As a part of the ongoing BEPS 2.0 project on addressing tax challenges
related to the digitalization of the economy, the OECD, on December 8, 2022,
released a public consultation document discussing the main components of
"Pillar One - Amount B." This document presents a new method for
pricing the "baseline distribution activities" by multinational
enterprises (MNEs) as per the arm's length principle. This approach aims at
simplifying and streamlining the transfer pricing process for these in-country
marketing and distribution activities while still ensuring that pricing is in
line with the arm's length principle. This article is aimed at providing a summary of critical elements of the public consultation document.
As a part of the ongoing BEPS 2.0 project on addressing tax challenges related to the digitalization of the economy, the OECD, on December 8, 2022, released a public consultation document discussing the main components of "Pillar One - Amount B." This document presents a new method for pricing the "baseline distribution activities" by multinational enterprises (MNEs) as per the arm's length principle. This approach aims at simplifying and streamlining the transfer pricing process for these in-country marketing and distribution activities while still ensuring that pricing is in line with the arm's length principle.
The consultation document proposes that Amount B will cover the distribution of tangible goods, including as a sales agent or commissionaire and as a buy-sell distributor. However, it is currently being considered whether the scope of Amount B should also be extended to include services, software, and other digital goods.
It outlines the scope of Amount B proposing the definition of "baseline marketing and distribution activities" based on qualitative and quantitative criteria, a pricing methodology for in-scope transactions, documentation requirements for taxpayers, and a framework for resolving tax disputes based on tax certainty.
It is worth noting that Amount B of Pillar One has no proposed threshold for determining which multinational enterprises (MNEs) it applies to. This contrasts Amount A and the global minimum tax rules under Pillar Two, which have specified thresholds determining whether an MNE falls within their scope.
This consultation document includes specific questions on several outstanding issues and invites comments by January 25, 2023. The summary of the critical elements of this public consultation document is outlined below:
Scope of Amount B
The public consultation document intends to cover the following two types of intra-group transactions under the scope of Amount B:
- Buy-sell arrangements in which the tested party purchases goods from a related party for resale to unrelated parties, mainly in its local market; and
- Sales agency and commissionaire arrangements where the tested party contributes to the wholesale distribution of goods for another related party.
However, the inclusion of sales agency and commissionaire arrangements in the scope of Amount B may present challenges in developing a standardized pricing methodology, and the consultation document asks explicitly for feedback on whether these types of arrangements should be included.
To accurately delineate a marketing and distribution transaction, the taxpayers and tax administrations should evaluate whether the proposed scoping criteria for these two categories of transactions have been met. The scoping criteria being considered by the Inclusive Framework involve both qualitative assessments and quantitative measurements. For example, some of the qualitative assessment measures include that the distributor must:
- Document qualifying transactions in a written contract outlining responsibilities and obligations;
- Primarily operate in its market of residence;
- Not perform any economic activity other than core distribution, including manufacturing, R&D, procurement, and financing;
- Not perform any risk control functions that lead to an assumption of economically significant risks associated with the development, enhancement, maintenance, protection, or exploitation (DEMPE) of marketing intangibles.
- Not perform strategic sales and marketing activities that generate unique and valuable intangible assets relating to exploiting the products sold in the market.
- Should not undertake significant and valuable regulatory compliance activities, perform specialized technical tasks, own or generate unique intangible assets, or take more risks than necessary.
Some of the proposed quantitative measurements include:
- Permissible thresholds (to be defined) on sales to end-consumers through physical and online stores, annual marketing and advertising expenses, packaging and assembly expenses, and after-sales product support expenses.
- Limits on annual net sales from customers in other jurisdictions.
- The annual operating expenses of the distributor must be within a specific range (to be defined) as a proportion of its annual net sales.
The consultation document notes that the scoping criteria need to provide a complete and exhaustive list of activities that can be considered baseline marketing and distribution activities. Instead, they outline general characteristics that must be taken into account when determining whether a distributor performs such activities.
The public consultation document also notes that Amount B will not apply to controlled distribution transactions when one or more of the following exemptions apply:
- Controlled distribution transactions are covered by a bilateral or multilateral advance pricing agreement between the supplier and distributor countries for the relevant period.
- The most appropriate transfer pricing method selected is not the transactional net margin method (TNMM); remarkably, the comparable uncontrolled price (CUP) method.
- Where local market comparable are available; and
- Product-based exclusions, i.e., transactions involving the distribution of commodities and non-tangible goods, such as software products or digital goods.
Pricing Methodology for Amount B
The Amount B pricing methodology is designed for simplifying and streamlining the application of the arm's length principle to in-country baseline marketing and distribution activities in low-capacity countries.
The proposed pricing methodology will use standard benchmarking search criteria to identify comparable entities performing baseline marketing and distribution activities using publicly available databases.
For Amount B pricing purposes, the search criteria have been designed to represent the population of businesses that primarily engage in wholesale distribution activities. Therefore, the dataset is subject to technical and econometric analysis to identify characteristics that reliably correlate with profitability. In addition, an analysis is being performed to understand the relationship between profit levels and geographical locations and to consider factors that may have a relationship with profits for the tested activities, such as industry relevance, asset intensity, and operating expense intensity.
While the final form of the output is still under consideration, the IF is currently exploring two options:
- Pricing Matrix approach, in which comparable marketing and distribution entities are divided into subgroups based on relevant economic characteristics, and a taxpayer determines its Amount B distribution return by matching itself to an appropriate subset; and
- Mechanical Pricing Tool approach, in which the Amount B distribution return is determined by translating the underlying data into a formula or set of quantitative adjustments to determine arm's length profitability returns based on the economically relevant characteristics of the tested party, such as regression equation or using adjusted net profit indicator.
Under Transaction Net Margin Method, the Operating margin (net profit divided by sales) is often used to determine the arm's length price of purchases from an associated enterprise for resale to independent customers. However, other profit level indicators are also being considered in the Inclusive Framework, such as the Berry ratio, return on sales with a Berry ratio guardrail, return on assets, or a combination of net profit indicators.
The Inclusive Framework is considering an Amount B pricing methodology that would consider a specific arm's length result or narrow range of results (smaller than the interquartile range) to achieve simplification and certainty. The consultation document also notes that comparability adjustments, including their impact on simplification and tax certainty, are being re-evaluated, as well as specific considerations for baseline distributors involved in purchases from multiple related parties.
The documentation requirements for Amount B are based on the existing requirements in Chapter V of the Transfer Pricing Guidelines. However, extensive documentation requirements proposed in the consultation document require the taxpayers to maintain certain additional information specific to Amount B, over and above the OECD's recommended requirements for local files. This additional information is expected to be included in the local file as outlined in the OECD Transfer Pricing Guidelines.
The consultation document notes that some jurisdictions may require taxpayers to notify them the first time their transactions fall under Amount B and provide the additional information specific to Amount B at the time of filing such notification.
The consultation document also states that MNE groups may decide to restructure their distribution arrangements with associated enterprises and third parties to avoid their controlled transactions involving the distribution of products falling under Amount B for various reasons, such as commercial, operational, tax compliance, or group-wide policy. MNE groups are free to reorganize their business operations, but tax administrations have the right to determine the tax consequences of the resulting structure. The consultation document also notes that the taxpayers are expected to take consistent positions year on year concerning the application of Amount B.
The consultation document also notes that some jurisdictions have raised concerns about applying Amount B to restructured distributors with built-in losses from prior fiscal years. Whether such losses are deductible depends on each jurisdiction's domestic legislation and procedures and is not covered in this guidance.
Amount B is expected to improve tax certainty and reduce disputes involving in-scope Baseline Marketing and Distribution Activities. However, there may still be disputes. Taxpayers can use mechanisms such as APAs and MAPs to prevent and resolve these disputes in the context of Amount B. The consultation document provides an overview of these mechanisms and considerations relevant to the application of Amount B.KNAV Comments
The consultation document outlines the progress made in defining in-country baseline marketing and distribution arrangements and how they may be identified and priced in accordance with arm's length principles. It also identifies areas where further work is being undertaken and solicits comments on all aspects of the work from the public. Amount B could benefit taxpayers and the tax administration if it is adequately implemented. Still, more work needs to be done, and many questions need to be addressed to determine how it will be scoped and administered.
While many low-capacity jurisdictions are in favor of including sales agency arrangements and commissionaire arrangements under the scope of Amount B, other jurisdictions have considered that it may be inappropriate to include sales agents or commissionaires in the scope of Amount B since it may lead to overcompensation of parties with relatively simple functionality. In this regard, careful consideration must be made of the functional and risk profile of the sales agent/commissionaire to avoid the risk of over-compensation compared to distributors. More clarity is required from Inclusive Framework as to whether the pricing methodology for sales agency/commissionaire should be different from the approach for buy-sell arrangements, or a different profit level indicator should be selected, or if specific comparability adjustments should be applied.
Looking at qualitative assessments and quantitative measurements, prima-facie, very few taxpayers would fall under Amount B. Amount B applies to only stripped-down distributors, i.e., distributors with no financial exposure and risk in respect of the goods distributed by them. MNEs may also set up local entities with more extensive functions to avoid such entities from the qualification for Amount B.
Even though the scope of Amount B is narrow, the pricing methodology and arm's length results will be necessary for transfer pricing purposes. Accordingly, businesses should evaluate the potential impact of Amount B on their existing inter-company pricing for the distribution arrangements and consider whether to include their inter-company transactions within or out of the scope of Amount B.
Our Global Transfer Pricing team can help you understand the impact of the Pillar One rules on your group and find ways to reduce increased taxation and complexity. We will update you on further developments. Please get in touch with our Global Transfer Pricing team if you have any questions or need assistance.