On December 8, 2022, the Inclusive Framework (IF) released a public consultation document on Pillar One Amount B (the “Consultation Document”) in connection with the ongoing OECD/G20 Base Erosion Profit Sharing (BEPS 2.0) project, addressing the tax challenges arising from the digitalization of the economy.
The Consultation Document is the most recent of several documents the IF has released as part of BEPS 2.0. It reiterates that Amount B is intended to streamline and simplify the pricing and documentation of baseline marketing and distribution functions, but, more importantly, it provides the first detailed insights into how the IF envisions Amount B could be designed and implemented since the Pillar One Blueprint that was released over two years ago.1 More specifically, the Consultation Document outlines the progress made in defining what baseline marketing and distribution arrangements are, how they may be identified in practice, and subsequently how in-scope transactions may be priced in a simplified and streamlined manner, in accordance with the arm’s length principle (ALP). The document is organized into four main sections:
- Scope of Amount B: This section is meant to define a streamlined and simplified approach to appropriately reflect the accurate delineation of in-scope transactions through a set of qualitative and quantitative criteria.
- Amount B Pricing Methodology: This section outlines a methodology to price these in-scope transactions including: (1) the determination of the transfer pricing method (Amount B pricing methodology) and (2) the determination of the application of the transfer pricing method (econometrics based or pricing matrix based).
- Documentation Requirements: Building on the existing documentation requirements in Chapter V of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD TPG), this section describes the additional information specific to Amount B that could be included as part of the local file.
- Tax Certainty: While Amount B is intended to improve tax certainty and reduce disputes, application of Amount B requires the use of judgement, which means disagreements may ensue. This section provides an overview of existing mechanisms taxpayers can avail themselves to prevent and resolve disputes regarding Amount B.
The IF recognizes that there are linkages across the scope and design of Amount B, and that the interrelations among these aspects pose challenges to achieving the IF’s stated objectives of Amount B (i.e., streamlining and simplifying compliance, decreasing controversy for Amount B, and remaining consistent with the ALP) while also striking an appropriate balance between reliability and administrability. For this reason, the Consultation Document also solicits contributions from the public with respect to certain elements of the technical design and eventual implementation framework of Amount B.
Kroll submitted, on January 20, 2023, a response to the IF’s call for stakeholders’ inputs. Our comments were informed by the ALP, the U.S. interpretation of the arm’s length standard, economic theory, statistics, econometrics and inputs from geographic market leaders reflecting the interests of our clients around the world. Our comments reflect the unambiguous concern we have for the complexities of the Amount B design proposed by the IF. Regardless of how the in-scope criteria is finalized, Amount B (as currently proposed by the IF) will provide taxpayers engaged in controlled baseline marketing and distribution transactions with a new transfer pricing method. In our opinion, this would neither serve to simplify nor streamline any aspect of in-scope transactions, but, in fact, do the opposite. Therefore, we emphasized two critical messages to the IF in our comments.
- First: For those taxpayers that do not view their baseline marketing and distribution transactions as needing further simplification, Kroll has taken the position that they should not be forced to switch their transfer pricing methodology to Amount B. Taxpayers should instead be given the option to apply Amount B or to stay the course and apply Chapter II Part I. Said differently, Amount B should be elective for taxpayers, and taxpayers only.
- Second: Amount B cannot introduce legal uncertainty that does not already exist. Therefore, if a taxpayer elects Amount B, Kroll proposed that once the first tax administration confirms the taxpayer’s eligibility to elect Amount B, the tax administration on the opposite side of the transaction will be bound by the determination of the first. The same condition would hold true if the first tax administration rejects the eligibility of the taxpayer to elect Amount B. With this mechanism in place, no taxpayer will end up in competent authority concerning its eligibility to use Amount B. Additionally, once misalignments around eligibility are alleviated, there is far less for tax administrations to dispute regarding the application of Amount B, when compared to application of the ALP via Chapter II Part I.
In addition to these two fundamental points, we offered extensive discussions and comments in the Kroll response submitted to the OECD, which are briefly summarized below:
Kroll believes that the Amount B framework and guidance should be incorporated into the OECD TPG and take the form of a safe harbor under the authority of Chapter IV Section E of the 2022 OECD TPG. Furthermore, Kroll advocates for the design of Amount B as an elective safe harbor that is (i) elective for taxpayers and (ii) not elective for tax administrations.
- It is preferable that the OECD TPG continue to serve as the sole controlling document to be considered by taxpayers for the interpretation of Article 9 of the Model Tax Convention on Income and on Capital, including the compliant administration of their transfer pricing policies. Incorporating the Amount B framework and guidance into the OECD TPG, as opposed to outside the OECD TPG as it is now, preserves this historic consistency.
- Assuming integration into the OECD TPG, Kroll believes that characterizing Amount B as an elective safe harbor under the authority of Chapter IV Section E is advisable because: (1) the OECD and IF can create such a safe harbor under existing authority and (2) it provides an existing framework that is consistent with the ALP. In fact, Chapter IV Section E goes into detail in its discussion of safe harbors in the context of administrative simplification. It provides a solid foundation to guide the design and implementation of Amount B in a way that is consistent with longstanding interpretations of the ALP including, most notably, avoiding the need to override Chapter II Part I (selection of the most appropriate method) by deeming Amount B the most appropriate method in all cases involving entities with transactions in-scope of Amount B, which, in our opinion, would be a dangerous precedent to set.2
- In our opinion, designing the safe harbor as elective for only the taxpayer is critically important. A meaningfully elective safe harbor, from the perspective of the taxpayer, is one that provides a guarantee that whichever course is chosen by the taxpayer (i.e., whether to elect the safe harbor or apply Chapter II Part I) will be respected by tax administrations on both sides.3 Designing Amount B as a safe harbor that is elective for both the taxpayer and taxing administration allows for the situation where an election by the taxpayer can be trumped by the election of a tax administration, which then has the authority to adjust on that basis. This is not a taxpayer elective safe harbor but rather makes Amount B mandatory in those jurisdictions that, as a matter of administrative practice or domestic law, decide to apply it automatically to every single controlled transaction in-scope of Amount B.
- Lastly, we believe that alternative designs for Amount B, such as: (1) a mandatory safe harbor; or (2) another specified method applicable to Chapter II Part I not only pose daunting challenges, but do not meet the IF’s objective(s) of streamlining and simplifying compliance and decreasing controversy. Furthermore, a mandatory safe harbor could have the unintended consequence of causing changes to the commercial or financial relationship between an entity with transactions in-scope of Amount B and the counterparty, which could qualify as a business restructuring within the meaning of Chapter IX of the 2022 OECD TPG.
Kroll recommends the Amount B pricing methodology either (a) implement an econometric approach alongside a pricing matrix where econometrics are used to identify key variables, such as operating leverage, that should inform the pricing matrix or (b) implement a pricing matrix without an underlying econometric analysis. To be clear, Kroll does not currently support the use of an econometrically estimated regression as the Amount B pricing method.
- Although, conceptually, we believe that econometrics can be a powerful tool to obtain a measure of an arm’s length result, we also believe that, as a practical matter, the use of econometrics for that purpose is challenging. For example, a model that is too simple could legitimately be viewed as formulary apportionment, which would be inconsistent with the ALP (and violates a stated objective of Amount B), while a sophisticated model that takes care of all relevant technical issues will be nearly impossible for most taxpayers and tax authorities to understand well enough to take an informed position as to the reliability of its output vis-à-vis the output of alternative transfer pricing methods
- Therefore, we believe the architecture of the Amount B pricing methodology should favor simplicity over complexity (if the cost of simplicity does not exceed its benefits). For this reason, a pricing matrix approach is preferred to an econometric approach because it uses discrete variables, which are much less complex than the continuous variables required in an econometric regression approach. In this spirit of simplicity, application of a pricing matrix approach should be limited to the one or two variables that have the most explanatory power in differences across profitability of distributors.4 Kroll believes that measures of operating and financial leverage should be front and center to help explain these differences.
- Lastly, Kroll recommends designing documentation requirements concerning the election of the safe harbor of Amount B that clearly pare down what taxpayers would have faced with an application of the most appropriate method of Chapter II Part I. Incentivizing taxpayers to voluntarily elect the safe harbor should be achieved not only by a simplified pricing methodology but also by a clear compliance benefit.
In summary, Kroll believes that Amount B should be incorporated in the OECD TPG and recommends that Amount B take the form of a taxpayer-elective safe harbor under the authority of Chapter IV Section E. Kroll feels this simplified approach best satisfies the objectives set out by the IF (i.e., streamlining and simplifying compliance, decreasing controversy for Amount B and remaining consistent with the ALP) while still approximating an accurate measure of an arm’s length result.
1.For those who may not remember, Amount B was introduced in the Pillar One Blueprint, released in October 2020. The Blueprint dedicated only 12 pages explaining the purpose of Amount B and briefly discussing key design features being considered. It is sufficient to say that additional guidance was much needed.
2.If Amount B is designed as an elective safe harbor within the meaning of Chapter IV Section E of the 2022 OECD TPG, then taxpayers electing the safe harbor will be excused from an application of Chapter II Part I of the 2022 OECD TPG as the option will exist to deem Amount B the most appropriate method for an in-scope transaction. We would like to make the important distinction that having Amount B deemed the most appropriate method via the election of a safe harbor is quite different from deeming Amount B to be the Chapter II Part I most appropriate method for all in-scope transactions, which would be the case if Amount B is designed as a mandatory safe harbor. It is the latter case that, in our opinion, creates a dangerous precedent.
3.It may be reasonable to have two taxing jurisdictions disagree as to whether a controlled transaction is in-scope of Amount B or not, but it is not reasonable, once that determination is made and affirmed, to put a taxpayer in a position of uncertainty as to the acceptability of its election by the relevant taxing jurisdictions.
4.As mentioned above, Kroll believes that econometrics can play a critical role in identifying what those “one or two variables” should be but should be strictly limited to this purpose.