The Initiative Formerly Known as Amount B

On February 19, 2024, the OECD released a final report on Pillar 1 Amount B, which provides guidance on Special Considerations for Baseline Distribution Activities (BDA) and referred to herein as the “BDA Guidance.” This guidance will be incorporated into the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022 (OECD TPG) as an annex to Chapter IV and effective for fiscal years commencing on or after January 1, 2025.

The BDA Guidance comprises eight sections that collectively provide characteristics of in-scope distributors, a framework for pricing in-scope distribution transactions and guidance on documentation, transitional issues and tax certainty considerations. The objectives of the BDA Guidance are three-fold: facilitating compliance, preventing transfer pricing disputes from arising and helping resolve disputes more efficiently.¹

Most notably, the BDA Guidance presents a simplified and streamlined approach (referred to herein as the “SSA”) for pricing in-scope transactions—formerly referred to as Amount B—that approximates an arm's length outcome for BDA within the jurisdiction of the tested party.²

The SSA applies to qualifying transactions, which are identified as (1) buy-sell marketing and distribution transactions; and (2) sales agency and commissionaire transactions. These transactions involve the resale (or facilitation of the resale) of products to third-party customers at the wholesale level. For a qualifying transaction to be in-scope of the SSA, it must exhibit characteristics that makes it reliably priced using a one-sided transfer pricing (TP) method (with the distributor, sales agent or commissionaire being the tested party) and where the tested party incurs annual operating expenses between 3% (on the lower bound) and between 20%-30% (on the upper bound) of annual third-party revenues. Said differently, an accurate delineation of the transaction should conclude that the transactional net margin method is the most appropriate specified method to analyze a qualifying transaction that is in-scope of the SSA. The BDA Guidance also clarifies that any transactions deemed to be out-of-scope for application of the SSA should be evaluated strictly according to the principles articulated in the remainder of the OECD TPG.

Section 5 of the BDA Guidance provides a pricing framework and lays out a three-step process to determine a return on sales for in-scope distributors, which is summarized below.

• Step 1: Determine the relevant industry grouping of the tested party and identify the corresponding column in the pricing matrix.
• Step 2: Determine the relevant factor intensity classification of the tested party from the five possible classifications and identify the corresponding row in the pricing matrix.³
• Step 3: Identify the range from the pricing matrix that corresponds to the intersection of the industry grouping(s) and the factor intensity classification of the tested party. The return derived from this step will produce a range equal to the return on sales percentage derived from the pricing matrix +/- 0.5%.

The BDA Guidance also presents two additional quantitative guardrails for calculating adjustments to the base range identified in Step 3 above, that include:

• An operating expense cross-check that takes the applicable return on sales of the tested party from the pricing matrix (derived in Step 3 above) and calculates the equivalent return on operating expenses ratio, which is then compared to an operating expense cap-and-collar range based on the tested party’s OAS intensity. To the extent the equivalent return on operating expenses for the tested party is outside the cap-and-collar range, an adjustment is made; and
• A data availability adjustment that is intended to account for cases where there is no or insufficient data in the global dataset for a particular tested party jurisdiction. For qualifying jurisdictions, a net risk adjustment is made to the base range with reference to the sovereign credit rating of the qualifying jurisdiction.

Any point in the adjusted range (or the base range if neither of these adjustments are necessary) can be relied upon for purposes of demonstrating compliance with the SSA and pricing qualifying, in-scope transactions.

Additionally, the BDA Guidance identifies the main items of information that can be useful in substantiating the taxpayer’s position on the applicability of the SSA, including those items that may already be prepared in an existing local file.

Initial Observations and Commentary

The BDA Guidance and the introduction of the SSA force multinational enterprises (MNEs) to re-evaluate their current transfer pricing policies governing baseline marketing and distribution transactions specifically for tangible property.⁴ MNEs will have to weigh the pros and cons based on their specific fact patterns of applying the SSA vs. the principles and process in the remainder of the OECD TPG (i.e., select and apply the most appropriate method). For many MNEs, marketing and distribution transactions are not contentious—they have battle-tested sets of distribution comparables that have consistently achieved an outcome that is acceptable from all perspectives. For these MNEs, the BNA Guidance may actually create uncertainty where there previously wasn’t, especially when the taxpayer relies on the same method in multiple jurisdictions and some of these jurisdictions adopt a mandatory SSA while others do not. So, while one of the stated objectives is to prevent transfer pricing disputes, for many taxpayers the BDA Guidance potentially may cause the opposite.

Nevertheless, for most MNEs, the immediate focus will be to evaluate the potential impact(s) of the SSA. Like any transfer pricing issue, the materiality of the impact(s) will be dependent on the specific fact pattern of each company. For some, the impact(s) might be directly observed in a change to the effective tax rate (via a change in pricing). For others, there may be more indirect impacts, such as a change to reserves for uncertain tax positions (UTP) reporting or increased compliance burdens. In making these calculations and subsequent decisions around changes to pricing, some of the questions MNEs will have to grapple with include:

1. Will the tax authorities come to the same conclusion around characterization of my transaction(s) with respect to being included or excluded as a qualifying, in-scope transaction where the SSA can be (or should be) applied? Although the BDA Guidance provides references to certain other areas of the OECD TPG that can be used to guide a qualitative evaluation, there is no prescriptive guidance on this assessment. The IF is working on an additional optional qualitative scoping criterion that can be used to identify distributors performing non-baseline activities, but this characterization issue will remain subjective, which means there is sure to be disparity between the viewpoints of taxpayers and taxing authorities on this matter. For example, the BDA Guidance states that to be considered a qualifying transaction, it must be reliably priced using a one-sided method; however, the OECD TPG is not as specific on how to make such a determination, as a practical matter. The position may be taken that any commercial relationship that strays from a “plain vanilla” arrangement, where pricing is set on an ex-ante basis and you accept the results at the end of the year, will qualify as a “unique and valuable” intangible/contribution that makes a two-sided method more appropriate.⁵ An interesting question is whether, in the context of a potentially in-scope transaction, an intercompany contract that guarantees a distributor, on an ex-ante basis, a fixed positive ex-post return (which is not typically seen in third-party transactions) would itself qualify as an intangible that would disqualify the transaction.
   
   
2. What countries will adopt the SSA? Achievement of the stated objectives for the SSA is largely dependent on widespread adoption. While this is not stated explicitly in the BDA Guidance, the point is thinly veiled. Notwithstanding this issue, there is also the question of whether jurisdictions that accept the SSA will choose to implement the approach as mandatory or elective for tested parties located in-country. In the absence of widespread adoption and conformity in implementation of the SSA, the result will likely add complexity (e.g., additional compliance burdens and/or multiple TP policies governing distribution transactions), which is contrary to the objectives of tax certainty and stability.
   
   This notion of added complexity is particularly relevant for the U.S. For example, historically, there hasn’t been a material difference in terms of following the OECD TPG or the U.S. TP Regulations with respect to in-scope tangible property transactions; however, with the SSA being incorporated into the OECD TPG, this will change because there is no analog to the SSA in the U.S. TP regulations. While the U.S. has stated its support for the SSA (and its preference that the SSA is mandatory)⁶, the U.S. Department of Treasury has not indicated that it will (or that it intends to) revise the U.S. TP regulations accordingly to reflect this change to the OECD TPG.⁷ Without explicit guidance in the U.S. TP regulations, telling taxpayers to handle qualifying, in-scope transactions differently, the arm’s length standard prevails and the best method rule must be satisfied, the outcome of which may, or may not, align with the SSA. However, IRS’s reticence to address this issue may not be unfounded. Given the recent trend of litigation challenging the validity of regulations, via the IRS’s violation of the Administrative Procedure Act (APA), coupled with the foundational nature of the best method rule to the U.S. TP regulations, it may be very difficult for the IRS to make a method mandatory without risking a challenge on the legitimacy of such provision. Some comfort may be gained from the historic position of the IRS that taxpayers that follow the OECD TPG comply with Section 482. That said, we also observe in-field audits where the IRS has challenged an OECD method used to support a U.S. tax filing position. Needless to say, it would be very useful, particularly for taxpayers interested in proactively understanding the impacts of the SSA, for the IRS to publicly state how it intends to view taxpayers that use the SSA for U.S. tax filing positions.
   
   
3. How will taxing authorities use the pricing matrix in practice? The BDA Guidance is clear that the pricing matrix should not be used to establish a “floor” or “ceiling” for returns to distribution activities (nor for any purpose other than the prescribed use therein); however, it is not unreasonable to think that, as a “consensus measure” of distribution returns among the IF countries, the SSA pricing matrix will be used more broadly (e.g., as the basis for proposed adjustments in exam). As a result, will financial auditors compel U.S. taxpayers to do an analysis of returns under the SSA even if they decline to rely on it? Tangentially, will financial auditors use the SSA pricing matrix to determine the reserve position for UTP reporting? In either case, taxpayers that initially did not want to apply the SSA may find themselves more willing to do so.

Other interesting issues that may arise as the SSA is more broadly implemented and applied globally include: (1) does applying the SSA to a transaction change the commercial or financial relations between the associated enterprises and therefore qualify as a business restructure under Chapter IX; and (2) does the pricing approach in the SSA run afoul of the arm’s length standard.

Kroll’s transfer pricing professionals can help you think through these and any other issues/questions that may arise as you process, interpret and evaluate how the BDA Guidance impacts your company.

Sources:
¹The BDA Guidance makes it clear that it is meant as simplifying the pricing of in-scope distribution arrangements and should not be viewed as a revision to the general principles conveyed in the OECD TPG, nor used to interpret the application of the OECD TPG for any transactions out-of-scope of the SSA.
²Only in jurisdictions that choose to apply the SSA will such approach be treated as achieving an arm’s length outcome. Otherwise, like other elective approaches in the OECD TPG, the outcome determined under the SSA by a jurisdiction that has chosen to apply it is non-binding on the counterparty jurisdiction and will not be treated as providing an arm’s length outcome in those jurisdictions that choose not to apply the SSA.
³The factor intensity classification comprises two components: operating asset intensity (OAS) and operating expense intensity (OES). Each of the five factor intensity classifications (A-E) have a specific threshold or range of ratios for each intensity factor. These metrics are indirect proxies of risk believed to contribute to variations of returns in the cross-section.
⁴Transactions involving the marketing or distribution of commodities, digital goods or services are excluded from the scope of the SSA.
⁵The BDA Guidance states that if both parties to a potentially qualifying transaction contribute unique and valuable intangibles, the SSA may not be suitable to apply.
⁶At a Federal Bar Association conference on March 5, 2024, Christoper Bello of the Treasury Office of International Tax Counsel made it clear that the U.S. is in support of the [SSA].
⁷On March 7, 2024, the House Ways and Means Committee released a report addressing the impacts of Pillar 1, within which it discussed the steps to implementation of Amount A and Amount B, as well as estimated the economic impact Pillar 1 would have on the U.S. There was no discussion about Treasury issuing regulations to integrate a safe harbor similar to the SSA into the U.S. Transfer Pricing Regulations.