Pillar One: Amount B

The OECD Inclusive Framework has published a report incorporating changes to the OECD Transfer Pricing Guidelines on Amount B of Pillar One. The report deals with the optional rules for applying a simplified approach to transfer pricing on so-called baseline marketing and distribution activities between related entities and is particularly aimed at aiding tax administrations in low capacity jurisdictions. It is important to note that unlike Amount A, which will only apply to about 100 of the largest multinational enterprises (MNEs), Amount B is intended to apply to all MNEs that are engaged in "in-scope arrangements".

As a result of the report, additional sections are added to the OECD Transfer Pricing Guidelines as an Annex to Chapter IV covering special considerations for baseline distribution activities and jurisdictions may adopt this approach from 2025.

Background

Pillar One is part of the agreed two pillar solution reached by the OECD and the Inclusive Framework on Base Erosion and Profit Shifting (IF) to introduce changes to the international tax landscape to deal with problems created by the digital economy. Political agreement was reached in June 2021 on the two pillar approach and this was followed by the publication of a "Statement on a Two-Pillar Solution to Address the Tax Challenges Arising From the Digitalisation of the Economy". For full details see our earlier Insights article.

Amount B was initially introduced in the original Blueprint published in October 2020. In December 2022, the OECD published a public consultation document on the calculation of Amount B seeking feedback on both the scoping criteria and also the pricing methodology of Amount B. The February 2024 report sets out the optional rules for the adoption of this streamlined and simplified to transfer pricing of baseline marketing and distribution activities.

Amount B - what it is

Amount B provides for an optional simplified and standardised remuneration for related party distributors that perform "baseline marketing and distribution activities". The intention is to standardise, simplify and streamline the pricing of such baseline activities to reduce administration and disputes in this area which commonly gives rise to disagreements between taxpayers and tax authorities, in a manner that is broadly aligned with the arm's length principle and intended to approximate an arm's length pricing amount.

Jurisdictions can choose to apply the simplified and streamlined approach to qualifying transactions of eligible baseline distributors for in-scope transactions for fiscal years commencing on or after 1 January 2025.

A jurisdiction that chooses to apply the simplified and streamlined approach may choose to apply it using one of two options. Under the first option, a jurisdiction can permit resident entities to elect to apply the simplified and streamlined approach. Under the second option, a jurisdiction can require the use of the simplified and streamlined approach in a prescriptive manner by its tax administration and resident entities.

Since Amount B is an optional approach, there will be situations where one jurisdiction chooses to apply it and the counter-party jurisdiction does not. In those circumstances, the Amount B outcome is not binding on the counterparty jurisdiction. However, subject to their domestic legislations and administrative practices, members of the Inclusive Framework commit to respect the outcome determined under the simplified and streamlined approach to in-scope transactions where such approach is applied by a low-capacity jurisdiction and to take all reasonable steps to relieve potential double taxation that may arise from the application of the simplified and streamlined approach by a low-capacity jurisdiction where there is a bilateral tax treaty in effect between the relevant jurisdictions. The Inclusive Framework will work on the implementation of this commitment in 2024, including through the development of competent authority agreements. The Inclusive Framework will agree on the design elements and on the list of low-capacity jurisdictions within scope of this commitment by consensus in 2024. The Inclusive Framework will agree on the list of low-capacity jurisdictions by 31 March 2024.

Scope of Amount B

"Baseline marketing and distribution activities" for the purposes of Amount B is intended to cover the broad marketing, sales and logistics functions, such as buying goods for resale, performing promotional or advertising functions, warehousing goods, identifying customers, concluding sales and processing orders, invoicing and collection or providing customer support.

In particular, Amount B will cover the following transactions:

• Buy-sell marketing and distribution transactions where the distributor purchases goods from one or more associated enterprises for wholesale distribution to unrelated parties: and
• Sales agency and commissionaire transactions where the sales agent or commissionaire contributes to one or more associated enterprises' wholesale distribution of goods to unrelated parties.

In addition, to fall within scope:

• the qualifying transaction must exhibit economically relevant characteristics that mean it can be reliably priced using a one-sided transfer pricing method, with the distributor, sales agent or commissionaire being the tested party; and
• the relevant party in the qualifying transaction must not incur annual operating expenses lower than 3% or greater than an upper bound of between 20% and 30% of the its annual net revenues.

A transaction will, however, be out of scope of Amount B where:

• the qualifying transaction involves the distribution of non-tangible goods, services or the marketing, trading, or distribution of commodities; or
• the relevant party carries out non-distribution activities in addition to the qualifying transaction, unless the qualifying transaction can be adequately evaluated on a separate basis and can be reliably priced separately from the non-distribution activities.

The report contains further detailed commentary on each of these elements.

As part of the current workstream, the Inclusive Framework is working on an additional optional qualitative scoping criterion that jurisdictions may choose to apply as an additional step to identify distributors performing non-baseline activities for the purpose of the simplified and streamlined approach. The Inclusive Framework will conclude this work by 31st March 2024, with any additions to be incorporated into the OECD Transfer Pricing Guidelines. This is seen as an important element for some jurisdictions, with India in particular indicating it considers such an element essential.

Amount B pricing methodology

The Transactional Net Margin Method (TNMM) is chosen as the most appropriate method under the approach. However, an exception is provided that allows the comparable uncontrolled price (CUP) method using internal comparables that can be reliably used to price the in-scope transaction to be applied instead.

The approach to determining the appropriate return for a party involved in in-scope activities involves a three-step process.

Firstly, it is necessary to determine the relevant industry group of the party.

Secondly, it is necessary to determine the relevant "factor intensity classification" of the party based on the three preceding years which is based on permutations of various thresholds of net operating asset intensity (OAS) and operating expense intensity (OES).

Thirdly, using the relevant industry group and the factor intensity, it is necessary to identify a range from the pricing matrix produced by the OECD. This is a matrix prepared based on the financial information derived from a global dataset to provide the basis for the approximation of arm's length results and which has been translated into the pricing matrix.

The pricing matrix indicates that the return for baseline marketing and distribution activities should be in the range of between 1.5% and 5.5% return on sales, depending on the industry and the factor intensity of the relevant entity. The pricing matrix is used to provide a range equal to the return on sales percentage plus or minus 0.5%. Any point within that acceptable range can be relied on for the purposes of demonstrating transfer pricing compliance.

The return determined from the pricing matrix can be further adjusted in two ways:

1. An operating expense cross-check is applied as a guardrail within which the primary return on sales net profit indicator is applied. Where the application of the return on sales net profit indicator produces a result outside of the pre-defined operating expense cap-and-collar range specified in a table reproduced at paragraph 5.2 of the report, the profitability of the party will be adjusted appropriately.

2. A data availability mechanism which is relevant for qualifying jurisdictions (yet to be defined) where an additional adjustment comprising the OAS multiplied by a net risk adjustment based on the sovereign credit rating of the qualifying jurisdiction is made to the return from the pricing matrix (see paragraph 5.3 of the report).

The pricing matrix and the financial data points pertaining to the adjustments above will be reviewed annually and updated where necessary.

Documentation

Section 6 of the report covers the documentation requirements in the context of Amount B. In essence, it is assumed that the local file requirements currently required under Chapter V of the OECD Transfer Pricing Guidelines will include sufficient information to examine the taxpayer's position under the streamlined and simplified approach. In particular, section 6 identifies items of information of relevance to Amount B that could be included as part of the local file. However, jurisdiction's may consider the introduction of targeted documentation requirements and may consider simplifying the requirements for small and medium enterprises.

When a taxpayer is seeking to apply the simplified and streamlined approach for the first time, the taxpayer should include in its local file, or in any other documentation relevant to the application of the approach, a consent to apply the approach for a minimum of three years, unless transactions are no longer in scope during that period, or there is a significant change in the taxpayer's business, and notify that circumstance to the tax authorities of the jurisdictions involved in the transaction.

Transitional issues

The report recognises that groups may wish to reorganise business models to fall within scope of Amount B. The report notes that where groups attempt to artificially reorganise their arrangements to derive tax advantages from the application of the Amount B approach, tax authorities may adopt targeted approaches to prevent the use of the approach for tax planning.

Double taxation

As mentioned above, the Amount B approach is an optional one that jurisdictions are not obliged to implement. That begs the question what happens where one jurisdiction applies the Amount B approach and the counter-party jurisdiction adopts a more traditional transfer pricing approach to the relevant transactions and there is a mismatch in the results.

In those circumstances, the report makes it clear that any Mutual Agreement Procedure that arises as a result of that disagreement should be conducted and based on the remainder of the Transfer Pricing Guidelines rather than Amount B.

"In a Mutual Agreement Procedure or resulting arbitration procedure, where one or more of the jurisdictions relevant to the Mutual Agreement Procedure has not chosen to apply or accept the simplified and streamlined approach, then the competent authorities of both jurisdictions engaged in that Mutual Agreement Procedure must justify their positions based only on the remainder of these Guidelines. Specifically in such cases, the simplified and streamlined approach under this guidance must not be considered or referenced by the relevant competent authorities as an approach which is treated as leading to an acceptable outcome. This includes for the purposes of conducting the Mutual Agreement Procedure, as a basis of a resolution of the Mutual Agreement Procedure, or by any party (including arbitrators) in the conduct of any arbitration procedure."

Nevertheless, as mentioned earlier, members of the Inclusive Framework have committed to respect the outcome determined under the simplified and streamlined approach to in-scope transactions where such approach is applied by a low-capacity jurisdiction and to take all reasonable steps to relieve potential double taxation that may arise from the application of the simplified and streamlined approach by a low-capacity jurisdiction where there is a bilateral tax treaty in effect between the relevant jurisdictions. Clearly, however, further work is required to work out this commitment, including the list of low-capacity jurisdictions.

Comment

The report repeatedly emphasises the importance of both the need for Amount B to simplify and streamline the pricing of in-country baseline marketing and distribution activities and the need for the outputs to be consistent with the arm's length principle, and this is reflected in the comprehensive work that appears to have been undertaken by the Inclusive Framework. There will, however, remain challenges in applying these rules. For example, the detailed scoping criteria necessary to ensure Amount B is only applied to specific types of entities, for Amount B to provide an arm's length outcome, may in practice exclude distributors of many MNEs from benefitting from Amount B.

Equally, it is clear that some countries remain concerned about the approach. India in particular has included a number of reservations, including the lack (at this stage) of any qualitative criteria for identifying baseline distributors and the lack of a list of low-capacity jurisdictions. It considers that both of these elements should be completed before political commitment is required.