Tax challenges in the digital economy – Amount B of Pillar One
December 2023 | SPECIAL REPORT: CORPORATE TAX
Financier Worldwide Magazine
December 2023 Issue
The Organisation for Economic Co-operation and Development (OECD) is an organisation developed for the purpose of promoting sustainable economic growth and building and developing better economic policies. Lately, a large focus of the OECD has been on base erosion and profit shifting (BEPS), which aims to ensure multinational enterprises (MNEs) pay their fair share of taxes and not use gaps or loopholes to redirect profits to low or no-tax jurisdictions. To assist with this, the OECD introduced the Inclusive Framework (IF) on BEPS to ensure interested countries and jurisdictions (there are approximately 143 IF members at present) including developing economies, can participate on an equal footing in the development of standards on BEPS-related issues, while reviewing and monitoring the implementation of the BEPS project.
Digitalisation and globalisation have had a profound impact on economies and these changes have brought challenges to the existing rules for taxing international business income. These rules are largely over 100 years old and are no longer fit for purpose in an increasingly interconnected world, resulting in some MNEs not paying their fair share of tax despite the large profits garnered. To close these gaps, the OECD and IF created a two-pillar approach to address tax challenges and tax avoidance, and to ensure MNEs are adhering to international fair taxation principles. The main focus of these pillars is to address tax challenges arising in the digital economy. Each pillar aims to target a specific area or gap which MNEs may use to avoid tax payments in their jurisdiction. However, this article will focus on Amount B of Pillar One only.
Goals of Pillar One
The overall goal of Pillar One is to address and modernise the tax framework for the digital economy. In doing so, it identifies large MNEs and ensures profits from cross-border transactions are reallocated accordingly to the specific countries in which goods and services are sold, even if they do not have a physical presence (nexus) there.
Pillar One encompasses ‘Amount A’ and ‘Amount B’ and aims to improve tax certainty and reduce disputes between taxpayers and tax authorities. Simply put, Amount A allows tax authorities to tax the income of very large foreign MNEs even where there is no taxable presence in that jurisdiction, and Amount B aims to ensure a fixed return for certain baseline marketing and distribution activities taking place in a jurisdiction.
What is the purpose of Amount B?
Amount B is a component of Pillar One introduced to aid, simplify and streamline the transfer pricing (TP) process of pricing baseline marketing and wholesale distribution activities. It has been developed by the OECD to simplify the administration of TP rules for tax authorities, significantly reduce compliance costs for taxpayers, and ultimately address tax challenges arising from pricing these transactions. Amount B is also intended to enhance tax certainty and reduce controversy between tax authorities and taxpayers.
In summary, Amount B aims to identify a standard baseline return for activities that fall in scope and provide a geographically consistent approach to assess these transactions.
What exactly are baseline marketing and distribution activities?
Simply put, MNEs are considered to be distributors when they buy goods and market and sell them to customers. For the purpose of Amount B, “baseline marketing and distribution” activities comprise of the marketing, sales and logistics functions of buying goods for resale and performing the associated advertising functions. In broad terms, Amount B applies to transactions including: (i) buy-sell arrangements, where an MNE purchases goods from an enterprise in another jurisdiction for resale; and (ii) sales agency and commissionaire arrangements, where an MNE contributes to the distribution of goods for one of its related group entities.
These baseline marketing and distribution activities can be assessed according to a specific scoping criterion, including both qualitative and quantitative factors, to be considered to fall within the ambit of Amount B, as it is currently contemplated. However, Amount B does not provide an exhaustive list of baseline marketing and distribution activities but refers to distributors needing to perform “core distribution functions”.
Some proposed criteria include whether the distributor has a written contract in place for such activities, whether they distribute in the local market, or whether they undertake particular compliance activities or perform technical services, to name a few.
For a transaction considered to be in scope, it must be priced according to a one-sided TP method, with the transactional net margin method being suggested by the OECD. In establishing the pricing for the transaction, the return on sales or operating margin has been identified as the most appropriate profit level indicator to use.
The OECD currently proposes two alternative approaches to identify transactions in scope – Alternative A and Alternative B – based on the particular qualitative scoping criterion applied to baseline marketing and distribution activities. Alternative A proposes no additional qualitative scoping criterion, while Alternative B only considers distributors that make ‘baseline’ contributions, excluding ‘non-baseline’ distributors.
Pricing
Transactions falling within scope are to be priced in one of two ways.
First, pricing matrix. This is a matrix or grid of arm’s length returns using a return on sales ratio. The applicable arm’s length return will depend on features specific to the distributor, such as the industry in which it operates, or the level of operating assets or expenditure. In addition to this, the pricing framework includes features to potentially adjust for geographical differences or the availability of data. To apply the pricing matrix, the distributor would be compared to the targeted return on sales ratio (between 1.5 and 5.5 percent) based on its industry and supporting factors.
Second, mechanical pricing tool. This pricing tool derives a formula or set of adjustments to determine an arm’s length return aligned with particular characteristics of the distributor.
Importantly, there are no monetary value thresholds applied to the baseline marketing and distribution activities for MNEs to be in scope. Further consultation and discussions around this scoping criteria are being advanced and implemented by the OECD.
Request for comments
On 17 July 2023, the OECD released a public Consultation Document for Amount B of Pillar One. The OECD provided opportunities for stakeholders to submit responses on the Consultation Document and express their views and opinions on implementation of Amount B.
In their responses, stakeholders pointed to key areas of concern and identified items needing further evaluation and development. Some of the key issues raised are outlined below.
Scope of activities. One area of concern was the lack of certainty around baseline marketing and distribution activities that are in scope, and that the criterion may be limiting or too narrow. By narrowing the application of Amount B, this will misalign with the original goal of streamlining and achieving tax certainty and simplification. Some stakeholders believe that the scoping criteria may present differing views in which some marketing and distribution activities may warrant higher returns than others, which may not be addressed accurately according to the proposed pricing methods. Some consider Amount B to be a ‘safe harbour’ and MNEs should be able to opt out, if given the choice.
Pricing methodology. Stakeholders seem to be divided over implementation of Alternative A or Alternative B. Supporters in favour of Alternative A want the implementation of Amount B to remain streamlined and simplified and do not believe the additional qualitative scoping is required.
Supporters of Alternative B, on the other hand, believe the additional qualitative scoping is required to refine the distributors that will be in scope, to prevent those MNEs which are performing more than ‘baseline’ functions to be incorporated.
Digital goods. The OECD also requested comments on whether Amount B should include the wholesale distribution of digital goods. This may present some challenges as it is not always easy to distinguish between what constitutes digital goods and digital services, and Amount B is intended to exclude digital services from its scope of activities. Some stakeholders support the inclusion of digital goods in scope to not narrowly interpret the meaning of ‘wholesale’ distribution.
Dispute resolution. While Amount B is intended to alleviate tax disputes and reduce administrative matters, its proposed inclusion does not provide dispute resolution mechanisms in the event that tax authorities misinterpret its scope and application.
What comes next?
The OECD plans to finalise and complete its work on Amount B by the end of 2023, and to publish the approach in the January 2024 edition of the OECD Guidelines. Although differing views and opinions have been presented, stakeholders are ultimately looking for an easily defined, clear consensus on what Amount B entails, and to achieve the main goal of alleviating the tax administrative burden on taxpayers.
Marcus Stelloh is a partner and Jodie Allman is a consultant at BDO Tax Services (Pty) Ltd. Mr Stelloh can be contacted on +27 76 584 9626 or by email: mstelloh@bdo.co.za. Ms Allman can be contacted on +27 62 175 5642 or by email: jallman@bdo.co.za.
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Marcus Stelloh and Jodie Allman
BDO Tax Services (Pty) Ltd.
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