Transactional net margin method. [152] Xx. Xxxxxxxxxx used the TNMM as a reasonableness check on the price the appellant paid for ranitidine. This method compares net profits between companies. To apply this method, Xx. Xxxxxxxxxx compared the appellant's rate of return after research and development costs with those of independent companies involved in preparing and selling pharmaceutical products. Xx. Xxxxxxxxxx eliminated any companies that (1) that did not have sales in all four years from 1990 – 1993, (2) had less than $50 (U.S.) million in annual sales and (3), had an average research and development to sales ratio greater than three percent, because these latter companies might own significant technological intangible assets. [153] The appellant spent more than three percent of sales on research and development during the years in question43 but Xx. Xxxxxxxxxx thought it was appropriate to use the three percent comparison because the appellant had spent substantially less than that for many years prior to the years in question: Since the process of taking a drug from discovery and development through marketing approval can take 10 to 12 years, if not longer, current spending on pharmaceutical research and development, even if it is ultimately successful, may not be expected to result in a commercialized product until perhaps 10 or 12 years later. Even though Glaxo Canada's research and development spending in 1990 through 1993 was greater than 3 percent, that spending could not have resulted in sales of new drugs during 1990 - 1993. As a result, it is appropriate to compare Glaxo Canada to firms that spent less than 3 percent. [154] Thus, Xx. Xxxxxxxxxx concluded that the appellant's profitability was higher than the profitability of the independent companies. [155] In his rebuttal expert report, Xx. Xxxxx declared that: [I]t is far from clear that these are suitable companies for comparison without taking into account research and development costs, manufacturing, marketing practices, investment policies and other attributes that would affect margins. I cannot reach a conclusion that the comparisons made are valid at all. [156] I cannot accept Xx. Xxxxxxxxxx'x analysis on this issue. His reasoning for excluding the companies with higher research and development to sales ratios is not reasonable. There is insufficient evidence of other functions undertaken by the comparators.
Transactional net margin method. The final of the five OECD methods of setting a TP accordingly to the arm’s length principle is the TNMM. When using this method, a corporations operating profit is related to a suitable base consisting of, for example assets, costs or turnover. The operating profit used is the one arising from a transaction made with an associated corporation. TNMM consists of comparing an operating margin, or another suitable profit level indicator, with an equivalent margin (SKV M 2007:25). What margin that is used for comparison is influenced by how well the value of the assets, employed in the calculations, are measured and the factors affecting if specific costs shall be marked up, passed through or entirely excluded from the calculation (OECD TP guidelines, 1995). This last mentioned margin, shall be equal to one that the concerned corporation obtained with, for example an independent corporation. If this situation is not possible to obtain, then the operating margin can be collected from a comparable transaction performed by an independent and comparable corporation. Such an operating margin can however be in need of adjustments, the reason for this is that the margin needs to be adapted to the differences between the chosen comparable transaction and the transaction that is “under investigation” (SKV M 2007:25) (OECD TP guidelines, 1995). If there are differences in the features of the transactions that are being compared, then this method can still be used. This since the operating margin does not become affected to such differences in the same degree as the price does, and this is an advantage with the TNMM (SKV M 2007:25) (OECD TP guidelines, 1995). Another advantage with this method is that it is only necessary to analyze one party (SKV M 2007:25). This data might not be available at the time of the controlled transaction, which makes the method hard to apply at the time when the transaction is performed (OECD TP guidelines, 1995).
