23 de fevereiro de 2024 • 7 minute read
Recent OECD Pillar 1 Amount B report offers complex path to “simplified and streamlined” transfer pricing for routine distributors
On February 19, 2024, the Organisation for Economic Co-operation and Development (OECD) published a report entitled, “Pillar One – Amount B: Inclusive Framework on BEPS” (the Report). The third OECD Amount B document published in just over a year, the latest release aims to simplify the application of transfer pricing rules in regard to baseline marketing and distribution activities, as well as reduce tax burden and compliance costs, among others.
By replacing taxpayer-selected comparables-based profit ranges with fixed rates of return for qualifying distribution-related transactions, Amount B has the potential to render many companies’ transfer pricing policies and intercompany pricing agreements obsolete, thereby forcing companies to redesign their pricing policies, revise intercompany agreements, and modify transfer pricing documentation.
OECD expects full implementation of Amount B starting in 2025.
OECD Pillar 1 Amount A and B
Pillar 1 originated as an OECD initiative to design a new taxing regime for digital companies. Amount A of Pillar 1 sets forth new taxing principles allowing “source” jurisdictions to tax profits in excess of 10 percent of a handful of the largest, most profitable technology and consumer product companies. Amount A is driven by concerns that existing income sourcing and transfer pricing rules do not reflect the economic realities of the digital age, with the alleged result that many large digital companies were not paying an appropriate level of tax in “source” jurisdictions whose consumers utilized the companies’ digital services.
Amount B of Pillar 1 aims to respond to a different set of concerns with tax administration – namely, that many of the 142 countries that have participated in the expanded OECD “inclusive framework” Pillar 1 and 2 projects lack the resources or expertise to enforce existing transfer pricing rules. In addition, many OECD member countries have argued that the existing facts-and-circumstances-based transfer pricing rules lead to excessive controversy for taxpayers engaged in “routine distribution” activities, and that such controversy could be avoided through a set of objective transfer pricing targets for such routine activities.
Unlike the limited set of taxpayers affected by Amount A, the scope of Amount B includes nearly all companies that engage in routine wholesale distribution of tangible goods.
New transfer pricing regime for baseline distribution activities
To qualify for Amount B, a tested party must be characterized as a “routine distribution” entity – a wholesale distributor of tangible goods either as a buy-sell entity or a sales commissionaire entity. In addition, the tested distributor may not provide material services or engage in financing activities and may not distribute commodities or digital goods. There are additional quantitative screens for expense intensity and cost allocation limitations that are also necessary to qualify for Amount B.
If a transaction qualifies, Amount B establishes a three-step process to test the results of the distribution transaction under a new “simplified and streamlined” approach.
First, the tested entity is placed into one of three broad industry classifications that result in lower, median, and higher operating profit (EBIT) targets.
Second, the transactions are placed into one of five categories based on “factor intensity,” which is computed based on the distribution entity’s levels of (a) operating expenses to sales and (b) operating assets to sales for the tested transactions, with profit targets being lower for lower ranges of factor intensity and higher for higher ranges of factor intensity.
Third, the Amount B fixed rate of return for the transactions expressed as a percentage of sales is determined using a matrix based on the industry category of the taxpayer and the tested party’s factor intensity level.
Some additional adjustments to the profit levels in the OECD Amount B matrix may be required for perceived high-risk jurisdictions.
Lastly, the Report adopts a “cap and collar” based on operating expense ratios to limit the impact of Amount B for entities with especially high or low levels of operating expense to sales revenues.
Implementation issues
Amount B does not require local country approval, as OECD will amend the OECD Transfer Pricing Guidelines to reflect the Amount B guidance. However, adoption of the Amount B regime is optional for each OECD Inclusive Framework country, which may implement Amount B either on an elective, safe-harbor basis by taxpayers or on a mandatory basis for taxpayers and the tax authority. Formal adoption of Amount B by the US would require an amendment to the relevant transfer pricing regulation in §482-5.
The list of countries implementing Amount B in either elective or mandatory form is scheduled for posting on the OECD website by March 31, 2024. Separate qualitative screening criteria for eligibility to Amount B may additionally be adopted by March 31, 2024. A country’s or company’s election of Amount B does not require reciprocal acceptance by the transactional counterparty jurisdiction, and differences among countries in their treatment of Amount B are to be resolved in the Mutual Agreement Procedures (MAP).
Initial observations
Amount B offers taxpayers certainty in jurisdictions that implement Amount B while imposing significant challenges for companies that are in scope. Amount B will likely eliminate many low-level distribution audits. However, qualification for Amount B will require new accounting and financial segmentation analyses that may be difficult to implement. For entities performing both routine distribution and non-distribution activities, careful segmentation of the revenues, costs, and assets of the two activities are required.
The pricing matrix is comprised of three industry groups and five levels of factor intensity, resulting in 15 pricing points, ranging from an EBIT level of 1.5 percent of sales to 5.5 percent of sales. Each pricing point in the matrix has a range of +/- 0.5 percent. Some companies, especially in higher-operating-margin industries, may appreciate a fixed rate of return for their distributors. Alternatively, some companies in lower-margin industries may find the rates of return uncomfortably high, leaving little to no taxable income in the counterparty even with the cap-and-collar guardrail. The relatively narrow range of +/- 0.5 percent of sales will require close monitoring of an Amount B tested distributor’s financial results to ensure the year end result is within the Amount B specified range.
The Report explicitly states that a transaction that does not fall within the scope of Amount B should not be interpreted such that the appropriate return will be either above or below the pricing matrix. However, the tenor of the Report suggests most inbound countries will view a failure to meet the eligibility threshold of Amount B as an indication that the entity may be more than a “routine distributor,” and therefore will treat the pricing matrix as a floor and attempt to negotiate a higher rate of return.
Perhaps most notably, that the 142 Inclusive Framework members could not agree to make Amount B elective or mandatory – and instead chose to leave that decision to each country – highlights the profound differences that remain in regard to avoiding disputes on required taxable profit levels for these routine transactions. One country, India, highlighted numerous parts of the Report where it differs, presumably signaling that that country will not adopt Amount B.
The mix of jurisdictions adopting Amount B as a safe harbor, adopting Amount B as mandatory, or failing to adopt Amount B will likely create a complex web of reporting requirements that will necessitate redesigning transfer pricing policies, redrafting of intercompany agreements, modifying software systems for intercompany transactions, and modifying transfer pricing documentation. Moreover, there may be a dramatic surge in MAP cases to resolve conflicts among jurisdictions adopting Amount B as a safe harbor, as a mandatory provision, or not at all.
What’s next?
OECD expects to publish additional Amount B guidance by March 31, 2024, as well as incorporate Amount B guidance into the OECD Transfer Pricing Guidelines in advance of the expected Amount B implementation beginning January 1, 2025.
DLA Piper will issue additional insights and suggestions over the next several weeks. For more information, please contact the authors.
By replacing taxpayer-selected comparables-based profit ranges with fixed rates of return for qualifying distribution-related transactions, Amount B has the potential to render many companies’ transfer pricing policies and intercompany pricing agreements obsolete, thereby forcing companies to redesign their pricing policies, revise intercompany agreements, and modify transfer pricing documentation.
OECD expects full implementation of Amount B starting in 2025.
OECD Pillar 1 Amount A and B
Pillar 1 originated as an OECD initiative to design a new taxing regime for digital companies. Amount A of Pillar 1 sets forth new taxing principles allowing “source” jurisdictions to tax profits in excess of 10 percent of a handful of the largest, most profitable technology and consumer product companies. Amount A is driven by concerns that existing income sourcing and transfer pricing rules do not reflect the economic realities of the digital age, with the alleged result that many large digital companies were not paying an appropriate level of tax in “source” jurisdictions whose consumers utilized the companies’ digital services.
Amount B of Pillar 1 aims to respond to a different set of concerns with tax administration – namely, that many of the 142 countries that have participated in the expanded OECD “inclusive framework” Pillar 1 and 2 projects lack the resources or expertise to enforce existing transfer pricing rules. In addition, many OECD member countries have argued that the existing facts-and-circumstances-based transfer pricing rules lead to excessive controversy for taxpayers engaged in “routine distribution” activities, and that such controversy could be avoided through a set of objective transfer pricing targets for such routine activities.
Unlike the limited set of taxpayers affected by Amount A, the scope of Amount B includes nearly all companies that engage in routine wholesale distribution of tangible goods.
New transfer pricing regime for baseline distribution activities
To qualify for Amount B, a tested party must be characterized as a “routine distribution” entity – a wholesale distributor of tangible goods either as a buy-sell entity or a sales commissionaire entity. In addition, the tested distributor may not provide material services or engage in financing activities and may not distribute commodities or digital goods. There are additional quantitative screens for expense intensity and cost allocation limitations that are also necessary to qualify for Amount B.
If a transaction qualifies, Amount B establishes a three-step process to test the results of the distribution transaction under a new “simplified and streamlined” approach.
First, the tested entity is placed into one of three broad industry classifications that result in lower, median, and higher operating profit (EBIT) targets.
Second, the transactions are placed into one of five categories based on “factor intensity,” which is computed based on the distribution entity’s levels of (a) operating expenses to sales and (b) operating assets to sales for the tested transactions, with profit targets being lower for lower ranges of factor intensity and higher for higher ranges of factor intensity.
Third, the Amount B fixed rate of return for the transactions expressed as a percentage of sales is determined using a matrix based on the industry category of the taxpayer and the tested party’s factor intensity level.
Some additional adjustments to the profit levels in the OECD Amount B matrix may be required for perceived high-risk jurisdictions.
Lastly, the Report adopts a “cap and collar” based on operating expense ratios to limit the impact of Amount B for entities with especially high or low levels of operating expense to sales revenues.
Implementation issues
Amount B does not require local country approval, as OECD will amend the OECD Transfer Pricing Guidelines to reflect the Amount B guidance. However, adoption of the Amount B regime is optional for each OECD Inclusive Framework country, which may implement Amount B either on an elective, safe-harbor basis by taxpayers or on a mandatory basis for taxpayers and the tax authority. Formal adoption of Amount B by the US would require an amendment to the relevant transfer pricing regulation in §482-5.
The list of countries implementing Amount B in either elective or mandatory form is scheduled for posting on the OECD website by March 31, 2024. Separate qualitative screening criteria for eligibility to Amount B may additionally be adopted by March 31, 2024. A country’s or company’s election of Amount B does not require reciprocal acceptance by the transactional counterparty jurisdiction, and differences among countries in their treatment of Amount B are to be resolved in the Mutual Agreement Procedures (MAP).
Initial observations
Amount B offers taxpayers certainty in jurisdictions that implement Amount B while imposing significant challenges for companies that are in scope. Amount B will likely eliminate many low-level distribution audits. However, qualification for Amount B will require new accounting and financial segmentation analyses that may be difficult to implement. For entities performing both routine distribution and non-distribution activities, careful segmentation of the revenues, costs, and assets of the two activities are required.
The pricing matrix is comprised of three industry groups and five levels of factor intensity, resulting in 15 pricing points, ranging from an EBIT level of 1.5 percent of sales to 5.5 percent of sales. Each pricing point in the matrix has a range of +/- 0.5 percent. Some companies, especially in higher-operating-margin industries, may appreciate a fixed rate of return for their distributors. Alternatively, some companies in lower-margin industries may find the rates of return uncomfortably high, leaving little to no taxable income in the counterparty even with the cap-and-collar guardrail. The relatively narrow range of +/- 0.5 percent of sales will require close monitoring of an Amount B tested distributor’s financial results to ensure the year end result is within the Amount B specified range.
The Report explicitly states that a transaction that does not fall within the scope of Amount B should not be interpreted such that the appropriate return will be either above or below the pricing matrix. However, the tenor of the Report suggests most inbound countries will view a failure to meet the eligibility threshold of Amount B as an indication that the entity may be more than a “routine distributor,” and therefore will treat the pricing matrix as a floor and attempt to negotiate a higher rate of return.
Perhaps most notably, that the 142 Inclusive Framework members could not agree to make Amount B elective or mandatory – and instead chose to leave that decision to each country – highlights the profound differences that remain in regard to avoiding disputes on required taxable profit levels for these routine transactions. One country, India, highlighted numerous parts of the Report where it differs, presumably signaling that that country will not adopt Amount B.
The mix of jurisdictions adopting Amount B as a safe harbor, adopting Amount B as mandatory, or failing to adopt Amount B will likely create a complex web of reporting requirements that will necessitate redesigning transfer pricing policies, redrafting of intercompany agreements, modifying software systems for intercompany transactions, and modifying transfer pricing documentation. Moreover, there may be a dramatic surge in MAP cases to resolve conflicts among jurisdictions adopting Amount B as a safe harbor, as a mandatory provision, or not at all.
What’s next?
OECD expects to publish additional Amount B guidance by March 31, 2024, as well as incorporate Amount B guidance into the OECD Transfer Pricing Guidelines in advance of the expected Amount B implementation beginning January 1, 2025.
DLA Piper will issue additional insights and suggestions over the next several weeks. For more information, please contact the authors.
