IN THE SUPREME COURT OF CANADA (ON APPEAL FROM THE FEDERAL COURT OF APPEAL) HER MAJESTY THE QUEEN GLAXOSMITHKLINE INC.

Transcription

1 Court File No IN THE SUPREME COURT OF CANADA (ON APPEAL FROM THE FEDERAL COURT OF APPEAL) BETWEEN: HER MAJESTY THE QUEEN - and - GLAXOSMITHKLINE INC. Appellant (Respondent) Respondent (Appellant) FACTUM OF THE APPELLANT ON APPEAURESPONDENT ON CROSS-APPEAL (REDACTED) (Pursuant to Rules 42 and 43 of the Rules o/supreme Court o[canada, S0Rl ) Counsel for the appellant Myles J. Kirvan Deputy Attorney General of Canada Department of Justice Bank of Canada Bui lding East Tower, 9 th Floor 234 Wellington Street Ottawa, Ontario K IA OH8 Per: Wendy Burnham Tel.: (6 13) Fax: (613) wbumham@iusticc.gc.ca Counsel for the respondent Osler, Hoskin & Harcourt LLP Barristers and Solicitors I First Canadian Place Toronto, Ontario M5X 18 8 Per: Tel. : Fax: AI Meghji (416) (416) amcgh; i<?oslclcom Agent for the appellant Department of Justice Bank of Canada Building East Tower, Room Well ington Street Ottawa, Ontario KIA OH8 Per: Christopher Rupar Tel.: (6 13) Fax: (6 13) c h ri~toph e r.ru par@ justice. gc.ca Agent for the respondent Osler, Hoskin & Harcourt LLP Suite Albert Street Ottawa, Ontario KIR 7Y6 Per: Tel.: Fax: Patricia Wilson (613) (613) pwilson@osler.com

2 1 TABLE OF CONTENTS PAGE PART I - STATEMENT OF FACTS... 1 Overview... 1 Background Facts... 2 Proceedings in the courts below... 6 PART II - QUESTIONS IN ISSUE... 9 PART ill - ARGUMENT ARGUMENT ON APPEAL A. Transfer pricing and arm's length principles B. The Federal Court of Appeal's interpretation does not respect the text, context or purpose ofs. 69(2) of the Act (a) l'ext (b) Context and purpose C. The Federal Court of Appeal erred in adopting the Gabco test (a) The Gabco test is incompatible with the arm's length principle (b) Adoption of the Gabco test caused the Federal Court of Appeal to ask the wrong question (i) The Court of Appeal's approach cannot yield an arm's length comparable (ii) The Court of Appeal's question does not respect the separate entity approach (iii) The Court of Appeal ignored the respondent's structure and did not apply the transactional approach..., D. Conclusion RESPONSE ON THE CROSS-APPEAL A. Introduction B. The first argument: the respondent has not discharged the onus C. The second argument: referral to the trial judge does not defeat the limitation periods in the Act D. The Federal Court of Appeal has discretion to refer a matter back PART IV - COSTS PART V - ORDER SOUGHT PART VI - TABLE OF AUTHORITIES PART VII - STATUTES RELIED ON... 43

3 1 PART I - STATEMENT OF FACTS Overview 1. Cross-border transfer pricing within multinational groups - the prices at which an enterprise transfers property or provides services to an associated enterprise - can result in a number of problems for both taxing authorities and for the multinationals themselves. Transfer prices are commonly determined in the absence of market competition and may be set with a view to shifting profits to low-tax jurisdictions. Parliament's response to transfer pricing issues in the years in question included s. 69(2) of the Income Tax Act which deemed the transfer price to be the reasonable arm's length price. In interpreting this provision, however, the Federal Court of Appeal has applied a test that is not compatible with the arm's length principle and has left Canadian jurisprudence at odds with the approach adopted by its partners in the Organization for Economic Cooperation and Development (OECD). 2. The OECD has, for many decades, advocated consistent treatment of cross-border transactions through the application of the arm's length principle. Integral to its application is the requirement that taxing authorities treat members of a multinational group as if they were operating as separate entities rather than as inseparable parts of a single unified business and, ideally, that the standard be applied to each transaction independently of other transactions. As a member of the OECD, Canada adheres to this principle. 3. Between 1990 and 1993, the respondent bought the drug ranitidine from its non-resident sister company for five times the price that two Canadian generic drug companies were paying for the same commodity~ The Minister of National Revenue reassessed to apply s. 69(2) to the purchase, reducing the price to the arm's length price paid by these Canadian companies. The trial judge accepted the comparators chosen by the Minister as appropriate indicators of the arm's length price that was reasonable in the circumstances and, with a slight adjustment, upheld the reassessments. 4. The Federal Court of Appeal overturned the decision of the trial judge. In doing so, it interpreted s. 69(2) in a way that conflicts with the words, context and purpose of the provision and is incompatible with OECD principles. It fell into this error by concluding that the

4 2 "reasonable business person" test articulated in Gabco Limited v. Minister o/national Revenuea case decided for a different purpose under a different provision - applied to detennine the reasonable ann's length amount in a transfer pricing situation. By adopting this test, the court lost sight of the particular transaction and the particular good being transferred and swept into the analysis a number of considerations that have no place in ascertaining what the reasonable price for the purchase ofranitidine would be ifit had been bought on an ann's length basis. 5. This decision is contrary to this Court's statements on the meaning of ann's length and that a taxpayer's transactions are to be respected. It is also contrary to the OECD's approach that the ann's length principle should ideally be applied on a transactional basis. 6. While the Court of Appeal overturned the trial judge's decision, it did not substitute its own opinion as to the transfer price. Instead, it sent the matter back to the trial judge for reconsideration taking into account the circumstances it identified as relevant under the Gabco test. The respondent has cross-appealed on the basis that the Court of Appeal ought to have allowed the appeal and set aside the judgment of the Tax Court alleging that the reassessments were "demolished". Since the Court of Appeal made no finding as to the correctness ofthe reassessments or the factual assumptions underlying the reassessments, the reassessments remained valid. Having decided that the detennination of the transfer price ought to be made by the trial judge who heard the evidence, the Court of Appeal was correct to send the matter back for reconsideration. Background Facts 7. The respondent, GlaxoSmithKline Inc., is the successor corporation of Glaxo Canada, a wholly owned subsidiary of Glaxo Group Limited, a United Kingdom corporation, which, in tum, is wholly owned by Glaxo Holdings pic, also a United Kingdom corporation. Glaxo Holdings pic heads a group of integrated multinational corporations which discover, develop, manufacture and distribute phannaceutical products throughout the world, using both subsidiary companies and unrelated distributors in local markets. I 1 Reasons for Judgment of the Tax Court of Canada (Tax Court Reasons), Appellant's Record, Vol. I, p. 7, para. 10.

5 3 8. In 1972, Glaxo Group Limited and Glaxo Canada entered into a Consultancy Agreement whereby Glaxo Group Limited granted to Glaxo Canada various services and intangibles, including the right to manufacture, use the trademarks, have access to information about, be provided with technical assistance, and sell specified Glaxo Group Limited drugs. Glaxo Canada paid a 5% royalty to Glaxo Group Limited for these intangibles In 1976, Glaxo Group Limited discovered the pharmaceutical ingredient ranitidine, which relieved stomach ulcers without the need for surgery. Ranitidine formulations were approved for sale in Canada in 1981 and were launched for sale by Glaxo Canada in 1982 under the brand name Zantac The primary manufacture of ranitidine within the Glaxo group was undertaken by two subsidiaries of Glaxo Holdings pic, Glaxochem Ltd., based in the United Kingdom, and Glaxo Pharmaceuticals (Pte) Limited, based in Singapore. 4 The profits from the manufacture and sale of ranitidine in Singapore were tax free between 1982 and 1992 and taxed at 10% thereafter Both primary manufacturing companies sold the ranitidine mostly to Adechsa S.A., a related company located in Switzerland. Adechsa, in turn, sold the ranitidine to Glaxo Canada, other related parties and unrelated distributors throughout the world at prices dictated by Glaxo Holdings plc On October 1, 1983, Glaxo Canada signed a Supply Agreement with its sister company, Adechsa, for the purchase of ranitidine. 7 For the years 1990 to 1993, Glaxo Canada paid Adechsa between $1,512 and $1,651 per kilogram for ranitidine. 8 2 Consultancy Agreement dated December 8,1972 between Glaxo Group Limited and Glaxo Canada Inc., Exhibit A-0074, Appellant's Record, Vol. IV, pp Tax Court Reasons, Appellant's Record, Vol. I, p. 5, para Ibid., p. 8, para Ibid., para Ibid., para Supply Agreement dated October 1,1983 between Adechsa and Glaxo Canada - Ranitidine, Exhibit A- 0075, Appellant's Record, Vol. IV, pp Tax Court Reasons, Appellant's Record, Vol. I, p. 6, para. 5.

6 4 13. The average actual cost to Glaxo Phannaceuticals (Pte) Limited of producing ranitidine during the period in question was $146 per kilogram The 1972 Consultancy Agreement with Glaxo Group Limited was amended to add provisions for services and intangibles relating to Zantac. IO 15. On July 1, 1988, the Consultancy Agreement was replaced with a Licence Agreement between Glaxo Canada and its parent, Glaxo Group Limited. In return for paying a royalty of 6% on net sales of drugs, including Zantac, Glaxo Canada received the following services and intangibles: 11 (a) the right to manufacture, use and sell products; (b) the right to the use of the trademarks owned by Glaxo Group Limited, including Zantac; ( c) the right to receive technical assistance for its secondary manufacturing requirements; (d) the use of registration materials prepared by Glaxo Group Limited, to be adapted to the Canadian environment and submitted to the Health Protection Branch; ( e) access to new products, including line extensions; (f) access to improvements in drugs; (g) the right to have Glaxo group companies sell Glaxo Canada any raw materials; (h) marketing support; and (i) indemnification against damages arising from patent infringement actions. 9 Report of Dr. Jack Mintz dated January 10, 2006, Exhibit R-0504, Appellant's Record, Vol. VIII, pp. 42-3, para. 72; Report of Clark Valuation Services Ltd. dated April 15, 2005, Exhibit R-0418, Appellant's Record, Vol. VII, p. 39, Table 2; Transcript of Doug Welsh, April 26, 2006, Appellant's Record, Vol. III, p. 109, p. 113, Consultancy Agreement between Glaxo Group Limited and Glaxo Canada dated December 8, 1972, Exhibit A-0074, Appellant's Record, Vol. IV, pp II Tax Court Reasons, Appellant's Record, Vol. I, p. 9, para. 14; Licence Agreement dated July I, 1988 between Glaxo Group Limited and Glaxo Canada Inc., Exhibit A-0072, Appellant's Record, Vol. IV, pp

7 5 16. The corporate structure of the Glaxo group of companies relevant to this appeal was as follows: 12 Glaxo Holdings pic (United Kingdom) / Glaxo Group Limited Giaxo Far East (Pte) Ltd. (United Kingdom) Clearing Company I (Singapore) ~ ~ Glaxochem Ltd. I Glaxo Canada Adechsa RanitMine Jactory I Clearing Company Glaxo Pharmaceuticals (United Kingdom) (Switzerland) (Pte) Limited RanitMine Jactory (Singapore) 17. During the taxation years in issue, 1990 to 1993, Glaxo Canada remitted withholding tax in respect of the royalties it paid to Glaxo Group Limited under the Licence Agreement for the services and intangibles received, as set out in paragraph 15 above. On the other hand, Glaxo Canada treated the amounts paid to Adechsa for the purchase of ranitidine as fully deductible costs of goods sold. No withholding taxes were remitted in respect of the purchases of ranitidine from Adechsa The tax strategy of Glaxo Holdings pic was to make as much profit in Singapore, tax free, and then to make as much ofthe remainder of the Glaxo group's profit in the United Kingdom. The amounts paid to Adechsa by Glaxo Canada for the purchase of ranitidine basically flowed through Adechsa to Singapore tax free By 1990, two Canadian drug companies, Apotex Inc. and Novopharm Ltd., were selling generic ranitidine formulations in Canada in direct competition with Zantac in the market for anti-ulcer drug therapies. Both companies purchased their ranitidine from arm's length 12 Tax Court Reasons, Appellant's Record, Vol. I, p.76, Appendix III. 13 Ibid., p. 29, para Ibid., p. 8, para. 13 and p. 29, para. 77.

8 6 manufacturers, paying between $194 and $304 per kilogram. 15 Like Glaxo Canada, these companies acquired ranitidine by way of simple purchase and sale agreements, without any intangibles as part oftheir purchase The Minister of National Revenue disallowed the deduction of the price paid to Adechsa in excess of the highest monthly price per kilogram of ranitidine paid by Apotex and Novopharm to their arm's length manufacturers. 17 The disallowance was based on s. 69(2) of the Income Tax Act,18 which applies where a taxpayer is not dealing at arm's length with a non-resident and pays an amount greater than the amount "that would have been reasonable in the circumstances if the non-resident person and the taxpayer had been dealing at arm's length". In such a case, the transfer price is deemed to be the reasonable amount determined on an arm's length basis. Proceedings in the courts below: Tax Court of Canada 21. At trial, the issue was whether the transfer prices for ranitidine applied by the Minister, based on the prices paid in arm's length purchases by Apotex and Novopharm, were appropriate. The respondent argued that Apotex and Novopharm were not good comparators because the ranitidine they purchased was different from Glaxo-manufactured ranitidine and the circumstances surrounding their purchase transactions were different. The respondent urged the court to find that the third party European licensees were the best comparators. 19 Both parties agreed that CUP (comparable uncontrolled price) was the preferred method for determining transfer prices in this case The trial judge accepted the CUP methodology and, after reviewing the evidence in light of the criteria established by the OECD for determining comparability, concluded that Apotex and 15 Ibid., p. 6, para. 6 and p. 12, para Ibid., p. 46, para bid., p. 6, para R.S.C. 1985, c. 1 (5th Supp.), as amended. 19 Tax Court Reasons, Appellant's Record, Vol. I, p. 27, para Ibid., p. 26, para. 64.

9 7 Novophann were appropriate comparators.21 He rejected the respondent's reasons for asserting that they were not. 22 He also rejected the respondent's argument that the European licensees were good comparators, concluding that the European markets and transactions differed significantly from the Canadian markets and transactions and it was not possible to adjust for the differences. 23 In particular, he found that the transactions between Adechsa and the European licensees were fundamentally different from its transactions with Glaxo Canada because the European licensees generally received the ranitidine and a variety of intangibles for a single consideration. 24 He also found that, in any case, the respondent had not established the transfer price to the European licensees The respondent's reliance on the European licensees as comparators required it to argue that what was at issue was the cost of selling Zantac in Canada (i.e., including the cost of the intangibles and not just the cost of purchasing the commodity, ranitidine). 26 The respondent's expert, Dr. Ballentine, bundled the royalty payments that Glaxo Canada made to Glaxo Group Limited under the Licence Agreement with the transfer price it paid to Adechsa under the Supply Agreement in order to attempt to achieve comparability The trial judge concluded that the only transaction in issue was the purchase of ranitidine under the Supply Agreement, unencumbered by intangibles which were acquired and paid for in a separate transaction with a different party.28 There was no issue concerning the royalty amount paid for the intangibles under the Licence Agreement. The Supply Agreement and the Licence Agreement covered separate matters; each stood alone and was to be considered independently With a $25 per kilogram adjustment for granulation in the respondent's favour. 22 Tax Court Reasons, Appellant's Record, Vol. I, pp , paras Ibid., p. 47, para Ibid., p. 48, para Ibid., p. 47, para Ibid., p. 28, para Ibid., p. 28, para. 75 and p. 48, para Ibid., p. 10, para Ibid., p. 28, para. 74, p. 29, para. 78 and p. 30, para. 79.

10 8 Federal Court of Appeal 25. At the Federal Court of Appeal, the respondent argued, for the first time, that in order to determine the transfer price under s. 69(2) of the Act, it was necessary to interpret the words "reasonable in the circumstances" in accordance with the reasonable business person test articulated by the Exchequer Court in Gabco Limited v. Minister o/national Revenue. 3o The court agreed and formulated the question to be "whether an arm's length Canadian distributor of Zantac would have been willing, taking into account the relevant circumstances, to pay the price paid by the appellant [Glaxo Canada] to Ade.chsa" The court concluded that the trial judge erred in applying the "fair market value" as evidenced by the Apotex and Novopharm purchases ofranitidine and in ignoring the Licence Agreement. 32 It listed five relevant circumstances - all arising from the Licence Agreement or Glaxo Canada's position in the Glaxo group - that it held had to be considered in determining whether a distributor of Zantac would have been willing to pay the price the respondent paid. 33 It allowed the appeal and remitted the matter back to the Tax Court for reconsideration Gabco Limited v. Minister o/national Revenue, 68 DTC 5210 at 5216 (Ex. Ct.) (Appellant's Book of Authorities, Tab 8). 31 Reasons for Judgment of the Federal Court of Appeal (Federal Court of Appeal Reasons), Appellant's Record, Vol. I, p. 110, para Ibid., p. 108, para Ibid., p. 109, para Ibid., p. 111, para. 82 and p. 112, para. 84.

11 9 PART II - QUESTIONS IN ISSUE 27. Did the Federal Court of Appeal err by applying the reasonable business person test to the interpretation of s. 69(2) of the Act? 28. Did the Federal Court of Appeal err in interpreting s. 69(2) by failing to apply the ann's length principle on a transaction-by-transaction basis and on the basis that members ofthe multinational group are operating as separate entities? 29. In the cross-appeal, did the Federal Court of Appeal err in ordering that the matter be returned to the trial judge for further determination?

12 10 PART III - ARGUMENT 1. ARGUMENT ON THE APPEAL A. Transfer pricing and arm's length principles 30. Transfer prices are defmed by the OECD as "the prices at which an enterprise transfers physical goods and intangible property or provides services to associated enterprises".35 Shared interests of members of a multinational group can result in the avoidance of tax through price distortions in transactions between members. 36 Since transfer prices within the group are determined in the absence of market competition, they are often set with a view to transferring profits to low-tax jurisdictions in order to minimize tax payable. Pricing decisions within a multinational group, therefore, can have a significant impact upon the profits of an individual member of the group and upon the tax revenues of the country in which it operates. 31. While transfer pricing is an international problem, and one which the OECD member countries have tackled through agreement on certain basic principles, nevertheless it is the responsibility of each country to legislate its own solutions within its taxation regime consistent with these principles. For the taxation years in issue in this case to s. 69(2) of the Act was Canada's transfer pricing provision intended to ensure that the amount a taxpayer paid or agreed to pay to a non-resident for a particular good or service may not, for tax purposes, exceed a reasonable arm's length price. 37 Although s. 69(2) has since been replaced by s. 247(2), effective for the 1998 and subsequent taxation years, both provisions incorporate the arm's length principle. Section 69(2) stated: 69. (2) Where a taxpayer has paid or 69. (2) Lorsqu'un contribuable a paye ou agreed to pay to a non-resident person est convenu de payer it une personne nonwith whom the taxpayer was not dealing residente avec qui i1 avait un lien de 35 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD: July 1995), preface, para. 11 (Appellant's Book of Authorities, Tab 32). 36 The Queen v. General Electric Capital Canada Inc., 2010 FCA 344 at para. 55,2011 DTC 5011 (Appellant's Book of Authorities, Tab 9); Report of the Royal Commission on Taxation, Vol. 4 (1966), p. 561 (Appellant's Book of Authorities, Tab 31); Report of the OECD Committee on Fiscal Affairs, entitled "Transfer Pricing and Multinational Enterprises" (OECD: 1979), preface, paras. 2-3 (Appellant's Book of Authorities, Tab 30). 37 Information Circular 87-2, International Transfer Pricing and Other International Transactions (IC 87-2), para. 6 (Appellant's Book of Authorities, Tab 33).

13 11 at arm's length as price, rental, royalty or dependance, soit a titre de prix, loyer, other payment for or for the use or redevance ou autre paiement pour un bien reproduction of any property, or as ou pour l'usage ou la reproduction d'un consideration for the carriage of goods or bien, soit en contrepartie du transport de passengers or for other services, an.marchandises ou de voyageurs ou d'autres amount greater than the amount (in this services, une somme superieure au subsection referred to as "the reasonable montant qui aurait ete raisonnable dans amount") that would have been les circonstances si la personne nonreasonable in the circumstances if the residente et Ie contribuable n'avaient eu non-resident person and the taxpayer had aucun lien de dependance, ce montant been dealing at arm's length, the raisonnable est repute, pour Ie calcul du reasonable amount shall, for the purpose revenu du contribuable en vertu de la of computing the taxpayer's income presente partie, correspondre a la somme under this Part, be deemed to have been ainsi payee ou payable. [Non souligne the amount that was paid or is payable dans l'original] therefor. [Emphasis added] 32. The Minister detennined that the provision was engaged in this case because Glaxo Canada paid to Adechsa (a non-resident with whom it was not dealing at ann's length) a price for the purchase of ranitidine that was greater than "the reasonable amount" - being the amount "that would have been reasonable in the circumstances if... [Adechsa] and... [Glaxo Canada] had been dealing at ann's length". The Minister reassessed the respondent to disallow the portion of the price that exceeded that reasonable ann's length price. 33. The trial judge upheld the Minister's assessment except for a small adjustment of $25 per kilogram to reflect the cost of granulation of the ranitidine. However, the Federal Court of Appeal applied the test of the reasonable business person in interpreting s. 69(2) and concluded that the question to be asked was "whether an ann's length Canadian distributor ofzantac would have been willing, taking into account the relevant circumstances, to pay the price paid by the appellant [Glaxo Canada] to Adechsa" In adopting a test developed under s. 67 of the Act (limiting deductible expenses to those that are "reasonable in the circumstances"), the Court of Appeal has failed to interpret the words of s. 69(2) in a manner consistent with this Court's directions on statutory interpretation. As a result, the decision is incompatible with a proper interpretation of the provision and with Canada's commitment to adhere to the transfer pricing principles adopted by the OECD member countries. 38 Federal Court of Appeal Reasons, Appellant's Record, Vol. I, p. 107, para. 71 and p. 110, para. 81.

14 12 B. The Federal Court of Appeal's interpretation does not respect the text, context or purpose of s. 69(2) of the Act 35. It is now well-established that in interpreting the words of a statute, it is necessary to detennine the intention of the legislator by considering the text, context, and purpose of the provisions at issue. 39 Where the words of a statute are clear and unequivocal, those words will playa dominant role in the interpretative process. Where the words of a statute give rise to more than one reasonable interpretation, the ordinary meaning of words will playa lesser role, and greater recourse to the context and purpose ofthe Act may be necessary.40 (a) Text 36. The issue is what interpretation ought to be given to the words "reasonable in the circumstances if the non-resident person and the taxpayer had been dealing at arm's length". By using these words, Parliament has clearly indicated its intention that the price for cross-border goods and services between related entities - " the reasonable amount" - must be detennined on the basis of the ann's length principle. 37. The arm's length concept has been in the Act for many years and was considered by this Court in 1972 in Swiss Bank 41 and more recently in McLarty.42 In both cases, this Court described an ann's length transaction as one that "will reflect ordinary commercial dealing between parties acting in their separate interests". The "reasonable amount" for purposes of s. 69(2) is, therefore, the amount at which parties acting in their separate interests in ordinary commercial dealing would transact. To use the words of the trial judge in a recent transfer pricing case: Lipson v. Canada, 2009 SCC 1 per Lebel J. at para. 26, [2009] 1 SCR 3 (Appellant's Book of Authorities, Tab 12). 40 Placer Dome Canada Ltd. v. Ontario (Minister of Finance), 2006 SCC 20 per Lebel J. at para. 22, [2006] 1 SCR 715 (Appellant's Book of Authorities, Tab 15). 41 Swiss Bank Corp. et al. v. Minister of National Revenue, [1974] SCR 1144 at 1152 (Appellant's Book of Authorities, Tab 24). ' 42 Canada v. McLarty, 2008 SCC 26 at para. 43, [2008] 2 SCR 79 (Appellant's Book of Authorities, Tab 4). 43 General Electric Capital Canada Inc. v. The Queen, 2009 TCC 563 at para. 196,2010 DTC 1007 (Appellant's Book of Authorities, Tab 9).

15 13... the concept of "dealing at arm's length" used in the context of the transfer pricing rules to determine a market price for a transaction refers to how independent parties negotiating with each other in the marketplace would behave -- the vendor or service provider, for the purpose of achieving the highest price or best terms for his goods or services, and the other party, the purchaser, for the purpose of acquiring the goods or services at the lowest price. 38. The words of s. 69(2) also indicate Parliament's intention that the arm's length principle be applied separately to each price paid: "where a taxpayer has paid... as price... for... property... the reasonable amount shall... be deemed to have been the amount that was paid...". That is to say, s. 69(2) requires taxpayers to treat each purchase of a particular good or service as a discrete transaction for purposes of applying the arm's length principle. 39. On the facts in this case, the question becomes what price would Glaxo Canada pay to buy ranitidine in a hypothetical arm's length transaction in which the vendor and purchaser were acting in their separate interests - Adechsa seeking the highest price and Glaxo Canada seeking the lowest price. (b) Context and purpose 40. The mischief Parliament was addressing with s. 69(2) - the problem of transfer pricing - is an important element in the interpretation of the provision. As indicated above in paragraph 30, multinational corporations can, through transfer pricing, distort prices as between members of the group. For a national tax authority, the concern is that the appropriate income and expenses of a company that is part of a larger multinational group be taken into account in its jurisdiction Canada's response was to deem the transfer price to be the reasonable arm's length price. This solution was in keeping with her obligations as a member of the oecn 45 and its Model Tax 44 Transfer Pricing Guidelinesfor Multinational Enterprises and Tax Administrations (OECD: July 1995) preface, para. 2 (Appellant's Book of Authorities, Tab 32). 45 See OECD Council recommendation of May 16, 1979 attached as an annex to Report of the OECD Committee on Fiscal Affairs, entitled "Transfer Pricing and Multinational Enterprises" (OECD: 1979), pp (Appellant's Book of Authorities, Tab 30); OECD Council recommendation of July 13, 1995 in Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD: July 1995), pp. A-I to A3 (Appellant's Book of Authorities, Tab 32); Article 5(b) of the OECD Convention (Appellant's Book of Authorities, Tab 28); and paragraph 18(b) of the OECD Rules of Procedure (Appellant's Book of Authorities, Tab 29).

16 14 Convention on Income and on Capital. 46 The central tenet of the international transfer pricing regime is the arm's length principle. Article 9(1) of the Model Tax Convention, which has remained unchanged since it was introduced in 1963, describes the principle in terms of "independent enterprises".47 It reads, in part, as follows: 48 [Where] conditions are made or imposed between... two [related] enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly. 42. In addition to the Model Tax Convention, the OECD has issued commentaries on Article 9(1) in respect to transfer pricing principles and methodologies: the principal report being issued in 1979,49 followed by a more comprehensive commentary or guidelines in As noted by the trial judge, these documents (referred to as commentaries for simplicity) are reflected in CRA's Information Circular 87-2, International Transfer Pricing and Other International Transactions 51 and form the basis of the Minister's assessing policy with respect to transfer pricing Model Tax Convention on Income and on Capital (OEeD, 1997) (Appellant's Book of Authorities, Tab 27). 47 Report of the OECD Committee on Fiscal Affairs, entitled "Transfer Pricing and Multinational Enterprises" (OEeD: 1979), p. 57, footnote 2 (Appellant's Book of Authorities, Tab 30). 48 Model Tax Convention on Income and on Capital (OEeD, 1997) (Appellant's Book of Authorities, Tab 27). 49 Report of the OECD Committee on Fiscal Affairs, entitled "Transfer Pricing and Multinational Enterprises" (OEeD: 1979) (Appellant's Book of Authorities, Tab 30). 50 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OEeD: July 1995) (Appellant's Book of Authorities, Tab 32). 51 Dated February 2, 1987 and replaced on September 27, 1999 by Information Circular 87-2R, International Transfer Pricing (IC 87-2R). 52 Tax Court Reasons, Appellant's Record, Vol. I, p. 23, para. 59; IC 87-2R, para. 4 (Appellant's Book of Authorities, Tab 27).

17 The parties were in agreement in the courts below, and the courts accepted, that the interpretation and application ofs. 69(2) of the Act is informed by the OECD commentaries,53 a position consistent with this Court's endorsement of their use in treaty interpretation. 54 Although the 1995 commentary postdates the years under appeal, both parties and the trial judge relied on it, the trial judge noting that it was more detailed and provided more examples than the 1979 commentary and that neither party could point to any inconsistencies with its predecessor. 55 A further revision was issued in 2010 but it contains no changes which are relevant to the circumstances of this appeal. 44. According to the 1995 commentary, the OECD endorses the arm's length principle because it produces "appropriate levels of income between members of... [multinational groups], acceptable to tax administrations".56 It achieves this by providing "the closest approximation of the workings of the open market in cases where goods and services are transferred between associated enterprises".57 It has been accepted worldwide as the international norm and is included in most Canadian tax treaties In order to ensure that the arm's length principle is applied in a way that minimizes the risk of double taxation, the OECD members have accepted that fundamental to the principle is the 53 See also SmithKline Beecham Animal Health Inc. v. R., 2002 FCA 229 at para. 8, [2002] 4 CTC 93 (Appellant's Book of Authorities, Tab 22). 54 Crown Forest Industries Ltd. v. Canada, [1995] 2 SCR 802 at paras (Appellant's Book of Authorities, Tab 6); see also Prevost Car Inc. v. Canada, 2009 FCA 57 at paras. 8-12, [2010] 2 FCR 65 (Appellant's Book of Authorities, Tab 16). 55 Tax Court Reasons, Appellant's Record, Vol. I, p. 31, para Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD: July 1995), para (Appellant's Book of Authorities, Tab 32). 57 Ibid. 58 Li, Jinyan et ai., International Taxation in Canada: Principles and Practices, Lexis Nexis p (Appellant's Book of Authorities, Tab 26); see also, DSG Retail Ltd. v. Revenue and Customs Commissioners, [2009] UKFTT 31 (TC) (Appellant's Book of Authorities, Tab 7); Bausch & Lomb Inc. v. Commissioner, (1989) 92 T.C. 525; affirmed at 933 F.2d 1084 (U.S. Court of Appeals for the Second Circuit) (Appellant's Book of Authorities, Tab 2); Xilinx, Inc. v. Commissioner, 598 F.3d 1191 (U.S. Court of Appeals for the Ninth Circuit) (Appellant's Book of Authorities, Tab 25); Serdia Pharmaceuticals (India) Private Limited v. Assistant Commissioner of Income Taxation, ITA nos Muml06, 3032IMuml07 and 2531IMuml08 (Appellant's Book of Authorities, Tab 19); Roche Products Pty Limited v. Commissioner of Taxation, [2008] AATA 639 (Appellant's Book of Authorities, Tab 17); Commissioner o/taxation v. SNF (Australia) Pty Ltd. [2011] FCAFC 74 (Appellant's Book of Authorities, Tab 5).

18 16 assumption that each member of a multinational group is to be treated as a separate entity rather than as an inseparable part of a single unified business and is subject to tax on the income arising to it. 59 In this way, considerations which relate to its relationship within the multinational group that would not be present in an open market transaction can be elimina!ed. 6o Attention is thus focused on the nature of the dealings between those members and the particular transaction generating the inquiry As well, integral to the arm's length principle is the application of the transactional approach. As stated in paragraph 1.42 of the OECD's 1995 commentary "[i]deally, in order to arrive at the most precise approximation of fair market value, the arm's length principle should be applied on a transaction-by-transaction basis".62 As indicated above, the words of s. 69(2) require that each transfer is to be treated as a separate transaction Under the transactional approach, generally the structure of the actual transaction should be respected. In exceptional circumstances, outlined in the same commentary, the transaction can be recharacterized, but none of those exceptions is applicable in this case. 64 At paragraph 1.36 of the commentary the OECD states: A tax administration's examination of a controlled transaction ordinarily should be based on the transaction actually undertaken by the associated enterprises as it has been structured by them, using the methods applied by the taxpayer insofar as these are consistent with the methods described in Chapters II and III.[... ] This is consistent with this Court's approach in cases such as Shell Canada and Singleton Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (DECD: July 1995), preface, para. 5; para. 1.6 (Appellant's Book of Authorities, Tab 32). 60 Ibid., preface, para Ibid., paras. 1.6, Ibid., para See above, para Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (DECD: July 1995), para (Appellant's Book of Authorities, Tab 32). 65 Shell Canada Ltd. v. Canada, [1999] 3 SCR 622 at para. 39 (Appellant's Book of Authorities, Tab 20); Singleton v. Canada, 2001 SCC 61 per Major 1. at para. 34, [2001] 2 SCR 1046 (Appellant's Book of Authorities, Tab 21).

19 Consistency in application of the ann's length principle throughout the international community results in advantages for both states and taxpayers. One of its major advantages is that it provides broad parity of tax treatment between multinational entities and independent enterprises. 66 As well, it provides assurance both to national tax authorities that appropriate amounts are being reported in their jurisdictions and to the multinational corporations that they will not be subject to double taxation, as can happen if different tax authorities take different views of the adjustments which ought to be made for the purposes of computing tax liability A proper interpretation of s. 69(2) requires that it be interpreted in the context of the problem the provision was intended to address - namely, the issues arising froln transfer pricing. There has been no suggestion by either party or the courts below that s. 69(2) is incompatible with the OECD principles nor that these principles should not be followed. A proper interpretation requires that the transfer price be an arm's length price determined on the assumption that the non-resident and the taxpayer are operating as separate entities, that the inquiry focus on the particular transaction in issue and that the structure adopted by the taxpayer be respected by the taxing authorities. The trial judge's interpretation is a textual, contextual and purposive interpretation of s. 69(2) compatible with Canada's commitment to apply these principles. The Federal Court of Appeal's interpretation is not. C. The Federal Court of Appeal erred in adopting the Gabco test 50. The test endorsed by the Federal Court of Appeal is not compatible with the application of the arm's length principle expressly mandated in s. 69(2). For that reason, it is not an appropriate mechanism for ascertaining "the reasonable amount" for purposes of a transfer pricing adjustme.nt under that provision. It is also not consistent with the OECD requirements that in applying that principle the focus must ideally be restricted to the particular transaction, the purchase of ranitidine Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD: July 1995), para. 1.7 (Appellant's Book of Authorities, Tab 32). 67 Ibid., preface, para. 12; Report of the aecd Committee on Fiscal Affairs, entitled "Transfer Pricing and Multinational Enterprises" (OECD: 1979), para. 32 (Appellant's Book of Authorities, Tab 30). 68 See above, para. 46.

20 The court applied the reasonable business person test enunciated by the Exchequer Court in 1968 in Gabco Limited. 69 The issue in that case was whether the remuneration paid to one of the company's employees (who was also one of the two principal shareholders and the younger brother of the managing shareholder), and deducted by the company in computing its income, was "reasonable in the circumstances" under s. 12(2) of the Act (now s. 67). The court formulated the test as follows: 70 It is not a question of the Minister or [t]his court substituting its judgment for what is a reasonable amount to pay, but rather a case of the Minister or the Court coming to the conclusion that no reasonable business man would have contracted to pay such an amount having only the business consideration of the appellant in mind. In concluding that the amounts paid were reasonable, the court looked at all of the circumstances and stated that the company was not restricted to payment commensurate with the work done, but could also take into account other considerations such as expected future benefits that would accrue to the company as a result of having the younger brother involved in the business. Under s. 67, it is not for the Minister or the courts to second-guess a taxpayer's business judgment. Providing the judgment is reasonable having only the business considerations of the taxpayer in mind, s. 67 will not apply to disallow the deduction. (a) The Gabcotest is incompatible with the arm's length principle 52. While the courts have accepted the Gabco test as an appropriate test to determine whether an outlay or expense is "reasonable in the circumstances" under s. 67 ofthe Act/ 1 prior to the Federal Court of Appeal's decision in this case, the test had not been applied in any case to interpret "the reasonable amount" in s. 69(2). Although the Court of Appeal referred to the Tax Court case of Safety Boss, in support of its conclusion that the Gabco test should govern in 69 Gabco Limited v. The Minister o/national Revenue, 68 DTC 5210 (Ex. Ct.) (Appellant's Book of Authorities, Tab 8). 70 Ibid., at Petro-Canada v. Canada, 2004 FCA 158 at para 62, 2004 DTC 6329 (Appellant's Book of Authorities, Tab 14); see also, Federal Court of Appeal Reasons, Appellant's Record, Vol. I, p. 107, para. 72.

21 19 matters arising under s. 69(2), no such determination was made by the Tax Court in that case.72 Furthermore, in Shell Canada Ltd., this Court noted that "Parliament intended s. 67 to apply primarily to those deductions claimed under the provisions of the Act that do not have their own internal limiting clauses" and that s. 67 could not apply in such a case "without distorting the plain meaning of the more specific provision".73 Since s. 69(2) is a specific provision with its own internal limiting clause, it is not appropriate to interpret it by applying a test developed under the more general s. 67. As indicated below, application ofthe Gabco test does, in fact, distort the meaning of s. 69(2). 53. The analysis required under s. 69(2) is very different from the s. 67 analysis; the former requires a determination of the arm's length price, the latter does not. As the words in s. 69(2) make clear, the question is not simply whether the price paid was "reasonable in the circumstances", but "reasonable in the circumstances if the non-resident person and the taxpayer had been dealing at arm's length". The Court of Appeal appears to have focused only on the words "reasonable in the circumstances" and, at best, paid lip service to the arm's length requirement. 54. The facts of Gabco itself illustrate that the situation of the reasonable business person is not the same as that of ordinary commercial dealing between parties acting in their separate interests. In Gabco, the court held that the remuneration paid to the younger brother was reasonable even though it did not reflect payment commensurate with the work done as one would expect in an arm's length relationship. Under the reasonable business person test, there may be other considerations that affect the reasonableness in the circumstances - considerations that would not be present in an analysis of an arm's length situation. 55. For evidence in this case of such considerations, one need look no further than the example cited by the trial judge in which Glaxo Canada was offered the opportunity to buy ranitidine from 72 Federal Court of Appeal Reasons, Appellant's Record, Vol. I, p. 106, para. 71; Safety Boss Limited v. The Queen, 2000 DTC 1767 at paras (TCC), [2000] 3 CTC 2497 (Appellant's Book of Authorities, Tab 18). 73 Shell Canada Ltd. v. Canada, [1999] 3 SCR 622 at para. 51 (Appellant's Book of Authorities, Tab 20).

22 20 ACIC (a non-glaxo source) at a significantly lower cost than ranitidine from Adechsa. 74 The respondent and its parent decided not to make the purchase, expressing concern, inter alia, that such a purchase would jeopardize Glaxo group's worldwide transfer pricing strategy.75 The decision may well have been a rational one. However, Glaxo group's transfer pricing strategy is not a circumstance that is relevant in determining an arm's length price. 56. Under s. 69(2), the price deemed to be the transfer price is not the price that a reasonable business person in his circumstances would consider reasonable - it is the price that a purchaser in an arm's length transaction would pay. Unlike s. 67, where the inquiry into reasonableness determines whether, in all of the circumstances, the amount is reasonable, in s. 69(2) Parliament has mandated that the Minister and the courts must limit their analysis to those circumstances which would be considered if the parties were dealing at arm's length. This is done by comparing the price paid in a similar arm's length transaction with the price paid by the taxpayer or by other methods appropriate in the circumstances. 57. Paragraph 1.15 of the OECD's 1995 commentary states that the application of the arm's length principle is generally based on a comparison of the conditions in a controlled transaction with the conditions in transactions between independent enterprises. 76 The deeming provision in s. 69(2) reflects the need to determine what the comparable arm's length price would be. Indeed, the OECD commentaries provide explicit guidelines on the methodology acceptable to ensure that the arm's length principle is applied. In this case, the parties' experts agreed that the appropriate methodology was the CUP (comparable uncontrolled price) methodology but disagreed as to which CUP was comparable. 77 For both parties, however, the issue at trial was to find an arm's length price for the purchase ofranitidine that could be used as a comparator with the price paid by Glaxo Canada to Adechsa. It was not, as the Federal Court of Appeal would require, to determine whether the price the respondent paid was reasonable given the circumstances arising from the Licence Agreement. 74 Tax Court Reasons, Appellant's Record, Vol. I, p. 17, para Ibid. 76 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (DECO: July 1995), para (Appellant's Book of Authorities, Tab 32). 77 See above, paras

23 The reasonable business person analysis does not require the use of a comparable arm's length transaction. A price may be reasonable under the Gabco test, but not necessarily be an arm's length price. Applying the Gabco test to the facts in this case, as the Federal Court of Appeal would do, can only tell us whether it mayor may not have been reasonable for Glaxo Canada, given all its circumstances (including those arising from its Licence Agreement with its parent) to agree to pay the price for ranitidine dictated by Glaxo Holdings pic. It can tell us nothing about what the arm's length price for the simple purchase of ranitidine would be in the open market. (b) Adoption of the Gabco test caused the Federal Court of Appeal to ask the wrong question 59. Having decided that the appropriate test was the reasonable business person test, the Federal Court of Appeal incorrectly concluded that the trial judge was required "to determine whether an arm's length Canadian distributor of Zantac would have been willing, taking into account the relevant circumstances, to pay the price paid by the appellant to Adechsa.,,78 It stated: 79 In a real business world, presumably an arm's length purchaser could always buy ranitidine at market prices from a willing seller. However, the question is whether that arm's length purchaser would be able to sell his ranitidine under the Zantac trademark. In my view, as a result of the approach which he took, the Judge failed to consider the business reality which an arm's length purchaser was bound to consider if he intended to sell Zantac. [emphasis added] The court concluded that the trial judge erred by "iglloring" the circumstances arising from the Licence Agreement with Glaxo Group Limited which it viewed as "a crucial consideration" in ascertaining the arm's length price for the ranitidine purchased from Adechsa For the years under appeal, Glaxo Canada was subject to two distinct contractual agreements with respect to ranitidine. 81 The first was a Licence Agreement with its parent Glaxo 78 Federal Court of Appeal Reasons, Appellant's Record, Vol. I, p. 110, para Ibid., p. 108, para Ibid., p. 108, para. 78 and p. 110, para Tax Court Reasons, Appellant's Record, Vol. I, p. 9, para. 14.

24 22 Group Limited signed in 1988 (replacing an earlier 1972 agreement) in which Glaxo Canada acquired a number of services and intangibles from its parent in return for payment of a 6% royalty on net sales of drugs. The services and intangibles included, inter alia, the right to manufacture, use and sell products and to use trademarks owned by Glaxo Group Limited, including Zantac. 82 Although there was no express term in the contract that Glaxo Canada was required to purchase ranitidine or any other active ingredient from a Glaxo-approved source, the trial judge found that such a requirement did, in fact, apply to the agreement The second contract was a Supply Agreement with Adechsa, a Swiss-based Glaxo clearinghouse for the sale ofranitidine to the local Glaxo companies, including Glaxo Canada. 84 Under this contract, Glaxo Canada purchased ranitidine at a price set by Glaxo Holdings plc. 85 The trial judge found as a fact that the only item of value received by Glaxo Canada under the Supply Agreement was ranitidine The Minister's reassessment adjusted the price paid by Glaxo Canada for the purchase of ranitidine under the Supply Agreement; the royalty rate applicable to the services and intangibles under the Licence Agreement was not in issue. In fact, the respondent's expert at trial testified that he had seen no evidence to suggest that the royalty rate was an inadequate return to Glaxo Group Limited. 87 The only transaction in issue is the purchase of ranitidine and the only parties involved are Glaxo Canada and Adechsa. 63. By adopting the Gabco test of the reasonable business person, the court was misled in formulating the question as it did. The inquiry it advocates is not consistent with s. 69(2) nor with OECD principles. In particular, the court's question cannot provide the objective comparables required to determine whether the prices paid to Adechsa are arm's length; nor does it respect the separate entity or transaction-by-transaction approaches. 82 Ibid.; for the complete list, see above, para Ibid., p. 32, para. 86; p. 33, para Ibid., p. 8, para Ibid., p. 10, para Ibid., p. 10, para Transcript of Dr. Bell, April 4, 2006, Appellant's Record, Vol. III, p. 106, lines 10-22; see also, Transcript of Dr. Ballentine, April 6, 2006, Appellant's Record, Vol. III, pp , p. 3320,1. 7 to 3321,