The Supreme Court of Canada has opened the door to allowing foreign multinational corporations to dodge their Canadian tax liabilities by siding with British drugmaker GlaxoSmithKline in its 20-year tax battle with the federal government.
The high court endorsed an appeals court ruling about "transfer pricing," which allows multinationals to charge their subsidiaries high prices for ingredient costs in order to reduce Canadian profits.
The Department of National Revenue had challenged Glaxo Canada's use of a licence agreement that allowed it to pay Glaxo Swiss subsidiary Adechsa between $1,512 and $1,651 per kilogram for the purchase of ranitidine, the active ingredient in the anti-ulcer drug Zantac.
Glaxo also paid parent company Glaxo Group a six per cent royalty on net sales of Zantac.
The price of ranitidine exceeded the $194 to $304 per kilogram charged to Canadian generic pharmaceutical companies Apotex Inc. and Novopharm Inc. by arm's-length suppliers.
The government successfully argued in Tax Court that applying the "reasonable" charges to Glaxo Canada would have increased the subsidiary's net income for 1990 to 1993 by $51 million. But the Federal Court of Appeal in July 2010 overturned the Tax Court's decision and rejected the department's argument that fair market value paid by generics was the relevant measure. It sent the calculation back to the Tax Court for a redetermination.
Writing for the Supreme Court, Justice Marshall Rothstein said in a ruling released Thursday the Tax Court "erred in refusing to take account of the licence agreement."
"The generic comparators do not reflect the economy and business reality of Glaxo Canada and, at least without adjustment, do no indicate the price that would be reasonable in the circumstance, had Glaxo Canada and Adechsa been dealing at arm's length."
Queen's University tax law expert Art Cockfield said the ruling is a win for Glaxo and could prompt others to adopt sophisticated cross-border tax structures to shift profits to low-tax jurisdictions.
"There's massive flows going back and forth and companies have an incentive to game the system by shifting profits always to the lowest-tax country," he said. "It's negative for Canada because it supports aggressive international tax planning that sends revenues outside of the country."
Canada's lower corporate tax rate than the U.S. could, however, insulate it from such profit shifts between companies with operations on both sides of the border, Cockfield added.
