OTTAWA (Reuters) - The Supreme Court of Canada ruled on Thursday in favor of GlaxoSmithKline Plc in a tax case centered on whether the drug conglomerate charged its Canadian unit excessive prices for ingredients so that it could avoid Canadian taxes.
Dealing with the taxes of GlaxoSmithKline's Canadian subsidiary in 1990-93, the case marked the first time that Canada's top court has dealt with the issue of transfer pricing, an area of tax law under growing scrutiny worldwide.
Transfer pricing refers to how multinational corporations value goods and services moving across international borders from one corporate unit to another. The prices are frequently managed to reduce corporations' global tax costs.
The court ruled unanimously that it was appropriate for Glaxo's Canadian unit to pay more for drug ingredients than a generic drug maker might pay because of benefits that flow to the unit from its license agreement with GlaxoSmithKline.
GlaxoSmithKline lost on one point, and as a result the case will be sent back to tax court to decide what a reasonable price would have been for the Canadian unit to have paid. This price will be seen as higher than what generic drugmakers would pay.
The ruling "may make it easier for foreign companies to dodge Canadian tax liabilities," said Art Cockfield, a tax law expert and professor at Queen's University in Kingston, Ontario.
Multinationals are constantly moving goods, services and assets across borders, with internal payments flowing among subsidiaries. By managing the pricing of transfers, companies can shift profits to low-tax countries from high-tax ones.
Transfer pricing management is legal, but sometimes national authorities rule against corporations that push too hard.
Global standards call for setting transfer prices at levels resembling those on the open market. Drug and technology firms - with intellectual property easily shifted from one country to another - are often involved in transfer pricing disputes.
The Glaxo case will "substantially influence transfer pricing jurisprudence in Canada ... There are a bunch of transfer pricing cases now in the pipeline in Canada," said Al Meghji, a partner with law firm Osler Hoskin & Harcourt LLP, who represented Glaxo.
Glaxo Canada, the name of the Canadian unit during the period referred to in the case, bought ranitidine, used to make Glaxo's successful stomach ulcer drug Zantac, from a foreign affiliate for more than 10 times the cost of manufacturing it.
That price was also five times the maximum amount that generic drugmakers Apotex Inc and Novopharm Ltd (now owned by Teva Pharmaceutical Industries) paid for ranitidine.
The Canadian government reassessed Glaxo Canada's tax return to reflect what a generic company would have paid an arm's-length manufacturer for the ingredient. Glaxo objected and took the case to court.
Some, or all, of the ranitidine was made by Glaxo's Singapore facility, which at the time had a tax rate of zero to 10 percent. Having the Singapore subsidiary book more of the profits meant the Glaxo group's overall tax burden would be lower because it would book less income in higher-tax Canada.
Glaxo and the U.S. Internal Revenue Service in 2006 resolved what was at the time the largest transfer pricing dispute in IRS history. The company agreed to pay the IRS $3.4 billion in a case that centered on tax years 1989 through 2005.
In Canada, the Supreme Court agreed with Glaxo's argument that it was legitimate for Glaxo Canada to pay more than a generic company because the subsidiary was getting other benefits from the global company, including access to a range of patented drugs, and the know-how required to get approvals for drug products, and to make and sell them.
"It appears that Glaxo Canada was paying for at least some of the rights and benefits under the license agreement as part of the purchase prices for ranitidine...," Justice Marshall Rothstein wrote in the 7-0 decision.
He said it was not appropriate to compare what Glaxo paid with what generic companies paid. Such comparisons "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."
The name of the case is Her Majesty the Queen v. GlaxoSmithKline Inc (33874)
Additional reporting by Kevin Drawbaugh and Patrick Temple-West in Washington; Editing by James Dalgleish, Peter Galloway and Tim Dobbyn