Pillar 1 Amount B has no income threshold and is applicable to many businesses operating across borders.
Amount B will be included in the OECD Guidelines for Transfer Pricing between Multinational Enterprises and Tax Authorities (2022), which will become one of the widely applicable international rules.
Jurisdictions may elect to adopt the Amount B method for covered transactions of entities under test in their jurisdictions for financial years beginning on or after January 1, 2025.
Summary of content
On 19 February 2024, the Organisation for Economic Co-operation and Development ("OECD") published its final report on Pillar One Amount B (the "Report"). The report aims to simplify the application of the arm's length principle to underlying distribution activities, with a particular focus on the needs of jurisdictions with low regulatory capacity (the "Amount B Approach", "Amount B" or the "Method").
In collaboration with other OECD and the G20 Project on Addressing the Tax Challenges of Digitalising the Economy (hereinafter referred to as "BEPS 2.").0 items") measures, Pillar 1 amount B is not subject to the income threshold, so it will have a wide applicability.
The report will be included in the Transfer Pricing Guidance for OECD Multinational Enterprises and Tax Authorities (2022) (the "OECD Transfer Pricing Guidelines") as part of this widely applicable international rule.
Jurisdictions may elect to use the Amount B method for in-scope transactions of the tested parties in their tax jurisdiction for financial years beginning on or after 1 January 2025.
The report clarifies the scope of distributors and sales** and how to price covered related party transactions. The distribution of non-tangible goods and services, as well as the marketing,** or distribution of bulk commodities, are not covered by Amount B.
The amount B method is a three-step analysis that determines operating margins for in-scope distributors.
The report also contains guidance on documentation (in particular local transfer pricing documentation), transition issues and tax certainty considerations.
Discuss specifically
Background
In October 2021, the OECD issued a statement that the 136 countries that are members of the Inclusive Framework Tax Jurisdictions have a positive response to BEPS 20 There was a high level of consensus on the scope of Pillars 1 and 2 of the project, as well as the implementation plan.
In December 2022, the OECD published a working draft on Amount B. The working draft did not reach consensus in the Inclusive Framework and was primarily intended to solicit input from various stakeholders. In July 2023, the OECD published a second exposure draft, reflecting the further development of Amount B and also elaborating on some of the remaining issues.
progress
After two rounds of exposure drafts on amount B, the OECD published a report approved by the OECD G20 BEPS Inclusive Framework (with reservations from India). The report will be annexed to Chapter IV in the OECD Transfer Pricing Guide.
Other work to be done
The report points out other work being done on amount B:
An update to the commentary to Article 25 of the OECD Model Tax Treaty to include specific language relating to tax certainty and avoidance of double taxation to ensure that jurisdictions that have not adopted amount B still retain the option in all dispute resolution mechanisms – which is expected to be released shortly.
Additional qualitative criteria for determining the scope of application that may be available to jurisdictions are expected to be completed by 31 March 2024, and any additions will be included in the OECD Transfer Pricing Guidance
List of jurisdictions with low collection capacity – expected to be completed by March 31, 2024.
An inter-authority agreement to avoid double taxation and double non-taxation that can be used in the context of bilateral tax treaty relationships is expected to be enacted during 2024 when the amount B approach is applied in jurisdictions with low regulatory capacity.
A framework for gathering information on the practical application of amount B after it has been running for a period of time – expected to be developed during 2024.
Further study of the interdependence between Pillar 1 Amount B and Amount A is expected to take place prior to the signing and entry into force of the Amount A multilateral convention.
Implementation of amount b
The OECD will publish a list of jurisdictions that have opted for the amount B method.
For jurisdictions that choose to adopt the amount B approach, amount B will be deemed to have provided an arm's length result.
The outcome of a jurisdiction's determination based on the amount B method is not binding on the counterparty's tax jurisdiction.
Jurisdictions that choose to adopt the amount B approach can do so in one of the following ways:
1) allow respondents residing in their tax jurisdiction to opt in to the amount B method; Or.
2) Require their tax authorities and the respondents in their jurisdiction to adopt the amount b method.
Either way, the report notes that transactions that fall beyond the scope of amount B should be assessed for arm's length in accordance with the guidance elsewhere in the OECD Transfer Pricing Guidelines. In addition, the guidance should not be construed as a "floor" or "ceiling" on which distribution activities should be rewarded.
The OECD noted that some tax jurisdictions that are not part of the Inclusive Framework may be affected by these rules as Amount B is included in the OECD Transfer Pricing Guidance.
The mechanism of amount b
The report describes the mechanism of the amount b method, which involves:
Scope of applicable transactions
Apply the principle of the most appropriate method
Determine returns
Documentation
Transition issues
Tax certainty and elimination of double taxation
1) Scope of applicable transactions
The report stipulates that transactions with applicable amount B include:
Distribution transactions under the purchase and sale model, where a distributor purchases goods from one or more related parties and distributes them wholesale to non-related parties;
Sales and commission transactions, i.e., the sale of goods by a person or seller assisting one or more related parties in the wholesale distribution of goods to non-related parties.
Wholesale is defined as distribution to any type of customer other than the end consumer. In addition, distributors who are engaged in both wholesale and retail sales are also considered to be engaged in wholesale distribution only if their net retail revenue does not exceed 20% of their total net revenue, calculated based on the weighted average of the past years.
If an eligible transaction meets a specific scope criterion, the transaction will be subject to amount B. Qualifying transactions must exhibit the relevant economic characteristics of the underlying distribution and can therefore be reliably priced using unilateral transfer pricing methods using a distributor, sale** or commission** as the tested party. This means that distributors should not:
There are any unique and valuable contributions.
Assume and control certain significant economic risks.
In a qualifying transaction, there is a high degree of integration with related parties in terms of functions, risks, assets, etc., and it is not possible to reliably assess their contribution alone.
In addition, in Qualifying Transactions, the Tested Party's annual operating expenses as a percentage of its annual net sales must not be less than a 3% lower limit, or higher than a 20% to 30% upper limit.
Amount B excludes the distribution of non-tangible goods and services, as well as the marketing,** or distribution of bulk commodities. Commodities are also clearly defined.
2) Apply the principles of the most appropriate method
In assessing the transfer pricing methods applicable to transactions within these scopes, it is not necessary to prove that one method is inadequate, nor is it necessary to conduct an in-depth analysis or testing of all transfer pricing methods in each case. If the amount B method is used to price eligible transactions, the general transaction net profit method is considered to be the most appropriate method.
The report notes that in a limited number of cases, the use of a comparable uncontrolled** method of internally comparable information may be more appropriate than the transactional net profit approach, particularly where the necessary information is available to tax authorities and taxpayers. In this case, the comparable uncontrolled** method can be used instead of the transactional net profit method.
3) Determine the return
The report provides step-by-step guidance on how to price transactions within the scope of the applicable amount B:
Use a pricing matrix to determine returns, based on the distributor's industry, operating expense intensity, and net operating asset strength.
Apply a cross-checking mechanism for operating expenses to reduce anomalous results.
Use data availability mechanisms to make adjustments to eligible jurisdictions.
Pricing matrix
The report includes a pricing matrix of arm's length results, based on financial data from comparable companies engaged in underlying distribution activities around the world. The data is taken from the results of the benchmarking analysis described in Appendix A of the report.
The operating profit margin was selected as the net profit indicator for transactions within the scope of the assessment amount B.
The independent trading intervals derived from the pricing matrix are based on three industry groupings and five classifications of net operating asset strength and operating expense intensity (providing 15 different potential operating margins). The operating margin of the independent trading results is reduced from 150% to 550% range. If the taxpayer applying the amount b method reports an operating profit margin that is not above or below the target operating profit margin determined under the specific business facts5% or less, it will be adjusted.
Industry groupings refer to the following categories:
Group 1: Perishables, groceries, household consumables, building materials and supplies, plumbing supplies, and metals.
Group 2: IT Hardware & Components, Electrical Components & Consumables, Animal Feed, Agricultural Supplies, Alcohol & Tobacco, Pet Food, Apparel & Footwear & Other Apparel, Plastics & Chemicals, Lubricants, Dyes, Pharmaceuticals, Cosmetics, Health & Wellness Products, Home Appliances, Consumer Electronics, Furniture, Home & Office Supplies, Prints, Paper & Packaging, Jewellery, Textiles, Leather & Fur, New & Used Family Vehicles, Vehicle Parts & Supplies, Mixed Products, and not in Group 1 or Section Products and components listed in Group 3.
Group 3: Medical machinery, industrial machinery (including industrial and agricultural vehicles), industrial tools, industrial components and miscellaneous supplies.
The following table shows distributor operating margins based on Net Operating Asset Strength (OAS), Operating Expense Intensity (OES) and Industry Grouping:
Cross-check operating expenses
Then, by applying the cross-checking of operating expenses, the range of operating profit margin and net profit indicator is formed (upper and lower bound). If a distributor's EBIT determined according to the pricing matrix results in the ratio of operating expenses to EBIT exceeding the upper and lower bounds, then the EBIT will need to be adjusted accordingly.
The upper and lower bound ratios are as follows:
Data availability mechanisms for eligible jurisdictions
In addition, the report provides an adjustment mechanism if there is no or insufficient data in the tax jurisdiction of the eligible test party among comparable businesses around the world.
If the DUT is located in an eligible tax jurisdiction, adjustments will be made to the returns determined in accordance with the steps above (i.e., net risk adjusted and net operating asset intensity percentage).
Applications
The financial ratios used to use the amount b method should be determined in accordance with the "applicable accounting standards". The report defines "applicable accounting standards" as "any accounting standards that are permitted to be relied upon in the tax jurisdiction of the respondent engaged in the underlying distribution activity, and any other accounting standard that is permitted to be used in that jurisdiction for the purpose of applying the simplified method".
Regular updates
According to the report, the analysis of the margin range and the upper and lower limit ratios of operating expenses in support of Amount B will be updated every five years (unless an interim update is deemed necessary), while financial and other data will be updated annually.
4) Documentation
The documentation requirements for amount B build on the existing documentation requirements contained in Chapter 5 of the OECD Transfer Pricing Guidelines (in particular local documentation). According to the report, the documentation should include: an explanation of the definition of the qualifying transactions within scope (including a functional analysis), written contracts, calculations required to apply the pricing framework, financial data segments, and financial data reconciliations.
When a taxpayer first applies for the use of amount B, the taxpayer shall agree to the use of amount B in his local file or any other relevant document for at least three years, unless the transaction is no longer within the scope of application during this period or there is a significant change in the taxpayer's business. Taxpayers are required to notify the tax authorities of the jurisdictions involved in the transaction of their intention to apply for the use of the amount B method.
5) Transition issues
The report notes that, in some cases, some MNE groups may undergo business restructuring to conform or not comply with the scope of the amount B method. The report reiterates that MNE groups can self-organize their business operations as they see fit, and that the tax authorities are not empowered to instruct MNE groups on how to structure their organisation or where to set up their business operations. However, the report notes that the tax authorities have the power to determine the tax consequences of restructuring structures and apply the guidance on corporate restructuring in Chapter 9 of the OECD Transfer Pricing Guidelines.
According to the report, some affiliates may attempt to artificially make restructuring arrangements to derive tax benefits from the application of the amount B method. Jurisdictions can take steps to address these issues.
As mentioned in the report, the amount B method may be applicable to restructured distributors who have accumulated losses in previous financial years. The tax treatment of these losses, and in particular whether they are deductible, will depend on the domestic legislation and administrative procedures of each tax jurisdiction.
6) Tax certainty and elimination of double taxation
The report describes the potential for double taxation** and procedures for mitigating double taxation.
Some jurisdictions may take advantage of the relevant provisions in their domestic laws to exempt them from double taxation through unilateral consequential adjustments. However, most jurisdictions can only consider consequential adjustments in the Mutual Agreement Procedure ("MAP") under bilateral tax treaties. In MAP or arbitration proceedings arising therefrom, where one or more jurisdictions related to MAP do not choose to apply or accept the amount B method, they must use the relevant guidance in the OECD Transfer Pricing Guidelines to justify the transfer pricing adjustment they are requesting, rather than using the amount B method.
Agreements entered into under Article 25 of the Model OECD Tax Treaty (including bilateral or multilateral APAs, as well as MAP cases) prior to the implementation of Method B will continue to be valid for qualifying transactions.
Impact
Because Amount B is not subject to income thresholds (unlike Pillar 1 Amount A and Pillar 2), it has a broad scope of application. Businesses should consider whether they have transactions that may fall within the scope of Amount B and assess the potential impact of the Amount B approach on these transactions.
Companies should pay attention to whether and how jurisdictions relevant to their business choose to implement Amount B, including assessing whether their in-scope transactions are likely to involve both implementation and non-implementation of Amount B.
Companies should also pay attention to the amount B method implementation date in the relevant tax jurisdiction, as this may be related to the accounting of tax implications, and thus the effective tax rate of the group. We anticipate that this will be a point of discussion in statutory audits.
This article is prepared for general information purposes only and is not intended to be relied upon as accounting, tax, legal or other professional advice. Please ask your advisor for specific advice.