Mon, Jan 6, 2020

Duff & Phelps Comment Letter to the OECD’s Unified Approach Under Pillar One

In response to the Organisation for Economic Co-operation and Development (OECD)’s request for comments relating to the public consultation document titled, “Secretariat Proposal for a ‘Unified Approach’ under Pillar One” issued on October 9, 2019, managing director Simon Webber and director Andrew Cousins in the Transfer Pricing practice submitted a comment letter to the OECD on the Secretariat’s Unified Approach proposals in the spirit of assisting with making the tabled proposal as workable as possible.


Summary of Proposals Relating to Scope

We propose that the new approach be adopted in a limited manner initially, so that it has time to be understood, adapted and refined through experience before it is implemented more broadly. In this initial phase:

  • The types of business operations that were the prime drivers of concerns around digital economy taxation issues, through their remote interaction with users, could be included in the scope; but
  • Consideration should be given to incorporating other types of businesses that are benefiting from the monetization of digitalized market and consumer information so that all countries with a material interest in its success have a meaningful stake in its design, development and refinement.

When only some segments of the business have characteristics of highly digitalized businesses, the Unified Approach providing the new taxation right should be applied only to those segments rather than to the entire organisation.

Industries and/or business segments which have clearly demonstrable locally established and taxed distribution channels or channel partners should be excluded.

The reasons behind these proposals are discussed in the subsections below.

Interaction with Consumers/users

Since one of the primary goals of the project is to head off the introduction of unilateral measures by countries around the world through globally coordinated action, this suggests that the focus of Pillar One should be on the characteristics of those business channels that are actually being targeted by such unilateral measures. By contrast, changing the way the whole global tax system operates for the majority of businesses is akin to using a sledgehammer to crack a nut. By way of illustration, the UK expects to earn just £400 million per year from its unilateral Digital Services Tax proposal by 2022, in comparison with total corporation tax receipts in 2018/19 of £55.1 billion.

The key feature of the highly digitalized businesses that have formed the core of the debate is that they owe their existence to the internet and take advantage of the remote access to markets that the worldwide web brings. For these types of businesses, digital access dispenses with the need for a local seller because interaction with the consumer/user takes place through a digital medium of some sort. To the extent that this interaction with the consumer/user is to be considered taxable, it is the fact that it has taken place through a digital terminal, distinct from any other channel/presence, and is dependent for its visibility on the connections offered by the worldwide web that places it outside the traditional tax system. It should therefore be explicit that, while the new approach may not be expressly limited to digital businesses, its applicability is most suited to those consumer-facing businesses that generate a majority of revenues through online channels.

The challenge with attempting to define the scope of the new taxing right around “consumer-facing” businesses, where “consumer” encompasses the idea of “user”, is to render the term sufficiently targeted as to address the perceived omissions of the existing international tax system with respect to digital channels. Giving meaningful definition to this term is important to avoid inappropriate application of the new approach to the majority of large MNE Groups without consideration to their degree of digitalization.  Such a broad application would impose a new, untried global system of international taxation on all or a large swathe of companies around the world, where arguably no such change is needed, and before such system has been appropriately tested.  

At the core of this concern is the breadth of possible interpretations of the term “consumer-facing.” Traditional manufacturers of goods aimed at consumers, be they food and beverages, tobacco, pharmaceuticals, household products, apparel, consumer electronics, or motor cars, typically do not sell direct to consumers but rather through consumer-facing third-party distributors and retailers. Their businesses may be classified as business-to-business (B2B) rather than business-to-consumer (B2C). Nevertheless, such manufacturers typically advertise direct to the consumer. When the consumer has a complaint about the product, it is typically the manufacturer’s customer service organization that will tackle the complaint and will bear the risks associated with product failures. It is the manufacturer’s reputation that is at risk in the mind of consumers in the event of product recall. Therefore, a construction of “consumer facing” businesses could be built where such manufacturers would be included, even though the operations of these businesses are clearly B2B. This would provide a reach for the new taxation right under the Unified Approach that is broader than necessary to address the concerns raised by the digitalized economy operations.  

Further, many B2C-classified companies have substantial and long-standing operations with tax-paying permanent establishments that may be using digital tools and gathering consumer data to improve or expand their product and service offerings. Even where on-line sales are made these may also be through local organizations. For many businesses exploring remote sales or exploitation of consumer data, the operation of these new digital elements of their businesses may well be nascent and pose only a limited distortion to the fairness of the international tax system. The broad application of the new taxation right would, in such instances, exceed the challenges this program of work is intended to address.

The proposal’s explicit exclusion of extractive industries would suggest that the possibility of including a majority of other industries is still on the table. We feel this would be an unnecessary overreach of this initiative at this time, especially considering the current state of untested development of the proposals. This potentially wide breadth of scope for the new approach risks creating more problems than it solves, in upsetting an established taxation system that works well for a majority of MNE Groups, creating radical change for unclear benefits in many countries and industries.  

The Frequently Asked Questions section of the OECD’s website inviting public input on the Secretariat Proposal for a "Unified Approach" under Pillar One states, in response to the question “Which businesses would (be) considered to be in the scope of the proposal?”: 

The scope would be limited to large businesses that interact remotely with users in market jurisdictions, even if the business has no or a limited physical presence in that jurisdiction. It would also apply to other businesses that market their products to consumers, and which may use digital technology to develop remotely a consumer base with limited or no physical presence in the jurisdiction where these consumers generally reside.  
This explicit limitation of scope to remote interaction, absent from the Secretariat’s actual proposal, is to be welcomed.  

We suggest that the scope be explicitly limited to businesses with a material and significant portion of their business revenues and profits arising specifically from digital interactions and exploitation of products, services and/or data with end users. Such businesses would, for their own financial gain, transact with users digitally, provide a digital service, or use related data for advertising or other indirect income, whether directly or indirectly. The conditions should be set such that only material, profitable businesses are initially subject to the new taxing approach, rather than having a blanket mandatory adoption across a large swathe of industry and taxpayers.

With that said, it is clear that digitalization is expanding in an increasing number of business models and eventually similar issues will arise for many types of businesses and industries. We are cognizant of the negotiation and outcome distortions and inequities that can result from too “close” an application of any new approach that may impact one country or group of taxpayers more than others. If the ultimate goal is to remake a more equitable international tax system for a broader digitalizing economy, then all countries and digitalizing businesses should have a participating stake in its design, development and refinement. As such, in addition to the companies that are of primary focus, consideration should be given to incorporating other types of businesses that are benefiting from the monetization of digitalized market and consumer information so that all countries with a material interest in its success have a meaningful stake in its design, development and refinement.

As such, we believe that a limited initial application of the new taxing approach to a focused group of companies, ensuring that all material countries have a stake in its success, would be wiser and less disruptive, until the benefits are proved in concept and the implementation issues are resolved.  

Defining the MNE Group

The introduction of a new approach for some MNE Groups (perhaps based on industry classification) and not for others means that two international tax systems would operate concurrently. This seems strange to us. It seems that it is the type of activity (operation through digital channels) that should determine whether the new approach is called for.  

The identification of the MNE Groups affected by the Unified Approach is better done by reference to the channel of the activity (i.e. done through online channels) rather than by reference to industry, so as to allow for future development in operating models across industries. 

Furthermore, application of the new taxation right to the entirety of businesses may be too broad in many instances. The scope of the business to be covered by the new taxing right could be narrowed to business channels that are dependent on the internet for the generation of revenues as a result of their interaction with consumers/users through that medium.  

Coverage of Different Business Models and Sales to Intermediaries

There is a clear intention among the unilateral measures proposed or enacted by a number of countries to capture revenue from businesses whose multi-sided model is based on deriving revenues from sellers/advertisers who wish access to users of the service (social networks, search engines, online marketplaces). As such these models must clearly be within the scope of the new approach if it is to replace those unilateral measures.

A majority of traditional B2B consumer goods manufacturers, sell into markets through intermediaries, as do many other industries which rely on local partners to be the consumer-facing parties in their business models. The inclusion of businesses which clearly sell or distribute through local market intermediaries and channel partners, whether related or unrelated, in the new approach therefore threatens to bring a majority of large B2B businesses within scope, and to subject to additional tax elements of supply chains that are already adequately taxed for their contributions in-country either within the enterprise or its channel partners.  

Attribution of a new market taxing right in circumstances where business is channeled through an established physical presence in the market and where the arm’s length principle has not been found wanting will add unnecessary administrative complexity and inevitably result in double taxation. We think it preferable that only sales through direct to consumer digital channels, or monetizing consumer information, through remote channels or remotely, should be within the scope of the new approach, if unnecessary upheaval is to be avoided through replacement of a functioning system with a new and untested system.

Size of the MNE Group

It is optimistic to think that any new system, in particular one that is overlaid on top of an existing system, will be simple to administer. The proposed new approach is likely to be burdensome for all businesses determined to be in scope. Not only will the interactions with the existing system create new frictions, but it will also create significant administrative and compliance requirements for companies and tax administrations in far more countries than at present. Furthermore, the existing transfer pricing system will continue in parallel with the new approach, so there will be no diminution in existing work or controversy risk. The amount of administration is likely to be excessively burdensome for all but the largest groups and countries, with the costs of implementation and administration potentially exceeding the tax receipts in many jurisdictions.

As suggested, only large multinational enterprises with business models of current concern or those that are likely to become of concern should be included. As we discuss later, some form of central administration of the compliance aspects should be considered.

Industry Carve-Outs

If the scope of the new tax is correctly formulated, additional industry carve-outs need not be contemplated or not be numerous. If a broader view of inclusion is maintained, then more industry carve-outs than just the extraction industries would be warranted and necessary to minimize disruption and the broader cost of administration. 

New Nexus

Proposals Relating to New Nexus:

We propose that:

  • A common, agreed, centralized single tax determination and administration process should be established whereby a single tax return for Amount A is submitted that covers all the tax jurisdictions that will be affected.
  • The global tax return for Amount A should be the responsibility of the taxpayer.
  • The tax administration in the country of the parent taxpayer, or a designate country, should be the single filing point for this return. This country will be responsible for the secure and confidential dissemination of the global tax return to all impacted countries.
  • A designate country should be used only where the parent country has no interest in the issue or does not have the resources adequately to administer and to review the data and calculations, and the other country agrees to take on that burden.
  • Consideration should also be given to the determination, collection and distribution of the taxes relating to Amount A for each country by the same administering tax jurisdiction.
  • In order to be able to implement such a centrally administered tax collection and dissemination process, it would probably be necessary to apply a globally agreed tax rate on Amount A income.
  • Centrally calculated Amounts A and related distribution of taxes should be subject to annual joint peer review by a rotating group of tax authorities.
  • Consideration should be given to leveraging and perhaps enhancing the information exchange provisions of the Country-by-Country Reporting system.


  • Country sales thresholds for application of the new method should be set at a sufficiently high level to avoid overburdening multinational enterprises with additional tax administration paperwork and submissions in every country.

The reasons behind these proposals are discussed in the subsections below.

Defining and Applying Country Specific Sales Thresholds

For MNE Groups, it will be preferable that country specific sales thresholds are set sufficiently high so as not to impose undue levels of costly compliance in a multitude of jurisdictions where limited revenues are earned. If a lower threshold for tax is set, central administration of the return and collection process should be considered to avoid unnecessary administrative costs for companies and tax administrations which reduce taxable profits and tax revenues after collection costs. 

However, the consequence of setting such thresholds will be that only large market economies are likely to benefit from the new approach. Countries with small markets will need to have very low thresholds if they are not to miss out on their share of the associated revenues and profits.

We propose that, in order for there to be inclusion without undue additional administrative burden, a single global tax return filing is made in one jurisdiction which has administrative oversight and responsibility to disseminate that return to all impacted jurisdictions.

In fact, we believe that the formulaic nature of the new tax approach, its allocation to markets based on what is likely very granular customer/user data, the fact that these data are very likely held and would need to be generated centrally, and the difficulties in imposing tax administration locally where companies do not have a presence, strongly suggest that this is a tax that should be determined, administered, collected and disbursed from the country of the parent or a designated location or through some authorized collection agent. Tax authorities will want to retain powers of review and audit of this new tax, as is customary. Unfettered, this would likely lead to an avalanche of audit reviews of essentially the same data. We recommend that the primary responsibility for review of the data inputs, determination of income subject to tax in each country and the collection and disbursement of tax should rest with the tax administration of the parent jurisdiction.

Submissions from this designated tax administrator to local countries should include sufficient transparency of related information, and joint, rotating peer review. This would be a considerable departure from the way international tax system is currency administered. This would be more inclusive and largely obviate the need for sales limits or allow for the application of relatively low ones because the margin additional cost to the determination of taxes for each additional country would be acceptably low.

Calibration to Ensure Jurisdictions with Smaller Economies Benefit

As stated in 2.a. above, there is a conflict between trying to ensure that not only large market economies benefit from the new approach, while avoiding creating excessive compliance costs for MNE Groups through multiplication of the number of jurisdictions in which MNE Groups must pay tax.

If countries with smaller economies are to gain any benefit from the new approach, the sales thresholds in those countries will need to be set so low as to bring into question the need for thresholds altogether.  Therefore, there is a requirement that the new approach is designed with a view to administrative simplicity, e.g. operated through a centralized arrangement between the MNE Group’s parent and its tax administration, if the compliance burden is not to exceed the economic benefit of doing business in a jurisdiction.

Calculation of Group Profits for Amount A

Proposals Relating to Calculation of Group Profits

We propose that:

  • MNE Groups might elect to use global consolidated financial information instead of business segment information on administrative grounds, perhaps with conditions.
  • If business segment financial information is possible and considered reliable, MNE Groups might also elect to use global business segment financial information instead of regional or country specific business segment information on administrative grounds, perhaps with conditions.
  • A single agreed audited and auditable accounting standard should be used for all Amount A calculations.  
  • If that is not possible or practical, a list of approved “effectively equivalent” accounting standards should be agreed, preferably those applicable to audited publicly listed companies.

The reasons behind these proposals are discussed in the subsections below.

Appropriate Metric for Group Profit

Profit before tax as per the MNE Group’s consolidated financial statements would be a sensible starting point for group profits, but it seems to us that it is wholly inappropriate to seek to apply Amount A based on a whole group’s profits, when sales through a digital channel may be immaterial or even non-existent. Establishing relevant taxable profits pertaining solely to digital channels, our preference, from the consolidated financial statements might be a major task, as records may not be readily available based on business line and numerous allocations between business lines may need to be created and agreed.

We propose that MNE Groups be able to elect whether they disclose information on a consolidated basis instead of a business segment basis for administrative ease. However, this might come with restrictions, such as having to declare that no such business line analysis exists or has been done at any point, or that the approach is applied to all businesses included in the financial statements provided. 

Adjustments for Differing Accounting Standards

If a single-return, consolidated profits approach is not undertaken, the impact of differing accounting standards could significantly complicate the determination and reliability of Amount A. Amount A should be determined for all countries using the same single accounting standard or distrust and double taxation will arise. Countries will also have a tax incentive to change their accounting standards to benefit their allocations. A single, audited and auditable accounting standard for all financial statements used to determine Amount A would be beneficial, to avoid inconsistent results between companies and countries.

These accounting standards might be international financial reporting standards or the generally accepted accounting principles used for audited, publicly listed financial statements of the parent company. We note, however, that GAAP standards for revenue recognition and other key elements of the financial statements may also vary. The level of audit scrutiny of financial statements also varies by country. As such, the initiative would probably need to consider these areas.

Calculating Group Profits Based on Business Line. Considerations of Regional Profitability

As stated above, we believe that calculation of Amount A should be limited to profits identified as pertaining to digital channels only. Clearly, if calculation of Amount A is limited to digital channels only, segmentation by business line will be essential, so that only the residual profit relating to the business operating through the digital channels is reallocated. Nevertheless, this will entail a compliance burden on the MNE Group, requiring assignment of costs between business lines, where these have not already been separately identified.

On the other hand, if almost all business groups are going to be subject to the new approach on all their profits, whether from a digital channel or not, there is little or no advantage to the MNE Group in analyzing the amount by business line or region. Calculating the profits for Amount A by business line obviously makes for a potentially more fair and reasonable allocation of profits, as far as countries are concerned, but at significant administrative cost for the MNE Group.  

Similarly, further attribution of Amount A by region, taking into account regional profitability, will allow more accurate fine-tuning of profits per jurisdiction, but the advantage is to those countries in the most profitable regions, as they are the ones that stand to lose the most compared with their tax take under the arm’s length principle, not to the MNE Group, which has little to gain from the additional analysis. The MNE Group, by contrast, will be placed under a far greater administrative burden, calculating residual profit for a number of regions multiplied by a number of business lines.

An election to use consolidated global business segment financial data should be available for administrative ease, perhaps with conditions.

Determination of Amount A (Determination of Residual Profit and Allocation):

Proposals Relating to Determination of Amount A 

We propose that:

  • The general level of routine returns used in the determination of Amount A should be a simplified common form set at a level that would cover all routine returns on the business and also preclude companies from the application of the approach if their profitability is below that level.
  • Since the routine returns used in the determination of Amount A determine the profits subject to tax as Amount A, those routine returns should be seen as upper boundaries for determining Amounts B and even Amount C unless there is very clear evidence of other non-routine contributions with markets.
  • The allocation of residual profit to “markets” should reflect only the non-routine contribution by markets relative to the non-routine contribution of the other aspects such as technology, product/service design, business model, strategic management, centrally managed brands, etc. 
  • We prefer that this is determined on an objective basis rather than by an arbitrary, negotiated measure, perhaps using relative investments or costs.
  • In any event, however this level is determined, it should be the same level applied to the determination of Amount A across all countries.
  • The allocation keys applied to determine the attribution of the residual “market” profit to each market jurisdiction should be clear and unambiguous and determined in the same manner for all countries.
  • Care should be taken to burden the affiliate entities earning the Amount A profits with the correct amount of relevant Amount A tax.
  • See prior proposals in Section 2 above with regard to a global centrally prepared Amount A tax return and its administration.

The reasons behind these proposals are discussed in the subsections below.

Complexity or Simplicity

Challenges in identifying appropriate returns for routine activities will include the following:

  • Ensuring that all routine activities are indeed recognized.
  • Ensuring that the return allocated to routine activities is appropriate per industry and per region/market.  This may require a multiplicity of percentages.
  • Achieving agreement from all participating countries on the percentages to be used.

Failure to achieve agreement on these basics will result in double taxation. Assume, for example, that the OECD states that routine low value adding intra-group services will be considered to attract a profit based on cost plus 5%, whereas a certain country X insists that all intra-group services provided from it must attract a mark-up on costs of at least 20%. The residual profit for division under Amount A will be overstated, resulting in double taxation.

An alternative would be to apply an adequate general margin that would cover all industries and their routine returns. 

Additionally, if the routine returns used to calculate Amount A are less than the returns used to calculate Amounts B plus Amount C, structural double taxation is a real possibility. To avoid this and the resulting controversies, the routine return used in the calculation of Amount A could also be used to set a boundary for Amounts B and C.

It is therefore vital that a multilateral dispute resolution process, including mandatory binding arbitration, be a necessary condition for any such approach.

Residual Profit Market % for Amount A

Similar equitable determination and double tax issues will apply to the percentage of residual profit (i.e., after general routine deductions) used to calculate non-routine “market” contributions.  

The allocation of residual profit to “markets” should reflect only the non-routine contribution of markets relative to the non-routine contribution of the other aspects such as technology, product/service design, business model, strategic management, centrally managed brands, etc. We prefer this to be determined on some objective basis rather than by an arbitrary measure. One approach might to be to look at long term levels of related expenses on the non-routine contributions as a proxy for their relative value and changes in value through the development of a business. This might be done at an industry or company level. This “markets” allocation of the residual must also be agreed and consistently applied across all countries in a transparent way to minimize controversy.

As discussed previously, we also believe that the risks of double taxation are such that the administration of the new tax in Amount A should be performed by the nation of the parent company, with adequate peer review and information-sharing on all allocations provided to all participating countries. 

Local Market Allocation Keys for Amount A

Similar challenges are likely to attend the choice and measurement of allocation keys, with different countries favoring different allocation keys, depending on how advantageous they may be. While populous countries may favor an allocation based on in-country sales, this will not favor smaller jurisdictions and may not even be an appropriate metric in many cases where it is the exploitation of user data across countries that might be at issue.

How are profits to be allocated in situations where there are users but no sales in a jurisdiction? In multi-sided business models, there are potentially situations where no revenues in the deemed market jurisdiction would be recognized by the party subject to the new taxation rights and where the company that might be subject to calculation of a market return might not have information available to make revenue-based allocations. Consider a situation where Company A in Country X pays Company B in Country Y to advertise A’s goods/services to non-paying users of Company B’s website in Countries X, Y and Z. There would be no revenues recognized in Country X or Z – rather only in Country Y with respect to these advertising activities. In this circumstance, Company B may be able to track users in Countries X, Y and Z and link them with revenues received from Company A, but it is not a given that such user data can necessarily be correlated directly with sales revenues.

A clear rubric for identifying and measuring taxable revenues related to exploitation of valuable local market factors should be determined. Similarly, a commonly agreed measure and mechanism for allocating the burden of the tax on Amount A among the entities that currently earn those residual profits should be used.

The determination and weighting of these factors should not be open to interpretation by different countries or double taxation will inevitably run rife and unfettered.

Administration of Amount A

The determination of Amount A profits, the allocation of Amount A to markets, and the identification of the entities and countries that should bear the tax cost will necessarily be based on company data regarding its activities and exploitation in markets or users from markets that is very likely to be held centrally, and would need to be analyzed centrally. In addition, it is likely to include consumer and company-confidential elements that may not otherwise be necessary for the determination of a company’s tax liabilities.

We believe that it will be important to administer the determination of Amounts A and related tax income and tax burden to each country centrally, preferably by the tax administration of the parent company or a designate. We have discussed the potential operation of such a proposal in prior sections and do not repeat the discussion here.

Elimination of Double Taxation in Relation to Amount A

Proposals Relating to Double Taxation in Relation to Amount A 

We propose that:

  • Some form of accelerated audit review, appeal and adjudication/arbitration mechanism be created and employed to administer the determination of Amount A and related tax liabilities.
  • As a minimum the new approach should be tied to mandatory binding arbitration for all tax authorities to minimize controversy time and costs for both multinational enterprises and tax administrations.
  • These measures could be deployed efficiently through the use of multilateral instruments but will require broad consensus and participation among participating countries.

The reasons behind these proposals are discussed in the subsections below.

Identifying Relevant Taxpayers Subject to Relief

The complexity of the proposed new approach is not to be underestimated, in so far as residual profit may be reallocated from one or many legal entities to potentially many market jurisdictions. The relevant residual profit may currently be spread among multiple entities, e.g., through normal transfer pricing arrangements as well as cost-sharing arrangements. The OECD’s emphasis on the DEMPE functions in the analysis of intangibles requires division of residual profits among contributory entities. By way of example, 6 cost-sharing participants in different countries yielding residual profit to 10 market jurisdictions would imply 60 reassignments of profit from individual entity to individual markets.

Building on Existing Methods of Double Tax Relief

While administratively simpler to elect a single entity from which the residual profit is reallocated, this would cause an imbalance in the tax burden or associated transfer pricing between the entities earning the market contributions being taxed in Amount A. An adjustment to the allocation of Amount A between entrepreneur X and market Y will have a knock-on effect to the profits of IP contributors and participants in the residual profit in country Z, even though they have no direct relationship to market Y.  

The existing bilateral methods of double tax relief are likely to be slow and cumbersome in addressing the challenges thrown up by the new approach. Taking further the example above, where six IP owners in a cost-sharing arrangement yield profit to ten market jurisdictions, it appears that full tax relief would currently require 60 double tax treaties, whether or not they even exist. In the absence of a centralized multilateral dispute resolution process, including mandatory binding arbitration, the risk is that tax relief will only be partial at best.

Ensuring that Existing Mechanisms for Eliminating Double Taxation Continue to Operate Effectively and As Intended

The challenge to the existing mechanisms is that current MAP numbers across the globe show little sign of diminishing. The addition of the new approach will potentially add such a large burden to the MAP load as to slow down further an already slow process. We believe that the dispute resolution process with taxpayers and between countries needs to be reimagined.


Amount B

Proposal with Respect to Amount B

We propose that:

  • If a fixed return (or returns) is to be used for Amount B, it is essential that the functions and risks to be covered are tightly defined, to avoid challenges under Amount C.

The reasons behind this proposal are discussed in the subsection below.

The Need for a Clear Definition of the Activities that qualify for the Fixed Return

Clear definitions are required in respect of all aspects of the new approach if total chaos is not to ensue and the activities that qualify for the fixed return Amount B would be no exception in this regard.  Allocation of fixed returns is only possible if very precise definitions are utilized. The fact that a large number of tax disputes relate to distribution functions is indicative of this. “Marketing and distribution” covers a whole range of functions and levels of responsibility, which vary, not just from one industry to another or from one business to another but within even a single MNE Group. Some or all activities out of sales and marketing, logistics, transportation, warehousing, storage, inventory management, etc., may be included in the catch-all term “marketing and distribution” and the level of return for performing all of these functions will differ from performing just one or two of them. Equally, the level of risk undertaken by the distribution entity, whether limited or fully-fledged, is highly determinative of the level of return.

Unless the level of functions and risks determined to be covered by Amount B is precisely defined, arguments over Amount C will abound. The risk is that Amount B will be perceived as an absolute minimum return, from which tax authorities will seek to argue upwards, through the attribution of profit to additional functionality and/or risk over and above the baseline activity.

A Determination of the Quantum of the Return

Distribution, sales and marketing returns may vary from one industry to another, from one market to another and from one company to another, according to levels of profitability. Empirical studies in the past for various advanced pricing agreements may have already shown that over time most distributors in different regions and industries tend to earn returns in a relatively narrow band. However, when unusual circumstances arise, say contraction or losses, or rapid growth and high profits, these distributors can earn both above and below those normative ranges. Many of the industries this measure seeks to target might well be in one of those unusual circumstances. If it were simple to identify fixed baseline returns for such activities that were universally respected across all circumstances, it would likely have been done before now.

A single fixed percentage is highly unlikely to result in any administrative or compliance benefits, as it would simple result in transfer pricing issues being addressed through Amount C in many cases. The more precisely the return may be linked to observable returns in different industries and different regions, the more acceptable the formula will be.


Amount C/Dispute Prevention and Resolution

We propose that:

  • The relationship between the routine returns in Amount A, Amount B and Amount C be clearly established and the conditions for there being Amount C returns be clearly enunciated, so as to avoid double counting in respect of the calculation of Amounts A and B.
  • To reduce controversy, mandatory binding arbitration should be introduced across all participating jurisdictions.

The reasons behind these proposals are discussed below.

Amount C is merely transfer pricing as we know it through the application of the arm’s length principle.  Amount C may be viewed as beyond the “Unified Approach”, representing the arm’s length principle applicable for the calculation of routine returns that are not deemed to fall within the purview of Amount B and for non-routine returns outside of those awarded to the market under Amount A. Thus, returns for all manufacturing activities, intra-group services, financing activities, strategic activities, R&D and IP will still, apparently, be governed by the arm’s principle in Amount C.

Insofar as that is the case, Amount C will be no different in its treatment from all the other prices traditionally determined using the arm’s length principle through a functional analysis. Such opportunities as are offered by existing or prospective dispute prevention and resolution mechanisms, whether APAs, ICAP or mandatory binding MAP arbitration, will continue to be common to all facets of transfer pricing.  

However, Amount C will no long be “alone”. Rather than transfer pricing “business as usual” for these other activities, there will now need to be specific relationships to the activities representing Amount A and Amount B.  These relationships will need to be clarified before additional taxable profits can be reliably assessable as Amount C. Without this clear delineation, it is easy to envisage situations where Amounts B and Amounts C, as assessed by local countries, exceed the amount of routine returns in the calculation of Amount A implying significant additional non-routine contributions by the taxpayer in the local market, perhaps where none or far less were indicated through a reasonable functional and DEMPE analysis. In fact, if not adequately addressed, countries would have an incentive to target increases in Amount C. This will lead to more uncertainty and controversy, rather than less, with further double taxation as a natural consequence. In this context, prevention or resolution of assessments under Amount C may require more, not less, policy work than just defining the distribution functions outside of the “Unified Approach”.

Given the strong possibility of an increase in controversy over the existing application of the arm’s length principle, and an increased likelihood of double taxation, reimagining taxpayer and intergovernmental dispute resolution to be stronger, quicker and more certain is going to be a critical part of the successful introduction of program and the “Unified Approach”.

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