On 19 February 2024 the OECD Inclusive Framework (IF) published the Pillar One Amount B Report (Report). This Report provides guidance on an optional application of a simplified and streamlined approach (S&S Approach) to baseline marketing and distribution activities (BMDA). The S&S Approach provides a pricing framework whereby a 3-step process determines a Return on Sales (RoS) for in-scope distributors. No minimum revenue threshold is applicable for the S&S Approach. Jurisdictions can choose to apply the S&S Approach for fiscal years beginning on or after 1 January 2025. The Report has been incorporated into the OECD Transfer Pricing Guidelines (TPG) as an Annex.
1. Background
Potential transfer pricing disputes related to BMDA may result in challenges for tax administrations and compliance burdens for taxpayers. The S&S Approach – formerly known as Amount B – is aimed at approximating an arm's length outcome for in-scope BMDA to enhance compliance and efficiently resolve disputes. It is incorporated as an Annex to Chapter IV of the TPG to be specially applied to BMDA. The S&S Approach is based on the TPG and its principles and should not be considered a revision or interpretation tool for other transactions.
2. Overview
The Report consists of the following key elements:
- The S&S Approach is aimed at approximating an arm's length outcome for in-scope BMDA.
- If jurisdictions choose to adopt the S&S Approach, they can (i) authorize tested parties to apply the S&S Approach, or (ii) require the use of the S&S Approach as mandatory for in-scope BMDA.
- To be eligible for the S&S Approach, qualifying transactions must be in scope and meet the scoping criteria.
- The transactional net margin method (TNMM) RoS is – in principle – chosen as the most appropriate method and net profit indicator.
- The arm's length remuneration for BMDA of a taxpayer under the S&S Approach can be determined through a pricing matrix by assessing the (i) net operating asset intensity, (ii) operating expense intensity, and (iii) industry group.
- Taxpayers should include the relevant information to assess the application of the S&S Approach in the local file or any other relevant documentation. When a taxpayer wants to apply the S&S Approach for the first time, it should include its consent to apply the approach for a minimum of 3 years in such documentation.
- Specific considerations on mutual agreement procedures (MAPs) concerning the application of the S&S Approach have been included in the Report covering situations (i) where one jurisdiction applies the S&S Approach and the other does not, and (ii) where there is a dispute on the application of the S&S Approach between jurisdictions. Bilateral or multilateral advance pricing arrangements (APAs) and MAPs obtained prior to the implementation of the S&S Approach would continue to be valid in relation to covered qualifying transactions.
3. What can taxpayers do?
Taxpayers can assess whether their activities are in scope of the application of the S&S Approach and whether their returns for these activities would align with the pricing matrix. The S&S approach is expected to simplify the pricing of certain distribution activities, but still requires a functional analysis and assessment of the various metrics.
4. Entry into force
Jurisdictions can choose to apply the S&S Approach for fiscal years beginning on or after 1 January 2025. India seems to be the only jurisdiction that has made various reservations to the Report and that various aspects should be further defined and designed.
5. Further details on the key elements of the Report
5.1 General
For further background on this S&S Approach, we refer to our previous publications and submissions (December 2022 and July 2023) on Amount B.
5.2. Choices of application of the S&S Approach
The outcome determined under the S&S Approach by a jurisdiction is non-binding in the counter-party jurisdiction if it does not choose to apply the S&S Approach (reference is made to 5.7 in respect of the subsequent MAP considerations). Jurisdictions can choose between two options for application of the S&S Approach: (i) a jurisdiction can permit tested parties resident within its jurisdiction to apply the S&S Approach, or (ii) a jurisdiction can require the use of the S&S Approach as mandatory when a taxpayer is in scope. Out-of-scope transactions should be evaluated according to the other sections of the TPG. Moreover, according to the Report, the S&S Approach should not be interpreted to set any precedent for returns on (out-of-scope) distribution activities in general.
5.3. Transactions in scope
"Qualifying transactions"
The following controlled transactions could qualify
for the S&S Approach:
- Buy-sell marketing and distributions transactions where the distributor purchases goods from one or more associated enterprises for wholesale distribution to any type of unrelated parties except end consumers; and
- Sales agency and commissionaire transactions where the sales agent or commissionaire contributes to one or more associated enterprises' wholesale distribution of goods to any type of unrelated parties except end consumers.
Scoping criteria
In addition, to be in scope of the S&S Approach
the following scoping criteria must be met:
- The qualifying transaction must exhibit specific economically relevant characteristics so that it can be reliably priced using a one-sided transfer pricing method, with the distributor, sales agent, or commissionaire as the tested party.
- The tested party's annual operating expenses must range within the quantitative threshold.
- The qualifying transactions must not involve the distribution of non-tangible goods, services, or commodities
- The tested party must not conduct non-distribution activities alongside the qualifying transaction that cannot be evaluated and priced separately.
The Report also includes a commentary section to clarify and illustrate the application of the scoping criteria to qualifying transactions.
5.4. Applicable method
The TNMM is chosen as the most appropriate method under the S&S Approach. An exception is provided for instances that the comparable uncontrolled price (CUP) method can reliably be used for pricing the in-scope transactions. The actual use of this CUP method may be rare – as the distribution of commodities is excluded from the scope. The RoS is used as the net profit indicator for the purpose of establishing pricing outcomes for in-scope transactions.
5.5. Pricing matrix and adjustment
The arm's length remuneration for BMDA under the S&S Approach can be determined through a pricing matrix by assessing the tested party's (i) net operating asset intensity, (ii) operating expense intensity and (iii) industry group. The return provided in the pricing matrix will be considered acceptable with a range of plus or minus 0.5%. Tax administrations should use the RoS percentage derived from the pricing matrix to adjust the margin of the controlled transaction when the margin reported by a relevant taxpayer falls outside the range. The datapoints of the pricing matrix will be updated annually and the ranges of the pricing matrix only every five years (unless market conditions warrant an interim update).
Furthermore, the Report provides two profitability adjustment mechanisms. First, the profitability of tested parties will be adjusted in case the return on operating expenses of the tested party falls outside the pre-defined operating expenses cap-and-collar range. Second, taxpayers in qualifying jurisdictions (i.e., the list of qualifying jurisdictions will be published and updated every 5 years on the OECD website) will need to earn an adjusted RoS dependent on the sovereign credit rating of the qualifying jurisdiction and the operating intensity of the tested party.
5.6. Documentation
Taxpayers should have sufficient and reliable information available to allow tax administrations to assess whether the scoping criteria are met, and whether the pricing methodology has been applied properly. The following items of information may be relevant for the application of the S&S Approach with respect to the in-scope qualifying transaction (non-exhaustive list):
- accurate delineation of the transaction (including functional analysis and context);
- concluded agreements;
- calculations showing the determination of the relevant revenue, costs and assets; and
- transfer pricing reconciliation (i.e., allocation schedules showing how the transfer pricing method ties to the annual financial statements).
Fortunately, most taxpayers will have this information available in their local file or other relevant documentation.
Finally, when the taxpayer is seeking to apply the S&S Approach for the first time, the taxpayer should include in its local file, or other relevant documentation, its consent to apply the approach for a minimum of 3 years (if the facts and circumstances remain unchanged).
5.7. Tax certainty and elimination of double taxation
Specific considerations on MAPs concerning the application of the S&S Approach have been included in the Report. This concerns the following MAP situations (i) where one jurisdiction applies the S&S Approach and the other does not, and (ii) where there is a dispute on the application of the S&S Approach between jurisdictions. In case only one jurisdiction applies the S&S Approach, the positions under a MAP should be determined based on the remainder of the TPG and not the S&S Approach. However, it is intended that application of the remainder of the TPG would result in a similar outcome as the S&S Approach. The next update of the commentary on Article 25 of the OECD Model Tax Convention is expected to align with the agreed wording of the Report. Bilateral or multilateral APAs and MAPs, obtained prior to the implementation of the S&S Approach, would continue to be valid in relation to the covered qualifying transactions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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