Following the announcement in our tax flash of 13 July 2023 and the previous consultation of December 2022 (see our article of 22 December 2022 the OECD’s Inclusive Framework (IF) is again seeking public comments on the main design elements of Amount B under Pillar One. Amount B provides a simplified and streamlined approach to the application of the arm’s length principle to baseline marketing and distribution activities (BMDA), with a particular focus on the needs of low-capacity jurisdictions. This simplified approach can be applied by all taxpayers with qualifying in-scope BMDA concerning goods; there is no revenue threshold applicable like for Amount A of Pillar One and Pillar Two. This new consultation document presents the work undertaken to date, but it does not yet reflect the final views of the IF. Following this consultation, the IF expects to complete the further work on Amount B – such as whether it will be a safe harbour or a prescribed method for the pricing of BMDA – by year end. The main elements of Amount B that have been updated in this new consultation document concern qualifying transactions, scope, pricing methodology and tax certainty.
The following controlled transactions would qualify for Amount B:
a) Buy-sell marketing and distribution transactions where the distributor purchases goods from one or more associated enterprises for wholesale distribution to unrelated parties; and
b) Sales agency and commissionaire transactions where the sales agent or commissionaire contributes to one or more associated enterprises’ wholesale distribution of goods to unrelated parties.
Based on the new consultation document Amount B will cover a broader set of qualifying transactions compared to the previous version, because, e.g., the wholesale distribution to unrelated parties would no longer need to primarily take place only in the local market. As we suggested in our previous consultation comments of 25 January 2023, such amendment should ensure that distributors active in multiple jurisdictions will also be eligible for the simplified approach offered by Amount B rules.
Qualifying transactions should subsequently be accurately delineated in accordance with the OECD Transfer Pricing Guidelines (TPG), considering all five comparability factors and the economically relevant characteristics of the transaction, prior to the application of the Amount B scoping criteria.
In respect of the scoping criteria the consultation document explicitly mentions one key open question as to whether a separate qualitative scoping criterion is required to identify distributors that perform non-baseline activities. Two alternatives have been included to address this issue: “Alternative A”, which does not require a separate qualitative scoping criterion to identify and exclude non-baseline contributions, and “Alternative B”, which does require a separate qualitative scoping criterion to identify and exclude non-baseline contributions. Hence, the precise definition of “baseline” distribution activities is subject to further consideration by the IF to achieve an appropriate balance between quantitative and qualitative metrics.
For a qualifying transaction to be in-scope of Amount B:
a) The qualifying transaction must exhibit economically relevant characteristics that mean it can be reliably priced using a one-sided transfer pricing method, with the distributor, sales agent or commissionaire being the tested party; and
b) The tested party in the qualifying transaction must not incur annual operating expenses lower than 3% and greater than 50% (under Alternative B) or 30% (under Alternative A) of its annual net sales.
If a qualifying transaction is in scope based on the above, it will nevertheless be out of scope if:
a) The tested party makes specific non-baseline contributions to the transaction (under Alternative B);
b) The qualifying transaction involves the distribution of services or the marketing, trading, or distribution of commodities; or
c) 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, can be reliably priced separately from the non-distribution activities, and meets specific administrative criteria.
These new scoping criteria, especially under Alternative A, enable a broader range of taxpayers to be potentially in-scope for Amount B (e.g., by no longer only applying to in-country distributions). We already suggested broadening the scope and application of Amount B in our previous consultation comments of 25 January 2023, where we also mentioned the possible exception now included under c) above.
The IF has further developed a global dataset of companies involved in BMDA. The financial information derived from that global dataset has formed the basis for the approximation of arm’s length results that have been translated into a pricing matrix, which is to be updated periodically. Return on sales is going to be applied as the net profit indicator for the purpose of establishing arm’s length pricing outcomes for in-scope transactions (i.e., TNMM return on sales). This pricing matrix is to be used to determine the arm’s length return for a tested party involved in qualifying in-scope transactions for the relevant period based on two different variables: the relevant industry grouping and the factor intensity classification (based on (i) the operating asset to sales ratio, and (ii) the operating expense to sales ratio).
Based on econometric analysis, geographic differences seem to influence the profitability of BMDA in a small number of jurisdictions for which relevant data is available. Therefore, a preliminary adjustment mechanism has been developed to address such geographic differences. As baseline distributors may exhibit different functional profiles and operating expense ratios, a corroborative mechanism is introduced to address low and high functionality. A Berry ratio cap-and-collar approach with a maximum ratio of 1.50 and a minimum ratio of 1.05 will apply as a corroborative test. This approach intends to prevent entities with relatively low operating expenses from being over-remunerated and in case of high operating expenses from being under-remunerated under Amount B.
According to the IF, competent authorities shall endeavour to resolve mutual agreement procedures (MAPs) regarding the application of Amount B. Unfortunately, the IF has not included mandatory binding arbitration in the new consultation document for such Amount B disputes. The document also mentions that any outcomes of MAPs and concluded advance pricing agreements from prior to the introduction of Amount B should prevail over the outcomes of the application of this new simplified and streamlined approach to avoid uncertainty and discussion on already settled disputes. In our view this should be helpful in trying to avoid a retroactive effect of Amount B in respect of in-scope activities.
Input from stakeholders on the consultation document can be provided until 1 September 2023. The IF specifically requests input on:
1. The two presented alternatives of scoping (i.e., with or without a separate qualitative scoping criterion); and
2. The appropriateness of:
a. the proposed pricing framework;
b. the application of the proposed pricing framework to the wholesale distribution of digital goods (this application is still under discussion within the IF);
c. country uplifts within geographic markets, as the dataset for the pricing matrix has been determined on a global basis; and
d. the criteria to apply Amount B utilising a local database to be produced by the relevant tax administration, as application of the global dataset may result in potential material data availability gaps for certain jurisdictions.
Following the public consultation, the work on Amount B should be completed by the IF by year end. Also, the final report on Amount B is expected to be incorporated into the TPG by January 2024.
What can taxpayers do?
Based on the new consultation document, taxpayers can assess whether the proposed Amount B simplifies and streamlines the pricing of their BMDA. Our Pillar One and Transfer Pricing teams are available to support you in analysing and modelling the impact of the Pillar One rules on your group and exploring ways to mitigate increased taxation and complexity.
We will keep you informed about further developments. Should you have any question or need assistance in assessing the impact of these rules, please contact a member of our Pillar One team or your trusted Loyens & Loeff adviser.
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