What effect do the Pillar 1 Amount B developments have on Transfer Pricing? 

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One of the most debated topics in the international tax arena is Pillar 2, the global minimum corporate tax. Alongside this, work on Pillar 1 continues at full speed under the initiative of the OECD. In this article, we aim to provide a general summary of the significance for transfer pricing of the Pillar 1 initiative for Amount B for which the OECD’s aim is to simplify transfer pricing for baseline marketing and distribution costs. 

Pillar 1, Amount B, represents a new international tax regulation that affects all multinational enterprise groups, regardless of size, provided they meet certain criteria.  

In this article, we will examine the scope, implementation, and practical implications of Pillar 1 Amount B in line with the OECD’s Final Report published in February 2024 and the supplementary guidance released on June 17, 2024. 

Scope 

The OECD aims to eliminate complexities related to transfer pricing compliance for core marketing and distribution activities through Amount B calculations. In this context, covered transactions and excluded transactions are clearly defined.  

More specifically, the qualifying controlled transactions include ‘buy-sell’ marketing and wholesale distribution transactions as well as the sales agency and commissionaire transactions. There are some areas excluded from the scope of amount B, which concern distributors that assume certain economically significant risks or own unique and valuable  intangible assets; distributors of non-tangible goods or services;  distributors of commodities; or when the tested party carries out non-distribution activities in addition to the qualifying transaction that cannot be adequately evaluated on a separate basis and reliably priced separately. 

In addition to qualitative descriptions, there are also some quantitative criteria to be met such as operating expenses/net income ratios. 

Implementation Principles 

The implementation of Amount B generally involves redefining operating margins (i.e. operating result/net sales) for eligible companies based on specified criteria without requiring a detailed benchmark analysis. The OECD expects taxpayers to apply this approach consistently for at least three years with a yearly update of the figures of the tested party, provided conditions remain unchanged. 

The countries covered by the OECD are defined as follows: 

• Lower and middle-income countries according to the World Bank group classification, excluding EU, OECD, and G20 members. 

• Lower and middle-income OECD or G20 Inclusive Framework member countries willing to implement Amount B. 

• Other lower and middle-income countries expressing a desire to implement Amount B. 

The list of covered countries will be published on the OECD website and reviewed every five years. Countries can also extend their political commitments bilaterally to other countries. The number of countries covered by the OECD at the time of writing is 66¹. These countries are not obliged to adopt Amount B legislation, but it is political commitment that the application of the amount B process by one jurisdiction will be accepted by the other for those that adopt the Amount B approach.  

Steps According to the Final Report 

The simplified approach under Amount B involves the following steps: 

• Global Return on Sales Matrix: The Global Return on Sales Matrix sets target operating margins for three different categories based on sector groups and 5 factor intensity classifications relating to operating assets and operating expenses.  

• Operating Expense Cross-Check: This check is a control mechanism applied to the return on sales determined under Amount B, to align with the objectives of the simplified and streamlined approach. Whenever the newly determined return on sales falls below or exceeds the operating expense range set as the upper and lower limits by the OECD, an adjustment will be made until the return on sales reaches the appropriate limit.  

• Necessary Country Adjustments (data availability mechanism): This adjustment criterion is to address situations where weak comparable data comes from certain countries in the datasets used to determine global returns on sales. Accordingly, an additional profit margin will be added to the target return on sales determined by the matrix for these qualified countries. This adjustment will be based on the credit ratings assigned to countries by international rating agencies. According to the secondary report published in June 2024, the credit rating at which adjustment could apply BBB+ and below.  

Documentation 

The simplified and streamlined approach also requires adequate documentation in order to enable tax authorities to assess whether the qualifying transactions meet the scoping criteria.  Such documentation should contain information around the contractual terms, the functional analysis including accurate delineation and other relevant piece of information to be included in the Local file. 

Challenges 

The most significant challenge in implementing Amount B is achieving a consensus among all Inclusive Framework member countries, as ensuring uniform application is quite difficult. With effect from January 1, 2025, countries can incorporate Amount B into their legislation and mandate it, offer it as an elective option, or choose not to adopt it at all. 

In this context, if a country allows its taxpayers to use Amount B for tested transactions, the results will not be binding on the counterpart country. However, within the OECD framework, other countries are expected to accept financial outcomes in countries implementing Amount B as a political commitment. Additionally, enhancing the effectiveness of dispute resolution mechanisms is crucial, and this issue is continuously emphasised in the report. 

Comments and Recommendations 

As global tax frameworks continue to evolve, Amount B potentially represents a significant step towards greater efficiency and predictability in international taxation. However, several challenges need to be addressed before and during the implementation of this approach. These include: 

• Each Inclusive Framework (IF) member country should clarify its position and choose one of three options. Steps should be taken to prevent double taxation, and commitments from IF members to support the covered countries should be obtained.  

• The Mutual Agreement Procedure (MAP) is not effectively used by every country’s tax administration. Although it is one of the mandatory minimum standards under BEPS Action 14, MAP has not reached the desired level of effectiveness in many IF countries.  Ideally MAP should be operated uniformly across all IF member jurisdictions 

• For Multinational Enterprises (MNEs), having a segmented balance sheet and income statement is crucial for the application of Amount B. However, ensuring an auditable and reliable segmentation can still be operationally challenging for MNEs. MNEs need to design processes to produce reliable audited data for the implementation of amount B in relevant jurisdictions 
• Financial simulations to assess the impacts of amount B are strongly recommended due to the following main challenges: 

• Tax issues relating to : 

• The payment of lower or higher corporation tax in the countries concerned; 

• An increase in the Group’s effective tax rate; and 

• The payment of additional withholding taxes when dividends are distributed. 

• Potential Monetary issues relating to : 

• Exchange controls 

• Availability of foreign currency; and 

• The risk of devaluation of funds that are frozen in certain countries. 

• MNEs with subsidiaries in the covered countries should closely monitor the legislation in these countries. Therefore, we emphasise the importance of closely monitoring both the legislation and the financial results of these group entities engaged in core sales and distribution activities. Based on the legislation options, MNEs should choose the best option that suits their strategy for global compliance.  

• The OECD Final Report demonstrates the application with several practical examples. However, given real-world companies’ financials and complex operational situations, the existing examples are not sufficiently explanatory. 

This is a general overview of Pillar 1 Amount B based on the information obtained from the Final Report and supplementary documents published by the OECD.