Canadian Lawyer

"The court clearly endorsed the notion that transfer pricing is not an exact science. It acknowledged that businesses should be given some leeway in determining their pricing, and that if prices are within a 'reasonable range', the requirements of the legislation will be satisfied." Adrienne Woodyard, Davis LLP Rothstein wrote in the 7-0 decision. But while the top court sided with Glaxo, it sent the case back to the Tax Court to determine what a reasonable price would have been for the Canadian subsidiary to pay. That, critics say, left the biggest question unanswered — what amounts, if any, of the purchase price should be allocated to intellectual property rights? It is the first time the SCC has addressed the rules on transfer pricing. Some say the decision means the rules have changed, but Al Meghji, a partner with the tax group at Osler Hoskin & Harcourt LLP who represented Glaxo, says it didn't really rewrite the law on transfer pricing, but rather "clarified that commercial common sense is a central aspect of transfer pricing and pricing should be done in a way that's reflective of markets." In its approach, the CRA tried to assess the price of the Zantac in absolute terms in isolation from other factors, whereas Glaxo took the approach that assessed the price in relation to factors such as its licensing agreements and the value of the right to market under the brand name Zantac, says Adrienne Woodyard of the taxation law group at Davis LLP in Toronto. "The court confirmed that in this case, context is important." What the SCC decided is that it's reasonable from a transfer-pricing perspective to look at the other related agreements the non-arms'-length parties can enter into. "Transfer pricing is the search for a reasonable range rather than the correct price," says Salvatore Mirandola of Borden Ladner Gervais LLP. "In appropriate circumstances it's OK to look at related transactions to determine an appropriate transfer price." The Glaxo decision also signals transfer pricing should be looked at as a valuation and getting the right valuation in the right country is key. "All the Supreme Court did was decide that companies have to look at all the business principles; they just can't isolate the one transaction," says Dale Hill, a partner with Gowling Lafleur Henderson LLP. Hill says the CRA has ramped up resources for transfer pricing audits in the last year and its not alone. Tax authorities around the world are under increasing pressure to reinforce their efforts, as governments grow concerned about eroding revenues. "Auditors seem to be pursuing multinationals [that] engage in transfer pricing with a degree of vigour we have not previously seen," agrees Woodyard. The CRA has 465 full-time staff focused on transfer pricing, according to a recent Ernst & Young study. "It's an enormous amount of resources focused on cross-border transactions between non-arms'-length parties and a lot of those parties are big multinational companies," says Hill. Hill should know. For 16 years he worked at the CRA on transfer pricing audits and negotiated about 400 cases globally before moving to the tax practice at Gowlings eight years ago. "This decision is really about bringing back the business-principle test," says Hill. In Glaxo, "the Supreme Court agreed with the Federal Court and said you have to take into consideration all the business factors. This case will make CRA go back and look at the basic underlying profit of the company and determine whether they are getting enough profit overall on their sales based on their assets, functions, and risks that they are performing in that jurisdiction. What the judge said in Glaxo is you can't just look at the cost of the ranitidine — you have to look at all the intangibles and determine how much profit is made." Woodyard adds: "The court clearly endorsed the notion that transfer pricing is not an exact science. It acknowledged that businesses should be given some leeway in determining their pricing, and that if prices are within a 'reasonable range', the requirements of the legislation will be satisfied." The fear, she says, has been the prospect of the CRA refusing to recognize that its own assessment of a "reasonable" transfer price is not  the only valid one. "After Glaxo, the CRA will not be able to treat its own assessments as if they are written in stone." In any event, with more focus on transfer pricing from the CRA, companies face potentially time-consuming and expensive audits — even where a business has been careful to meet the "contemporaneous documentation" requirement, which is necessary to avoid a non-deductible penalty if the CRA disagrees with its pricing. Another problem for businesses is the potential for double taxation, says Woodyard. If a corporation in Canada pays a fee to its U.S. parent that is higher than the "arms'-length" price, the Canadian company will be denied a deduction to the extent the fee is considered excessive, but the U.S. parent will have already paid tax on the higher amount it received. When this occurs, the parties can request the matter be resolved under the "mutual agreement procedure" found in the applicable tax treaty. Then the two revenue authorities have to try to resolve the question of how to allocate the taxation of profits. If they can't agree, they may have to go to arbitration, which can take years to resolve. www.CANADIAN L a w ye r m a g . c o m Jan uary 2013 49

• Cover