South Africa - Pillar One and Amount B

This article was originally published in Issue 70 of Tax Chronicles Monthly (May 2024)

The Organisation for Economic Cooperation and Development (OECD) is an organisation which was formed to promote sustainable economic growth and improve economic policies. The OECD has been focused on base erosion and profit shifting (BEPS), ensuring that multinational enterprises (MNEs) pay their fair share of taxes and do not exploit loopholes to divert profits to low- or no-tax jurisdictions.

The OECD introduced the Inclusive Framework (IF) on BEPS to enable over 140 IF members, including many developing economies, to participate equally in setting standards for BEPS-related issues and oversee the implementation of the BEPS project.

Digitalisation and globalisation have had a profound impact on economies, challenging the existing rules for taxing international business income. These rules, often over a century old, are no longer deemed as sufficient in today’s interconnected world. This has led to the perception that certain MNEs are not paying their fair share of taxes, despite significant profit generation. The OECD, via the IF, has adopted a two-pillar approach to address the tax challenges and avoidance, with a view to ensuring that MNEs comply with international fair taxation principles. These pillars focus on addressing tax challenges arising from the digital economy. This article specifically delves into Amount B of Pillar One.

Expanding the scope of Amount B under Pillar One: Simplifying transfer pricing for baseline marketing and distribution activities

Amount B has recently been revised, extending its applicability to all enterprises, specifically those 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

Amount B is concerned with simplifying existing transfer pricing requirements for taxpayers which 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. Notably, baseline marketing and distribution activities are the subject of many transfer pricing controversy cases, including 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 which determine an arm’s length outcome. According to the OECD, Amount B is intended to promote tax clarity, minimise compliance and administrative expenses, aid low-capacity jurisdictions, and assist with the issue concerning a lack of local market comparables.

Scope of Amount B

The final OECD report on Amount B (Amount B Report) determines whether a transaction (referred to as qualifying transaction) falls within the scope of Amount B through considering the following:

The qualifying transaction must exhibit economically relevant characteristics and can be reliably priced using a one-sided transfer pricing method, with the distributor, sales agent, or commissionaire being the tested party.
The tested 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 tested party’s annual net revenues.

The definition of distributor includes wholesale distributors, meaning it only includes the distribution to any type of customer except end consumers. Additionally, a distributor that carries out both wholesale and retail distribution is deemed to carry out solely wholesale distribution if its net retail revenues do not exceed 20% of total net revenues, calculated based on a weighted average for the past three years.

Qualifying transactions will nevertheless be out of scope if:

The qualifying transaction involves the distribution of non-tangible goods, services or the marketing, trading, or distribution of commodities.
The tested 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.

Amount B's Approach to implementing an arm's length return

The Amount B Report provides step-by-step guidance on how to price an in-scope transaction. In summary, the following steps need to be followed:

Use the pricing matrix to determine the return, taking into account the industry groupings and the factor intensity in relation to operating expenses and assets.
Apply the operating expense cross-check as a guardrail to mitigate abnormal results.
Apply an adjustment using the data availability mechanism for qualifying jurisdictions.

In essence, the Amount B Report is applying the transactional net margin method, with a return on sales (ROS), (also known as operating margin) as the profit level indicator. The arm’s length range derived from the pricing matrix within the Amount B Report is based on three industry groups and five categories of factor intensities resulting in 15 different potential ROS percentage. The percentages considered to be acceptable, prior to potential risk adjustments for tested parties in qualifying jurisdictions, vary from 1.50% to 5.50%. There is an acceptable variance of 0.5% compared to the percentages provided. Only results over or under the identified data point for the particular fact pattern (including the variance) would need to be adjusted accordingly.

"The Amount B Report provides step-by-step guidance on how to price an in-scope transaction."

Then, a guard rail is applied to prevent particularly low-operating expense-intense entities from being over-remunerated under the simplified and streamlined approach and, conversely, high-operating expense entities from being under-remunerated under the approach.

The data availability mechanism accounts for cases where there is no or insufficient data in the global dataset for a particular tested party jurisdiction. The ROS is adjusted, inclusive of 1) a net risk adjustment percentage of the qualifying jurisdiction with reference to the sovereign credit rating of such qualifying jurisdiction, and 2) the net operating asset intensity percentage (not to exceed 85%).

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 yet clear how such a debate would unfold in South Africa.

Even though the Amount B Report is now final, it is still uncertain whether the South African Revenue Service (SARS) will accept Amount B and how that would play out with MNEs, in jurisdictions with a policy mismatch (eg, if SARS accepts Amount B and the counterparty’s revenue authority does not, or vice versa).

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 Amount B Report suggests that this is likely going to be addressed by domestic law and is not within the scope of the guidance. However, it is not clear whether an entity performing baseline marketing and distribution activities can now operate at a loss, even though this is unlikely even in the absence of the Amount B guidance. Commercial operations do not operate in a policy vacuum; though, and it is worth emphasising that, in reality, 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, which all put pressure on already thin profit margins.

Within this context, it is also essential to emphasise that, in contrast to several other BEPS 2.0 initiatives, Amount B does not incorporate specific financial thresholds. Consequently, it carries the capacity to impact a broad range of MNEs.

Documentation

The documentation requirements as per the Amount B Report build on the existing local file documentation requirements included in Chapter V of the OECD Transfer Pricing Guidelines, which are mirrored by South African transfer pricing legislation. In summary, the local file should include an explanation on the delineation of the in-scope qualifying transaction, written contracts, calculations showing the determination of the relevant revenue, costs and assets allocated or attributed to the in-scope transaction.

Considering this is new, the Amount B Report also stipulates that where a taxpayer is seeking to apply Amount B for the first time, the taxpayer should include in its local file consent to apply Amount B for a minimum of three years, unless the transactions fall out of scope during that period or there is a significant change in the taxpayer’s business. The taxpayer is also required to notify the tax authorities of the jurisdictions involved in the qualifying transaction of its intention to apply Amount B.

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).
The Amount B Report also specifies that the financial data and other data points will be reviewed annually and updated as necessary, providing a framework for maintaining the approach's accuracy over time.
India has provided reservations on the incomplete nature of the report owing to the non-inclusion of the definitions of low-capacity jurisdictions and qualifying jurisdictions, and an appropriately designed optional qualitative scoping criterion. Further, India also provided reservations on various aspects of the Amount B design, including the operating expense cross-check mechanism and the overall design of the pricing methodology. A developing country which is also part of BRICS recording such reservations, questions whether South Africa will have similar concerns.
The Amount B Report stated that the IF will agree on the list of low-capacity jurisdictions by 31 March 2024; however, this list has not yet been released (as this article went to press) – this creates doubt as to when the list will be released and how this may impact implementation.

Marcus Stelloh
Patrick McLennan
BDO in South Africa

Other documents

OECD (2024), Pillar One – Amount B: Inclusive Framework on BEPs, OECD/G20 Base Erosion and Profit Sharing Project;
OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022.

Tags: base erosion and profit shifting (BEPS); multinational enterprises (MNEs); Inclusive Framework (IF) on BEPS; Amount B of Pillar One