GlaxoSmithKline Inc. v. The Queen

GlaxoSmithKline Inc. v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2008-05-30
Neutral citation
2008 TCC 324
File numbers
98-712(IT)G
Judges and Taxing Officers
Gerald J. Rip
Subjects
Income Tax Act
Decision Content
Docket: 98-712(IT)G
BETWEEN:
GLAXOSMITHKLINE INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeals heard on February 27, 28, March 1, 2, 5, 6, 7, 8, 9, 20, 21, 22, 23, 27, 28, 29, 30, April 3, 4, 5, 6, 11, 12, 24, 25, 26, 27, May 1, 2, 3, 4, 15, 16, 17, 18, 29, 30, 31, June 1, 5, 6, 7, 12, 13, July 17, 18 and
19, 2006 at Toronto, Ontario.
Before: The Honourable Gerald J. Rip, Associate Chief Justice
Appearances:
Counsel for the Appellant:
Pierre Barsalou, Sébastien Rheault, Eleni Kouros, McShane Jones and Ben Tomlin
Counsel for the Respondent:
Naomi Goldstein, Myra Yuzak and Karen Janke
____________________________________________________________________
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1990, 1991, 1992 and 1993 taxation years and assessments made under Part XIII of the Act with respect to the alleged failure of the appellant to withhold tax on dividends deemed to be paid to a non-resident shareholder in 1990, 1991, 1991 and 1993 are allowed and the matters are referred back to the Minister of National Revenue for reconsideration and reassessments only to decrease the excess amounts (as described in the reasons for judgment) paid by the appellant for ranitidine by $25 per kilogram and to adjust the amounts of withholding tax accordingly.
Costs shall be paid by the appellant; the parties may make representations as to the quantum of costs.
Signed at Ottawa, Canada, this 30th day of May 2008.
"Gerald J. Rip"
Rip A.C.J.
Citation: 2008TCC324
Date: 20080530
Docket: 98-712(IT)G
BETWEEN:
GLAXOSMITHKLINE INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Rip A.C.J.
Note to Reader
In order not to add to lengthy reasons for judgment, four appendices have been attached to these reasons and form part of the reasons. The appendices include a ruling on a motion by the appellant pursuant to section 100 of the Tax Court of Canada Rules (General Procedure) (Appendix I), a diagram of the corporate structure of the Glaxo corporations headed by Glaxo Holdings (Appendix II), a List of Witnesses and the subject of their testimony, listed in order of appearance at trial (Appendix III) and a Glossary of terms used during trial, some of which are included in these reasons (Appendix IV). [The Glossary was adapted from a Glossary submitted by the appellant at trial.] There was an effort to have these appendices in as concise a form as possible for ease of reading.
[1] GlaxoSmithKline Inc. ("Glaxo Canada") appeals income tax assessments in which the Minister of National Revenue ("Minister"):
a) reassessed the appellant for its 1990, 1991, 1992 and 1993 taxation years by increasing its income for each year on the basis that the appellant overpaid its non-arm's length supplier for the purchase of ranitidine hydrochloride ("ranitidine"), applying sections 3, 4 and 9 and subsections 69(2) of the Income Tax Act ("Act")[1] ("Part I assessments"); and
b) assessed the appellant for tax under Part XIII of the Act for amounts deemed to have been paid by the appellant as dividends in 1990, 1991, 1992 and 1993 to its non-resident shareholder, Glaxo Group Limited ("Glaxo Group"), in accordance with subsections 56(2), 212(2) and 214(3) of the Act. Alternatively, the respondent says that the appellant, pursuant to paragraph 246(1)(b) of the Act, is deemed to have made payments in 1990, 1991, 1992 and 1993 to its shareholder to which Part XIII of the Act applies ("Part XIII assessments").
[2] The appeals were heard on common evidence.
INTRODUCTION
[3] Ranitidine is the active pharmaceutical ingredient ("API") in a drug that was marketed by the appellant in Canada under the brand name Zantac. The drug was prescribed to relieve stomach ulcers without the need for surgery. Before the discovery of ranitidine the most successful API used to relieve ulcers was cimetidine. Cimetidine was marketed by a competitor of the appellant under the brand name Tagamet. Ranitidine was discovered by the appellant's parent company in 1976 and was approved for sale in Canada in 1981. Zantac was launched by the appellant in 1982.
[4] During the period under appeal other pharmaceutical companies ("generic companies") were selling generic versions of Zantac in Canada. These companies purchased ranitidine for much less than the appellant. According to the Minister, a reasonable amount for the appellant to have paid for ranitidine was the price paid by these other companies.
[5] Glaxo Canada paid Adechsa S.A., a person with whom it did not deal at arm's length, the following amounts for ranitidine during the years in appeal:
Taxation Years
Price per kilogram[2]
1990
$1,512
1991
$1,575
1992
$1,635
1993
$1,651
[6] At the same time the generic companies in Canada paid the following amounts to their suppliers of ranitidine:
Taxation Years
Price per kilogram
1990
$292 - $304
1991
$244 - $289
1992
$220 - $253
1993
$194 - $248
[7] In making the Part I assessments the Minister did not permit the appellant, in computing its income for the years in appeal, to deduct the amounts by which the purchase prices paid to Adechsa for a kilogram of ranitidine exceeded the highest price paid by the generic companies for a kilogram of ranitidine at the appropriate time.
[8] The appellant's position is that the Part I assessments have no basis because the price it paid for the ranitidine "closely mirrored [the price paid by] . . . independent third parties in comparable circumstances" and the amounts paid by the appellant were "reasonable in the circumstances" within the meaning of subsection 69(2) of the Act. The appellant also submits that its business model and circumstances are not comparable to those of the generic companies. The respondent's position is that the appellant did not pay a reasonable price for the purchase of ranitidine in order to minimize profit in Canada and move the profit to a related corporation in a low tax jurisdiction.
Subsection 69(2) of the Act
[9] Subsection 69(2) of the Act, in force during the period in appeal, read as follows:
Where a taxpayer has paid or agreed to pay to a non-resident person with whom the taxpayer was not dealing at arm's length as price, rental, royalty or other payment for or for the use or reproduction of any property, or as consideration for the carriage of goods or passengers or for other services, an amount greater than the amount (in this subsection referred to as 'the reasonable amount') that would have been reasonable in the circumstances if the non-resident person and the taxpayer had been dealing at arm's length, the reasonable amount shall, for the purpose of computing the taxpayer's income under this Part, be deemed to have been the amount that was paid or is payable therefor.
Lorsqu'un contribuable a payé ou est convenu de payer à une personne non-résidente avec qui il avait un lien de dépendance, soit à titre de prix, loyer, redevance ou autre paiement pour un bien ou pour l'usage ou la reproduction d'un bien, soit en contrepartie du transport de marchandises ou de voyageurs ou d'autres services, une somme supérieure au montant qui aurait été raisonnable dans les circonstances si la personne non-résidente et le contribuable n'avaient eu aucun lien de dépendance, ce montant raisonnable est réputé, pour le calcul du revenu du contribuable en vertu de la présente partie, correspondre à la somme ainsi payée ou payable.
Preliminary Facts
[10] Glaxo Canada is a wholly owned subsidiary of Glaxo Group, a United Kingdom corporation, which in turn is a wholly owned subsidiary of Glaxo Holdings PLC, also a corporation headquartered in the United Kingdom. Glaxo Holdings headed an integrated multinational group of entities, which discovered, developed, manufactured and distributed pharmaceutical products throughout the world. Glaxo World[3] products are sold through subsidiaries and unrelated distributors in local markets.
[11] Pharmaceutical products are manufactured in two basic stages, referred to as primary manufacturing and secondary manufacturing. Primary manufacturing is making the active pharmaceutical ingredient for a pharmaceutical product. Secondary manufacturing includes the process of putting the active ingredient into a delivery mechanism or packaging, such as a tablet, liquid, or gel.
[12] Two Glaxo World companies carried on the primary manufacturing of ranitidine: Glaxo Pharmaceuticals (Pte) Limited[4], a corporation incorporated and carrying on business in Singapore, and Glaxochem Ltd., a United Kingdom corporation located in Montrose, U.K. Upon completion of the primary manufacturing process, the ranitidine was sold at a uniform price by the primary manufacturer to one of two Glaxo World clearing companies: Adechsa S.A., a Glaxo World company based in Switzerland, and Glaxo Far East. The clearing companies then sold the API to local companies in various countries at a variety of prices. Glaxo Holdings established the price of the API based on the price the local company could expect to fetch on sales of Zantac in its local market. During the period in appeal, the ranitidine purchased by the appellant was manufactured in Singapore and sold to the appellant by Adechsa.
[13] Adechsa had an agreement with the Swiss tax authorities under which it agreed to pay tax on the basis that it earned a minimum profit of four percent.[5] Few taxes were paid by the Singapore manufacturer because it qualified for a ten‑year pioneer relief tax holiday that began in 1982. After the expiry of the ten‑year period, the tax rate was ten percent. Under the pioneer relief program, Glaxo World benefited from "tax sparing" between Singapore and the United Kingdom. Glaxo World's Singapore company did not pay any tax on the profits earned in Singapore; income apparently was deemed by the United Kingdom tax authority to have been fully taxed at the current Singapore tax rate. When the profits were brought into the United Kingdom in the form of dividends, United Kingdom tax was payable only on any excess in terms of the United Kingdom tax rate over the Singapore tax rate. Glaxo World's transfer pricing arrangements allowed Singapore to earn gross profits of around ninety percent in Singapore on the sale of ranitidine to Adechsa during the period 1990 to 1993. During the same period, Glaxo Canada was earning gross profits of around 57 percent. According to a memorandum by Lionel Halpern, the "Group" taxation controller of Glaxo Holdings, Glaxo World's strategy to minimize its taxes worldwide was:
1. to make as much profit as possible in Singapore;
2. to make as much of the remainder of the Group's profit as possible in the U.K.; and
3. to ensure the Group does not pay tax on the same profit twice.[6]
AGREEMENTS
[14] Glaxo Canada had two contracts with respect to Zantac: a "Licence Agreement" dated July 1, 1988 with Glaxo Group and a "Supply Agreement" with Adechsa dated October 1, 1983.[7] Under the terms of the Licence Agreement, which applied to all drugs and not just Zantac, Glaxo Canada paid a six percent royalty to Glaxo Group on its net sales of Zantac and Glaxo Group provided the following services and intangibles to Glaxo Canada:
a. right to manufacture, use and sell products;
b. right to the use of the trademarks owned by Glaxo Group, including Zantac;
c. right to receive technical assistance for its secondary manufacturing requirements;
d. the use of registration materials prepared by Glaxo Group, to be adapted to the Canadian environment and submitted to the Health Protection Branch ("HPB");
e. access to new products, including line extensions;
f. access to improvements in drugs;
g. right to have a Glaxo World company sell Glaxo Canada any raw materials;
h. marketing support; and
i. indemnification against damages arising from patent infringement actions.
[15] The Supply Agreement between Glaxo Canada and Adechsa granted the appellant the right to purchase ranitidine and set out the price of the ranitidine. The transfer price was established by Glaxo Holdings. Adechsa's role was to administer the transfer prices. The Supply Agreement also provided protection against foreign currency exchange, indemnity insurance and the provision of intellectual property to "the extent that [the appellant] shall not previously have received it or shall not otherwise receive it directly from [Glaxo Group]".
[16] The respondent argued that the only item of value received under the Supply Agreement was the ranitidine. Respondent's counsel submitted that the protection against foreign currency fluctuations was largely irrelevant given that under the Agreement either party could change the currency. Glaxo Canada was charged separately by Glaxo Group for indemnity insurance in each of the years under appeal. With respect to the additional intellectual property, the appellant’s general counsel, Mr. McTeague, admitted that he wasn't sure what intellectual property remained to be provided under the Supply Agreement given the wide ambit of the Licence Agreement. Thus, according to the evidence, the only item of value received by Glaxo Canada under the Supply Agreement was ranitidine.
THE CANADIAN PHARMACEUTICAL INDUSTRY
Regulation
[17] The prescription pharmaceutical market in Canada was regulated by the HPB of Health Canada during the period under appeal. Prescription pharmaceuticals could not be marketed in Canada without approval from the HPB. The HPB had the responsibility of evaluating the safety, effectiveness and quality of all drugs and medical devices before they could be marketed in Canada.
[18] During the period 1980 to 1993, the HPB was responsible for the review of New Drug Submissions ("NDS"). The HPB was ultimately responsible for ensuring that all drugs, including ranitidine products, were safe and effective for their intended use. A NDS was made by the appellant for ranitidine tablets. When a NDS is prepared for a new chemical entity, the data provided may be divided into information relating to the following sections:
a. Chemistry and Manufacturing of the Product: the drug substance (API) and dosage forms must meet appropriate standards and the drug must be manufactured in a manner that allows the product to exert its inherent pharmacologic effects.
b. Pharmacologic Properties of the Drug: This information provides the results of all studies performed in vitro or conducted in vivo in animals. The purpose of these experiments is to elucidate the basic pharmacologic effects of the drug.
c. Toxicities of the drug: Toxicological studies are undertaken in animals to determine the adverse effects of each new drug, with the purpose of predicting the possible toxicities the compound may show in humans.
d. Effects of the Drug in Humans: These clinical studies explore the absorption, distribution, metabolism and excretion of the drug in humans, as well as its ability to treat the disease of concern and its adverse effects.
Generic Drugs
[19] At all relevant times a compulsory licensing system existed in Canada which allowed the marketing and sale of a generic version of patented pharmaceutical products, including ranitidine products, in exchange for a royalty of four percent paid to the patent owner. Thus, a generic company could sell a generic version of a drug to the public notwithstanding that the patent for the drug was still in effect.
[20] Like innovator companies such as the appellant, generic companies were required to satisfy HPB's standards with regard to the proposed product's safety, efficacy and quality. However, unlike innovator companies, generic companies did not have to provide evidence of clinical testing. Instead, HPB would accept adequate published data on drug safety and accept published clinical data from well controlled trials.
[21] Generic manufacturers therefore sought to establish that their drug products were equivalent to those of innovator companies for which a Notice of Compliance had been issued. This was accomplished by submitting complete chemistry and manufacturing data establishing chemical equivalence, as well as bioavailability studies to demonstrate bioequivalence. A Notice of Compliance by HPB for a NDS constituted a declaration of equivalence, as the generic product had been determined to be pharmaceutically equivalent and bioequivalent to the Canadian innovator product. [8]
[22] Two companies, Apotex Inc. and Novopharm Ltd., began selling generic ranitidine products in Canada in 1987 and 1989, respectively. Apotex and Novopharm purchased ranitidine from arm's length manufacturers. The sales of the generic ranitidine products had a negative impact on Zantac's market share; Zantac's share during the period under appeal dropped from 38 percent to 20 percent of unit sales of tablets. The appellant's market share as a percentage of total sales of all ranitidine products declined from 49 percent to 40 percent.
Formularies
[23] During the years in issue, the provinces operated government-funded drug plans in order to ensure that Canadians covered by provincial health insurance received the necessary pharmaceutical products and to maintain the affordability of these required drug products. For this purpose, each of the provinces established a drug formulary, which is a listing of those drugs for which the government pays some or all of the cost. If a drug is not listed on its formulary, the province's insurance plan does not pay for the drug and the consumer/patient must pay for the drug out of his or her own pocket. This negatively affects sales.
[24] Mr. Lorne Davis, a pharmacologist for the Saskatchewan Prescription Drug Plan, explained that each provincial government regulates admission of a drug to its formulary. Submission for approval to a formulary does not derogate from the requirement that each innovator or generic drug product must also be approved by HPB, but only those drugs approved by a provincial government will be listed on that province's formulary. Generally, the formulary is published and distributed to the province's doctors to make them aware of the drugs that are on the formulary. Such information would influence the doctors' decisions about what drugs to prescribe to their patients. For generic products, inclusion on the formulary means the generic drug has been approved as being interchangeable with the innovator product and that it can be substituted by a pharmacist when filling a prescription.
[25] Generic products were listed at a lower retail price than innovator drugs. And, even as between themselves, the generics competed to list on the formularies at a lower price. According to Mr. Fahner, Vice-President, Finance at Apotex, the first generic product on a market typically sells at 80 to 85 percent of the price of the branded product. The next generic product that enters the market usually would be priced slightly under the first generic, and so on.
[26] Mr. Fahner explained that because of the provincial substitution programs, the generic companies directed their sales efforts towards pharmacists, as opposed to doctors. In addition to offering their products at prices that were less than the branded products, the generic companies sought to market their products by providing volume discounts, mostly to the large pharmacy chains, and delivering incentives to the smaller independently owned pharmacies. The goal was to have various pharmacies stock a wide range of the generic company's drug products, which would lead to greater sales. In some cases the provinces tendered contracts (mostly for hospitals sales) to the least expensive generic product distributor.
[27] One of the main purposes of provincial drug insurance plans is to reduce the cost of drugs in Canada. To that end, the drug plans allowed for the substitution of less expensive generic products where such products were available. For a time the provincial drug plans allowed the prescribing of the more expensive innovator products where the prescribing physician included the notation "no substitutions" on the form. Later, the provincial drug plans required mandatory substitution, that is, the drug plan would not pay any of the cost of the more expensive branded innovator product where there existed a less expensive generic product. Mr. Fahner testified that Saskatchewan stopped accepting no-substitution prescriptions in 1991.
MARKETING AND PRICING
[28] When ranitidine was discovered, Glaxo Group's then Chief Executive Paul Girolami (later Sir Paul and head of Glaxo Group)[9] was advised by his Research Director that Zantac was superior to Tagamet because of its greater selectivity, more favourable safety profile, higher efficacy and easier dosage regimen. As a result, Sir Paul decided that Zantac should be priced at a substantial price premium of approximately 20 percent to Tagamet to reflect that superiority, and that the global marketing platform for the product would be focused on the demonstrated advantages of Zantac over Tagamet.
[29] Once launched, Zantac achieved significant sales volume and overtook Tagamet as the premier anti-ulcer drug. It became, according to Paul Meade, who worked in Glaxo's marketing group in both Canada and the United Kingdom, the "gold standard in ulcer therapy".
Marketing
[30] As was the case with other pharmaceutical products, the marketing of Zantac was restricted to claims supported by data and approved by regulatory authorities. Glaxo Group established a world-wide marketing strategy for Zantac which was implemented by each subsidiary at the local level. The British parent's "core marketing strategy" for Zantac was based on the medical uses of the drug product. Its main claim was that Zantac lessened or prevented gastric ulcers and esophagitis. Mr. Meade described the marketing plan as follows:
Zantac will be positioned as a major evolutionary advance in the management of peptic ulcer and other acid pepsin-aggravated disorders of the upper gastrointestinal tract. Zantac contributes three important new parameters to ulcer therapy - simplicity of dosage, unsurpassed efficacy and a remarkable freedom from clinically significant side reactions.
[31] Glaxo Group made the decision to promote a particular product such as Zantac and did the initial research and product development and then provided this information to the local distributor. In Canada, the appellant added a "Canadian flavour", in the words of Mr. Woloschuk, who worked in marketing at Glaxo Canada from 1976 to 1996. He explained that the way a product is sold in England may not be the same way it is sold in Canada. The strategy, he declared, was "sell the product and [stress that] it's good for this indication, but we need to change that to make it more Canadian".
[32] Each local Glaxo World distributor, including the appellant, was required to apply the message in its local market. Glaxo Group provided written material to the distributors and sponsored marketing workshops which were attended by employees of its distributors. The local distributors then communicated the Glaxo message to their local markets. Marketing personnel in Canada delivered promotional directives and material to the local sales managers, who would then oversee the marketing efforts of a team of local sales representatives. The local sales representatives would visit local doctors and communicate to them the various marketing information about Zantac. The appellant's goal was to convince doctors to prescribe Zantac over other ulcer-relief products.
Anti-Generic Marketing Strategies
[33] When the generic companies were preparing to enter the ranitidine market in Canada in 1985, Glaxo Canada was very aggressive in attempting to abort or at least delay the generic companies' efforts. This is notwithstanding the appellant's position at trial that the generic companies were not its competitors. Five tactics to deal with the generics were set out in a document entitled "Report on the Genericization of Zantac in Canada" ("Report"): legal challenges, positioning, sales force, brand image, and investment in the brand, including the launch of an ultrageneric drug.
1) Legal Challenges
[34] According to the Report, "all legal avenues to have the generic removed from the market, or delisted from provincial formularies were pursued." In 1987, Mr. K.F. Read, the appellant's Director of Regulatory Affairs, attempted to convince HPB to refuse a generic company a Notice of Compliance for a ranitidine product by raising potential safety concerns. The appellant also tried to obtain an injunction against HPB, but failed. In his reasons for an order dismissing the application for an interim injunction Rouleau J., was of the view that the appellant's "sole motive . . . in bringing this application . . . [was] . . . to prevent competition in a market where it has . . . enjoyed a virtual monopoly".[10] An appeal to the Federal Court of Appeal was dismissed. Mr. Jacques Lapointe, who was the appellant's president during the years in appeal, agreed that the application was "one of the tactics" used by Glaxo Canada to fight the availability of generic ranitidine in Canada.
2) Positioning
[35] The appellant sought to establish Zantac as the standard of excellence in ulcer therapy. The superior profile of Zantac was compared and contrasted with the questionable quality of the generics to physicians, pharmacists and provincial formularies.
3) Sales Force
[36] Once generics entered the market, the appellant expanded on its sales force and created a Pharmacy Service Sales Force to deal exclusively with pharmacies. This allowed the Physician Sales Force to concentrate exclusively on physicians. The appellant launched an anti-generic campaign, which included the "no‑substitution campaign". The Physician Sales Force sought to persuade doctors to include the phrase "without substitutions" or "no substitute" on Zantac prescriptions which meant that a pharmacist could not substitute a generic product in place of Zantac. The Pharmacy Service Sales Force encouraged pharmacists to stock and dispense Zantac instead of a generic drug for all customers, who were not covered under a provincial drug plan.
[37] In addition, the Glaxo Hospital Savings Plan was devised to enable Glaxo Canada to compete effectively with generic ranitidine in the Canadian hospitals. Under this plan, hospital pharmacists received an on-invoice discount and a volume discount based on the whole portfolio of the drugs purchases. The initial on-invoice discount for Zantac products was 25 percent. The rebate was increased to 40 percent and then to 45 percent. The discounts allowed the appellant to match the price of generic ranitidine products in hospitals.
4) Brand image
[38] Mr. Faheem Hasnain, a Glaxo official discovered by respondent's counsel, explained that Zantac's success in Canada was due to the brand's perception in the marketplace. "That was our ace in the hole." He added that "what it came down to is marketing . . . we had a pretty good marketing team, in fact we had a great marketing team". There was a perception in the marketplace that Zantac was a high-quality, superior agent. He acknowledged that every marketing campaign takes into account local nuance and local understanding of customer base. In Canada, for example, the advertising campaign played on the suggestion that there were quality problems with generics and that it was only with Zantac that the patient could be sure of the quality.
[39] In 1988, ACIC, a Toronto manufacturer of ranitidine, offered to sell its product to Glaxo Canada. The proposed price was a one time payment of $240,000 for research and thereafter $350 to $400 per kilogram. Jacques Lapointe testified that Glaxo Canada and Glaxo World had some concerns about the ramifications of entering into an agreement with this supplier. In a letter dated April 21, 1988 to Jeremy Strachan of Glaxo Holdings, Mr. Lapointe wrote:
From a marketing point of view the longer we can keep Novopharm from entering the market with a second generic ranitidine the better we are able to defend our position against Apotex who are recognized in the marketplace to have a definite quality problem. It would also be much more difficult to defend against generics if the generics' quality was equal to or superior to that offered by Zantac.
There could be significant financial implications as well. We have been challenged, as you know, by Revenue Canada on transfer pricing of ranitidine in view of the availability of raw material on the world market in the $350 price range. … In addition to the argument concerning the inclusion of development costs in Glaxo material, another possible defence would be the poor quality of this cheaper material from off-shore sources. ACIC's unnegotiated offering price for material of good quality is $400 and this from a Canadian source. If we were to enter into a purchase agreement at this price, however, the world-wide ramifications would need to be critically assessed. Such a precedent could jeopardize transfer pricing on a much larger scale.
. . .
Our planned course of action is to stall [ACIC] for as long as possible. We have requested a further sample of the initial batch which will be sent to John Padfield's laboratories for evaluation along with the report of our analysis as soon as available. Assuming that the quality of this material is confirmed, we may want to consider tying up this source of production indefinitely before the material becomes available in the marketplace.
[Emphasis added.]
[40] Glaxo Canada ultimately decided not to purchase ranitidine from ACIC. Mr. Lapointe testified that the reason for this was because its marketing strategy involved the claim that Glaxo manufactured ranitidine was superior to the generic ranitidine and that the only way to be sure you were getting a quality product was to buy Zantac. In his view, if the appellant started sourcing its ranitidine from a supplier that could be available to the generics, it would lose credibility in the positioning of the product. Mr. Lapointe testified that this decision was not related to any concerns about the quality or purity of ACIC's ranitidine.
[41] Canada was unique in that it was one of the first markets in which generic drugs were available and it had provincial formularies with mandatory substitution. While Glaxo World may have one marketing plan for most drugs that also applied across Canada, Lapointe agreed that for certain products there would be different marketing plans for Quebec and even in some provinces where mandatory substitution of generics was at a different level. Mr. Meade also agreed that the appellant "did certain things differently" in Quebec. Language and cultural differences, he said, made that province different.
5) Investment
[42] In 1989, Glaxo World launched another ranitidine product in the Canadian market to compete directly with the generics on price. Glaxo Canada formulated its ranitidine into finished ranitidine products for sale to Kenral Inc. ("Kenral"), a corporation owned by the Upjohn Company of Canada. The product sold under the Kenral label was identical to Zantac, save for the brand name. According to Paul Lucas, Senior Vice-President, Corporate Mobility for the appellant, this was the first voluntary agreement Glaxo World had negotiated with a generic company and the royalty of six percent payable by Kenral "was a much better deal" than the four percent payable by the generic companies. Mr. J.W. Cuttle, Marketing Management Kenral, said Kenral was created to compete in the generic market as an ultrageneric. He defined an ultrageneric product as one that is manufactured by the originating brand‑name pharmaceutical company but is sold in the generic market segment at generic prices.
[43] A business plan for the appellant for the five-year period 1991/92 to 1995/96 discussed various strategies to grow market share for Zantac while protecting it "from competitive inroads" at a time when Zantac's sales were declining due to the presence of the generics and the potential competition from Omeprazole, a new anti-ulcer product that had recently entered the market. Strategies included fragmenting the market with line extensions, continued promotional efforts for Zantac's long‑term use on enhancing the company image and support to physicians, pharmacists and consumers.
[44] By 1993 Zantac had lost significant market share to the generics in Canada; the decision was made to cease promotion of Zantac rather than to fight a losing cause. This was a uniquely Canadian phenomenon. In the rest of the top ten markets, the central marketing strategy of investing heavily in Zantac to expand the market was still in effect as the patent had not expired.
Pricing and Third Party agreements
[45] As stated, Glaxo World's pricing strategy was to price their product at approximately a twenty percent premium to Tagamet. In Canada, the United Kingdom and the United States there were no government controls restricting the price and Glaxo World was free to determine the selling price of Zantac. However, in many countries the retail price ("in-market price") was set by the local government, often based on the cost of the API to the distributor or with reference to the in-market price in other countries. In those countries, Glaxo World had to negotiate price with government authorities. As a result, Glaxo World had an interest in setting high transfer prices for the API because a higher transfer price paid by the local Glaxo World distributor to Adechsa would often result in a higher in-market price, both in that country and in others that may rely on it.
[46] In many of the European markets Glaxo World undertook to promote and distribute Zantac through third-party distributors in addition to its local subsidiaries. These third-party distributors were also referred to during the testimony as foreign licensees and co-marketers. Dr. Gregory Bell, an expert in the pharmaceutical industry and transfer pricing, explained that a co-marketer is someone who sells the same chemical entity as the innovator, but under a different brand name. The primary functions performed by the third-party distributors were marketing, detailing and distribution. As was the case with Glaxo Canada, third parties used marketing tools provided by Glaxo World in the United Kingdom to promote to physicians the clinical advantages of their ranitidine products over Tagamet.
[47] Glaxo World used what is referred to as a resale-price method[11] to determine the transfer price of the API. Glaxo World and its distributors agreed that a gross margin of 60 percent would be retained by the distributors and the ranitidine was priced accordingly. To use a very simple example, if the ranitidine product was sold for $10 in Italy, the transfer price would be $4; if the ranitidine product was sold for $20 in France, the transfer price would be $8. Appellant's counsel described the process as follows:
the starting point for determining the price to the distributor was the in-market price for the finished ranitidine product;
from that in-market price the parties agreed, assuming specified conditions were satisfied, a gross profit margin the be retained by the distributor (approximately 60%); and
the remainder would be remitted back to Glaxo Group in the form of transfer price, royalties,[or both]. Where the distributor was to pay both transfer prices and royalties, they would be considered together to determine the distributor's gross profit margin after payment of the royalty.
[48] Mr. Fisk made it clear that the price of the API had no connection to its manufacturing costs or to the costs of the generic products. He explained that "the driver was the in‑market price and, obviously, you know, Group's guidelines in terms of what an appropriate level of gross margin would be". According to Mr. Hasnain, a 60 percent gross margin was chosen because they determined that it would give a sufficient return to the distributors to properly market the drug.
[49] According to Dr. J. Gregory Ballentine, an economist who was qualified as an expert in transfer pricing, this pricing method allows for consistency of returns for similar functions across similar markets, notwithstanding different in‑market prices in different countries. However, the respondent contends that the process is circular in that Glaxo World determines the transfer price based on its target in-market price and the pricing authority determines the approved in-market or reimbursement price based on the cost of the API.
[50] Contractual arrangements varied from country to country. In some countries, there was a Licence Agreement with Glaxo Group; in others, with the local Glaxo subsidiary. In most countries intangibles, for example the right to use a Glaxo Group trademark and the right to marketing support, were included in the purchase price of the ranitidine and the royalty payment, if one was specified, was waived. This can be contrasted with Canada, where there was a royalty payable to Glaxo Group pursuant to the Licence Agreement. Under the terms of each Licence Agreement, all local Glaxo distributors were required to purchase granulated ranitidine from a Glaxo Group approved source and to sell the licensed product under a trademark owned or controlled by Glaxo Group. This is similar to the appellant's agreement.
[51] Dr. Ballentine explained that Glaxo entered into the co-marketing agreements for various strategic reasons, including achieving a higher in-market price, to obtain earlier product registration and to limit the entry of other competitors. For example, in France and Italy Glaxo's co-marketing agreements allowed it to negotiate a high reimbursement price from the government. In Spain and Portugal the government limited the number of brands or licenses for each product. Glaxo World's goal was to protect the market from "pirates" who buy ranitidine from non-approved sources by signing up the major players as co‑marketers and thereby flood the market to limit the opportunities from other firms to buy from non-approved sources and compete.
[52] A good illustration of why co-marketing agreements were so important to Glaxo World is the marketing agreements with Menarini, an Italian company. In Italy, the first country in which Zantac was sold, all ranitidine products were reimbursed at the same price, which was set by the government. The reasons for partnering with Menarini included the weakness of patent protection in Italy, to take advantage of the influence Menarini had with the Italian health authorities to obtain quick registration approval and the perceived advantage of using an Italian-based company in order to obtain a high in-market price. On cross‑examination, Mr. Fisk agreed that the fundamental element in getting a high in-market price approved by the government was the high price of the API to the distributors. Had Menarini been purchasing ranitidine for a lower price, the approved in-market price for both its product and Glaxo's product would have been lower.
[53] In a witness statement David John Richard Farrant, Glaxo Group Developing Trade Areas Director from 1981 to 1988, explained that Glaxo believed that the Italian owned company would be more likely than Glaxo to negotiate a high price. As it turns out, this strategy worked "spectacularly well", and they obtained an Italian price which was at a 44 percent premium to the price of Tagamet, much higher than expected. Mr. Fisk testified that securing a high in-market price in Italy was particularly important because this was the first time the Glaxo World strategy of achievin