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Executive summary
On 8 December 2022, the Secretariat of the OECD released a consultation document on Amount B of Pillar One in connection with the ongoing OECD/G20 project on Addressing the Tax Challenges Arising from the Digitalization of the Economy (the BEPS 2.0 project). Amount B is aimed at simplifying and streamlining the transfer pricing of in-country baseline marketing and distribution activities, while ensuring outputs consistent with the arm’s-length principle.
It is important to note that there is no threshold proposed for multinational enterprises (MNEs) to be within scope of Amount B; this is in contrast to both Amount A of Pillar One and the global minimum tax rules under Pillar Two, where specified thresholds would apply for determining whether an MNE is within scope.
This consultation document outlines the main design elements of Amount B, focusing on the scope, the pricing methodology, and the current status of discussions concerning an appropriate implementation framework.
The consultation document is described as presenting work undertaken to date, which is viewed as having reached sufficient level of detail and stability that public comments would be appropriate and helpful, but it does not reflect the final views of the Inclusive Framework member jurisdictions.
The OECD Secretariat hosted a webinar on 8 December 2022, summarizing key points of the consultation document, topics still under discussion in the Inclusive Framework and specific areas for which comments are sought. During the webinar, the Secretariat indicated that the intention is for Amount B to be implemented effective in 2024.
Detailed discussion
Background
In January 2019, the OECD began the BEPS 2.0 project with the release of a Policy Note describing two pillars of work: Pillar One addressing the tax challenges of the digitalization of the economy and the allocation of taxing rights to market jurisdictions and Pillar Two addressing remaining concerns about potential BEPS activity and tax rate competition among countries.1 The project is being conducted through the Inclusive Framework, in which 141 jurisdictions are participating currently.
Since the start of the project, the OECD has released a series of documents on the development of the two pillars, including the release in October 2020 of detailed Blueprints on both Pillar One and Pillar Two.2 This was followed in July 2021 with the release of a high-level statement reflecting agreement of members of the Inclusive Framework on key parameters with respect to the two pillars.3
In October 2021, political agreement was reached on key parameters of both pillars together with an implementation plan. Of the 141 participating jurisdictions, 137 members of the Inclusive Framework have joined this agreement.4
Amount B, which was referenced in the October 2021 agreement, relates to the application of the arm’s-length principle to in-country baseline marketing and distribution activities, with a particular focus on the needs of low-capacity countries. On 30 September 2022, the Inclusive Framework approved revising the original timeline for Amount B to allow for the technical work to be completed by mid-2023, aligning with the timeline for Amount A.
The consultation document is the first publication on details with respect to Amount B since the October 2021 Inclusive Framework agreement. Written comments from stakeholders are requested by 25 January 2023. Comments are sought with respect to specific questions and the overall technical approach to the Amount B design features. The consultation document indicates that the Inclusive Framework will consider the comments received with the objective of releasing the final Amount B deliverable by mid-2023.
Overview
The consultation document addresses the following topics:
Amount B mandate and goals
Scope of Amount B
Amount B pricing methodology
Amount B documentation requirements including transitional issues
Tax certainty with respect to Amount B
The document notes that the design elements of Amount B (namely scope, pricing methodology and implementation) are significantly interlinked and dependent upon one another.
The scope of Amount B is outlined in Section 3 of the consultation document, which defines the controlled transactions that would be subject to Amount B by setting out qualitative and quantitative criteria and providing certain exemptions.
Ongoing work on the pricing methodology for in-scope transactions is summarized in Section 4 of the consultation document, including benchmarking criteria, net profit indicators and comparability adjustments, as well as points on which further analysis is required.
The consultation document indicates that upon completion of the design of Amount B, the Inclusive Framework will be in position to consider the best implementation framework for Amount B. Inclusion of the Amount B rules in the OECD Transfer Pricing Guidelines (TPG) is noted as the ideal way to achieve the objectives of Amount B, in particular adherence to the arm’s-length principle and capacity to mitigate the risks of double taxation and double non-taxation, taking into account the different legal systems of the Inclusive Framework member jurisdictions. This would also imply that no changes in treaties would be necessary to implement Amount B, which was stated by the OECD Secretariat during the webinar. However, the document states that there is no agreement on the form of implementation and that other options are being explored, including consideration of the mandatory or elective nature of Amount B. These options range from designing Amount B as a safe harbor to prescribing it as the interpretation of how the arm’s-length principle applies to baseline marketing and distribution activities. The document further notes that resolution of these matters could have an impact on the design of some aspects of Amount B.
The key points covered in each section of the consultation document are summarized below.
Introduction, Amount B mandate and goals
The consultation document notes that distribution arrangements, including sales, marketing and logistics functions, are often subject to transfer pricing disputes. Many disputes relate to the accurate delineation of the arrangement, focusing on whether the arrangement involves baseline functions or more complex activities. Disputes are also common with respect to the selection of the transfer pricing method, the appropriateness of the benchmarking analysis, the identification of comparables for certain geographic markets and the need for comparability adjustments. Consequently, the Inclusive Framework is seeking to streamline and simplify the pricing of baseline marketing and distribution functions, with a particular focus on the specific needs of low-capacity jurisdictions in administering the application of the arm’s-length principle to such functions.
Scope of Amount B
Amount B would apply to the following intra-group transactions:
Buy-sell arrangements where the tested party purchases goods from foreign related parties for wholesale distribution primarily in its local market.
Sales agency and commissionaire arrangements where the tested party contributes to the wholesale distribution for a related party (to the extent they exhibit similar economically relevant characteristics as those outlined in the scoping criteria for Amount B).
The consultation document notes that many Inclusive Framework jurisdictions are of the view that the second category should be included, but that some Inclusive Framework members are of the view that including sales agents or commissionaires in the scope of Amount B could lead to overcompensation of parties with relatively simple functionality. Stakeholders are specifically invited to provide comments on this matter.
For these two categories of transactions, taxpayers and tax administrations should review whether the scoping criteria are met. The scoping criteria currently under discussion in the Inclusive Framework reflect a mix of qualitative assessments and quantitative measurements:
A written contract must be in place for the transaction, reflecting the division of responsibilities, obligations and rights and the division of economically significant risks. The contract should not contain terms that are inconsistent with the other scoping criteria. The consultation document notes that discussion is ongoing on whether a written contract should be mandatory.
The distributor must distribute primarily in its market of residence, with no more than a to-be-specified percentage of its annual net sales from customers in other jurisdictions.
The distributor must not perform any economic activity for which it should be remunerated at arm's length other than the core distribution function. Disqualifying economic activities may include manufacturing, research and development, procurement and financing. Indicators from the financial statements that could be used to identify such activities are outlined in the consultation document.
The distributor must not perform any risk control functions (within the meaning of 1.65 of the TPG) that lead to the assumption of economically significant risks that are associated with the development, enhancement, maintenance, protection or exploitation of unique and valuable marketing intangibles.
The distributor should not undertake activities that relate to creating or obtaining the rights to distribute in the market when that activity itself would be remunerated at arm's length or perform technical or specialized services for third party customers that are valuable and remunerable or would play a significant role in maintaining the customer relationship in the market.
The distributor must not perform strategic sales and marketing activities that would generate unique and valuable intangibles related to the exploitation of the products.
None of the customers of the distributor should represent more than a to-be-specified percentage of its net sales.
Specified ancillary activities would be allowed to be undertaken within to-be-specified thresholds.
The ratio of annual operating expenses over annual net sales of the distributor must be within a to-be-specified range.
The distributor would be expected to not assume economically significant risks above a limited level.
The distributor must not own any unique and valuable intangibles assets, including marketing intangibles, and would be expected to have no or limited ownership of market access rights or regulatory licenses.
Amount B will not apply to controlled distribution transactions that are covered by a bilateral or multilateral advance pricing agreement for the period in question between the countries of the supplier and the distributor or that involve distribution of products subject to the product-based exclusion.
The consultation document indicates that the scoping criteria do not provide an exhaustive and comprehensive list of activities that qualify as baseline marketing and distribution activities, and instead describe general features that must be considered in determining whether a distributor performs baseline marketing and distribution activities.
The consultation document requests comments on potential exemptions and product-based exclusions from applying the Amount B pricing methodology, which are under discussion in the Inclusive Framework. One exemption being considered would apply when the most appropriate transfer pricing method for a transaction is not the transactional net margin method (TNMM) but another method, in particular the comparable uncontrolled price (CUP) method. This exemption could apply on a rebuttable presumption basis, i.e., taxpayers and tax administrations have the option to rebut the presumption that the TNMM is the most appropriate method.
A second exemption being considered would apply in situations where local market comparables are available. Such a rule would require a definition of what a market comparable is and one suggestion is that such comparables be identified by using the common benchmarking search criteria under the Amount B pricing methodology and focusing on comparables that operate in the same or in a homogenous market as the tested party.
The Inclusive Framework is also considering product-based exclusions for commodities and non-tangible goods. Finally, consideration is being given to exclusions for specific activities performed, which if performed by a distributor would lead to it falling out of the scope of Amount B. The consultation document notes that if such activities are performed at a low functional intensity, they might be considered ancillary such that they should not trigger an exclusion.
Amount B pricing methodology and Annex A
The consultation document indicates that the Amount B pricing methodology is still under development and references several key design features being considered:
Common benchmarking search criteria to align international comparables search practices
A technical and econometric analysis to understand how returns vary with geographic region, or jurisdiction, and consider quantitative factors that may have a relationship with profits for the tested activities (e.g., asset intensity, industry, operating expense intensity). The technical analysis is still ongoing, and input is being requested
The common benchmarking criteria and technical analysis are intended to lead to the development of a set of baseline marketing and distribution comparables. The financial information derived from that set would then be translated into arm’s-length results tailored where possible to the characteristics of the tested party and made available for use by tax administrations and taxpayers. Two output options are being considered by the Inclusive Framework: (i) a pricing matrix where comparable marketing and distribution entities would be grouped in subsets according to their economic characteristics; and (ii) a mechanical pricing tool to translate the data resulting from the common criteria benchmarking study into a formula or set of quantitative adjustments to derive arm's-length returns adapted to the tested party features (e.g., regression equations, adjusted net profit indicators)
In applying the TNMM, the operating margin (return on sales) is currently regarded as the most appropriate net profit indicator. However, alternatives are under discussion in the Inclusive Framework, such as the Berry ratio, return on sales with a Berry ratio guardrail, return on assets or use of a combination of net profit indicators.
The consultation document indicates that to achieve simplification and certainty, the Inclusive Framework is assessing the potential benefits of an Amount B pricing methodology that would consider a specific result or a very narrow range of results (e.g., smaller than the interquartile range). The document notes that further work on this is needed.
The consultation document also notes that further consideration is being given to comparability adjustments, including whether adjustments could be practically applied without undermining the intended simplification and tax certainty of Amount B. In addition, the document notes specific considerations with respect to baseline distributors involved in purchases from multiple related parties.
Documentation requirements and transitional issues
The documentation requirements under Amount B build upon the existing documentation requirements included in Chapter V of the TPG and could include additional items of information specific to Amount B. The consultation document notes that some jurisdictions may wish to introduce a procedure whereby taxpayers are required to notify the first time their transactions fall in scope of Amount B. As part of the first-time notification procedure, tax administrations could require the taxpayer to provide the items of information specific to Amount B.
The consultation document notes that there may be situations where some MNE groups may undertake business restructurings to fall in or out of scope of Amount B. MNE groups are free to organize their business operations as they see fit and tax administrations do not have the right to dictate to MNE groups how to design their structure or where to locate their business operations. Tax administrations, however, have the right to determine the tax consequences of the structure resulting from the reorganization and the provisions of Chapter IX of the TPG on business restructurings would apply.
The consultation document states that, in principle, the fact that an MNE group has intentionally reorganized its distribution arrangements to meet the scoping criteria should not prevent the application of Amount B to price the qualifying transactions. It further notes that some jurisdictions have raised concerns with respect to situations where, because of a restructuring, Amount B applies to a restructured distributor with built-in losses from prior fiscal years. The document indicates that the tax treatment of such losses, in particular whether they should be deductible, depends on each jurisdiction’s domestic legislation and administrative procedures.
Tax certainty
The consultation document states that Amount B is expected to improve tax certainty and reduce disputes involving in-scope baseline marketing and distribution transactions, by providing a common and consistent framework to identify in-scope transactions and a pricing methodology. It further indicates that to address situations in which disagreement exists between tax administrations or between taxpayers and tax administrations, taxpayers can avail themselves of existing mechanisms aimed at preventing or resolving disputes.
For dispute prevention, taxpayers may seek to obtain tax certainty regarding the application and effects of Amount B through advance pricing agreements or the mutual agreement procedure (MAP).
For dispute resolution, a corresponding adjustment to eliminate double taxation could be requested or a MAP could be implemented. In some cases, a primary adjustment and corresponding adjustment to a controlled transaction to which Amount B applies may affect the pricing of other controlled transactions that one or both of the parties may have with other associated enterprises of the MNE group; in such cases multilateral resolution may be available, to the extent there are bilateral tax conventions concluded among the different jurisdictions concerned. Where competent authorities are not able to reach an agreement under MAP, the taxpayer, under certain conditions, may be able to request arbitration of unresolved issues in relation to the application of Amount B.
The consultation document also notes that agreements reached under MAP prior to the adoption of Amount B should prevail. However, in the case of ongoing and prospective MAP cases, the guidance on Amount B should be considered.
Implications
The consultation document provides important information on the technical work that has been undertaken on Amount B by the Inclusive Framework, including an indication of the thinking to date on key design aspects of Amount B and key open points still under discussion. While there is significant further work to be done, the OECD Secretariat has indicated that the target for implementation of Amount B is 2024.
Amount B is not proposed to be subject to a revenue threshold, unlike other BEPS 2.0 measures, and thus would be widely applicable. Businesses should consider the potential impact on their distribution arrangements and consider potential changes to either bring transactions in or out of scope. Because transactions covered by bilateral and multilateral Advance Pricing Agreements are proposed to be excluded from Amount B, businesses may want to review their current approach to the use of such mechanisms. Furthermore, businesses may want to consider taking the opportunity to engage with the OECD and country policymakers through the consultation process. It also will be important to continue to monitor developments with respect to both Pillar One and Pillar Two closely over the coming months.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Belastingadviseurs LLP
- Ronald van den Brekel
- Marlies de Ruiter
- Oana Popescu
Ernst & Young Limited (New Zealand)
- Matt Andrew
Ernst & Young LLP (United Kingdom)
- Joel Cooper
- Jp Borman
Ernst & Young LLP (United States)
- Barbara M. Angus
- Jose A. (Jano) Bustos
- Tracee J Fultz
- Mike McDonald
- Joana Dermendjieva
For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.
