Exploring Amount B: Can it Deliver Tax Certainty?

The Organisation for Economic Co-operation and Development (OECD) is swiftly moving towards incorporating ‘Amount B’ of Pillar One into the OECD Transfer Pricing Guidelines, with a projected implementation date set for January 2024. Amount B has been designed to simplify the application of the arm’s length principle to baseline marketing and distribution activities, ultimately aiming to enhance tax certainty surrounding the transfer pricing treatment of certain type of distribution function.

In this tax alert, we delve into the construct of the proposed changes and explore the potential implications these changes may hold for multinational corporations. Stay tuned as we closely monitor these developments and provide further updates.

 

Background

Amount B is an integral part of the OECD Two-Pillar Solution. Whilst Amount A aims to transform the current international taxation rules, which are based on a separate-entity approach, by reallocating taxing rights to certain income generated by the multinational groups to market jurisdictions, Amount B was introduced to address numerous tax disputes related to certain type of distribution function.

The concept of Amount B was initially presented in the OECD Secretariat’s Proposal for Unified Approach in October 2019. The proposal explored the idea of using fixed returns for baseline marketing and distribution functions in market jurisdictions, building upon the existing transfer pricing framework. The aim was to provide certainty to taxpayers and tax administrations and alleviate dissatisfaction with the complexity of current transfer pricing rules.

Specific details regarding Amount B were scarce in the October 2020 Report on Pillar One Blueprint, and progress on this aspect stalled until December 2022 when it resurfaced in the OECD public consultation document, attracting significant feedback and comments from various stakeholders. As of mid-2023, there has been notable progress on Amount B, as indicated in the Outcome Statement issued by the Inclusive Framework on 11 July.

Recently, on 17 July, an expanded guidance outlining the potential construct of Amount B was released, with a deadline for comments set for 1 September 2023. It is strongly encouraged that multinational groups actively participate in shaping this crucial component of the new international tax framework. The plan is to expedite the development of the Amount B architecture, with the goal of incorporating it into the OECD Transfer Pricing Guidelines by January 2024.

 

Scope

The proposed scope has undergone significant expansion since the December 2022 proposal, where distributors must meet an extensive and detailed set of scoping criteria. The updated scope now encompasses wholesale distributors engaged in the marketing and distribution of physical goods through:

• Buy/sell arrangements, or
• Acting as sales agency and commissionaires.

Retail de minimis activities are permitted if the annual net retail sales do not exceed 20% of total net sales.

However, the in-scope distributors must not own unique or valuable intangibles or assume economically significant risks. Discussions are ongoing regarding whether to include distributors of digital goods within the scope of Amount B.

The latest consultation document defines core distribution functions as those potentially incorporating activities such as the purchase of goods for resale, identifying new customers and managing customers relationships, providing certain after-sales services, implementing promotional advertising or marketing activities, warehousing goods, processing orders, performing logistics, and handling invoicing and collection.

In addition, the consultation document currently presents two alternatives defining the scope and pricing framework and has invited comments on this: “Alternative A”, which does not require a separate qualitative scoping criterion and only considers quantitative factors, and “Alternative B”, which requires a separate qualitative scoping criterion in addition to quantitative factors.

Exclusions

Non-distribution activities may lead a distributor to fall outside of scope of Amount B. These activities include manufacturing, research and development, procurement, or financing as long as they are non-incidental to the qualifying transaction. However, a baseline distributor may still potentially be considered within the scope of Amount B if it is possible to reliably segment its profit and loss statement (P&L) and price the distribution transaction separately from non-distribution activities.

Additionally, the distribution and marketing of services and the distribution of commodities are excluded from the scope of Amount B.

 

Pricing Framework

To be considered within the scope of Amount B, a qualifying transaction must be reliably priced using a one-sided transfer pricing method, with the distributor being the tested party. Further, the tested party in should not incur annual operating expenses lower than 3% and greater than 30% or 50% (to be further discussed) of its annual net sales.

The consultation document states that the most reliable comparison is made at the level of net profit indicators and that the Transactional Net Margin Method is considered as the most appropriate method to price qualifying transactions.

The suggested approach to approximate arm’s length results involves a pricing matrix that is segmented through (1) a ratio of operating assets to sales intensity (OAS) to operating expense to sales intensity (OES) and (2) an industry grouping that considers the characteristics of distributed products and the relationship with the levels of generated returns. The results are expressed through Return on Sales (ROS) figures, ranging from 1.5% to 5.5%.

Moreover, the consultation document proposes a mechanism to address geographical differences in qualifying jurisdictions, as the independent comparables tend to generate higher returns in certain countries. This mechanism is based on a country risk adjustment determined by reference to the sovereign credit rating or utilizing a qualifying local dataset.

Additionally, a corroborative test is prescribed using an implied Berry ratio cap (1.50) and collar (1.05) approach; if the actual result falls outside the range, the distributor’s remuneration would be adjusted to bring it to the nearest edge. This measure aims to avoid excessive or insufficient remuneration of baseline distributors with varying functional profiles.

 

Key Observations

It is essential to acknowledge the significant progress made and the positive developments for taxpayers. Notably, the scope of Amount B has been expanded, and the documentation criteria can now be derived from the local files. Furthermore, the latest consultation document provides an example of the country risk adjustment mechanism and a benchmarking search strategy, which had not been openly presented to date. These examples foster better alignment between taxpayers and tax administrations.

Below, we outline our additional observations on the current construct of Amount B and the implications for multinational groups.

Losses

The current version of the proposal refers to the potential treatment of carry-forward losses treatment, which may be addressed through domestic legislation. However, the document does not specify whether the wholesale distributors are now permitted to operate at loss. It is worth noting that independent wholesale distributors, especially limited risk distributors, tend to generate leaner profit margins compared to retailers, and they face fierce competition from e-commerce entities.

Over the past three years, the Covid-19 pandemic has presented significant challenges, leading to disruptions in supply chains. Wholesalers now encounter difficulties stemming from economic downturns in major economies, along with inflation risks and currency fluctuations, which may further absorb already slim profit margins. Given the current economic conditions, meeting the margins established in the pricing matrix may potentially be a challenging task.

Tax certainty - safe harbours

The implementation of Amount B remains to be determined regarding whether it will take the form of a safe harbour or a mandatory measure for all qualifying distributors. Adopting a safe harbour approach could pose challenges, as it will not provide tax certainty for both sides of the distribution transaction.

Tax certainty - advance pricing agreements / mutual agreement procedures

As per the consultation document, any agreement reached through a mutual agreement (including both APA and MAP cases) before the adoption of Amount B will take precedence concerning the covered qualifying transactions. However, it is important to note that this statement does not extend to margins fixed under local tax rulings or those yet to be negotiated during APA renewals. In addition, local competent authorities are encouraged to apply the simplified Amount B approach in resolving new MAP cases.

 

Recommendations

The observations mentioned above could be crucial considerations for companies when deciding whether to opt in or out of the Amount B construct. We recommend multinational groups to revisit the functional profile of their distributors and evaluate how Amount B might affect their current transfer pricing policies, by considering whether its implementation would represent a positive simplification or might trigger possible adverse tax consequences (eg, a business restructuring under Chapter IX of the OECD TP Guidelines). Considering the very tight deadline for implementation within the next five months, this should be a top priority for in-house transfer pricing professionals.

If you require additional information or wish to understand the specific implications of the Amount B proposal on your business, please reach out to the authors of this tax alert or your trusted DLA Piper advisor.