#11715, # 11755-20
P. Tang
This is in reply to your letter of November 15, 1994 concerning the GST status of certain "royalty" payments received by XXXXX in connection with the sale of XXXXX tablets XXXXX and XXXXX inhalator products XXXXX in Canada. We apologize for the delay in replying.
In your memo, you have briefly summarized the relevant facts of this case. We would like to emphasize the following important points again here:
1. XXXXX is in the business of research, manufacture and sale of new pharmaceutical products. It imports XXXXX from its XXXXX manufacturing affiliates to repackage and sell in Canada.
2. It has received approval (for the marketing of these products in Canada) from the XXXXX[.]
3. Both XXXXX are included in Part [I] of Schedule F to the Food and Drug Regulations, and the supply of these products will qualify as a zero rated supply under paragraph 2(b) of Part [I] of Schedule VI to the Excise Tax Act. (the "Act").
4. In 1989, XXXXX entered into two separate distribution agreements (referred to hereinafter as the "Agreements") with XXXXX to market XXXXX (referred to hereinafter as the "Drugs") in Canada. Both agreements have similar terms and conditions.
5. The Agreements provide for the sale of the "Drugs", and the granting of the exclusive right (referred to hereinafter as the "Right") to XXXXX to purchase and distribute the Drugs in Canada. In the Agreements, the consideration for the granting of the Right is provided separately from the sale price of the Drugs.
6. Under the agreement covering the sale of XXXXX is charged an amount as a "royalty" in respect of the distribution rights granted to XXXXX (paragraph 5). The agreement also provides (in paragraph 6) that in the event that XXXXX should decide to sell XXXXX in Canada other than to XXXXX, XXXXX must pay a specific amount to compensate XXXXX[.]
7. Under the XXXXX agreement, XXXXX is charged an amount as a "royalty" for use of the "Technology" and in respect of the exclusive distribution rights granted by XXXXX (paragraph 7). Technology represents all know-how, formulations, testing methods, and other information regarding XXXXX that are required by XXXXX to assess and grant a Notice of Compliance (for the sale of XXXXX in Canada).
You request our view as to whether the "royalty amounts" paid by XXXXX pursuant to the Agreements would be zero-rated because these amounts are in respect of a zero-rated supply (prescription drugs), and whether each agreement would be construed as a single (zero-rated) supply or as multiple (zero-rated and taxable) supplies.
Our Comments:
Royalty Payments
The supply of the Drugs by XXXXX will qualify as a zero-rated supply by virtue of paragraph 2(b) of Part [I] of Schedule VI to the Act because the Drugs qualify as "drugs included in Schedule F to the Food and Drug Regulations" that may only be sold with a prescription. The Right granted by XXXXX is however, not a drug. It is intangible property (an intellectual property right) whose value depends on the value of the underlying Drugs XXXXX[.] This exclusive right is different and distinct from the Drugs, and it is clearly NOT "a drug included in Schedule F to the Food and Drug Regulations". Hence, it is our view that the supply of the Right will not qualify as a zero-rated supply under paragraph 2(b) of Part [I] of Schedule VI to the Act. (It is noted that, under the XXXXX agreement, one royalty amount is charged by XXXXX for the supply of the distribution right as well as the provision of the Technology. This will not affect our view above since the provision of the Technology is a taxable supply of information. The amount of consideration included as a "royalty" will be subject to tax).
Single Supply or Multiple Supplies
We have considered the facts of this case in light of the Policy Statement No. 077. It is our conclusion that the sale of the Drugs and the granting of the Right pursuant to the Agreements will not constitute the making of a single composite supply, but two separate multiple supplies for the following reasons:
• the supply of the Right is different and separate from the supply of the Drugs. The sale of the Drugs can be made to XXXXX without the granting of the Right at the same time (e.g. see paragraph (6) of the XXXXX agreement).
• The sale of the Drugs and the granting of the Right are NOT interconnected, interdependent or intertwining each other.
• Each of the supplies is provided separately in the Agreements, and the consideration for each of the supplies is calculated separately.
• The Drugs and the Right are acquired by XXXXX for different and unrelated use. The Drugs are acquired by XXXXX for resale, while the Right is necessary to monopolize the supply/sale of the Drugs in Canada.
As discussed in Policy Statement No. 077, no one particular factor alone can determine whether a transaction constitutes the making of a single supply or multiple supplies. It is however, our view that, in considering the above facts as a whole, a better argument can be made that the sale of the Drugs and the granting of the Right by XXXXX are two separate supplies. The latter is not a zero rated supply.
Section 138 Consideration
The consideration for the supply of the Drugs and the consideration for the provision of the Right are calculated and charged separately under different paragraphs in the Agreements. Hence, it is our view that section 138 of the Act would not apply in the circumstances since the supply of the Right and the supply of the Drugs cannot be said to have been made for "a" consideration, as required under paragraph (a) of that section.
We trust the above will be of assistance to you. Should you wish to discuss this file further, please do not hesitate to contact Anny Roy (954-2560), Serge Bernier (952-9580), Lalith Kottachchi (952-9588), Gerry O'Reilly or François Paris (952-8812).
H.L. Jones
Director
General Applications Division
GST Rulings and Interpretations.
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