As part of its ongoing work on Pillar One, the OECD is seeking public comments on the main design elements of Amount B. This particular element of Pillar One provides for a simplified and streamlined approach to the application of the arm’s length principle (ALP) to in-country baseline marketing and distribution activities (BMDA), with a particular focus on the needs of low-capacity jurisdictions (LCJ). The document presents the work undertaken to date, but it does not yet reflect the final views of the OECD’s Inclusive Framework (IF).
The public consultation document released on 8 December 2022 outlines the main goals and design elements of Amount B seeking stakeholders’ inputs in relation to specific questions included in the document. As recognized by the OECD, the main challenge in designing Amount B relies on the significant linkages across its three main design elements, which are the following:
It defines the controlled transactions that would be subject to Amount B and sets out qualitative and quantitative criteria to help that determination.
If the scoping criteria are met and the taxpayer is therefore within scope, Amount B will apply a specific methodology to price such in-scope transactions first by determining the transfer pricing (TP) method to utilise, and second by defining the basis through which an ALP price may be set (i.e. benchmarking criteria, the net profit indicators and the comparability adjustments)
It refers to the parameters for determining the BMDA to which Amount B applies. The OECD is currently assessing the appropriateness of different means of implementing Amount B with the expectation that its guidance will have a broad and consistent application amongst jurisdictions. The OECD notes that this could be achieved through the inclusion of the Amount B guidance in the OECD Transfer Pricing Guidelines (OECD TPG). However, there is not a common view on the form of the implementation at this stage and other options are being explored (e.g. mandatory or elective nature of Amount B, designing Amount B as a safe harbour, prescribing Amount B as the interpretation of how the ALP applies to BMDA, etc.).
Amount B is intended to simplify and streamline the pricing of in-country BMDA, while ensuring outputs consistent with the ALP for all in-scope transactions, based on the guidance provided in the OECD TPG. As such, the design of Amount B requires due consideration of the trade-off between these goals and an appropriate balance to be struck between reliability and administrability.
Amount B would apply to the following intra-group transactions (“Qualifying transactions”), where either category of tested party is referred to collectively as “Distributors”:
- Buy-sell arrangements where the tested party purchases goods from one or more 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 tested party contributes to wholesale distribution of goods for a related party and to the extent they exhibit economically relevant characteristics similar to those outlined in the scoping criteria for Amount B.
In addition, Amount B would apply if the aforementioned Qualifying transactions also meet the “Scoping criteria” which contain a mixture of qualitative assessments that relate to the economically relevant characteristics of the controlled transaction, as well as quantitative measurements that may be derived from the financial statements of the Distributor. The IF is currently evaluating a set of scoping criteria, which includes, inter alia, the following:
- Taxpayers must document their qualifying transactions in a written contract that reflects the division of responsibilities, obligations and rights and the assumption of the economically significant risks associated with the distribution activities and should not contain terms that are inconsistent with the other scoping criteria noted below.
- The Distributor must distribute primarily in its market of residence, where the annual net sales generated by the Distributor from customers located in other jurisdictions do not exceed a certain percentage (to be agreed) of its annual net sales.
- The Distributor must not perform any economic activity for which it is, or should be, remunerated at arm’s length other than its core distribution function. These disqualifying activities may include any one or a combination of the following: Manufacturing, R&D; Procurement; and Financing.
- The Distributor must not perform any risk control functions that lead, to the assumption of economically significant risks by the Distributor based on an accurate delineation of the transaction, that are associated with the DEMPE 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 the creation or obtaining of such rights would itself be remunerated at arm’s length, or perform technical or specialised services for third party customers that itself 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 relevant to sales in the market if those activities would, under the accurate delineation of the transaction, themselves generate unique and valuable intangible assets relating to the exploitation of the products sold in the market;
- None of the customers of the Distributor should represent over a certain percentage (to be agreed) of its net sales;
- Certain ancillary activities are allowed to be undertaken within certain permissible thresholds.
- The ratio of annual operating expenses over annual net sales of the Distributor is in a given range to be agreed.
- The Distributor would be expected to not assume economically significant risks above what may be defined to be a limited level
- The Distributor must not own any unique and valuable intangible assets, including marketing intangibles and it would be expected to have no or limited ownership of market access rights or regulatory licenses, that create barriers to entry.
The consultation document presents two exemptions from the application of Amount B, when the qualifying transaction is: (i) covered by a bilateral or multilateral advance pricing agreements (APAs); or (ii) involves the distribution of certain products such as commodities and digital (non-tangible) goods.
Amount B’s pricing methodology currently builds upon the following objectives:
- To rely on financial information of comparable independent entities drawn from commercial databases through the application of commonly agreed search criteria;
- To provide arm’s length results that account for the relevant economic characteristics of the tested party and the comparables; and
- To publish and periodically update the arm’s length results.
The pricing methodology is based on the Transactional Net Margin Method (TNMM); however, the IF is considering two exemptions that may impact this policy choice. The first exemption under consideration is whether the Amount B pricing methodology should not be applied when local comparables are available to price
the transaction. The second exemption under consideration would apply if a method other than the TNMM is the most appropriate method (MAM) in particular cases.
Concerning its key design features, Amount B’s pricing methodology is intended to establish clearly defined guidance on the benchmarking search criteria that will be used to identify a set of independent companies that perform BMDA consistent with those performed by taxpayers whose activities are in line with the scoping criteria.
Application of the common benchmarking search criteria, as well as additional screening and qualitative review to reflect the Amount B scoping criteria is expected to lead to the development of a set of BMDA comparables. Taking account of the outcome from the technical analyses currently being undertaken by the IF, 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. While the final output and form is still under consideration, the IF is currently exploring two output options:
- a pricing matrix approach; and
- a mechanical pricing tool approach.
Both output options, will broadly rely on the same underlying benchmarking and technical analyses.
The public consultation document also mentions some technical considerations for designing Amount B’s pricing methodology, which include:
- Selection of the net profit indicator;
- Selecting the most appropriate point in the range; and
- Cases of purchases from multiple related party suppliers.
The consultation document provides detailed guidance on the three-tiered approach to TP documentation, consisting of the master file, local file and the country-by-country report. It recommends jurisdictions to implement the master file and local file elements. It further provides a comprehensive list of information which should be maintained by the taxpayer to demonstrate compliance with Amount B. It envisages that such information would be included as part of the local file based on the OECD TPG.
It is expected that Amount B will improve tax certainty and reduce disputes involving in-scope BMDA. However, acknowledging that despite this improvement there could still exist disputes, the consultation document notes that, to address those situations, taxpayers can avail themselves of the different existing mechanisms aimed at preventing and resolving disputes (i.e. APAs and mutual agreement procedures (MAPs)), which can be also applied in the context of Amount B. The document provides an overview of those mechanisms and makes considerations relevant for the application of Amount B.
Interested parties can send to the OECD their comments on this consultation document by 25 January 2023. Input from stakeholders is particularly sought with respect to the specific questions laid out in the document. The OECD will consider this input with the objective of releasing the final Amount B deliverable by mid-2023.
What can taxpayers do?
Based on the consultation document, taxpayers that expect to be in scope can assess whether the proposed Amount B simplifies and streamlines the pricing of their in-country 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 the rules, please contact a member of our Pillar One team or your trusted Loyens & Loeff adviser.
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