1. Introduction
Within the context of BEPS 2.0, the OECD has published on the 19th of February 2024 the Report on Pillar One’s Amount B (the “Report”). In short, Pillar One is aimed at tackling the challenges digitalisation poses to the current international tax landscape. Alongside Amount A, which introduces a formulary-based reallocation of taxing rights to the market jurisdictions of large qualifying multinational enterprises, Pillar One also prescribes for a so-called Amount B. In short, Amount B introduces an optional simplified and streamlined approach (“SSA”) applicable for tax years beginning on or after 01 January 2025. It essentially consists of a standardised transfer pricing (comparability) analysis, focused on return-on-sales, for the pricing of baseline wholesale marketing and distribution activities of certain in-scope distributors part of a multinational group.
As per the press release on the Report[1], the need for simplification underpins the introduction of Amount B, particularly for so-called “low capacity jurisdictions”. Purportedly, the SSA caters for the needs of countries which might have “low fiscal implementation capacity”, in the sense that they may not have the necessary tools / know-how to enforce or otherwise generally apply a.o. the principles governed in the OECD Transfer Pricing Guidelines. Being recognised that a relatively high portion of current transfer disputes concern the pricing of the above-mentioned distribution and marketing transactions, Amount B is presented as a simplified and straightforward solution, that may allow these jurisdictions to better secure their tax revenues, diminish tax litigation as well as tax burden for taxpayers, and ultimately foster legal certainty.
Upon closer inspection though, several doubts may come to surface as to whether the goals put forward by the OECD can actually be attained by Amount B, at least as it currently stands. The several steps that need to be followed under the SSA for a(n) (as we will see) not necessarily definitive outcome to be obtained raises the question – does Amount B really constitute a stepping stone towards simplification or yet adds a disguised layer of complexity to the (already rather complex) international tax landscape?
2. Deep dive into Amount B
2.1 Overall mechanics and functioning
Though not dependent on a.o. minimum turnover thresholds, like Amount A, Amount B’s scope is limited, targeting in-scope distributors carrying out the following “qualifying transactions” (as per para. 10 of the Report):
- Buy-sell marketing and distribution transactions, where the distributor purchases goods from another group entity for wholesale distribution to third parties; as well as
- Sales agency and commissionaire transactions, where the entity contributes to the wholesale distribution of goods by another group entity to third parties.
Wholesale distribution, for these purposes, is to include the distribution to any customer aside from end consumers, that is, B2B activities. Retail distribution should therefore not be generally captured, except when the B2C distributor’s three-year weighted average net retail revenues do not exceed 20% of its three-year weighted average net total revenues. In that case, the retail distributor is deemed to solely carry out wholesale distribution activities for Amount B purposes – de minimis retail sales exception.
An accurate delineation of the “qualifying transaction” should be subsequently undertaken in following the guidance proscribed in Chapter I of the OECD Transfer Pricing Guidelines, that is, through a functional analysis considering the functions performed, risks assumed and assets used (paras. 11 and 12 of the Report). The enterprises potentially in scope will then need to ascertain if “baseline activities” are performed. A two-folded test should be applied in this respect (Amount B’s scoping criteria – para 13 of the Report):
- Qualitative criteria: the delineated qualifying transaction needs to exhibit economic characteristics that allow the transfer price to be reliably determined through the use of a one-sided transfer pricing method, with the “simpler” party being the tested party for the purposes of the comparability analysis (i.e., the distributor, sales agent or commissionaire); and
- Quantitative criteria: the ratio of the potentially in-scope distributor’s annual operating expenses over its annual net revenues should fall within a range of 3% and an upper bound of 20% to 30%, based on a three-year weighted average. Tested parties falling outside this range should be filtered out, as arguably they may have a different functional profile, such that the pricing methodology might be expected to lose reliability.
Pursuant to para. 14 of the Report, qualifying transactions of in-scope distributors should nonetheless not fall within the realm of the SSA when the tested party carries out non-distribution activities, such as R&D, manufacturing or alike, that materialise in a valuable and unique contribution, coming hand-in-hand with the exposure to economically significant risks. This should be the case unless the distribution activities (expected to be low-risk and therefore “modestly” profitable/routine-like distribution) can be duly segmented, and thus adequately evaluated and priced separately from the non-distribution activities. Moreover, transactions involving the distribution of non-tangible goods, services, as well as the distribution and marketing of commodities should be also excluded.
Once in the presence of an in-scope transaction, the Report refers to the transactional-net margin method (“TNMM”) as the most appropriate method for their pricing (para 41 of the Report). Following this method, the operating profit margin (that is, the EBIT) on the tested transaction is compared with the profit margin that would have been realised on a comparable transaction with a third party and within comparable circumstances. The Report nevertheless recognises that the comparable uncontrolled price method (“CUP”), using internal comparables, could in some instances (albeit expected to be rare) be potentially more appropriate for the SSA application (para. 42 of the Report).
Moving to the pricing methodology, instead of resorting to a benchmark exercise focused on the individual case, in line with current practice, the SSA rather refers to the results of a more general comparability analysis. I.e., the OECD Inclusive Framework, in using agreed benchmarking search criteria, has put in place a global dataset of independent parties that carry out baseline distribution (and marketing) activities, as for what is required for Amount B purposes. On this basis, a global matrix has been produced, which essentially provides for an approximate arm’s length return for in-scope transactions, taking into account return on sales as a the net profit indicator. As per para. 44-46 of the Report, the return for in-scope transactions should be provided by selecting the appropriate tabs of the pricing matrix (please refer to the table below), and taking into account the following:
- Industry group, chosen from within 3 groups. Group 1 encompasses perishable foods, construction materials, etc., Group 2 encompasses IT hardware, animal feeds, jewelry, etc. and components not falling in the other groups, and Group 3 covers medical machinery, agricultural vehicles, etc. Though these groups were arguably segmented based on the levels of returns that baseline distributors operating within that sector receive, the Report does not refer to any underlying logic that would underlie this classification.
- Factor intensity classification, which may be broke down in 5 subcategories depending on the weighted average of the business’ three preceding fiscal years’ net operating assets intensity (i.e., the ratio of net operating assets to net revenue – “OAS”) and the operating expense intensity (that is, the ratio of operating expenses over the net revenue – “OES”).
Essentially, the resort to the pricing matrix may lead to 15 possible profit margins, ranging from 1.50% to 5.50%. A three-step procedure, as per para. 47 of the Report, should be subsequently followed to price the baseline distribution functions in a given concrete situation. The relevant return on sales percentage resulting from the above procedure may be used by the relevant enterprises, with a 0.5% variation.
Lastly, some verifications may be undertaken to test whether the results provided in using the pricing matrix are adequate or need to be further adjusted. In particular:
- An operating expense cross-check should be performed (paras. 51 and 52 of the Report). In this regard, if the return on sales, as determined under the pricing matrix, converted into a ratio of EBIT to operating expenses, falls outside the relevant applicable operating expense cap-and-collar range (as determined by reference to the enterprise’s factor intensity qualification), then an adjustment to the nearest edge of the range should be performed.
- Further, additional adjustments should be performed when the in-scope distributor operates in jurisdictions for which no or insufficient data can be retrieved from the global dataset and which can be classified as a “qualifying jurisdiction”, i.e., as a jurisdiction “where the data availability mechanism” specifically referenced in Section 5.3 of the Report “applies for the purpose of determining adjusted returns for tested parties located in those aforementioned jurisdictions”[2].
2.2 Amount B and Double Tax Treaties (“DTTs”)
Amount B’s SSA is optional, i.e., countries may choose to implement it, and those who opt not to do so, are not obliged to abide with the results of the application of the SSA in another involved jurisdiction. This should be the case regardless of in which side of the transaction is the SSA expected to be applied (para. 6 of the Report). For these jurisdictions, the results deriving from the SSA should not be (automatically) equated as an arm’s length outcome, including for the purposes of Articles 9 and 25 of the 2017 OECD Model Tax Convention on Income and on Capital (“MC-OECD”). The Inclusive Framework’s countries nonetheless express, as per the Report, a commitment to abide with the SSA results where appropriate and to ensure that a single taxation under the applicable DTTs is achieved. This should particularly be the case when the jurisdiction intending to apply the SSA is a “low-capacity jurisdiction” (list still to be published by the OECD), and it has been announced that competent authority agreements to implement the abovementioned commitment in the relevant tax treaty networks are to be put in motion (albeit countries such as India have already expressed their intention not to be bound by these commitments[3]).
For the jurisdictions that opt to implement the SSA, they may choose to make it mandatory for taxpayers or to rather act as an elective regime (para. 7 of the Report), and the results stemming from the SSA will be considered as an arm’s length outcome. As per the above, the underlying objective is to allow for simplification by generally providing an approximate arm’s length outcome for the jurisdiction of the tested party, whilst generally not setting aside the OECD Transfer Pricing Guidelines. Indeed, arguably the SSA is not intended to replace or otherwise take precedence over the later, but rather to co-exist with these.
The International Framework has nevertheless recognised that the SSA can potentially lead to instances of economic double taxation, namely where one of the jurisdictions involved applies this approach and the other does not, or in situations where the SSA is applied differently. The Report nevertheless advances “solutions” for these cases. In particular:
- In case a SSA primary adjustment is made, resulting in double taxation of a given qualifying transaction, a corresponding transfer pricing adjustment in the other relevant jurisdiction may be undertaken, namely through a downward adjustment to the tax liability of the associated enterprise (para. 71 of the Report).
- Moreover, and particularly in cases where one of the jurisdictions involved does not apply the SSA, double taxation may arguably be solved through the mutual agreement procedure (“MAP”), as per Article 25 of the MC-OECD (para 72 of the Report). In these instances, the jurisdiction not applying the SSA is to determine the position, within the MAP context, on the basis of the arm’s length principle and overall OECD Transfer Pricing Guidelines. Consequently, the jurisdiction applying the SSA should step down, and stop applying it, the solution being justified on the need to ensure a single taxation[4].
3. An additional layer of complexity?
Albeit aimed at providing a simplified approach and supposedly contributing to tax certainty and the minimisation of tax disputes, the current mechanics of Amount B, as described in section 2 above, seem far from being suitable to contribute to any of these objectives.
- Baseline activities and in-scope determination
For starters, though Amount B is aimed at minimising transfer pricing disputes concerning baseline marketing and distribution arrangements, oddly enough no guidance is provided on how to tackle disputes on the accurate delineation of a marketing and distribution arrangement. Putting it differently, the Amount B framework does not seem to help on the qualification (and consequently, on potential litigation resulting thereof) of the activities performed by a distributor, particularly in determining whether these go beyond a baseline or routine contribution role, or otherwise qualify as non-distribution activities not covered by Amount B. In this sense, the reference to qualitative features when ascertaining the scoping criteria seems to further blur what should and should not be considered as a baseline distribution (and marketing) arrangement. Indeed, taking the example of pharmaceuticals, the pricing matrix specifically refers to these pharmaceutical distributions as being “in scope”. Nonetheless, it may be that the obtaining of a regulatory license to distribute specific pharmaceutical products is needed. It is in this respect questionable whether the obtaining of such license (and resulting regulatory clearance thereof) could materialise in a valuable and unique contribution, that would therefore dictate the distributor’s exclusion from Amount B’s scope, particularly when these activities are frequently performed by pharmaceutical distributors[5].
Similarly, in order to demonstrate that a given transaction can be reliably priced in using a one-sided method, enterprises have to accurately delineate that same transaction. Essentially this means that a detailed transfer pricing analysis would in principle have to be undertaken to ultimately be able to resort to Amount B’s pricing matrix, whose initial objective was precisely to simplify the pricing of baseline in-scope transactions. The necessary functional analysis to be undertaken as a preliminary step within the SSA therefore seems to run afoul of Amount B’s overall simplification goal[6].
Further, though the quantitative criteria purposedly is based on (more) objective grounds to delineate what baseline activities should be, the Amount B framework seems to be silent on what exactly should be understood as operating expenses for these purposes. As flagged by some tax literature, the definition of operating expenses typically excludes expenses which are duly passed pursuant to the transaction’s accurate delineation, alongside costs incurred on financing, income taxes, investment activities as well as exceptional items[7]. The Report does not, in this respect, provide any guidance whatsoever on how should these pass-through expenses be identified and addressed. This is particularly pressing given that this is already a rather common area of dispute, which can further blur the assessment of which entities should and should not be covered by Amount B.
- Application within a cross-border context
As per the above, it is understood that, when the SSA leads to instances of double taxation, the jurisdiction applying the SSA should step down, to safeguard the principle of single taxation. Any other outcome would be incompatible with DTT relief provisions (particularly considering that the SSA is not yet foreseen in DTTs)[8]. A contrario, this means that, for DTT purposes, the SSA is understood to give rise to a result which does not abide with the arm’s length principle, as soon as the outcome deviates from that obtained through the application of Article 9 MC-OECD. As flagged by some tax literature[9], essentially this means that, where the result stemming from the SSA deviates from Article 9 MC-OECD, the SSA should in principle only have any relevance in a DTT context if it ends up being directly incorporated in the DTT at hand or through an international public law instrument, such as a multilateral convention, as otherwise its application would have to be withdrawn. Incorporating the SSA through an administrative agreement, as suggested in the Report, therefore does not seem to be sufficient in this respect, and could otherwise imply that institutions other than the judiciary were allowed to interpret treaty provisions, potentially running afoul the constitutional principles of the involved jurisdictions.
Adding the above to various sorts of computations that would have to be performed by, not only taxpayers, but also tax authorities, the question ultimately boils down as to whether Amount B actually does cater for any simplicity at all. Upon closer inspection, it is arguable whether that should be the case. In the end, the multiple scoping and testing exercises, as described in section 2 above, may even become obsolete, considering that any deviation from the normally applied transfer pricing principles governed by Article 9 MC-OECD would neutralise it and render the SSA’s outcome immaterial. Adding the optionality of the SSA to the equation, it seems doubtful whether legal certainty will in the end be safeguarded; conversely, more controversy may be expected to arise.
The SSA’s rationale (also) hinges on the possibility to allow (the yet to be defined) low-capacity jurisdictions to apply a streamlined transfer pricing approach, particularly considering that they may not have the mechanisms or know-how to apply the arm’s length principle as governed in Article 9 MC-OECD. Surprisingly though, these would nonetheless have to withdraw from the application of the SSA as soon as the other DTT jurisdiction discards the SSA by arguing that its outcome deviates from the result that would have arisen through the application of Article 9 MC-OECD.
Lastly, it should be highlighted that the SSA is to cover routine baseline activities, which by nature are expected to be moderately profitable. The question therefore arises as to whether it is justifiable to introduce another layer of complexity to the international transfer pricing framework (or so at least it seems) when ultimately only moderate/relatively low amounts of tax revenues may be at stake[10].
4. Conclusive remarks
It is doubtful whether Amount B may cater for its goals. Not only does it entail a complex sequence of steps, some of which actually require the accurate delineation of the transaction at stake, as it also leaves some rather disputed topics unanswered, such as how and when do the activities of a given distributor go beyond a baseline or routine contribution role. Its optional character may also give rise to questions as to whether the SSA can actually be effective, specially considering that, in a DTT context, an outcome deviating from that resulting from the application of Article 9 MC-OECD may suffice to bar its application. Simplification therefore does not seem to be enhanced, nor, oddly enough, otherwise preserved.
Vasco Chuaqui
March 2024
[1] Availabe here: https://www.oecd.org/tax/beps/release-of-report-on-amount-b-relating-to-the-simplification-of-transfer-pricing-rules-and-conforming-changes-to-the-commentary-of-the-oecd-model-tax-convention.htm
[2] Please refer to the “Definitions” section of the Report.
[3] Nor generally speaking to implement Amount B.
[4] Inter alia, para. 78 of the Report.
[5] KPMG, Observations to Amount B.
[6] KPMG, Observations to Amount B.
[7] KPMG, Observations to Amount B.
[8] Maarten Floris de Wilde, “Why S&S Approach as Amount B of Pillar One brings us nothing, at all”.
[9] Maarten Floris de Wilde, “Why S&S Approach as Amount B of Pillar One brings us nothing, at all”.
[10] Maarten Floris de Wilde, “Why S&S Approach as Amount B of Pillar One brings us nothing, at all”.