OECD Pillar One – Amount B transfer pricing distribution return
On 8 December 2022, the OECD published a consultation document on the main design elements of ‘Pillar One – Amount B’, outlining a new process for pricing baseline distribution activities in accordance with the arm’s length principle.
This follows the statement on the components of global tax reform, agreed by more than 135 members of the G20/OECD Inclusive Framework (‘OECD Inclusive Framework’) in October 2021. Since 2017, the member countries of the OECD Inclusive Framework have developed a ‘two-pillar’ approach. Amount B forms part of the Pillar One package on profit allocation.
Amount B will apply to all multinational businesses that undertake ‘routine’ distribution activities, and, unlike Amount A, is not limited to the world’s largest multinationals. The draft proposes that the scope of Amount B will cover the distribution of tangible goods (including as a sales agent or commissionnaire as well as a buy-sell distributor) although it remains under discussion whether this may be expanded to services and software or other digital goods. The consultation document sets out a number of areas where the OECD Inclusive Framework is looking for input from businesses and advisers in relation to the new framework for Amount B. This is a relatively ‘early stage’ document and there are several options included in the draft that are open for further debate before a final design decision is made.
The consultation document highlights the tension between simplification of the transfer pricing approach for distribution activities versus theoretical accuracy and taking into account commercial differences across businesses and regions. The document acknowledges in particular the needs of some countries, specifically low-capacity jurisdictions, in relation to simplifying transfer pricing administration. Businesses too will be looking for as much simplification as possible to reduce the compliance and transfer pricing audit burdens faced currently. The consultation document makes it clear that functional analyses and ‘delineation of the transaction’ will remain key to determining whether or not Amount B should apply and the arm’s length approach to be taken. The pricing methodology being developed, using a broad centralised Transactional Net Margin (‘TNMM’) approach, is intended to remove the need for businesses to undertake their own benchmarking exercises in relation to their in-scope distributors. Instead, the focus will be for businesses on (i) assessing whether distributors meet the scope criteria set out for Amount B to apply; (ii) making any necessary adjustments or calculations based on financial results to determine pricing and (iii) documenting Amount B outcomes in the transfer pricing local file. Businesses will be concerned that distributors might fall in and out of scope of Amount B in different years as a result of numerical criteria not being met. In other transfer pricing situations consideration is given to averaging results over more than one year to address such variations.
The OECD anticipates that Amount B will come into effect at the start of 2024 (to align it with other aspects of Pillar One such as Amount A and the removal of Digital Services Taxes and other unilateral measures). This means there is a now-familiar ambitious timetable, with the technical work on Amount B scheduled to be completed by mid-2023.
Amount B will apply to the following intra-group transactions:
- Buy-sell arrangements where the distributor purchases goods from another group entity resident in a different country for wholesale distribution to third parties based primarily in its local market; and
- Sales agency and commissionnaire arrangements where the entity contributes to the wholesale distribution of goods for another group entity.
Scoping criteria are being developed that will need to be considered as part of the accurate delineation of the distribution transaction. The scoping criteria do not provide an exhaustive list of qualifying activities but describe economically relevant characteristics, including qualitative and quantitative assessments:
- the business documents the transactions in a written contract which includes the responsibilities, obligations and rights and assumption of economically significant risks of the distribution activities and does not contain terms inconsistent with the scoping criteria;
- the distributor primarily distributes in its market of residence (with a cap on sales from customers located in other countries);
- the distributor does not perform any other economic activity for which it is (or should be) remunerated at arm’s length, including: manufacturing, research and development, procurement, and financing activities;
- the distributor does 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;
- the distributor does not: undertake activities that relate to creating or obtaining distribution rights where the activity would be remunerated at arm’s length; or perform any significant valuable specialised services for customers that would play a significant role in maintaining a customer relationship (e.g. regulatory activities or annual maintenance contracts);
- the distributor does not perform strategic sales and marketing activities that generate intangible assets relating to the exploitation of the products sold in the market;
- the net sales to any single customer does not exceed a (to be defined) proportion of total net sales;
- certain ancillary activities are permitted up to (to be defined) permissible thresholds, including distribution to end-consumers through physical and online stores, expenditure on marketing and advertising expenses, packaging and assembly expenses, and after-sales product support/processing product returns or similar support services;
- the ratio of operating expenses to net sales falls within a (to be defined) range;
- the distributor does not assume economically significant risks above a (to be defined) limited level, including market risk, credit risk, inventory risk, product liability risk, and foreign exchange risk;
- the distributor does not own any intangible assets such as marketing intangibles, and does not have ownership of market access rights or regulatory licences that create barriers to entry; and
- Amount B will not apply to transactions covered by a bilateral or multilateral advance pricing arrangement.
Both finished and unfinished goods, including components or intermediate goods, are within scope.
Amount B may not apply where an exemption or exclusion applies. Potential exemptions and exclusions being considered include:
- where a transfer pricing method other than the Transactional Net Margin Method is the most appropriate method e.g. comparable uncontrolled price (CUP);
- where local market comparables are available to price the transaction;
- transactions involving the distribution of commodities; and
- transactions involving the distribution of non-tangible goods.
The pricing methodology uses common benchmarking search criteria to provide a standardised approach to identifying comparable entities that perform baseline distribution activities in line with the scoping criteria.
The search criteria have been used to produce a global dataset that represents the available population of businesses that undertake wholesale distribution as their majority business activity. The dataset is being analysed to identify the economically relevant characteristics that correlate with levels of profitability. Analysis will take into account whether and how returns vary with geographic region or country, and in respect of both wholesale goods distribution and commissionnaire arrangements. Preliminary observations have indicated the following as potential factors: geography; industry; asset intensity and operating expense intensity.
The pricing methodology will be used to produce a set of baseline distribution comparables, which can be translated into arm’s length results tailored to the distributor in question. The output of the pricing methodology may be either:
- A matrix of arm’s length pricing outcomes in which comparable marketing and distribution entities are grouped into subsets in line with their relevant economic characteristics; or
- A mechanical pricing tool such as a formula or set of quantitative adjustments to derive arm’s length profitability returns aligned with the economically relevant characteristics of the distributor.
Work is ongoing on a number of technical considerations including: the selection of the net profit indicator for the purposes of the TNMM e.g. net profit margin or other metrics such as return on assets or berry ratio; selecting the most appropriate point where a range of arm’s length outcomes are determined under the Amount B pricing methodology; comparability adjustments; and purchases from multiple related party suppliers.
Businesses with transactions within the scope of Amount B will be required to provide additional information to tax authorities as part of the transfer pricing local file:
- a statement that the information is accurate and complete;
- explanation of the delineation of the in-scope transaction, including the functional analysis, the parties to the transaction and explanation of the fulfilment of scoping criteria;
- identification and explanation of other factors that might influence the accurate delineation of the transaction (e.g. a licence between the distributor and another group entity for the use of intangibles);
- financial accounts for the distributor for the current and three-five prior years – to be defined;
- information and allocation schedule tying the financial data used in respect of the scoping criteria back to the financial statements;
- explanation of the application and results of the Amount B pricing methodology for the transaction;
- explanation of any transitional issues e.g. business restructurings or transfers of intangibles;
- the written contract governing the transaction; and
- any existing unilateral and bilateral/multilateral advance pricing arrangements or other tax rulings and which are related to in-scope transactions.
Where disputes arise between businesses and tax authorities in relation to the application of Amount B (in particular, regarding whether a transaction meets the scoping criteria), existing tax dispute prevention and resolution mechanisms will apply, including advance pricing arrangements and mutual agreement procedures (MAP).
Any MAP agreement reached prior to the adoption of Amount B should take priority for transactions involving baseline distribution activities. For ongoing and prospective MAP cases, the guidance on Amount B should be considered
The OECD Inclusive Framework is assessing options for the implementation of Amount B and it seems likely that guidance should be included in the OECD Transfer Pricing Guidelines. Other considerations include whether Amount B should be a ‘safe harbour’ or whether Amount B should be prescribed as how the arm’s length principle applies to baseline distribution activities.
Comments on the draft rules are invited by 25 January 2023. The OECD Inclusive Framework aims to complete the technical work and release the final Amount B deliverable by mid-2023. The rules are intended to come into effect at the start of 2024.
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