The OECD and the Inclusive Framework (OECD/IF) issued a long-awaited public consultation document (PCD) concerning Pillar One Amount B (“Amount B”) last week. The 53-page-long PCD, issued on December 8, 2022, provides a snapshot of the current state of the technical development of the Amount B framework. Several technical issues are raised in the PCD as questions addressed to stakeholders (industry, advisors, NGOs), with a deadline of January 25, 2023, for interested parties to respond.
Amount B is meant to streamline the application of the arm’s length principle to baseline marketing and distribution functions of multinational enterprises. It would, for in-scope entities, serve as a “safe-harbor” meant to provide a geographically consistent transactional net margin method or comparable uncontrolled price return to such in-scope entities, without the need for an application of the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (TPG) to the controlled transactions.
The timeline for the finalization of the guidance for Amount B was postponed on September 30, 2022 to mid-2023. The effective date for the application of Amount B still remains uncertain.
The PCD provides a first detailed look at the Amount B framework. It is organized in four substantive sections, with sections one and two covering respectively scoping of Amount B and Amount B pricing methodology, and with sections three and four covering respectively documentation requirements and tax certainty.
Perhaps in response to multiple commentators who raised the concern that Amount B is fundamentally a transfer pricing framework developed outside the authority of Article 9 of the Model Tax Convention on Income and on Capital, and without appropriate coordination between the OECD TPG and Amount B, the “Background” and “Aim and Structure of Public Consultation Document” introductory sections emphasize two important points. These include:
- A reminder that the OECD/IF mandated on October 8, 2021, Working Party 6 (WP6) to undertake technical work concerning Amount B; and
- The statement that the OECD/IF is currently assessing the possible inclusion of Amount B guidance in the OECD TPG.
WP6 is the OECD working group in charge of Article 9 and the OECD TPG. It is the group that substantially re-wrote the OECD TPG during the Base Erosion and Profit Shifting (BEPS) 2013-2016 (with extension to 2016-2017) project. Taxpayers are likely to feel more comfortable knowing that the OECD/IF appears to recognize the importance of ensuring a coherently integrated transfer pricing framework under which Amount B is merely an addition, with possibly conforming changes to various chapters of the OECD TPG, to the existing OECD TPG. The OECD has historically maintained its TPG as a dynamic document substantially revised in 2010, 2017, and 2022. The incorporation of Amount B into the TPG would be procedurally in line with the addition of Chapter X on financial transactions, for example.
A notable development of the Amount B framework is of the inclusion of sales agents and commissionaires as in-scope entities. Previous information provided by the OECD/IF concerning Amount B only envisioned buy-sell entities (limited risk distributors or LRDs) as in-scope entities. The addition of sales agents and commissionaires appears to be motivated by the fact that “Amount B is not driven by the adoption of a specific marketing and distribution business model, but primarily by the level and type of functions performed, assets owned and risks assumed by the parties to the controlled transaction.” Para. 15.
A list of 11 scoping criteria ranging from the existence of a written contract (criteria a) to exemptions from Amount B (criteria l) is provided in the PCD. In-scope entities, generally speaking, will only be entities engaged in the wholesale distribution of tangible property. Para. 3. Further discussions are expected concerning retail distribution activities as the current PCD is limited to wholesale distribution.
Distribution of services and digital goods distribution are specifically excluded from the scope of Amount B. Para. 37. Special considerations are being discussed for the distribution of commodities.
In-scope entities will be those entities whose activities are primarily marketing, sales and logistic functions without the use of valuable intangible assets or the performance of high-value functions. Various qualitative and quantitative tests and analyses are suggested. The general concept scope limitation to baseline functions is maintained in the PCD, which now provides a first set of proposed strategies to delineate those in-scope entities.
Footnote 6 of the PCD resurrects the heated debates during BEPS regarding the correct interpretation of paragraphs 1.94 and 1.105 of Chapter I of the OECD TPG. These paragraphs address the entitlement of an entity to the upside and downside of the economically significant risks of intellectual property development within multinational enterprises.
Specifically, when an otherwise in-scope Amount B distributor contributes to the control and management of economically significant functions (DEMPE), should that entity remain in-scope or be excluded? Would the answer be different if the last sentence of paragraph 1.105 is interpreted as consistent with a fixed (possibly high) arm’s length return for the control and management function as opposed to requiring a profit split between the parties?
During BEPS, countries did not agree on the correct interpretation of paragraph 1.105 in paragraph 1.94 situations where more than one party is managing and controlling the economically significant DEMPE risks. The fact that the OECD/IF is seeking stakeholder’s input on this issue may suggest that various countries still do not agree as to the correct interpretation of these paragraphs.
The approach taken by the OECD/IF, in connection with the pricing methodology for determining Amount B, is to develop standard sets of baseline marketing and distribution companies, and to use econometric techniques to evaluate and measure the impact of various exogenous variables on the profit level indicator of companies. The idea would be to have a number of those sets (by geographys and other possible factors) regularly updated by the OECD/IF for the purpose of implementing Amount B.
The econometric approach, if successful, seemingly intends to further customize the arm’s length return of a specific entity in a specific market based on the specific values of the exogenous variables for that specific entity. Based on our understanding of the type of regressions the OECD/IF has developed, we do not have a high degree of confidence that this approach will succeed. Specifically, these types of regressions have well-known multicollinearity and heteroskedasticity issues that yield biased and imprecise estimates. Not surprisingly, the PCD states, “the current econometric modelling to date has been able to account for a small portion of variation in operating margin.” Para. 55.a.
Next Steps
In summary, taxpayers have a short window of opportunity to influence the Amount B framework and voice concerns about its scope, application or other potential issues. The state of development of the Amount B framework is still in a technical phase of bringing IF countries to agree on some basic conceptual issues that are highlighted throughout the PCD. The PCD, in a sense, asks more questions than it provides answers. However, it also appears to have narrowed down the options under consideration and may, therefore, reflect some level of consensus achieved on some of the technical issues.
Kroll’s transfer pricing practice is in the process of further analysis of the PCD with a view to provide feedback to the OECD/IF. Taxpayers interested in learning more about the PCD or interested in sharing their view with us about the PCD are encouraged to reach out to their Kroll transfer pricing advisor.
