BDO’s Global Transfer Pricing team on January 25 submitted comments to the OECD in response to a consultation document regarding Amount B of Pillar One. The comments focused on three areas: the proposed scope of Amount B, the pricing methodology, and tax certainty.
While the Inclusive Framework’s (IF’s) efforts in preparing the public consultation document are commendable, BDO’s Global Transfer Pricing team concluded that for Amount B to meet its goals of reduced taxpayer compliance costs and enhanced tax certainty, the IF should broaden the scope of activities that constitute acceptable baseline marketing and distribution activities. Moreover, the two pricing methodologies currently under discussion require much additional work to avoid imposing excessive administrative burdens for MNEs and tax authorities.
The goal of the IF’s two-pillar solution is to address the tax challenges arising from the digitalisation of the economy. More specifically, Amount A of Pillar One aims to ensure a simplified and fairer distribution of taxing rights for the digital economy. In its current form, Amount A would apply only to the largest, most profitable multinational enterprises (MNEs), that is, those with over EUR 20 billion in revenue and over 10% profit margins.
Amount B of Pillar One, in contrast, is intended as a simplified methodology for determining arm’s length returns for baseline distribution functions for MNEs of any size that meet the scoping criteria. The focus of Amount B is on enhancing tax certainty, reducing resource-intensive disputes between MNEs and tax authorities and addressing the needs of low-capacity jurisdictions (LCJs).
On December 8, 2020, the IF released “Public Consultation Document, Pillar One – Amount B,” which presents the current status of the development of an approach to implement Amount B. The consultation document covers three areas: scope, methodology and certainty. In all areas, the document reflects the unresolved tension between a system being designed for the greatest possible accuracy and one focused on administrability.
For example, the document proposes an alternative to benchmarking for in-scope distributors (and potentially commissionaires or agents). There are numerous proposed criteria for identifying these distributors. Taken together, applying these criteria could result in an overly restrictive approach that would likely result in relatively few MNEs being in scope of Amount B.
The pricing methodologies presented in the consultation document also raise questions. It is unclear why Amount B would need to disallow the use of a potentially more appropriate method, especially the comparable uncontrolled price (CUP) method, that might be appropriate in certain situations. There are also questions related to the selection of the net profit indicator (NPI) and the proposal for in-scope distributors to achieve a specific profitability point (or fall into a narrow range). In addition, the two pricing mechanisms currently under discussion -- a pricing matrix and a mechanical pricing tool – are in the early stages of development and many questions remain unanswered. The answers to those questions will determine whether the tool meets the goals of reliability and administrability for both MNEs and tax authorities.
As stated in the consultation document, Amount B is intended to be a simplification and streamlining measure in applying the arm’s length principle based on the guidance provided in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. To that end, Amount B defines what the consultation document describes as “a streamlined and simplified approach to appropriately reflect the accurate delineation of in-scope transactions … through the application of the scoping criteria listed in Section 3.”
However, In their current form, the scoping criteria seem overly restrictive for MNEs and may add, rather than reduce, complexity for tax authorities.
Functions, assets, and risk analysis
The consultation document embraces the functional analysis concept and provides that “as it would be unfeasible to establish an exhaustive list of the functions that the distributor should undertake, the application of Amount B should be guided by the general principle that the distributor may not perform any significant function that is not typical for independent distributors.”
The consultation document’s heavy reliance on a functions, assets, and risk (FAR) analysis to determine whether a transaction is in scope of Amount B may add to the complexity of the determination and augment, rather than reduce, the degree of uncertainty involved in the scope determination.
The consultation document proposes two product-based exclusions and one activity-based exclusion for determining whether a distribution transaction would be in scope for Amount B. The product-based exclusions would apply to non-tangible goods and commodities; the activity-based exclusion would exclude value-added activities.
The proposal to exclude digital property from the purview of Amount B seems particularly ironic, given that the original impetus for Pillar One was the perceived need to address the tax issues arising from the digital economy. The question as to why non-tangible goods are excluded from Amount B is more puzzling when considering that sales agents and commissionaires, which may have similar FAR profiles as software/digital good “distributors,” are being considered for inclusion.
The consultation document’s second product-based exclusion of commodities is explained with the observation that, in practice, the arm’s length price for the distribution of certain materials, goods or products in the commodities industry may be established through the CUP method, rather than the transactional net margin method (TNMM) relied upon for purposes of Amount B. However, the consultation document notes that the IF is considering allowing the CUP method for other purposes. If the CUP method is permitted under Amount B, then there is little reason to exclude distributors of commodities.
The Amount B pricing methodology seeks to provide an effective means to address the challenges that commonly arise in pricing baseline marketing and distribution activities. The overarching goal is to develop a methodology that allows MNEs to price their in-scope transactions and to simplify administration for tax authorities. To do so, the consultation document proposes the use of a single global comparables set for all in-scope distributors. The IF analysed the global comparables to identify correlations between certain economic factors and profitability. From this, two different approaches for pricing in-scope intercompany distribution transactions were developed -- a pricing matrix approach and a pricing tool. However, the consultation document noted that the design and form of the pricing tool is still under consideration, and technical challenges remain.
Point versus range of results
The consultation document proposes that in-scope distribution activities be required to achieve a specific Amount B profit level (point) or a very narrow range of results (smaller than the interquartile range), rather than a profit level within an arm’s length (interquartile) range. However, the consultation document acknowledges that further consideration is needed to understand the practical implications for both MNEs and tax administrations of targeting a specific arm’s length result for Amount B pricing purposes.
Amount B is intended as a simplification and streamlining measure in applying the arm’s length principle; therefore, the application of Amount B should be consistent with the OECD Guidelines. Moving away from the concept of an arm’s length range negates the reasons the range concept was adopted, including the fact that in general, transfer pricing is not an exact science. In addition, often the application of the most appropriate method produces a range of results, all of which are relatively equally reliable. Such a range embodies the notion that independent MNEs may not earn the same profits for a given transaction.
In all, the Amount B consultation document reflects the current thinking of the IF members, but it does not set out a unified approach for implementing it. There are many important decisions regarding scope and methodology still to be resolved among IF members, and many details that need to be addressed. How this is done will determine whether Amount B provides a simplifying framework as intended.
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