Professionals Breakfast Seminar

The McKesson Case – A Holiday Gift from Justice Boyle of the Tax Court of Canada: Ask and You Shall Receive(able) – Canada’s Latest Transfer Pricing Decision

On Friday, December 20th, the Tax Court of Canada released the long-awaited and lengthy decision of Justice Patrick Boyle in McKesson Canada Corporation v. The Queena case involving transfer pricing adjustments under section 247 of the Income Tax Act (the “Act”) and the limitation period in Article 9(3) of the Canada-Luxembourg Tax Convention.

McKesson Canada is the principal Canadian operating company in the McKesson Group. The core business of the McKesson Group and of McKesson Canada is the wholesale distribution of “over the counter” and prescription pharmaceutical medicine products. Effective December 16, 2002 McKesson Canada and its Luxembourg parent company, MIH, entered into a Receivables Sales Agreement (the “RSA”) and a Servicing Agreement. Under the RSA, MIH agreed to purchase all of McKesson Canada’s eligible receivables as of that date (about $460,000,000) and committed to purchase all eligible receivables daily as they arose for the next five years unless earlier terminated as provided for in the RSA and subject to a $900,000,000 cap. The price to be paid for the receivables was at a 2.206% discount to their face amount (if one takes into account that historically receivables were paid on average within 30 days, this rate equates to an annual financing rate of approximately 27%). The Canada Revenue Agency reassessed McKesson Canada’s 2003 taxation year on the basis that if the RSA had been made between arm’s length parties the Discount Rate would have been 1.013% and made a transfer pricing adjustment under section 247 of the Act of $26,610,000 (the taxation year of McKesson Canada under appeal ended March 29, 2003 and was approximately three and a half months long – the annualized transfer pricing adjustment was therefore approximately $80,000,000).

The Tax Court trial lasted 32 days over a period of five months from October, 2011 to February, 2012 and following the Supreme Court of Canada’s decision in Canada v. GlaxoSmithKline Inc. in October, 2012, both parties made further written submissions.

Under the RSA, eligible receivables were trade receivables owing by arm’s length customers not in default and whose receivables would not represent in the aggregate more than 2% of McKesson Canada’s then outstanding receivable pool. However, the 2% concentration limit on eligibility did not apply to McKesson Canada’s largest customers who accounted for about one-third of the sales. MIH had the right to put non-performing receivables back to McKesson Canada for a price equal to 75% of the face amount to be later re-adjusted to the amount actually collected and MIH did not otherwise have recourse against McKesson Canada for unpaid purchased receivables. The receivables under the RSA were expected to be collected in a short period of time (historically, payment was made by customers in 30 days) and the historical bad debt experience was .043%.

Under the Servicing Agreement, McKesson Canada agreed to service the accounts receivable and received a servicing fee of $9,600,000 annually regardless of the amount outstanding. The amount paid under the Servicing Agreement was not challenged by the CRA.

The amount payable for a purchased receivable under the RSA was determined by multiplying the face amount of the receivable by one minus the Discount Rate. The Discount Rate was defined to be the sum of (a) the Yield Rate which was equal to the 30 day Canadian dollar banker’s acceptance (BA) rate or the Canadian dealer offered rate (CDOR) on the first business day of the relevant settlement plus (b) the Loss Discount which was intended to reflect the credit risk of the McKesson Canada customers whose receivables were covered by the RSA and was set at 0.23 for the year under appeal. For the remaining term of the RSA commencing January 1, 2004, the Loss Discount was to be recalculated as often as MIH considered necessary based on the credit risk of certain customers plus (c) the Discount Spread which was set at the fixed rate of 1.7305% and related to the risk that (i) McKesson Canada’s credit worthiness deteriorated significantly and receivable debtors might set off their rebate entitlements in such event, (ii) the risk that McKesson Canada’s customers might increase their take-up of available prompt payment discounts, (iii) the risk that MIH might decide to appoint a new service provider who would require a greater servicing fee, and (iv) the need for the Discount Rate to fully cover MIH’s cost of funds.

Toronto Dominion Securities Inc. (“TDSI”) was retained by counsel for McKesson Canada to provide advice on the arm’s lengths aspects of certain terms and conditions of the RSA and certain components of the Discount Rate calculation at the time the RSA was entered into. The TDSI reports were relied on by McKesson Canada as contemporaneous documentation and, therefore, a transfer pricing penalty under subsection 247(3) of the Act was not assessed by the CRA (had there been no contemporaneous documentation, McKesson Canada would have been automatically subject to a penalty of 10% of the transfer pricing adjustment). Interestingly, Justice Boyle states in a footnote that the CRA may need to review its threshold criteria in respect of contemporaneous documentation under subsection 247(4) of the Act and that he would not “have expected last minute, rushed, not fully informed, paid advocacy that was not made available to the Canadian taxpayer and not read by its parent would satisfy the contemporaneous documentation requirements.”

Justice Boyle stated that the CRA reassessment was made under paragraphs 247(2)(a) and (c) of the Act and that the task of the Court was to determine whether the terms and conditions of the transactions carried out by the parties resulted in a Discount Rate that was within the range of what McKesson Canada and MIH would have agreed to, had their transaction applied terms and conditions which persons dealing at arm’s length would have used. Interestingly, in light of recent OECD discussion papers, he noted that the CRA did not directly or indirectly raise “any fair share or fiscal morality arguments that are currently trendy in international tax circles” and that “it wisely stuck strictly to the tax fundamentals: the relevant provisions of the legislation and the evidence relevant thereto”. He noted that issues of fiscal morality and fair share are within the realm of Parliament.

Justice Boyle sets out in detail the evidence from the two material witnesses and the five expert witnesses who testified and criticizes much of the expert evidence. In respect of the transfer pricing report prepared by a major accounting firm in 2005 in response to the CRA’s review of the RSA transaction, he states that the report was primarily a piece of advocacy work, “perhaps largely made as instructed” and that the examples used by the accounting firm resulted in “picking and choosing” and mixing and matching the performance of the receivable pools which resulted in “transparently poor advocacy and even more questionable valuation opinions”.

Mr. Justice Boyle also criticized the taxpayer in respect of the manner in which the appeal was undertaken “Overall I can say that never have I seen so much time and effort by an Appellant to put forward such an untenable position so strongly and seriously. This had all the appearances of alchemy in reverse.”

In determining the appropriate methodology to determine the Discount Rate, Justice Boyle did not accept the conclusions of any of the experts or their reports in their entirety although he acknowledged that the Court’s analysis was informed by the testimony and information provided by the witnesses. He notes that the purpose of the RSA transaction was to reduce McKesson Canada’s Canadian tax liability by paying the maximum under the RSA that was justifiable (interestingly, McKesson Canada had been profitable for the years prior to the RSA but after the RSA was executed, McKesson Canada operated at a loss) and that there is nothing wrong with taxpayers engaging in “tax-oriented transactions, tax planning, and making decisions based entirely upon tax consequences (subject only to GAAR which is not relevant to this appeal)”. However, Justice Boyle also notes that the reasons for, and predominant purposes of, non-arm’s length transactions form a relevant part of the factual context being considered.

He then reviewed the various elements of the Discount Rate. In respect of the Yield Rate, he accepted that the 30 day CDOR rate is appropriate. However, for the period in question, he stated that it was necessary to review the historical evidence in respect of when payment would be made and that the parties should have taken into account the fact that the first period had a “missing” fifteen days because the agreement was entered into in the middle of the month. In respect to the Loss Discount which was fixed by the RSA at 0.23% Justice Boyle stated that this should be based on historical data which showed write-offs of approximately 0.04% and even if the parties provided a buffer of 50% to 100% increase in write-offs, the Loss Discount would be in the range of 0.6% to 0.8%. In respect of the Discount Spread, Justice Boyle looked at the various elements which were included in this number and based on the historical data and the facts provided, stated that the servicing discount risk would be in the range of 0.17% to 0.25%, the prompt payment dilution discount would be 0.5% to 0.53%, the accrued rebate dilutions discount (which involves a customer paying a lesser amount in respect of its accounts taking into account an expected rebate) was not justified and that the interest discount which was intended to provide MIH with a return from a discounted purchase of receivables would be between 0.0% and 0.08% for a total Discount Rate range of 0.959% to 1.17%. Accordingly, because the taxpayer did not rebut the CRA’s assumptions in respect of a reasonable Discount Rate, the taxpayer’s appeal in respect of the CRA’s transfer pricing adjustment was rejected.

The second issue reviewed by the Court involves the shareholder benefit and withholding tax on the deemed dividend which resulted from the excess amount paid by McKesson Canada to its Luxembourg parent MIH under paragraph 214(3)(a) and subsection 15(1) of the Act. By utilising a Discount Rate which was greater than an arm’s length rate, McKesson Canada provided a benefit to MIH which is to be treated as a deemed dividend and is subject to non-resident withholding tax and McKesson Canada was jointly liable with MIH for the withholding tax under subsection 215(6) of the Act. The taxpayer did not deny this liability but stated that it was statute-barred because the Canada-Luxembourg Tax Convention specifically provided for a five-year limitation period (Article 9 (3)) and the reassessment of McKesson Canada in respect of withholding tax was issued after this period. Justice Boyle held that because Article 9(3) of the Convention only deals with Article 9(1) of the Convention in respect of transfer pricing adjustments and not deemed dividends and because there was no evidence that MIH was subject to any “extra tax” in Luxembourg because of the deemed dividend, the five-year time limit in Article 9(3) does not apply and, therefore, the withholding tax assessed against McKesson Canada was not subject to the limitation period in the Convention. Therefore the taxpayer’s appeal in respect of withholding tax was also dismissed.

As noted above, the decision is a lengthy one (probably one of the lengthiest Tax Court decisions). In his final footnote, Justice Boyle apologizes for the length of the decision and quoting Lord Neuberger of Abbotsbury from a 2013 address, states:

“we seem to feel the need to deal with every aspect of every point that is argued, that makes the judgement often difficult and unrewarding to follow. Reading some judgements one rather loses the will to live – and that is particularly disconcerting when it’s your own judgment that you are reading”.

It will be interesting to see whether McKesson Canada decides to appeal this decision and if it does so, how Justice Boyle’s decision will be dealt with by the Federal Court of Appeal.

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The McKesson Case – A Holiday Gift from Justice Boyle of the Tax Court of Canada: Ask and You Shall Receive(able) – Canada’s Latest Transfer Pricing Decision

Foreign-based Requirement Under Section 231.6 of the Income Tax Act Upheld by the Federal Court

The Canada Revenue Agency had an important win this week in its efforts to access information outside of Canada.  On March 20, 2013, the Federal Court issued its decision in Soft-Moc Inc. v. M.N.R.  2013 FC 291, dismissing Soft-Moc’s judicial review application to have the CRA’s decision to issue a Foreign-Based Information Requirement set aside or varied.

The CRA has broad powers to access information related to the determination of a taxpayer’s tax obligations.  Under subsection 231.6 of the Income Tax Act, these powers include the issuance of a Foreign-Based Information Requirement to obtain information or documents located outside of Canada.

In Soft-Moc, the CRA was conducting a transfer pricing audit and sought information from corporations in the Bahamas who provided services to Soft-Moc.  These corporations and their individual Bahamian resident shareholder owned 90% of the common shares of Soft-Moc.  The CRA issued a Foreign-Based Information Requirement to Soft-Moc under subsection 231.6(2) of the Income Tax Act.

The Requirement requested substantial amounts of information related to the Bahamas Corporations including extensive details of the services provided, customers, financial statements, costs and profits and employee data.  Soft-Moc applied for judicial review of the decision to issue the requirement.

Primarily, Soft-Moc argued that the information requested went well beyond that necessary to enable the CRA to complete the transfer pricing audit and that the decision to issue the requirement was, therefore, unreasonable.  Soft-Moc argued that a portion of the information requested was irrelevant and that some portions were confidential or proprietary.

The Court was not sympathetic to Soft-Moc’s arguments, noting the wide-ranging statutory powers of the CRA to collect information and the low threshold to be met in determining whether the requested information is relevant and reasonable.

This win, which was not surprising in light of the Federal Court of Appeal’s earlier decision in Saipem Luxembourg S.A. v. The Canada Customs and Revenue Agency, 2005 FCA 218, will encourage the CRA to continue to use foreign-based requirements more frequently and earlier in the audit process.

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Foreign-based Requirement Under Section 231.6 of the Income Tax Act Upheld by the Federal Court

CRA Releases New APA Report

On January 10, 2013, the Canada Revenue Agency released its 2011-2012 Advance Pricing Arrangement Program Report (previous reports are available here).

This is the eleventh year in which the CRA has issued such a report, which is generally intended to enhance taxpayer awareness of the APA program and to describe (i) current operational status, (ii) relevant changes, and (iii) issues that may affect the program in future years.

The general purpose of an APA is to create certainty between the taxing authorities of Canada and a foreign country concerning the transfer pricing of cross-border intercompany transactions.  In the absence of an APA governing such transactions, taxpayers may be exposed to higher audit risk relating to their intercompany transfer pricing methodologies, which may ultimately result in costly and time-consuming negotiations with the multiple tax authorities as well as potential litigation. Accordingly, the CRA encourages taxpayers to avail themselves of the APA program to mitigate the transfer pricing risk in the appropriate circumstances, particularly where the taxpayer engages in intercompany transactions of a recurring nature (i.e., frequent sale of goods between affiliates or the ongoing provision of intercompany services).

The APA program has proven popular with taxpayers over the years and the number of applicants continues to grow – the 2011-2012 fiscal year had the highest number of applicants to the program (34) since the 2007-2008 fiscal year.  The inventory of unresolved cases also continues to grow (the inventory increased from 96 at the end of the 2010-2011 fiscal year to 102 at the end of the 2011-2012 fiscal year).  In the 2011-2012 fiscal year, 17 new cases were admitted to the APA program whereas only 10 cases were completed (and one was withdrawn).  The large discrepancy between the number of applicants and the number of cases formally admitted to the program in the year is partially a reflection of the changes introduced by the CRA beginning in the 2010-2011 fiscal year requiring that taxpayers invest significantly more time and resources during the initial application/due diligence phase of the APA process and to provide a greater amount of financial and business information prior to acceptance into the program.  This results in a longer and more extensive “screening” process but is intended to eliminate inappropriate cases before they are accepted into the program inventory.

Other highlights of the Report include:

  • The average amount of time required to conclude a bilateral APA from acceptance into the program until completion was 44 months, which appears generally consistent with prior years;
  • The majority of APA’s relate to the cross-border transfer of tangible property.  Approximately 47% of APA cases in process relate to tangible personal property whereas cases involving tangible personal property and intra-group services represent approximately 31% and 22% of cases in process;
  • The transactional net margin method (“TNMM”) continues to be the most frequently used transfer pricing methodology in APA cases; and
  • APAs involving the United States represent approximately 71% of all APA cases that are in process (which is slightly lower than the percentage of completed APA cases that involve the United States).

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CRA Releases New APA Report

Another Tax Court hearing ordered for GlaxoSmithKline Inc. on the first transfer pricing case to reach the Supreme Court of Canada

This morning, the Supreme Court of Canada dismissed the Crown’s appeal in The Queen v. GlaxoSmithKline Inc., the first transfer pricing case to be heard by the Supreme Court of Canada under subsection 69(2) of the Income Tax Act (Canada) (the “Act”) and ordered the parties to return to the Tax Court of Canada for the determination of the appropriate transfer price.  The Supreme Court of Canada remitted the matter to the Tax Court of Canada:

[76]   . . . 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.

The Supreme Court endorsed and elaborated on the legal test set out by the Federal Court of Appeal and rejected the test applied by the Tax Court.  However, it is important to note that subsection 69(2) has been replaced by subection 247(2) of the Act which applies in respect of taxation years and fiscal periods beginning after 1997.  The taxation years at issue in this litigation were 1990-1993.

The reasons for judgment were delivered by Justice Rothstein for a panel of seven (the other members of the panel were the Chief Justice, Justice Deschamps, Justice Abella, Justice Cromwell, Justice Moldaver and Justice Karakatsanis).

By way of background, GlaxoSmithKline Inc. (“Glaxo Canada”) purchased ranitidine, the active ingredient in the anti-ulcer medication called Zantac, from a Swiss non-arm’s length source approved by Glaxo UK (“Adechsa S.A.”) which was part of the Glaxo Group in the U.K.  It did so at a price approximately five times higher than the price at which the same ranitidine was sold in the market to Canadian generic drug manufacturers who did not have the right to manufacture or sell Zantac.

Glaxo Canada could not have gone into the market to purchase ranitidine at the price paid by the generic drug manufacturers and use that ranitidine to manufacture and sell Zantac in Canada.  It had the right to manufacture and sell Zantac in Canada under an agreement with Glaxo Group pursuant to which it was required to purchase all of its ranitidine from Adechsa S.A. at a price determined by Glaxo Group.  Glaxo Canada entered into a Licence Agreement with Glaxo Group which allowed it to manufacture and sell Zantac in Canada in consideration of a royalty payment to Glaxo Group.  Glaxo Canada was also required to purchase the raw ingredient, ranitidine, from a source approved by Glaxo Group (i.e., Adechsa S.A.) under a Supply Agreement between it and Adechsa S.A.  During the years at issue, the price of ranitidine purchased by Glaxo Canada was $1500 per kilogram while identical ranitidine was available and was purchased by generic drug manufacturers at $300 per kilogram.

The 1985 version of subsection 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 arm’s 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 arm’s length, the reasonable amount shall, for the purpose of computing the taxpayer’s income under this Part, be deemed to have been the amount that was paid or is payable therefor.

The Decision of the Tax Court of Canada

The issue before the Tax Court was whether the amount paid by the taxpayer to the non-arm’s-length party was “reasonable in the circumstances.”  The Tax Court held that (a) the “comparable uncontrolled price” (or CUP) method was the most accurate way to determine the arm’s-length price for ranitidine and (b) the appropriate comparable transactions were the purchases of ranitidine by the generic manufacturers. Subject to a relatively minor adjustment, the Tax Court dismissed the taxpayer’s appeal.

The Decision of the Federal Court of Appeal

The Federal Court of Appeal allowed the taxpayer’s appeal. The Court of Appeal held that the Tax Court had erred in its application of the “reasonable in the circumstances” test, and that it should have inquired into the circumstances that an arm’s-length purchaser in the taxpayer’s position would have considered relevant in deciding what reasonable price to pay for ranitidine. The Court of Appeal set aside the Tax Court judgment and sent the matter back to the Tax Court to be reconsidered.

The Hearing Before the Supreme Court of Canada

At the hearing, Crown counsel emphasized the fact that the only transaction under review was the purchase of ranitidine.  As counsel put it at the hearing, you don’t throw into the analysis “the whole deal.”  She argued that the only question is “what is an arm’s length price to pay for ranitidine?”  Counsel contended that one must strip away the non-arm’s length circumstance (i.e., the requirement to buy ranitidine at a price set by Glaxo Group).

(a) Questions for the Crown at the Supreme Court Hearing

Justice Abella was concerned about whether it was fair for the Crown to compare (under the CUP method) on the one hand the price paid by Glaxo Canada for ranitidine that was destined to become Zantac and, on the other hand, the price paid by generic drug manufacturers for ranitidine that was not destined to become Zantac.  Justice Abella asked counsel whether “in the circumstances” in subsection 69(2) meant that you look at the whole deal.  Counsel argued that you can’t look at the whole deal.

The Chief Justice focused on the words of 69(2) “that would have been reasonable in the circumstances” and asked Crown counsel what is to be included in “the circumstances”.  Crown counsel contended that the only relevant circumstance is the price of ranitidine paid by the generic drug manufacturers in Canada.  The Crown maintained that one cannot take into account any “non-arm’s length” circumstance (e.g., that Glaxo Canada must pay the price set by Glaxo Group) and that all non-arm’s length circumstances must be stripped out of the analysis under subsection 69(2).

During the Crown’s reply argument, Justice Cromwell described the Crown’s position as: ”Whatever the deal is, we ignore it.”  Crown counsel agreed with that characterization.

Justice Moldaver asked counsel, in light of the decision of Parliament not to use the phrase “reasonable in the circumstances” in the successor provision to subsection 69(2) (subsection 247(2) of the Act), why would the Crown ignore that language and call the whole structure of the deal “background music” and not part of the “circumstances”.

Justice Rothstein remarked that Glaxo Canada was not simply purchasing ranitidine but was purchasing ranitidine for the purpose of resale as Zantac.  If Glaxo Canada went into the market like the generics and purchased ranitidine, they would not have been able to resell it as Zantac and Zantac is their business.  He asked Crown counsel why the words “reasonable in the circumstances” exclude the way that a business plans to use the product it is purchasing.  He noted that there is a “generic market” and a “brand product” market for most drugs.  He asked why those circumstances are not relevant in determining the price someone would pay for ranitidine to be used for “brand product” sales as opposed to ranitidine for ”generic product” sale.

In answer to some of these concerns, counsel referred to paragraph 89 of the reasons for judgment of the Tax Court:

[89]     If the legislature intended that the phrase “reasonable in the circumstances” in subsection 69(2) should include all contractual terms there would be no purpose to subsection 69(2); any MNE would be able to claim that its parent company would not allow it to purchase from another supplier. No MNE would ever have its transfer prices measured against arm’s length prices, because all MNEs would allege that they could purchase only from sources approved by the parent company. The controlling corporation in a MNE would structure its relationships with its related companies, and as between its related companies, in this manner or in some similar manner. There is no question that the appellant was required to purchase Glaxo approved ranitidine. The issue is whether a person in Canada dealing at arm’s length with its supplier would have accepted the conditions and paid the price the appellant did.

Justice Deschamps observed that if the Crown is looking at a transaction with a generic company, it is not looking at the same transaction.  Crown counsel responsed by saying that the transaction at issue is a simple purchase of ranitidine and the Minister is only trying to value that one transaction.

Justice Abella asked counsel whether it is relevant to the pricing analysis that this was not just a purchase of ranitidine but a purchase of ranitidine for the purpose of being sold as Zantac.  Crown counsel maintained that this was just a purchase of ranitidine as subsection 69(2) strips out the non-arm’s length element.

Justice Rothstein asked counsel what there would be to argue if the matter were remitted back to the Tax Court.  Counsel responded that the Minister’s position would be exactly the same (the price paid by Glaxo Canada was not “the reasonable amount”) based on the evidence of what the generic drug manufacturers paid.  The Crown concluded by arguing that you simply cannot find a comparator selling Zantac without the concomitant non-arm’s length circumstances.

(b) Questions for Glaxo Canada at the Supreme Court Hearing

Justice Abella asked counsel whether there was any way of determining whether $1,500 per kilogram was the “fair market value” of the ranitidine to someone in Glaxo Canada’s position.  How do you test the “reasonableness” of the $1,500 per kilo price?  Counsel responded by saying that that wasn’t the Minister’s case.  The Minister simply assessed on the basis that Glaxo Canada paid more than the generics did and that was the only relevant comparator.  Once that theory was set aside by Federal Court of Appeal, that was the end of it.

The Chief Justice asked counsel whether it would be possible for taxpayers to avoid Part XIII tax on royalties for the use of intellectual property if no actual royalty was paid but was, instead, effectively embedded in the cost of the goods.  Counsel replied that such “unbundling” is unnecessary as other provisions deal with abusive tax avoidance such as that.  In any event, there are no such allegations in this case by the Minister (i.e., that “unbundling” is required or that inappropriate tax avoidance has taken place).

The Chief Justice wondered whether the Minister’s allegation that Glaxo Canada paid too much shifted the onus to Glaxo Canada to fully engage in the “unbundling” debate.  Counsel responded that Glaxo Canada paid $1,500 per kilogram to Adechsa S.A. for the ranitidine and paid a separate royalty to Glaxo Group for the use of intellectual property.  The Minister never argued that Glaxo Canada was obliged to do any sort of unbundling in this case.

Justice Rothstein asked counsel whether once the Federal Court of Appeal determined that the wrong test had been applied, it should have remitted the matter back to the Tax Court to determine the non-arm’s length price based on the proper legal test (i.e. taking into account the particular business circumstances around the transaction).  Counsel argued that sending the matter back to the Tax Court would turn the rules of civil litigation in general, and tax litigation in particular, on their heads.  He contended that the Tax Court cannot try a case that was never pleaded by the Crown.  The Chief Justice wondered whether the taxpayer had not discharged its burden of showing that $1,500 per kilogram was “the reasonable amount”.  Counsel responded by observing that Glaxo Canada, at trial, had demolished the basis for the Minister’s assessment and, in light of the judgment of the Federal Court of Appeal, the burden shifts to the Minister – the burden does not remain on the taxpayer to demonstrate why the price charged for the ranitidine was “the reasonable amount”.  Glaxo Canada met the case pleaded against it and the Minister has no right to start all over again in respect of the taxation years at issue.  On the pleadings as they currently stand, there is no case to go back to the Tax Court.

The Decision of the Supreme Court of Canada

In a nutshell, the Court held that the legal test applied by the Tax Court was incorrect as it ignored the Licence Agreement and the Supply Agreement which formed part of the relevant circumstances surrounding the transaction at issue.  As there had been no factual determination of the appropriate transfer price in light of the correct legal test, the Court referred the matter back to the Tax Court to determine the appropriate transfer price.

More detailed commentary will follow in the days to come but, in the meantime, here are some of the more important passages in the decision:

The role of OECD Guidelines

[20]   In the courts below and in this Court, there has been reference to the1979 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.

The relevant circumstances

[38]   . . . The requirement of s. 69(2) is that the price established in a non-arm’s length transfer pricing transaction is to be redetermined as if it were between parties dealing at arm’s 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 arm’s length.

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[42]   Thus, according to the 1995 Guidelines, a proper application of the arm’s length principle requires that regard be had for the “economically relevant characteristics” of the arm’s length and non-arm’s 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.

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[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 taxpayer been dealing at arm’s length, it necessarily involves consideration of all 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 arm’s 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.

Stripping out non-arm’s length elements

[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-arm’s 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 Canada wished to market. An arm’s 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.

The use of generic comparators

[53]   . . . 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 arm’s length.

Glaxo Canada was paying for more than just ranitidine

[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 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 Canada’s 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.

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[59]   In addition, while, as Rip A.C.J. found, Glaxo Canada’s ranitidine and generic ranitidine are chemically equivalent and bio-equivalent, he also found that there was value in the fact that Adechsa’s ranitidine manufactured under Glaxo Group’s “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 arm’s 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 arm’s length comparisons under any of the OECD methods or other methods may be determined.

Part XIII (withholding) tax

[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 Canada’s 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.

Guidelines for the Tax Court of Canada in making its redetermination

[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 arm’s length has yet to be determined.  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.

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[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 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 arm’s 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 arm’s 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 arm’s length test of s. 69(2) should reflect these realities.

[64]   Fourth, in this case there is some evidence that indicates that arm’s 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).

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Another Tax Court hearing ordered for GlaxoSmithKline Inc. on the first transfer pricing case to reach the Supreme Court of Canada