With this in mind, in October 2021, the OECD/G20 Inclusive Framework (as part of its wider project to address the tax challenges arising from the digitalisation of the economy – for more background on the OECD’s two-pillar solution) agreed to simplify and streamline the application of the ALP to in-country baseline marketing and distribution activities and so Pillar One's Amount B was born. Public consultations were conducted in December 2022 and July 2023 to gather input and refine the approach.
On 19 February 2024, the OECD/G20 Inclusive Framework released a report on Amount B, which provides for an optional simplified and streamlined approach to applying the ALP to baseline marketing and distribution activities with a focus on the needs of low-capacity jurisdictions (LCJs).
In a nutshell, the report provides for a simplification measure which can be used to approximate an arm’s length result for in-scope baseline marketing and distribution activities. The reason for focusing on this area, according to the 2022 consultation, is that taxpayers and tax authorities generally face more hassle and conflict in this area than the tax or the transfer pricing challenge is worth. The simplified approach would ultimately allow tax authorities to focus on other, more significant, intra-group transactions.
Scope of the simplification measure
Qualifying transactions are either (i) buy-sell marketing and distribution transactions where the distributor purchases goods from associated enterprises for wholesale distribution to unrelated parties, or (ii) sales agency and commissionaire transactions where the sales agent or commissionaire contributes to wholesale distribution. A de minimis amount of retail distribution (i.e. distribution to end consumers) is allowed provided it does not exceed 20% of net revenues based on a three-year average.
To be considered in-scope, these qualifying transactions must meet certain criteria. These criteria include that the transaction must have economically relevant characteristics that allow reliable pricing using a one-sided transfer pricing method. Indicators that a one-sided transfer pricing method might not be suitable include where the contributions by each party are “unique and valuable” or where the distributor shares the assumption of economically significant risks.
There is also a quantitative filter which looks at whether annual operating expenses fall within a specified range relative to annual net revenues. The idea being that a high ratio of operating expenses to sales might indicate that additional functions are being performed.
During the consultation process, there was much debate about the addition of a qualitative filter. The report indicates that the Inclusive Framework is currently working on an additional optional qualitative scoping criterion: the work on this is to be concluded by 31 March 2024.
Transactions involving the distribution of non-tangible goods, services, or commodities are out of scope. Transactions where the tested party carries out non-distribution activities may fall out of scope unless they can be correctly segregated and reliably priced.
Application of the simplified approach
For in-scope transactions, the simplified and streamlined approach chooses the transactional net margin method with the return on sales as the net profit indicator as the most appropriate transfer pricing method as the default. However, there may be (rare) instances where the comparable uncontrolled price method using internal comparables could be more appropriate.
A pricing matrix based on information gathered from a global dataset consisting of companies that engage in baseline marketing and sales is then used to approximate an arm’s length outcome within the jurisdiction of the tested party, taking into account the taxpayer’s industry grouping as well other quantitative ratios (net operating asset intensity and operating expense intensity). This is intended to particularly help those jurisdictions with capacity constraints and/or who may not have access to appropriate comparables. A review and update of the data is to be carried out every five years, or earlier depending on market conditions. This seems a little odd considering the OECD’s general recommendation to update from scratch benchmarking studies every three years.
An optional approach?
The Amount B report has now been incorporated into the OECD Transfer Pricing Guidelines (TPG) as an elective approach. Jurisdictions can therefore choose whether or not to apply the simplified and streamlined approach. For those that do, they can decide whether to make the application of the regime elective or mandatory for residents of their jurisdiction.
However, the outcome determined under this approach will generally not be binding on counter-party jurisdictions that do not choose to apply the simplified and streamlined approach.
There is, however, an exception to this rule, which is that the Inclusive Framework members have committed to accept the outcome determined under the simplified and streamlined approach to in-scope transactions where such approach is applied by an LCJ. They have also agreed to “take all reasonable steps” to eliminate double taxation that may arise from the application of the approach by an LCJ, where there is a tax treaty between those jurisdictions.
Further work is being undertaken by Inclusive Framework to implement this commitment, including the development of competent authority agreements. The aim is to agree on the list of LCJs by 31 March 2024.
Will it achieve its aims?
There will be some administrative savings in terms of reducing the need for benchmarking studies, particularly where they may not be the data available. To benefit from the simplification measure, the accurate delineation of the intra-group transaction should not be neglected. Thus, there will still be documentation requirements to demonstrate that the transactions are in scope and that the use of the simplified approach is justified. There is always a risk for both taxpayers (and tax administrations) that the approximated outcome is higher (or lower) than would have been the case using normal arm’s length principles, but sacrificing precision and nuance is the price that often has to be paid to achieve simplicity.
In terms of reducing disputes, the jury is still out. Where both jurisdictions involved apply the simplified approach then undoubtedly there will be less scope for disputes. However, the limited scope of Amount B to wholesale (and not retail) distributors; to goods (and not all goods) rather than services also restricts the circumstances when it can be applied.
Further, it remains unclear how many jurisdictions will choose to apply this new approach. Some jurisdictions such as New Zealand and Australia have already clearly stated that they are not introducing Amount B into their legal system. India has made several reservations. Ultimately, too much flexibility for the countries in terms of implementation could prove counterproductive but this was probably the price to pay for such a heavily negotiated process. And, where a taxpayer trying to apply the simplified approach has dealings with jurisdictions that have chosen not to apply it, there remains a risk of double taxation. The report recognises that such a taxpayer could risk double taxation where a counterparty jurisdiction that is not applying the approach instead applies an adjustment under normal TPG provisions. Whilst a request for a corresponding adjustment can be made, or failing that, an application for the Mutual Agreement Procedure (MAP), the outcome must be justified under normal TPG provisions. The simplified approach “should not be considered or referenced” by competent authorities for the purposes of MAP or any arbitration procedure. This could negate many of the potential benefits of the simplified approach, both in terms of reducing compliance costs and reducing disputes.
What to expect next
As mentioned, Amount B now forms part of the TPG as an annex to Chapter 4. Jurisdictions can choose to apply the simplified and streamlined approach for in scope transactions from 1 January 2025.
Implementation will vary from jurisdiction to jurisdiction since some countries automatically incorporate the TPG into their domestic law while others will need to implement it domestically by enacting new laws. At EU level, it is not fully clear whether a unified approach is expected, as EU is now aiming at establishing EU-wide transfer pricing principles and rules through the Transfer Pricing Directive (currently undergoing technical examination in the Council).
There are a few outstanding deliverables, including the list of LCJs and the additional optional qualitative scoping criterion, both to be delivered by 31 March 2024. A further hurdle to surmount will be implementing the commitment to accept the application of the simplified approach by LCJs. More is expected on this during 2024.
Finally, the Inclusive Framework will review how the simplified approach is working, with a framework to gather the relevant information to do so also to be developed in 2024.
So there are still some moving parts, but the most crucial aspect in terms of whether this project is ultimately successful in achieving its aims will be whether jurisdictions choose to apply the approach at all.
The authors would like to thank Rita Simao Luis for her contribution to this article.
