BDO Transfer Pricing News

This article was originally published in the November 2023 issue of TAXTalk, the journal of the South African Institute of Tax Practitioners.

Originally, the scope of Amount B (a Pillar 1 component) was inextricably linked with Amount A, which predominantly applied to larger firms. Amount B, on the other hand, has recently been revised, extending its applicability to all enterprises engaged in baseline marketing and distribution activities such as buy-sell distributors, sales agents, or commissionaires.

The purpose of Amount B is to implement measures that simplify and streamline the application of the arm's length principle for baseline marketing and distribution activities within the designated scope and to bring about tax certainty, which includes the establishment of pricing matrices for industry groupings and factor intensities.

The significance of Amount B in simplifying transfer pricing

Whereas Amount A is concerned with the global tax structure as it currently[1] applies to the largest multinational enterprises (MNEs) globally that are profitable, Amount B is concerned with simplifying existing transfer pricing requirements for taxpayers that fall within the envisaged baseline marketing and distribution activities without a revenue or profitability requirement. Amount B’s focus is on streamlining transfer pricing rules for baseline marketing and distribution activities only, which are common activities performed by many MNEs.

Notably, baseline marketing and distribution activities are the subject of many transfer pricing controversy cases, specifically with low-capacity jurisdictions. Some tax experts argue that a dispute between tax certainty and the arm's length principle lies at the core of Amount B, whereas others may argue that this approach is similar to current analyses that determine an arm’s length outcome. According to the Organisation for Economic Co-operation and Development (OECD), Amount B is intended to promote tax clarity, minimise compliance and administrative expenses, aid low-capacity jurisdictions, and assist with the issue of lack of local market comparables.

Assessing new approaches for qualifying transactions in the scope of Amount B

The new draft report on Amount B envisages two new approaches to determine if a specific transaction falls within the scope of Amount B, labelled as ‘Alternative A’ and ‘Alternative B’. These alternatives aim to address challenges faced by distributors engaged in both baseline and non-baseline activities.

Under Alternative A, a transaction qualifies if the conditions outlined are met, regardless of whether the tested party also participates in non-baseline contributions.

Conversely, Alternative B necessitates additional scrutiny to establish whether the tested party indeed undertakes non-baseline contributions, potentially leading to their exclusion from Amount B's application.

OECD's approach to implementing an arm's length margin: internal benchmarking and profit level indicators (PLIs)

The OECD has conducted an extensive internal benchmarking exercise using data from the BvD Orbis database. The OECD is exploring two methods for implementing potential arm’s length margins:

1. Utilising a pricing matrix, which involves the use of relevant indicators (such as asset intensity or the ratio of operating expenses to sales) to calculate a specific margin.
2. Employing a mechanical pricing tool, which examines various profit drivers and determines a margin based on a variety of applied adjustments.

The OECD is considering applying the transactional net margin method, with a return on sales (ROS), also known as operating margin, as the price level index (PLI). As a guardrail, the OECD is considering applying a cap and collar approach to pricing baseline marketing and distribution activities. The guardrail is intended to prevent particularly low operating expense intense entities from being over-remunerated under the simplified and streamlined approach and, conversely, particularly high operating expense entities from being under-remunerated under the approach.

This means that the ROS is first applied, but then the Berry ratio is also considered to ensure that the ROS is within a reasonable range. The cap and collar range is suggested to be set between 1.05 and 1.50, which means that if the Berry ratio is less than 1.05 or greater than 1.50, then the ROS is adjusted so that the Berry ratio would fall on the respective upper or lower point in that range.

Amount B’s transfer pricing simplification and its potential implications for South Africa 

With the goal of simplification in mind, it is expected that the focus of transfer pricing discussions would move to assessing whether an entity falls in or out of scope of Amount B, depending on what favours an MNE, or tax authority; it is not clear how such a debate would unfold.

Since the specific structure of the final guidelines for Amount B remains unfinished, it is uncertain if the South African Revenue Service (SARS) will accept Amount B, even once it has become an integral part of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations and how that would play out with MNEs, which have a presence in jurisdictions that accept Amount B and others that do not. The situation may be similar to that with the low value-adding intra-group services section that was introduced into the OECD transfer pricing guidelines, to which SARS has given its reservations.

Some questions also remain about the prospective treatment of carry-forward losses, accumulated by entities that now fall within the ambit of Amount B. The OECD suggests that this is likely going to be addressed by domestic law. However, it is not clear if an entity performing baseline marketing and distribution activities can now operate at a loss, even though unlikely. It is worth emphasising that comparable independent entities may have lower profit margins or could be loss-making for various reasons. For example, these entities may experience supply chain interruptions and challenges because of economic downturns, inflationary threats, and currency fluctuations, all of which put pressure on already thin profit margins.

It is also essential to emphasise that, in contrast to several other Base Erosion Profit Shifting (BEPS) 2.0 initiatives, Amount B does not incorporate specific financial thresholds. Consequently, it has the capacity to impact a broad range of MNEs.

Analysing the distinct scopes and interplay of Amount A and Amount B in international taxation

Theoretically, there could be only an Amount B, without Amount A. Politically, that may be a bigger hurdle to overcome. As it stands, the current proposal is for Amount A and Amount B to coexist.

At this stage, however, Amount A and Amount B seem to lack the expected degree of integration, considering their different legal foundations and scope. The original design of Amount A included the concept of the ‘marketing and distribution safe harbour’ (MDSH) to prevent double counting of profits in cases where the local jurisdiction already has taxing rights. The MDSH adjustment seeks to address potential overlaps and reduce profit reallocations, thereby avoiding redundancy and ensuring equitable taxation.

Overall, this discussion emphasises the need for a more cohesive implementation approach between Amount A and Amount B as envisioned in the original design, to ensure a seamless and efficient international tax framework. Most will have heard rumours that Amount A is in a state of uncertainty and, even if those rumours are not formal, tax stakeholders are wondering what this will mean for Pillar 1?

Other conditions and exceptions for Amount B

There are numerous conditions and exceptions to be aware of. Key ones include:

• The tested entity should not engage in unrelated activities, with manufacturing, research and development, procurement, and financing specifically mentioned.
• In the context of intangibles, the tested entity should refrain from performing ‘risk control functions’ that would result in assuming economically significant risks associated with development, enhancement, maintenance, protection, and exploitation (DEMPE) functions.
• The tested entity should avoid engaging in strategic activities that lead to the creation of unique intangibles.
• Amount B will not be applicable if the baseline marketing and distribution activities are already covered by a bilateral or multilateral advance pricing agreement (APA).

What comes next?

The OECD plans to finalise and complete its work on Amount B by the end of 2023 and to publish the approach in the January 2024 edition of the OECD transfer pricing guidelines. Although differing views and opinions have been presented, stakeholders are ultimately looking for an easily defined, clear consensus on what Amount B entails and to achieve the main goal of alleviating the tax administrative burden on taxpayers. We are especially looking forward to:

1. Finding a good balance between quantitative and qualitative criteria to define baseline marketing and distribution activities.
2. Assessing the suitability of:
   • The implementation of the framework for distributing wholesale digital goods;
   • Country-specific adjustments within geographic markets; and
   • The criteria for using Amount B through local databases in specific jurisdictions.

Marcus Stelloh
Pinky Nkone
Rorisang Mosehlane
BDO in South Africa