BEPS 2.0: An update on Pillar 1 Amount B

In line with the recent developments on the Base Erosion and Profit Shifting (BEPS) 2.0 Two-Pillar Solution, the Organisation for Economic Co-operation and Development (OECD) released an updated public consultation document on Amount B in July with the objective of simplifying transfer pricing of certain baseline marketing and distribution activities in accordance with the OECD Transfer Pricing (TP) Guidelines.

The OECD had released an earlier public consultation document in December. Comparing the two documents thus far, the July document provides reduced scoping criteria to determine whether qualifying transactions are to be covered under Amount B. It likewise presented the pricing matrix for Amount B which is based on return on sales (RoS).

SCOPING CRITERIA
Baseline arrangements generally refer to distribution arrangements involving an enterprise distributing on a wholesale basis to third parties goods supplied by an associated enterprise (or related party). The distribution activities (or qualifying transactions) in-scope of Amount B include:

1. Buy-sell arrangements where the tested party purchases goods from a related party from a different jurisdiction for wholesale distribution to unrelated parties in the tested party’s local market; and
2. Sales agency and commissionaire arrangements where the tested party contributes to wholesale distribution of goods for a related party and to the extent they exhibit economically relevant characteristics similar to those outlined in the scoping criteria for Amount B.

A distribution activity falling under either of the above categories does not automatically mean that it is covered under Amount B. The consultation document likewise provided for scoping criteria. Accordingly, the qualifying transaction is in scope only if it satisfies the following:

• The qualifying transaction must exhibit economically relevant characteristics that can be reliably priced using a one-sided method (e.g., Transactional Net Margin Method (TNMM) under the principles of the OECD TP Guidelines, with the distributor being the tested party;
• The tested party in the qualifying transaction must not meet certain quantitative filters based on annual operating expenses and annual net sales.

Furthermore, a qualifying transaction would still be excluded from the scope of Amount B if:

• The qualifying transaction involves the distribution of services or the marketing, trading, or distribution of commodities; or
• The tested party has other non-distribution activities other than the qualifying transaction, unless information is available to adequately evaluate and reliably price the qualifying transaction separately in accordance with the principles of the OECD TP Guidelines.

PRICING FRAMEWORK
As to the most appropriate TP method to apply to the in-scope transactions, the consultation document provides that the TNMM is considered the most appropriate method for the purpose of applying the pricing methodology for Amount B. However, an exception would be when the application of the Comparable Uncontrolled Price (CUP) Method using internal comparables could be potentially more appropriate to apply in evaluating the qualifying transaction. This is consistent with the OECD TP Guidelines which provide that when there is a more direct method in evaluating the arm’s length nature of a transaction (i.e., CUP Method), it shall be preferred than the transactional profit methods such as TNMM.

Furthermore, the consultation document presented the pricing matrix to be applied for Amount B wherein there will be a two-dimensional mapping of the distributor based on its industry grouping and factor intensity. The applicable arm’s length return varies depending on the distributor’s industry, as well as level of operating assets and operating expense.

Determining the arm’s length return for a distributor in scope of Amount B involves the following three-step process:

1. Determine the relevant industry grouping and identify the applicable RoS in the pricing matrix provided in the matrix. For this purpose, the matrix provides three industry groupings categorized based on the products distributed.
2. Determine the relevant factor intensity classification. There are five factor intensity categories with each category representing a combination of asset intensity (i.e., operating asset to sales ratio) range and operating expense intensity (i.e., operating expense to sales ratio) range. For purposes of determining the factor intensity classification, the weighted average of the distributor’s most recent three-year financial period should generally be used.
3. Identify and apply the arm’s length range from the pricing matrix segment corresponding to the point where the industry grouping and factor intensity classification of the distributor intersect.

In addition to the default pricing matrix for Amount B, the consultation document likewise provided for a modified pricing matrix for qualifying jurisdictions. These jurisdictions include those that use a qualifying local dataset produced by the tax administration and those with a sovereign credit rating below BBB.

In the Outcome Statement on the Two-Pillar Solution released by the OECD last July 2023, the OECD mentioned that further work is still underway to ensure the appropriateness of the scope and pricing framework discussed above.

Nevertheless, it is targeted that the Inclusive Framework will approve and publish a final report on Amount B and incorporate key content into the OECD TP Guidelines by January 2024. It is therefore recommended that taxpayers stay ahead by maintaining relevant documentation on their related party transactions especially those involving distribution activities. These include, among others, necessary information for purposes of applying the scoping criteria including the functional analysis of the distributor, annual financial accounts, or written contracts or agreements, which may already be included in a TP documentation. These will aid the tax administrations in determining whether the company’s distribution activities meet the scoping criteria for Amount B and therefore, qualify for the application of the simplified approach under Amount B.

From a Philippine standpoint, while the Philippines is not an OECD member country, there are Philippine companies which are local distribution hubs of multinational entities. Thus, it is still important for distributors operating in the Philippines, especially those who may potentially fall under the purview of the scoping criteria for Amount B, to closely monitor the developments on Pillar 1 Amount B as these may have implications in their current transfer pricing policies.