In the wake of the recent Ted Opitz case, in which the Supreme Court of Canada issued a bizarrely partisan split ruling, written by two Harper appointees to the nation’s highest bench, accusing Liberals of trying to undermine democracy, I thought it would be useful to take a quick look at another recent ruling by the Supreme Court, also on a subject of some importance for Canadians. This one has to do with multinational corporations and tax laws. It’s an important subject. As I noted recently, since 1995, around one-third of Canada’s largest corporations have been bought out by foreign multinationals, mostly American and European.
This case has to do with pharmaceutical giant GlaxoSmithKline, which was charged by the Canadian Revenue Agency with what appears to be a form of tax avoidance.** In particular, between 1990 and 1993, Revenue Canada noticed that GlaxoSmithKline Canada was importing an anti-ulcer drug called Zantac (ranitidine) from a fellow GSK affiliate Adechsa and made in Singapore, at around $1600 per kilogram. In contrast, generic drug companies were purchasing the same active ingredient for around $200-$300 per kilogram.
Was GSK just getting a raw deal? Revenue Canada apparently didn’t think so. The corporate tax rate in Singapore was much lower, and GSK wasn’t paying taxes on the cost of the drug imports. They reassessed GSK’s taxes and charged them as though the difference between the book price one GSK subsidiary paid to another GSK subsidiary ($1600 per kg) and the real estimated value of the drug (up to $300 per kg). The total difference was about $50 million in taxes, spread out over three years.
We should cut through the medicalese to explain the point here. What Revenue Canada is concerned about is what could best be described, in hypothetical terms, as a tax evasion scheme — sort of ultra-white-collar corporate money laundering. The corporate tax rate in Country A is (say) 25%. But the tax rate in Country B is 5%. So Big Multinational Corporation’s subsidiary in Country A buys its goods from Big Multinational Corporation’s subsidiary in Country B at an exorbitantly inflated price. The Country A company writes off the expensive import on their taxes, and the Country B company reports it as income at the much lower tax rate. Presto: instant savings.
It’s possible, of course, that GSK was quite honestly using an internal revenue sharing formula because from their perspective, it doesn’t really matter. But Revenue Canada went after them because this appears to be a very easy way for corporations to escape paying taxes on sales in developed countries, including Canada. The fact that GSK did this with respect to ranitidine, between 1990 and 1993, suggests they do it with other drugs, both then and since. The fact that GSK does it suggests that other drug companies do it. The fact that drug companies do it suggest that other industries do it. And so on. I suspect it’s quite common. The transfer pricing problem is well recognized internationally; you can read more about it here. Governments try to restrict the practice, but lawsuits like this one suggest their efforts haven’t been entirely successful.
Is this wrong? I guess it depends on your perspective. It’s certainly a right that individuals as taxpayers don’t have. The precise equivalent would be if you had the right to split yourself into two legal persons, one of them resident in a high-tax province and one of them resident in a low-tax province, and then juggle your incomes between your split personalities in order to maximize your tax benefits.
Naturally, GSK didn’t agree with Revenue Canada. They appealed to the Tax Court, which ruled on it in 2008 (15 years after the fact… and now, we’re almost 20 years after the fact. Justice moves quick when you’re rich, no?) The Tax Court ruled in favour of the government and ordered GSK to pay up. Naturally, GSK appealed. At the federal court of appeal, they won a partial victory: the court didn’t agree that they should be acquitted outright, but it did agree that they shouldn’t have to pay the full difference between the trade value of the drugs as acquired by other companies and the book value which GSK Canada paid to GSK’s Adechsa. So the matter wound up in the Supreme Court.
Which, for the most part, agreed with GSK. GSK doesn’t need to pay the real market value of ranitidine, they agree, because it wasn’t just acquiring the drugs: it had a “license agreement” under which it was paying for a range of other more intangible benefits, like research, the Zantac trademark, etc. In essence, it agreed that when the local subsidiary of a major multinational corporation buys a drug from another subsidiary abroad of that same major multinational corporation, it’s entirely appropriate that it would be “charged” more for the drug because multinational companies have more brand names and research labs than their generic competitors do.
There’s a sense in which this sort of transfer pricing is unobjectionable. (From a legal perspective, apparently it’s completely unobjectionable, and we should respect that.) From a public policy perspective, however, I think it’s obvious why the Canadian government needs to change the tax code to eliminate this sort of behaviour. From the parent company’s perspective (e.g. GSK), it makes very little difference how the transfer prices are set. The manufacturing company could charge an artificially “low” transfer price, and have its losses effectively subsidized by the expanded “revenue” of the resale company; or, the manufacturing company could charge an artificially “high” price, so that the resale company appears to make very little or even no money. Ultimately, it’s all the same pot of money, so it makes no difference.
Except with respect to taxes. Whether it was intentional or not, the effect of this scheme in this case — and presumably the intended effect of this sort of scheme in many other cases — is that a bigger share of the revenue pie is assigned to a multinational corporation’s subsidiary in a low-tax jurisdiction, while the corporation’s subsidiaries in high-tax jurisdictions, like Canada, are given a smaller share of the pie.Put in those terms, the effects of the scheme are obvious. With respect to just one drug during just three years in the early 1990s, Revenue Canada claims that GSK was able to profit to the tune of $50 million in tax savings here in Canada.
The press is reporting this as though GSK won a great victory, but I think the matter is still unsettled. In this case, as disagreeable as I find the verdict, I think the Supreme Court probably looked at the law and ruled according to the principles it found there. If the Government of Canada wants to adjust the tax laws to better regulate multinational corporations, it will have to do so explicitly. In the meantime, says the Court, multinationals can continue to save taxes by engaging in transfer pricing.
But there are limits. It sent the matter back to the Tax Court to rule on exactly how much the extra “bundle” of special GSK rights and benefits is worth, in addition to the generic value of ranitidine. The Tax Court therefore is going to settle (if I read this right) on an amount somewhere between $300 per kg (the generic value) and $1600 per kg (the supposed GSK value), and then tax GSK on the difference. So GSK will pay somewhere between $50 million and zero in back taxes. We don’t know that amount yet. It will have to go back to the Tax Court for determination, and then that determination (I assume) can be appealed all over again. It may well be 25 years or more after the fact before GSK has to pay up, if indeed it has to pay up at all.
And how much did they save with respect to other drugs? How much money do multinationals transfer out of Canada in this fashion? Hard to say. But if you want to get in on the action, Canada’s largest legal and financial firms are there to help. Transfer pricing and tax reduction advice can be found from PriceWaterhouseCoopers, Gowlings, Grant Thornton, Deloitte, and others.
** Just so we’re clear here, I’m suggesting that GlaxoSmithKline, like other corporations, evades or avoids Canadian taxes according to the literal sense of those terms: they use particular accounting vehicles in order to pay a lower tax rate than they otherwise would have had to. I don’t mean it in the criminal sense of money laundering. In fact, according to the Supreme Court of Canada, they specifically aren’t engaged in anything like money laundering. This is legal behaviour. This is important to remember. I’m suggesting that the law needs to be changed, not that GSK is breaking the current law. The latter is a question I’m hardly qualified to assess, in any case.Tweet