Case Comment: GlaxoSmithKline Inc. (FCA) - Elusive Valuations of Bundled Transactions: Defining a Standard of Reasonableness in Transfer Pricing

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Introduction

The task of making valuations for transfer pricing involving bundled transactions has always been a daunting one. Placing dollar figures on exchanges between related companies for transactions incorporating a combination of goods, services, and intangibles is a considerable challenge for even the most well-versed tax practitioners.

Adding to the difficulty of making accurate assessments of these transactions is the unavailability of appropriate comparators. Often, due to the uniqueness and the exclusive nature of the combination being exchanged between non-arm's length companies (especially in the case of intellectual property rights), finding the "fair market value" may be impossible to do with any precision.

In the Federal Court of Appeal's recent decision, GlaxoSmithKline Inc. v. The Queen1, light was shed on the standard of reasonableness to be applied to such transfer pricing cases. The Court acknowledged that determinations of what is "reasonable" cannot be reduced to mechanized, formulaic assessments. The real-world business circumstances in which corporations operate should not be divorced from evaluations of whether or not the transfer prices paid were reasonable. To allow otherwise would be to condone a specious appraisal of fair market value in lieu of a genuine acknowledgement of the conditions under which multinational entities do business.

Background

Transfer pricing is defined as "the price that a member of a multinational group charges a foreign related party for goods, services and/or intangibles."2 With increasing globalization, the Canada Revenue Agency (the "CRA"), along with taxing authorities in other countries, has grown concerned by the potential for members of multinational entities ("MNEs") to erode the tax base by transferring profits to jurisdictions with lower tax rates, or to entities that have previously suffered losses.3

In an effort to combat these downward forces on the tax base, government authorities in Canada have established transfer pricing regulations that seek to ensure transfer pricing is not used as a mechanism for tax avoidance by MNEs. Where the CRA determines that a company has priced an inter-company transaction artificially low or high, it can reassess the transaction and in some instances impose a penalty equal to 10% of the transfer pricing adjustment.4

In order to decrease the potential for CRA scrutiny, the prices paid for goods, services and intangible assets, exchanged between related entities, should accurately reflect arm's length standards.5 Difficulty arises in making determinations of what price would prevail in the market in situations where the goods, services, or assets being exchanged are not made available to independent third parties. A further complication is that transfer pricing often involves "bundled transactions", scenarios in which a number of transactions for an assortment of goods, services, and intangibles are combined.6

In GlaxoSmithKline Inc., the issue under...