July 26, 2023
OECD releases public Consultation Document on Pillar One Amount B on baseline distribution
Among the series of technical documents released by the Organisation for Economic Co-operation and Development (OECD) on 17 July 2023 focusing on the ongoing OECD/G20 project on addressing the tax challenges of the digitalization of the economy (the BEPS 2.0 project) is a public Consultation Document on Amount B of Pillar One. Amount B provides for fixed returns for in-scope in-country baseline marketing and distribution activities.
The Consultation Document, which does not yet represent consensus of the Inclusive Framework on BEPS as there are remaining open issues, requests stakeholder input by 1 September 2023. It reflects further developments since the first consultation document on this topic which was released in December 2022.
Unlike Amount A of Pillar One and the global minimum tax rules under Pillar Two, there are no monetary thresholds (e.g., minimum global revenue) for Multinational Enterprise (MNE) Groups to be within the scope of Amount B. Amount B is intended to cover both buy-sell and agency arrangements. It is intended to exclude substantial retail sales and the trading, marketing or distribution of commodities, but the Consultation Document reflects the intention to include the wholesale distribution of digital goods. One vital area on which input is sought is whether the scope determination for Amount B should include an additional qualitative threshold.
For pricing under Amount B, the Transactional Net Margin Method (TNMM) is viewed as the most appropriate method (moderated by the Berry ratio), but tax authorities and taxpayers may advocate for the comparable uncontrolled price (CUP) method using internal comparables. The pricing-matrix approach proposed for determining the arm's-length return for in-scope transactions takes into account industry, geography, and functional and asset intensity. Notably, the potential exemption from Amount B for jurisdictions with local market comparables that was included in the prior consultation document has been replaced with a requirement for jurisdictions to prepare and publish their own local matrix in order to apply it as part of Amount B.
The outcome statement that the OECD released on 12 July 2023 indicates that the aim is for the Inclusive Framework to approve and publish a final report on Amount B by year-end so that Amount B can be incorporated into the OECD Transfer Pricing Guidelines by January 2024.
In October 2021, the OECD released a statement reflecting the high-level agreement of Inclusive Framework member jurisdictions on key parameters of Pillars One and Two of the BEPS 2.0 project, together with an implementation plan.1 As described in the October 2021 statement, Amount B would simplify and streamline 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.
During 2022, the OECD released working drafts on the nexus and profit-allocation rules under Pillar One in the form of consultation documents, including a document on Amount B released in December 2022.2 These working drafts did not yet reflect consensus agreement in the Inclusive Framework and were released to obtain input from stakeholders.
On 12 July 2023, the OECD released an outcome statement reflecting the agreement reached by 138 of the 143 Inclusive Framework member jurisdictions on the remaining elements of the BEPS 2.0 project.3 The statement noted that the Inclusive Framework recognizes that Amount B is a critical component of the broader agreement on Pillar One and has reached consensus on many aspects of the Amount B framework. The statement also indicated that further work will be undertaken on specific aspects of Amount B to ensure the appropriateness of the scope and pricing framework and that a consultation document would be released shortly. The statement announced the intention that the Inclusive Framework will approve and publish a final Amount B report by year-end and that Amount B will be incorporated into the OECD Transfer Pricing Guidelines by January 2024. In this regard, consideration will be given to both the needs of low-capacity jurisdictions and the interdependence of Amount B with the signing and entry into force of the multilateral convention with respect to Amount A. According to the statement, the timeline for implementing Amount B will take into account both of these considerations and the time that some jurisdictions will need to adopt relevant legislative changes and businesses will need to prepare.
The Consultation Document addresses:
The Consultation Document acknowledges that disputes over whether distribution arrangements qualify as "baseline," and disputes regarding pricing considerations for distribution arrangements, may involve administrative challenges for tax administrations and result in a compliance burden for taxpayers.
According to the document, the Amount B approach it contains is a simplified and streamlined approach that seeks to prevent disputes from arising and help resolve those that do arise in a more efficient manner.
The Consultation Document provides that the Amount B qualifying transactions are:
The Consultation Document defines wholesale distribution as distribution to any type of customer, except end consumers. Additionally, a distributor that carries out both wholesale and retail distribution is deemed to carry out solely wholesale distribution if its annual net retail sales do not exceed 20% of total annual net sales.
According to the Consultation Document, a qualifying transaction will be subject to Amount B if it satisfies the specified scoping criteria:
The Consultation Document proposes two alternatives to the scoping criteria, with the key differentiator between the two being whether an additional qualitative scoping criterion is required. Alternative A proposes no additional qualitative scoping exclusions. Under Alternative B, the scope of Amount B would only include distributors that fit within a definition of "baseline" distributor and that do not make "non-baseline contributions" that cannot be reliably priced under the proposed pricing method.
The jurisdictions supporting Alternative A are of the view that the additional criteria are simply not needed to achieve arm's-length pricing, would make Amount B far less administrable and certain, and would have the practical effect of making Amount B a "floor" on all controlled distributor returns.
The jurisdictions supporting Alternative B believe that absent the additional criterion Amount B would not reliably produce outcomes aligned with the arm's-length principle and would result in opportunities for base erosion and profit shifting.
The Consultation Document provides that distributors that perform non-distribution transactions can still be in-scope of Amount B if these transactions can be adequately evaluated and reliably priced on a separate basis (i.e., where segmentation can be applied). However, under a potential administrative simplification described in the document, a qualifying transaction would be out-of-scope if the tested party performs non-distribution activities and the proportion of indirect operating expenses allocated between the distribution and non-distribution activities exceeds 30% of the total costs.
The Consultation Document provides illustrations of situations in which segmentation may not be appropriate, as well as guidance on the practical allocation to distribution activities.
The Consultation Document states that the Amount B scope would exclude qualifying transactions for the distribution of services or for the marketing, trading, or distribution of commodities. Importantly, it appears that although the intended scope of Amount B includes the distribution of digital goods, it excludes the distribution of digital services.
Application of the most-appropriate-method principle to in-scope transactions
The Consultation Document states that in evaluating the choice of transfer pricing method for in-scope transactions, it is not necessary to prove that a particular method is not suitable, nor is it necessary that all transfer pricing methods are analyzed in depth or tested in each case. Rather, the TNMM should be considered the most appropriate method for purposes of applying the proposed pricing methodology to qualifying transactions. The Consultation Document recognizes that there may be rare instances in which applying the CUP method using internal comparables could be more appropriate than the TNMM. For these instances, Amount B provides an exception that can be asserted by either the taxpayer or the tax administration.
Determining the arm's-length return under Amount B
The Consultation Document indicates that further work will be done on the Amount B pricing methodology by year-end. That work will consider the appropriateness of the pricing matrix, the mechanisms to address geographic differences, and the application of the framework to the wholesale distribution of digital goods and the specific timing for the periodic updates. Stakeholder comments are sought on all aspects of the pricing framework and empirical data and analysis to support the comments are encouraged.
The Consultation Document contains a pricing matrix of arm's-length results based in part on financial information from a global dataset of companies involved in baseline marketing and distribution activities. The dataset is drawn from the results of a benchmarking study described in Annex A of the document.
Return on sales has been selected as the net profit indicator for pricing the in-scope transactions.
The arm's-length range derived from the pricing matrix is based on three industry groups and five categories of operating assets and operating expense intensities (providing for 15 different potential operating margins). The range of arm's-length results is between 1.50% and 5.50%. If the taxpayer applying Amount B reports a margin that is outside the identified range, the tax administration should adjust the result to the midpoint of the Amount B range.
The Consultation Document specifically provides that the pricing methodology and related guidance used for purposes of Amount B should not be applied for transactions that are out of the scope of Amount B.
Mechanism to address geographic differences
The Consultation Document states that the econometric analysis of the Inclusive Framework indicates that geographic differences may influence the profitability of baseline distribution in a small number of jurisdictions for which relevant data are available. Therefore, a modified approach and an adjustment mechanism are established to account for geographic differences identified in qualifying jurisdictions.
The qualifying jurisdictions for the modified approach are to be divided in three groups. The first group includes qualifying jurisdictions for which, based on local data, there are observed differences with the global dataset in terms of profitability. The second group includes qualifying jurisdictions for which there is no or insufficient data in the global dataset, but there is evidence of country risks (based on sovereign credit rating of the jurisdiction) that may influence arm's-length returns. Tested parties located in the second group of qualifying jurisdictions will earn adjusted returns based on a formula provided in the document. The third group includes qualifying jurisdictions for which a qualifying local dataset can be used instead of the global dataset. This third group includes jurisdictions not covered in the global dataset based on lack of information in the commercial database used. The tax authorities of these jurisdictions will produce a qualifying local dataset using a methodology similar to the one used to produce the global dataset. This local dataset will then be transformed into a local pricing matrix, which will be verified by the Inclusive Framework and published prospectively.
For all three groups of qualifying jurisdictions, the modified results will override and supplement the results presented in the default matrix.
Corroborative mechanism to address low and high functionality
The Consultation Document includes a three-step process to address situations in which certain arrangements may be at risk of being over- or under-remunerated for their functional contributions under the pricing matrix. In particular, a Berry ratio cap-and-collar approach is applied as a corroborative test and guardrail within which the primary return on sales net profit indicator is applied. The Berry ratio is defined as gross profits divided by operating expenses. According to the Consultation Document, this guardrail is intended to prevent low-operating-expense entities from being over-remunerated and high-operating-expense entities from being under-remunerated under Amount B. Where the application of the return on sales under the matrix produces a Berry ratio result outside the predefined cap-and-collar range, the profitability of the tested party will be adjusted to the nearest edge of the Berry ratio cap-and-collar range. The document defines this range to be between 1.05 and 1.50.
The Consultation Document indicates that the analysis supporting the arm's-length ranges referenced in the global dataset and the modified approach sets generally will be updated every five years, whereas the financial data and other datapoints, including the net risk adjustment percentage and the Berry Ratio cap-and-collar range will be updated annually.
The Consultation Document provides that the documentation requirements under Amount B will build on the existing documentation requirements included in Chapter V of the OECD Transfer Pricing Guidelines (i.e., local file and master file). This is more flexible than the documentation requirements described in the December 2022 consultation document, for example by referencing specified items of information that may already be included in a local file and that can be particularly relevant when assessing whether the transactions meet the scoping criteria.
The Consultation Document notes that when the taxpayer is seeking to apply Amount B for the first time, the taxpayer should include in its local file, or in any other relevant documentation, a consent to apply Amount B for a minimum of three years, unless transactions are no longer in-scope during that period or there is a significant change in the taxpayer's business. The taxpayer is required to notify the tax authorities of the jurisdictions involved in the qualifying transaction of its intention to apply Amount B.
In line with the December 2022 consultation document on Amount B, the Consultation Document notes that there may be situations in which some MNE Groups may undertake business restructurings to fall in or out of scope of Amount B. It reiterates that 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. It further states that tax administrations, however, have the right to determine the tax consequences of the structure resulting from a reorganization and the provisions of Chapter IX of the OECD Transfer Pricing Guidelines on business restructurings would apply.
The Consultation Document also notes that some associated enterprises may attempt to artificially reorganize their arrangements to derive tax advantages from applying Amount B. In such a case, the Consultation Document provides that tax authorities may use targeted approaches to address this concern.
The Consultation Document further notes that Amount B may apply to a restructured distributor with built-in losses from prior fiscal years, indicating that the tax treatment of those losses, in particular whether they can be deductible, depends on each jurisdiction's domestic legislation and administrative procedures.
The Consultation Document recognizes that there may be instances in which parties take diverging views on whether a taxpayer has appropriately applied Amount B. It indicates that situations in which disagreement exists between tax administrations or between taxpayers and tax administrations could be addressed through existing mechanisms aimed at preventing or resolving disputes (e.g., via unilateral corresponding adjustments in some jurisdictions or via mutual agreement procedures).
The Consultation Document also notes that agreements reached under mutual agreement procedure (MAP) prior to the adoption of Amount B should prevail. Advance Pricing Agreements (APAs) (unilateral, bilateral or multilateral) would also be respected, provided there is no breach of the critical assumptions. However, the terms of a unilateral APA may be affected if the tax administration of the counterparty to the qualifying transaction covered by the unilateral APA raises a transfer pricing adjustment and a MAP is initiated.
The Consultation Document provides important updates on the technical work Amount B following the initial consultation document released in December 2022. The scoping criteria have been significantly streamlined, although the Alternative B approach could reintroduce the scoping uncertainty that was present in the prior document. The discussion of pricing is much more detailed and includes empirical support for the parameters chosen. The list of remaining issues yet to be resolved is significantly shorter than in the prior document, but still reflects what may be fundamental differences between Inclusive Framework jurisdictions.
Importantly, the Consultation Document indicates in a footnote that further consideration will being given to the different means of implementing Amount B (e.g., designing Amount B as a safe harbor, prescribing Amount B, etc.). The approach that ultimately is chosen will significantly affect the impact of Amount B. Moreover, the intention to incorporate Amount B in the OECD Transfer Pricing Guidelines could result in different interpretations by different jurisdictions.
Because Amount B is not subject to a revenue threshold (unlike other BEPS 2.0 measures), it would be widely applicable. Businesses should consider the potential impact of Amount B on transactions that are in-scope and evaluate the potential impact of the Amount B approach on those transactions. In addition, 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 ongoing developments with respect to both Pillar One and Pillar Two over the coming months.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Belastingadviseurs LLP (Netherlands)
Ernst & Young Limited (New Zealand)
Ernst & Young LLP (United States)
Ernst & Young LLP (United Kingdom)
Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor
1 See EY Global Tax Alert, OECD releases statement updating July conceptual agreement on BEPS 2.0 project, dated 11 October 2021.
2 See EY Global Tax Alerts, OECD releases Progress Report on Amount A of Pillar One of BEPS 2.0 project: A detailed overview, dated 15 July 2022; OECD releases public consultation document on administration and tax certainty aspects of Amount A of Pillar One, dated 21 October 2022; OECD releases public consultation document on Amount B of Pillar One on baseline marketing and distribution functions, dated 15 December 2022; and OECD releases public consultation document on Pillar One Amount A and Digital Services Taxes, dated 23 December 2022.
3 See EY Global Tax Alert, OECD releases outcome statement on progress on Pillars One and Two of BEPS 2.0 project, dated 12 July 2023.