Amount B aims to standardize the remuneration of related party distributors that perform baseline marketing and distribution activities in a manner that is aligned with the arm's length principle. Its purpose is two-fold: First, Amount B is intended to simplify the administration of transfer pricing rules for tax administrations and reduce compliance costs for taxpayers. Second, Amount B is intended to enhance tax certainty and reduce controversy between tax administrations and taxpayers.
Pillar One assumes that distribution and marketing activities would be identified as in-scope based on a narrow scope of activities, set by reference to a defined "positive list" and "negative list" of activities that should and should not be performed to be considered in scope. Quantitative indicators would then be applied to further support and validate the identification of in-scope distributors. It is anticipated that amount B could be based on return on sales, with potentially differentiated fixed returns to account for the different geographic locations and/or industries of the in-scope distributors. Given the narrow scope of Amount B, there is currently no provision for Amount B to increase with the functional intensity of the activities of in-scope distributors. Amount B would not supersede advance pricing agreements or mutual agreement proceeding settlements agreed before the implementation of Amount B.
Under one proposal, the implementation of Amount B would operate under a rebuttable presumption, namely, that an entity that acts as a buy/sell distributor and performs the defined baseline marketing and distribution activities qualifying for the Amount B return would render it in scope, but that it will be possible to rebut the application of Amount B by providing evidence that another transfer pricing method would be the most appropriate to use under the arm's length principle. While one group of OECD members prefers a narrow approach, another group prefers a broader approach that would also provide standardized remuneration for commissionaires or sales agents, or for distribution entities whose profile differs from the baseline marketing and distribution activities discussed below.
Key Design Features Of Amount B: Scope. The key design features of Amount B cover: (i) scope, (ii) quantum and (iii) implementation. Regarding scope, Amount B would apply to the enterprises of multinational enterprise (MNE) groups that perform the defined baseline marketing and distribution activities in a market under an accurately delineated transaction. The accurately delineated transaction should consider the comparability factors outlined in the OECD Transfer Pricing Guidelines, including functions performed, assets owned, and risks assumed in the controlled transaction, which should be similar to those identified as being within the baseline marketing and distribution activities. Defining the baseline marketing and distribution activities would be achieved by reference to a positive and negative list of qualitative factors that closely relate to the performance of marketing and distribution activities. The controlled transactions in scope could consist of (i) the purchase of products from a foreign associated enterprise for resale to unrelated customers predominantly in the distributor's country of residence; or (ii) the performance of the defined baseline marketing and distribution activities by the distribution entity in its state of residence, transacting or dealing with a foreign enterprise.
Amount B would apply to a distribution entity that, according to the accurate delineation of the transaction, performs functions, owns assets and assumes risks that would characterize it as a routine distributor at arm's length. The in-scope marketing and distribution activities are first defined by reference to a list of typical functions performed, assets owned and risks assumed at arm's length by routine distributors. Second, a negative list of typical functions that should not be performed, assets not owned and risks not assumed at arm's length by routine distributors is included to qualitatively measure the additional factors that would cause a distributor to be outside the scope of Amount B. Certain quantitative factors would also be used to further support the identification of in-scope activities. If the accurately delineated transaction results in a characterization of the in-market enterprise as performing fewer or more than routine functions and assuming fewer or more than routine risks as defined under the baseline marketing and distribution activities, the remuneration commensurate with such activities and risks will be outside the scope of Amount B. Typically, an in-scope distribution entity would perform at least sufficient activities for it to be characterized as a routine distributor for which the return on sales profit level indicator would be appropriate at arm's length.
The baseline marketing and distribution functions typical of the performance of distribution activities by distribution entities in scope of Amount B may include: (i) importation of products for resale within the market; (ii) purchase of goods for resale within the market; (iii) development and maintenance of local customer relationships within the market; (iv) determination or negotiation of pricing and other contract terms with third party customers within the MNE group's pricing guidelines; (v) processing of orders and contracts with customers; (vi) management of logistics, warehousing and transportation of products to customers; (vii) general administrative functions such as sales invoicing and processing and collection of payments; (viii) marketing activities such as execution of global marketing plans in local jurisdictions and market research and (ix) routine pre-sale and after sale services, such as providing product information and handling complaints.
Amount B is not intended to cover distribution entities that perform functions such as (i) activities related to the development, enhancement, maintenance, protection and exploitation of marketing intangibles, such as decisions concerning investments or development costs; (ii) the performance of strategic sales and marketing functions such as developing strategic marketing policies or product development functions; (iii) activities related to the assumption of entrepreneurial risks and responsibilities in the controlled transaction: and (iv) activities related to the resale of products mainly to government entities or government contractors.
The assets used by the distribution entity in the performance of baseline activities in scope of Amount B may include: (i) ownership/lease of offices; (ii) ownership/lease of warehousing facilities; (iii) limited ownership of inventory; (iv) maintaining local customer lists and customer relationships; and (v) the right to sell in a market and use product name and brands, but not the ownership of valuable marketing intangibles such as local trademarks and brands.
The risks assumed by the distribution entity in the performance of baseline activities in scope of Amount B may include (i) limited market risks, such as variability in sales volumes: (ii) limited credit risks; (iii) limited inventory risk; and (iv) limited foreign exchange risk. Typically these entities would not be expected to assume risks that are economically significant for the MNE group as a whole.
In conjunction with considering the qualitative factors enumerated above, quantitative indicators could be used to identify in-scope distribution entities. These indicators take the form of quantitative thresholds closely linked to typical marketing and distribution activities which, if exceeded, may indicate that the distribution entity performs more than the baseline marketing and distribution activities. The following indicators may constitute appropriate quantitative proxies to support the determination of what may be an in- or out-of-scope distribution entity: (i) marketing and distribution expenses exceeding a fixed proportion of the total costs of the distribution business; (ii) presence of R&D costs exceeding a fixed proportion of total costs of the distribution business; (iii) amortization costs in excess of the total costs of the distribution business; (iv) product inventory or inventory write downs greater than a fixed proportion of the annual net sales of the distribution entity; and (v) accounts receivable greater than a fixed proportion of total finished product inventory.
A distribution entity performing a controlled transaction in scope of Amount B may also perform other activities, such as R&D, marketing or back-office services. In those cases, it will be necessary to determine whether Amount B can still be applied to the controlled activities in scope. This determination will depend on the facts and circumstances of each case. The availability of reliable segmented financial information for the different activities will also play a key role in deciding whether to price each type of activity separately or to adopt a holistic approach and consider the overall functionality of the entity.
On the assumption of a narrow scope, commissionaires, sales agents and other businesses that perform non-baseline marketing and distribution activities would not be within the scope of Amount B. This is principally due to the increased breadth of the work needed if they were to be included as in scope, the additional technical complexity and specificity that their inclusion would require, and the issue that the inclusion of both of these models would make it more difficult to reach consensus. Some OECD members favor a broader scope inclusive of commissionaires and sales agents, whereas others prefer the current narrow scoping criteria.
Key Design Features Of Amount B: Quantum. The fixed return provided to remunerate baseline marketing and distribution activities under Amount B is intended to deliver a result that approximates results determined in accordance with the arm's length principle. The TNMM is set forth in the Blueprint as the most appropriate transfer pricing method associated with the adequate remuneration for the baseline marketing and distribution activities performed by distribution entities in scope of Amount B, as net profit indicators are less affected by transactional differences and more tolerant to some functional differences between the transactions being compared. For the appropriate profit level indicator, a return on sales could be used as a fixed return for the transactions in scope.
Under one proposal, Amount B would operate on the basis of a rebuttable presumption, namely that a distribution entity that acts as a buy/sell distributor and performs the defined baseline marketing and distribution activities qualifying for the Amount B fixed return would be in scope. But it would be possible to rebut the application of Amount B by providing evidence that another transfer pricing method would be the most appropriate under the arm's length principle. For example, the presumption would be rebuttable if a sufficiently reliable CUP was available and under the specific facts and circumstances the CUP was the most appropriate transfer pricing method to use.
The OECD transfer pricing guidelines explain that arm's length prices may vary across different markets even for the distribution of the same or similar products. There may therefore be differentiated returns by region, with further technical work required to establish the specific regions and to understand the variance in arm's length returns by region. The fixed return could also need to vary by industry. This responds to the view that two distributors operating in different industries may experience divergences in their remuneration for a number of reasons, such as the type of products sold or the intensity and effort required to perform the marketing and distribution function. Under the arm's length principle, greater functionality should generally be accompanied by a higher profit potential. Conversely, lower functionality should generally be accompanied by a lower but less variable profit potential. On the assumption that the narrow scope of Amount B set out here is the one used, no attempt is made to account for functional intensity, as broadening the scope of baseline activities may increase complexity and increase the areas for dispute. However, functional intensity adjustments may be required if commissionaires and sales agents are included in the scope of Amount B, as these types of transactions may receive lower returns than buy/sell distributors.
Key Design Features Of Amount B: Implementation. Implementing Amount B in a coordinated and uniform fashion will reduce the risk of double taxation and double non-taxation. A narrow scope of Amount B may facilitate reaching a consensus by a large number of OECD members as it would be easier to agree on the appropriate set of baseline marketing and distribution activities, including the quantitative and qualitative indicators according to which distribution entities may be out-of-scope, and the appropriate means to be applied to set fixed returns. A narrow scope for Amount B could also be developed more efficiently, as it would negate the possible need to differentiate the returns based on the differing functional intensity of a broader spectrum of marketing and distribution entities.
Amount B would need to be implemented in three key ways: (i) under domestic law or regulation; (ii) where there is no treaty in place, a new treaty based dispute resolution mechanism may be required; and (iii) guidance to accompany domestic legislation and treaty provisions may be required, although the narrower approach to scope may again limit this requirement.
There is interest by some OECD members in exploring the feasibility of broadening the scope of Amount B, e.g. through an evaluation of how the remuneration may be standardized for commissionaires and sales agents or distribution entities that have a profile wider than the narrow scope marketing and distribution entities set out in the Blueprint. This raises issues that will need to be further considered to ensure that the fixed return profile for such activities is set in a manner that approximates results determined under the arm's length principle.
Visit us at mayerbrown.com
Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.
© Copyright 2020. The Mayer Brown Practices. All rights reserved.
This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.
