The Supreme Court of Canada has sided with GlaxoSmithKline PLC in a lengthy tax fight the drug giant has been waging with the federal government, in a ruling that some say expands the ability of multinationals to use a technique known as "transfer pricing" to shift profits outside of Canada's borders.
The court, weighing in for the first time on transfer pricing, handed a defeat to the Canada Revenue Agency in its battle with Glaxo over the way multinationals account for the profits they report to Canada's taxman and those they send to other, often lower-tax, jurisdictions.
Queen's University law professor Art Cockfield said Thursday's ruling could embolden companies that use transfer pricing: "They can take a more aggressive stance, and create these sorts of structures that shift profits to countries like tax havens."
But Prof. Cockfield and other tax law experts also acknowledge that the decision largely reinforces practices already used by multinationals, while beating back a CRA attempt to much more narrowly interpret the rules.
"This does not give taxpayers carte blanche, at all," said Claire Kennedy, a tax lawyer with Bennett Jones LLP in Toronto. "... It's not as though it's creating a huge opening in terms of transfer pricing."
Multinationals with local subsidiaries that sell their imported products in Canada must set a price, for tax purposes, that the subsidiary pays its parent for those goods. If the multinational wants to move more of its profits out of Canada, it can increase this "transfer price" that it charges its own subsidiary.
But according to tax laws in Canada and other countries, the prices subsidiaries pay must be equal to the "reasonable" cost an arm's-length business would pay. At the centre of the Glaxo fight was just how this should be defined.
From 1990 to 1993, the Canadian subsidiary of British-based Glaxo Group Ltd. told Ottawa it had paid a Swiss affiliate $1,512 and $1,651 a kilogram for the ingredient ranitidine, which it packaged as the stomach ulcer drug Zantac.
That price was five times the cost paid by generic producers for the same drug. This difference attracted Ottawa's attention, and it reassessed the company for $51-million in unpaid taxes, starting a complex and lengthy legal battle. Glaxo beat back the reassessment at the Federal Court of Appeal, and the government took it before the Supreme Court in January.
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-per-cent profit margin, the company said.
But lawyers for the Canadian government argued that tax laws mean only the comparable generic price should be taken into account.
In a unanimous decision, the Supreme Court disagreed, saying other factors, such as licensing agreements, should be considered when determining a reasonable arm's- length price. But it declined Glaxo's request to actually decide whether the price its Canadian subsidiary paid was fair, referring that question back to the Tax Court of Canada.
A CRA spokeswoman declined to comment on the decision. Glaxo lawyer Al Meghji, of Osler Hoskin & Harcourt LLP, praised the ruling, but said it does not open up new avenues for more aggressive transfer pricing.
Instead, he said, the court simply told the CRA to be realistic when it evaluates transfer pricing: "'Listen, don't be overly legalistic here, use some commercial common sense,' that's what I think the message is," Mr. Meghji said.
The case comes as tax authorities around the world pay closer attention to transfer pricing, and whether the practice is costing them revenue.