Smithkline is a manufacturer of pharmaceutical products. During the period relevant to this appeal, 1981 to 1986, Smithkline manufactured a drug named Tagamet, the active ingredient of which is cimetidine. During those years, Smithkline bought cimetidine from related corporations outside Canada. All of the assessments under appeal are based on the Crown’s allegation that the price paid by Smithkline for cimetidine during that period was $66,982,990 more than would have been reasonable in the circumstances if Smithkline and its suppliers had been dealing at arm’s length.
Following an audit the tax authorities issued assessments increasing Smithkline’s taxable income for 1981 to 1986 by a total of $66,982,990, and also reflect consequential adjustments to the investment tax credits for 1986 and 1987 and non-capital losses for 1987 to 1990. The increased income resulted from application of the CUP method.
Smithkline filed notices of objection against all of these assessments.
The Tax court dismissed the objections and decided in favor of the tax authorities.
Judgement of the Court of Appeal
The Court upheld the decision of the Tax Court and dismissed the appeal filed by Smithkline.
Excerpt
“[32] In this regard, it must be recalled that the Crown, based on the OECD Guidelines, has chosen to employ the CUP method for determining an arm’s length price for cimetidine. However, the OECD Guidelines also describe alternative pricing methods that the Crown has chosen not to employ. The choice of method depends upon finding appropriate comparators, which in turn depends upon analysis of points of difference and similarity between the structure, operations and activities of Smithkline and the various candidates for comparison (in this case, potentially all other Canadian pharmaceutical manufacturers). That might, at least in theory, include such things as profit margins and profitability.
[33] At the commencement of the pre-trial discovery process, Smithkline might have had a basis for attempting to discover information in the possession of the Crown that could lead to a train of inquiry that would explain why and how the CUP method was used in this case, or that would discredit either the use of the CUP method or the manner in which it was used, including the choice of comparator. In theory, such information might be subject to disclosure even if the Crown undertook not to use it at trial, because such an undertaking would not derogate from the fact that the information might have proven to be of assistance to Smithkline in strengthening its own case or weakening that of the Crown.
[34] However, in this case, the examinations for discovery took quite a different course, with the result that it is not necessary to reach any conclusion as to whether information about the profitability or profit margins of other pharmaceutical manufacturers is discoverable in pre-trial proceedings on the basis of a liberal reading of the pleadings. Nor is it necessary to deal with the arguments of the Crown that the degree of relevance associated with the requested information is so marginal that it would not justify the extraordinary effort it would require for the Crown to assemble and present it, or that section 241 of the Income Tax Act obliges the Crown to keep the information confidential despite Smithkline’s entitlement to pre-trial discovery.
[35] Prior to the commencement of the examination for discovery, Smithkline must have been aware of the theoretical connection between subsection 69(2) of the Income Tax Act and the many factual problems that may arise when trying to compare enterprises and their transactions. If information about the relative profit margins and profitability of potentially comparable pharmaceutical manufacturers was ever in the Crown’s possession (and there is a factual dispute on that question), the door to its discoverability closed on February 23, 1999 when counsel for Smithkline completed the examination for discovery of Mr. Truckle without asking for it.
[36] The door could have been reopened in one of two ways. First, it could have been reopened with leave of the Tax Court in a motion under subsection 93(1) of the Tax Court of Canada Rules (General Procedure). The hurdle faced by Smithkline in a motion to reopen an examination for discovery is well illustrated by the following comments of Prothonotary Hargrave in McLeod Lake Indian Band v. Chingee (1998), 149 F.T.R. 113 (T.D.), dealing with a similar provision of the Federal Court Rules, 1998. He said this at paragraph 18 (emphasis added):
To require Harry Chingee, whose discovery has been concluded, to answer further questions, the Plaintiffs must establish a special reason to do so. Here I have in mind Rule 235 which provides that “Except with the leave of the Court, a party may examine for discovery any adverse party only once.”. This rule is a watering down of what was, until about 1990, Rule 465(19) which required special reason in an exceptional case in order to obtain further discovery. The present form of the rule, however, ought not to be interpreted so as to easily allow further discovery, once an examination has been concluded, for discovery must, at some point, come to an end. In the present instance I would deny further discovery because the material on which counsel wishes to examine was available at the time of the discovery of Harry Chingee and, with diligence, might have been [put] to him at that time.
[37] Second, the door could have been reopened in the context of a question arising out of information provided after February 23, 1999 to fulfil an undertaking, to correct or clarify a previous answer, to answer a question taken under advisement, or to answer a question to which an objection had been made.
[38] Counsel for Smithkline argues that the Crown, in its various letters after February 23, 1999 culminating in the October 20, 2000 letter, opened the door by implicitly suggesting a comparison between the profit margins and profitability of Smithkline and other companies. I do not interpret the Crown’s comments in those letters as suggested by counsel for Smithkline. The Tax Court Judge correctly held that those comments address Smithkline’s own circumstances and nothing more.
[39] In my view, the Tax Court Judge was correct to refuse the motion to require the Crown to respond to the questions referred to above. I would dismiss this appeal with costs.”