The OECD on Dec. 8 issued a public consultation document on Amount B of Pillar One, an effort to simplify and streamline the transfer pricing of routine marketing and distribution activities in accordance with the arm’s length principle.
The public consultation document sets out the main design elements of Amount B – the scope of the rules, the pricing methods, and the current status of discussions regarding an implementation framework. Unlike prior Pillar One consultation documents, this document poses specific questions on a number of outstanding issues.
The OECD has requested comments on the issues raised in the consultation document by January 25, 2023.
In contrast to Amount A of Pillar One, Amount B is not limited in application to multinational entities (MNEs) above certain profitability or revenue thresholds. Rather, Amount B, with exceptions for distribution of commodities and non-tangible goods, would apply to all MNEs that undertake “routine” distribution activities.
The consultation document proposes that Amount B will cover the distribution of tangible goods, but it may be expanded to include services and software, or other digital goods.
During an OECD webcast immediately following the release of the consultation document, Kalale Mambwe, project manager with the OECD’s Tax Inspectors Without Borders, explained that a large portion of transfer pricing disputes arise in relation to distribution arrangements between related parties. In particular, disputes often revolve around the question whether the arrangement involves “baseline” distribution functions, or whether it involves more complex activities. Disputes also often arise as to the selection of the transfer pricing method, the benchmarking analysis (choice of comparables and profit measure) and comparability adjustments.
Given this potential for disputes and the compliance burden on taxpayers, the need to simplify the application of the arm’s length principle to baseline distribution arrangements became apparent to members of the Inclusive Framework. The IF also focused on the specific needs of so-called “low-capacity jurisdictions” in administering the application of the arm’s length standard to distribution arrangements.
Amount B would apply to two types of intragroup transactions -- buy-sell arrangements where the distributor purchases goods from associated enterprises resident in other jurisdictions for wholesale distribution to unrelated parties, primarily in its local market, and sales agency and commissionaire arrangements where the entity contributes to the wholesale distribution of goods for a related party (although the IF is seeking comment on whether sales agency and commissionaire arrangements should be included within the scope of Amount B).
If a transaction falls within one of these two categories, taxpayers or tax administration would review the Amount B scoping criteria listed in the consultation document, which set out the economically relevant characteristics that an in-scope transaction would exhibit, to determine whether the transaction is within the scope of Amount B.
The proposed scoping criteria include both qualitative elements (for example, whether the distributor performs perform any other economic activity for which it is (or should be) remunerated, including: manufacturing, research and development, procurement, and financing activities) and quantitative components (such as the ratio of research and development expenses to net sales).
Significantly, the consultation document states that Amount B will not apply to controlled distribution transactions covered by a bilateral or multilateral advance pricing agreement.
The guiding principle for the development of a pricing mechanism, according to the consultation document, is to simplify and streamline the application of the arm’s length principle to baseline marketing and distribution activities. To that end, the pricing methodology the IF is developing is based on a centralised transactional net margin method (TNMM) approach. The pricing methodology uses common benchmarking search criteria to identify comparable entities that perform routine distribution activities.
Currently, two different approaches being discussed. Under one approach, a “pricing matrix” would be constructed. Comparable marketing and distribution entities would be divided into subgroups by relevant economic characteristics, and a taxpayer would be able to identify its Amount B distribution return by matching itself to an appropriate subgroup based on its own economic characteristics. Under a second, formulaic approach, the Amount B distribution return could be determined by applying a regression equation (coefficients) based on econometric analysis of comparables to specific financial data of the tested party. A variation on the second approach involves using one net profit indicator as a starting point, and then applying adjustments based on financial or other characteristics of the tested party.
Work is ongoing on the technical details of the pricing methodology, and the consultation document highlights many open issues. For example, the IF is considering whether the Amount B pricing methodology should be applied when local market comparables are available, or when comparable uncontrolled prices (CUPs) are available.
The consultation document states that it builds on existing documentation requirements, and calls for taxpayers with transactions within the scope of Amount B to add specific items of information to their transfer pricing local files, including a statement declaring that the information provided to support compliance with Amount B is true, accurate and complete to the best of the taxpayer’s knowledge; an explanation of the delineation of the in-scope controlled transactions; the taxpayer’s annual financial accounts for the fiscal year concerned; and an explanation of the application of the Amount B pricing methodology to the controlled transaction and the results of that application.
The Amount B consultation document presents the work undertaken by the IF to date, but it does not reflect the group’s final views. It is clear from the many specific questions posed in the document that significant work remains to be done. Given this, the scheduled mid-2023 release date for the final Amount B deliverable is an ambitious goal.
Laurie Dicker
ldicker@bdo.com