Kartikeya Singh is a principal, Anthony Tufo is a senior associate, Shubhana Sattar is a senior manager, and Marco Fiaccadori is a principal in the transfer pricing practice of PricewaterhouseCoopers’ Washington National Tax Services. The authors thank Lili Kazemi for her contributions to this article and Pat Brown for his review and comments.
In this article, the authors explain the OECD inclusive framework’s amount B and the large effect it is likely to have on transfer pricing. They analyze the ways in which multinational enterprises can prepare for the various iterations that could arise as jurisdictions choose how to react to amount B.
The views expressed herein are solely those of the authors and do not necessarily reflect those of PwC. All errors and views are those of the authors and should not be ascribed to PwC or any other person.
Copyright 2024 PwC.
All rights reserved.
Introduction
The OECD inclusive framework’s introduction of the two-pillar solution is likely to have a significant effect on transfer pricing’s traditional landscape. While transfer pricing has never existed in a vacuum, the arm’s-length principle has generally been a stable and reliable guidepost for the tax community as to how to evaluate the pricing of controlled transactions from an income tax perspective. Notwithstanding the challenges and controversies that have accompanied its application, the arm’s-length principle has served as the common framework in the international arena. But the rules of the game appear to be changing.
Amount B — or the simplified and streamlined approach as it is now known — is part of pillar 1, which is in turn a piece of a broader project to address the tax challenges arising from the digitalization of the economy. The stated goal of amount B is to simplify the transfer pricing of certain baseline wholesale routine marketing and distribution activities.
The simplified and streamlined approach is still mired in political differences and will need further work and negotiations. A large cross section of stakeholders has expressed concerns (in over 600 pages of commentary) about many of the design and implementation aspects. In a February report, countries such as India publicly expressed objections and reservations with several design and operating principles (discussed below).1 New Zealand has confirmed it will not adopt amount B.2 Australia has indicated that it favors optionality and that amount B will not change its inbound distributor approach.3 United States Treasury officials have stated that a robust approach to amount B is necessary to move forward, with a clear link between amount B and the multilateral convention (MLC), which has not been released as of the time of writing this article.4
While the OECD intends to publish a list of countries opting into amount B, U.S. Treasury officials indicated that a mandatory approach to amount B is a “red line” that must be crossed before it can agree to the MLC.5 Other countries may be falling into one of these categories, resulting in a fragmented compliance landscape for taxpayers in relation to routine marketing and distribution transactions.
Multinational enterprises that find themselves within amount B’s scope will need to invest time and effort to understand and address the potential complications they could face. These could arise from the nuances of the operating rules applicable to scoping, pricing, documentation, and tax certainty. Failure to be adequately prepared for the direct and indirect consequences of these rules could raise double or multiple taxation concerns for some companies and make tax compliance and certainty more difficult. Not considering the potential effect of amount B on contemplated business transactions, operating model design, or supply chain planning may result in unanticipated knock-on effects that could carry significant costs and risks. Including amount B within the framework of companies’ transfer pricing policies, documentation, and potentially dispute resolution measures — like advance pricing agreements and mutual agreement procedures — will better prepare taxpayers. Adding to the challenge is the fact that different jurisdictions continue to make decisions and announce intentions about electing or opting out of amount B.
In this article we explore some of the practical considerations and implications that companies will face translating amount B from theory into practice. The article illustrates and highlights specific operational and modeling considerations associated with amount B’s implementation but is not intended to be an exhaustive list.
Final Amount B Report
Final Report and Future Direction
In February the inclusive framework released its final report on amount B. Report content has been incorporated into the OECD transfer pricing guidelines as an annex to Chapter IV, and taxpayers may apply the simplified and streamlined approach for fiscal years commencing on or after January 1, 2025. The report is a significant milestone in the inclusive framework’s efforts to simplify transfer pricing in the context of marketing and distribution functions.
In June the OECD released supplementary guidance on amount B of pillar 1, including definitions of “qualifying jurisdictions” for the purpose of applying the operating expense cross-check and data-availability mechanism. The supplementary guidance also includes a list of “covered jurisdictions” (previously referred to as low-capacity jurisdictions) within scope of the political commitment on amount B.
Applying the simplified and streamlined approach involves a multistep process to determine whether the relevant sales and distribution activities of a group entity fall within amount B’s scope and the applicable return on sales (ROS) — as the net profit indicator (NPI) — that would apply as the appropriate arm’s-length return for these activities. This process includes determining industry groupings and factor intensity classifications, applying an operating expense cross-check, and applying a euphemistically named “data availability mechanism,” which is an upward adjustment to the returns applicable to certain qualifying jurisdictions.
It is important to note that the report does not provide full tax certainty, and there are potential gaps in the amount B rules application. The unresolved areas reflect uncertainty around time and mode of implementation and continuing disagreements among participating countries. The transfer pricing outcome under amount B is not binding on nonadopting jurisdictions although there is an ostensible commitment to respect the outcome in covered jurisdictions, subject to conditions.6
Pricing Criteria
The pricing matrix (see Table 1) establishes a base return for group entities that perform baseline marketing and distribution activities and engage in “qualifying transactions” — buy/sell and distribution transactions involving tangible goods, sales agency, and commissionaire transactions — that meet the scoping criteria set forth in section 3.2 of the report. The ROS is the NPI used for the targeted return for an in-scope distributor as the tested party. The pricing matrix with the target returns is based on three industry groupings in columns and five possible “factor intensity” categories in rows for a total of 15 distinct target returns that range from 1.5 percent to 5.5 percent. Factor intensity refers to the combination of operating asset intensity (operating assets divided by sales) and operating expense intensity (operating expense divided by sales). A range of +/- 0.5 percent around each point in the pricing matrix is permitted.
Factor Intensity Category | Operating Asset Intensity | OPEX Intensity | Industry Group 1 | Industry Group 2 | Industry Group 3 |
|---|---|---|---|---|---|
[A] | >45% | Any | 3.5% | 5% | 5.5% |
[B] | 30%-45% | Any | 3% | 3.75% | 4.5% |
[C] | 15%-30% | Any | 2.5% | 3% | 4.5% |
[D] | <15% | ≥10% | 1.75% | 2% | 3% |
[E] | <15% | <10% | 1.5% | 1.75% | 2.25% |
The returns shown in the pricing matrix can be adjusted upward for certain “qualifying jurisdictions” under a “data availability mechanism” on the premise that these countries are underrepresented in the global data used in the construction of the pricing matrix. The adjustment that would apply under this mechanism adds an uplift to the target ROS specified in the relevant/applicable cell. The uplift is the product of a “net risk adjustment” — the sovereign default spread based on the sovereign credit rating of the relevant country (the qualifying jurisdiction) — and the operating asset intensity of the tested-party.
The target ROS for an in-scope entity under amount B is subject to a secondary check — the operating expense cross-check that applies a cap-and-collar range based on factor intensity. The tested party’s ROS is translated into a return on operating expenses and compared with the applicable operating expense cap-and-collar range specified in the report and provided in Table 2.
Factor Intensity | Default Cap Rates | Alternative Cap Rates for Qualifying Jurisdictions | Collar Rate |
|---|---|---|---|
High OAS (A) | 70% | 80% | 10% |
Medium OAS (B+C) | 60% | 70% | |
Low OAS (D+E) | 40% | 45% |
If the equivalent return on operating expenses falls within this range, no adjustment is needed. However, if it falls outside the range, the return on sales is adjusted up or down to align with the established cap-and-collar.
Example Application of Amount B
The following illustrates the application of the amount B simplified and streamlined approach using a numerical example involving a distributor that meets the amount B scoping criteria.
Before the application of amount B, the in-scope entity in the example is assumed to have functioned as a limited risk distributor (LRD) earning a targeted return under the controlled group’s transfer pricing policy designed to comply with the arm’s-length principle. The intercompany pricing for the LRD was set and tested using the transactional net margin method (TNMM) with the Berry ratio as the NPI. A Berry ratio of 1.15 was targeted and realized for the LRD under the group’s transfer pricing policy before the implementation of amount B and supported by the results observed for independent comparable distributors under the application of the TNMM.
For the purposes of the following illustrative example the LRD is assumed to fall within Industry Grouping 2 and Factor Intensity Group A — with an operating asset intensity of 45 percent. Based on this, the mandated return based on the pricing matrix under amount B for the in-scope LRD is an ROS of 5 percent. Lastly, the LRD is assumed not to be in a qualifying jurisdiction. Consequently, the data availability mechanism is not applicable for the in-scope LRD. Table 3 illustrates the effect of the application of amount B on the LRD.
| (A) | (B) | (C) | |
|---|---|---|---|---|
(1) | Third-Party Revenue | 10,000 | 10,000 | - |
(2) | Cost of Goods Sold | 8,850 | 8,500 | 350 |
(3) | Gross Profit | 1,150 | 1,500 | 350 |
(4) | Operating Expenses | 1,000 | 1,000 | - |
(5) | Berry Ratio | 1.15 | 1.5 | 0.35 |
(6) | Earnings Before Interest and Taxes (EBIT) | 150 | 500 | 350 |
(7) | EBIT Margin (ROS) | 1.5% | 5% | 3.5% |
Finally, the operating expense cross-check is performed to determine if the LRD is within the applicable cap-and-collar range. Under Factor Intensity Group A, the operating expense cap-and-collar range is 10 percent to 70 percent. If the LRD is outside the range, an adjustment will be made to the nearest bound. Table 4 shows how the operating expense cross-check is calculated.
| Calculation | Results Under Amount B |
|---|---|---|
Operating Expense | A | 1,000 |
EBIT (After Application of Amount B) | B | 500 |
Return on Operating Expense | C = B / A | 50% |
Since the return on operating expense is within the range of 10 percent to 70 percent, no additional adjustment is made to the EBIT of the LRD. The final ROS for the LRD under the application of amount B is 5 percent. As a result of the application of amount B, the LRD’s EBIT margin for income tax reporting purposes increases from 1.5 percent to 5 percent.
Amount B Documentation and Compliance
This section discusses the spectrum of positions that jurisdictions can take for implementing amount B and the implications of those choices for MNEs in relation to transfer pricing documentation and compliance. Despite the original intent to streamline the application of the arm’s-length principle to routine marketing and distribution transactions, the elective nature of the application framework raises the potential for additional complexity and uncertainty for taxpayers.
Complications From Different Adoption Ordering
Note that the amount B outcome in an adopting jurisdiction is not binding on a nonadopting counterparty jurisdiction. Ostensibly, there is a commitment from inclusive framework countries to respect the outcome under amount B in an adopting jurisdiction if it is a “covered jurisdiction,” subject to the jurisdiction’s domestic legislations and administrative practices.7 Figure 1 shows the scenarios a taxpayer may face with an in-scope transaction involving two counterparty jurisdictions. Each jurisdiction may choose one of the following options for amount B:
Nonadoption: Arm’s-length outcome in the jurisdiction is determined and evaluated under the standard OECD transfer pricing guidelines outside of amount B based on a full-scope application of the arm’s-length principle (given all the relevant facts and circumstances underlying the relevant intercompany transaction). In this case, the nonadopting country may or may not respect the outcome achieved under amount B in an adopting counterparty jurisdiction.
Adoption as a safe harbor: Amount B approach treated as providing arm’s-length outcome in adopting jurisdiction at the election of the taxpayer in the adopting jurisdiction.
Adoption as mandatory: Amount B approach treated as providing arm’s-length outcome in adopting jurisdiction for in-scope transactions.
| Transacting Country 1 | |||
Does not adopt amount B | Adopts amount B as safe harbor | Adopts amount B as mandatory | ||
Transacting Country 2 | Does not adopt amount B | X | ? | ? |
Adopts amount B as safe harbor | ? | √ Applies at option of MNE | √ Applies if opted in | |
Adopts amount B as mandatory | ? | √ Applies if opted in | √ | |
X Amount B does not apply in either jurisdiction. √ Amount B is respected in both jurisdictions. ? Amount B applies and is respected in one jurisdiction but may not be respected in a counterparty jurisdiction, especially if adopting jurisdiction is not a covered jurisdiction. | ||||
Figure 1 shows that the amount B optional adoption yields nine potential outcomes for taxpayers to navigate when dealing with just two counterparty jurisdictions. With more jurisdictions, the number of potential outcomes is orders of a magnitude higher.
Building on the scenarios depicted above, we consider a simple three-country scenario for a hypothetical taxpayer. The taxpayer is assumed to have a contract manufacturer in Jurisdiction 1 that sells finished goods to two related-party, full-risk distributors in Jurisdictions 2 and 3, respectively. Each jurisdiction’s choice about amount B adoption is shown in Table 5.
| Jurisdiction 1 | Jurisdiction 2 | Jurisdiction 3 |
|---|---|---|---|
Amount B adoption | Amount B not adopted and amount B outcome in adopting counterparty jurisdiction not respected | Amount B adopted as safe harbor | Amount B adopted as mandatory |
Assume that the transactions between the contract manufacturer in Jurisdiction 1 and each of the distributors in Jurisdictions 2 and 3 are governed by a consistent transfer pricing policy. Also, the functional and risk profile of each distributor is the same. Before amount B, the taxpayer is able to adopt a consistent and streamlined approach to documenting the two intercompany transactions — intercompany sale of products between the contract manufacturer in Jurisdiction 1 and the distributors in Jurisdictions 2 and 3. That documentation approach could entail a consistent and uniform selection of the “most appropriate method” (as defined in the OECD transfer pricing guidelines), the selection of the tested party (for example, possibly the contract manufacturer in this example) and NPI, and use of a consistent set of independent comparables (for example, manufacturing companies) that is used for each of the three jurisdictions.
The choices made by the jurisdictions on amount B lead to a fragmented compliance landscape for the taxpayer in the example such that it is no longer able to adopt a uniform and consistent documentation approach for the same type of intercompany transactions. The taxpayer would need to document compliance with amount B in Jurisdiction 3 and has the option of also using the approach in Jurisdiction 2. However, that approach will not work in Jurisdiction 1, in which the taxpayer may need to continue using the pre-amount B documentation and benchmarking analyses or some other approach that complies with the standard and full-scope application of the arm’s-length principle under the OECD transfer pricing guidelines outside of amount B.
Despite having a consistent transfer pricing model across jurisdictions, a taxpayer may be required to take disparate approaches to testing and documenting the arm’s-length results of intercompany transactions under amount B. The taxpayer’s documentation approach under amount B is more complicated and less streamlined than before. Lastly, the example above illustrates the inconsistencies created by only two distributors and one contract manufacturing entity. For taxpayers with several operating entities across jurisdictions the inconsistencies will multiply.
Given the various possible outcomes and uncertainties around the adoption of amount B, taxpayers may need to first review their global operations as a whole to determine in which jurisdictions they have operations, and those jurisdictions’ amount B adoption statuses. The taxpayer can then evaluate which countries have mandated amount B, adopted it as a safe harbor (category 1), or elected to not adopt it (category 2) and may ignore amount B outcomes in counterparty jurisdictions. If a majority of the jurisdictions in which the taxpayer has operations fall under category 1, the taxpayer can perform amount B modeling for them and identify potential strategies to use the amount B modeling for the category 2 countries as well.
MNEs will need to continuously monitor implementation in the jurisdictions applicable to their operations. Jurisdictions will announce their implementation intentions on a rolling basis, which could include “opting out” of applying the simplified and streamlined approach, treating it as a safe harbor, or mandating its use. The OECD plans to release an opt-in list by October, but companies should do their own due diligence to track local adoption and whether that entails a mandatory approach. There will only be a few months after that when the regime becomes effective.
One important consideration as companies transition from the status quo to the simplified and streamlined approach: the agreed results of in-process bilateral or multilateral APAs or MAPs under article 25 of the model tax convention obtained before amount B’s implementation will continue to be valid in relation to the covered qualifying transactions.8 Because there is little predictability on how amount B will play out, APAs and MAPs may be more important for some taxpayers.
Practical Implications for Typical Operating Models
This section looks at how different types of businesses and operating models might be affected by amount B implementation. The analysis relies on stylized examples to illustrate businesses that differ in terms of systemwide operating profit margins and supply chains that may face different challenges from the streamlined and simplified approach. They do not capture all the complexities that taxpayers will have to face in the real world.
Example 1
This example considers an in-scope, low-margin business with contract manufacturing and full-risk routine distributors.9 It manufactures, markets, sells, and distributes tangible products via a simple supply chain and operating model depicted in Figure 2.
The company’s simple operating model involves two types of entities — those engaged in the manufacture of products and those selling and distributing products to third parties. From a transfer pricing perspective and under the company’s intercompany pricing policy, the manufacturing entities operate as limited risk contract manufacturers, while the sales entities operate as routine distributors that perform routine functions and bear routine risks. Table 6 shows a profit and loss (P&L) statement covering a single year’s operating results for the company on a consolidated basis, as well as results realized by the contract manufacturer and routine distributor under the company’s transfer pricing policy.
Overall, the company earns an earnings before interest and taxes (EBIT) margin of 7.5 percent on $10 billion in sales for a total of $750 million in EBIT. Under the company’s transfer pricing policy, intercompany sales from the contract manufacturer to the distributor are priced under the TNMM with the contract manufacturer as the tested party. The NPI used for the tested party is the markup on total cost (MOTC) with a target of 7 percent. That value corresponds to the median value of MOTC results observed for independent comparable manufacturers. The arm’s-length range of MOTC results derived from those independent comparable manufacturers is 4 percent to 10 percent. For the year in question, the routine distributor realizes an EBIT margin of 2.4 percent. Even though the company’s transfer pricing policy and documentation approach applies the TNMM with the contract manufacturer as the tested party, the routine distributor’s EBIT margin results are within the arm’s-length range observed for independent routine distributors on a single-year and multiyear average basis.
| (A) | (B) | (C) | |
|---|---|---|---|---|
(1) | Third-Party Revenue | - | 10,000 | 10,000 |
(2) | Intercompany Revenue | 7,758 | - | - |
(3) | Total Revenue | 7,758 | 10,000 | 10,000 |
(4) | COGS | 5,000 | 7,758 | 5,000 |
(5) | Gross Profit | 2,758 | 2,243 | 5,000 |
(6) | Operating Expenses | 2,250 | 2,000 | 4,250 |
(7) | Internal | 2,250 | 2,000 | - |
(8) | Intercompany Charges | - | - | - |
(9) | EBIT | 508 | 243 | 750 |
(10) | NPI/Other Ratios |
|
|
|
(11) | Royalty Rate (on Third-Party Revenue) |
|
|
|
(12) | MOTC | 7% |
|
|
(13) | EBIT Margin (on Third-Party Revenue) |
| 2.4% | 7.5% |
Note: Figures in bold represented NPIs that are tested under an application of the TNMM in relation to the covered group’s transfer pricing policy — e.g., in the case shown, the intercompany transaction between the contract manufacturer and the routine distributor is priced and tested under the TNMM with the contract manufacturer as the tested party and using the MOTC as the NPI (with a target of 7 percent). | ||||
Table 7 shows how the amount B implementation affects the covered group in this example. There is no change in the company’s consolidated financials at the EBIT level. We assume that the jurisdiction of the routine distributor adopts amount B and makes it mandatory for taxpayers, and the routine distributor falls within Industry Grouping 2 and Factor Intensity Category A in relation to the pricing matrix. Assume also that all other scoping criteria for amount B are met in relation to the routine distributor. Recall that, by construction, the distributor does not perform nonroutine functions, own nonroutine assets, or bear nonroutine risks. While it is not the tested party under the TNMM as applied by the taxpayer in the context of its transfer pricing policy and documentation approach, the conditions for treating the distributor as the appropriate tested party under the TNMM are met in this example. Under a standard application of the TNMM, the taxpayer would have recourse to test the results of the distributor on a multiyear average basis to account for the routine risks borne by it and the potential for year-on-year variability in its results. However, under amount B the routine distributor in the example is required to have a mandated level of profit consistent with the ROS target specified in the pricing matrix for Industry Grouping 2 and Factory Intensity Category A: 5 percent.10
| (A) | (B) | (C) | |
|---|---|---|---|---|
(1) | Third-Party Revenue | - | 10,000 | 10,000 |
(2) | Intercompany Revenue | 7,500 | - | - |
(3) | Total Revenue | 7,500 | 10,000 | 10,000 |
(4) | COGS | 5,000 | 7,500 | 5,000 |
(5) | Gross Profit | 2,500 | 2,500 | 5,000 |
(6) | Operating Expenses | 2,250 | 2,000 | 4,250 |
(7) | Internal | 2,250 | 2,000 | - |
(8) | Intercompany Charges | - | - | - |
(9) | EBIT | 250 | 500 | 750 |
(10) | NPI/Other Ratios |
|
|
|
(11) | Royalty Rate (on Third-Party Revenue) |
|
|
|
(12) | MOTC | 3.4% |
|
|
(13) | EBIT Margin (on Third-Party Revenue) |
| 5% | 7.5% |
Assuming a mandatory adoption of amount B by the distribution jurisdiction, the taxpayer would need to report income corresponding to the mandated 5 percent ROS for that distributor in that jurisdiction. If the manufacturing jurisdiction (where the contract manufacturer is based) also adopts amount B or accepts the outcome under amount B adopted by the counterparty jurisdiction (the distribution jurisdiction in this case), the taxpayer is fine under amount B and does not face a threat of double taxation. However, this is by no means guaranteed. A manufacturing jurisdiction may choose to not adopt amount B and to not respect outcomes determined under amount B by an adopting counterparty jurisdiction.11 That scenario presents a problem for the taxpayer in this example.
The mandated ROS of 5 percent under the amount B pricing matrix for the routine distributor leaves the contract manufacturer with too low a return in relation to its functional and risk profile under a standard application of the arm’s-length principle. Instead of an MOTC of 7 percent that the contract manufacturer earned under the taxpayer’s pre-amount B policy, it now only earns 3.4 percent. That return is lower than the arm’s-length range of MOTC results — 4 percent to 10 percent — observed for benchmark independent manufacturers. Based on this and because the manufacturing jurisdiction is not obligated to respect amount B outcomes, the taxing authority in the manufacturing jurisdiction has grounds to impose an upward adjustment to the contract manufacturer’s taxable income (to raise its MOTC to an arm’s-length result between 4 percent and 10 percent).
The result of all of this is that a piecemeal adoption of amount B — possible within the framework of the final amount B report — raises the risk of transfer pricing controversy and economic double taxation for the taxpayer in the example. Unless things change, many companies will need to navigate these types of scenarios to manage and minimize these new risks.
Example 2
Figure 3 depicts the operating model — and different entities within that model — for an in-scope, high-margin business with principal entity and LRD. This hypothetical multinational business is both more complicated and more profitable than the one discussed above. The supply chain shown in the figure involves a company that owns and manages the company’s intangible property. That “IP Co.” licenses the IP rights to a principal company that performs entrepreneurial functions and bears entrepreneurial risks in the exploitation and deployment of the IP in the manufacturing, marketing, sale, and distribution of the company’s products. The IP Co. charges the principal a royalty equal to 5 percent of final third-party sales of products that embody the licensed IP. The principal does not manufacture products or sell those products directly to third parties. Instead, it purchases products from a related party — the contract manufacturer shown in the figure.
The principal then sells the products to a related party, the LRD, for further sale and distribution to unrelated parties. Under the company’s intercompany pricing policy, the contract manufacturer earns an MOTC of 10 percent — based on comparable independent manufacturers. The LRD earns a Berry ratio — gross profits divided by operating expenses — equal to 1.15 that is based on comparable independent distributors. Both the contract manufacturer and the LRD operate with stable profitability based on arm’s-length benchmark returns. The IP Co. earns royalties from all third-party sales. The principal bears risk related to fluctuations in market demand, supply issues, etc. and earns the “residual profits” that it retains after remunerating all the other parties based on the transfer pricing policy designed by the company (which, by assumption, is compliant with the arm’s-length principle).
Table 8 shows the P&L covering a single year’s operating results for the company on a consolidated basis as well as that realized by each entity — the IP Co., the contract manufacturer, the principal, and the LRD — under the company’s transfer pricing policy. Overall, the company earns an EBIT margin of 15 percent on $10 billion in sales for a total of $1.5 billion in EBIT. Of that total consolidated EBIT, the IP Co. earns $200 million (its intercompany royalty receipts of $500 million less its operating expenses which are assumed to be $300 million). The contract manufacturer earns EBIT of $600 million, which is dictated by the target MOTC of 10 percent under the company’s intercompany pricing policy (and assumed total costs of $6 billion). The LRD is assumed to have operating expenses of $1 billion (on total third-party sales of $10 billion) and earns total EBIT equal to $150 million based on the company’s transfer pricing policy that targets a Berry ratio of 1.15 for the LRD. Finally, the principal is the residual profit claimant and earns the company’s EBIT that is left — $550 million — after all the other entities whose returns are governed or shaped by the intercompany pricing policies and whose targets are remunerated under the arm’s-length principle.
Under the company’s transfer pricing policy, intercompany sales from the contract manufacturer to the LRD are priced under the TNMM with the contract manufacturer as the tested party. The NPI used for the tested party is the MOTC with a target of 7 percent. That value corresponds to the median value of MOTC results observed for independent comparable manufacturers. The arm’s-length range of MOTC results derived from those independent comparable manufacturers is 4 percent to 10 percent. For the year in question, the LRD realizes an EBIT margin of 1.5 percent. Even though the company’s transfer pricing policy and documentation approach applies the TNMM with the contract manufacturer as the tested party, the EBIT margin results of the LRD are found to be within the arm’s-length range observed for independent routine distributors on a single-year and multiyear average basis.
The hypothetical firm’s total tax cost is a function of the profit allocation — shaped by its operating model and transfer pricing arrangements — and the applicable tax rates in each jurisdiction. Those tax rates are assumed to be 15 percent in the principal jurisdiction and 25 percent everywhere else. The total tax cost for the firm on $1.5 billion in EBIT is $320 million, translating into an effective tax rate of 21.3 percent.
| (A) | (B) | (C) | (D) | (E) | |
|---|---|---|---|---|---|---|
(1) | Third-Party Revenue | - | - | - | 10,000 | 10,000 |
(2) | Intercompany Revenue | 500 | 6,600 | 8,850 | - | - |
(3) | Total Revenue | 500 | 6,600 | 8,850 | 10,000 | 10,000 |
(4) | COGS | - | 5,000 | 6,600 | 8,850 | 5,000 |
(5) | Gross Profit | 500 | 1,600 | 2,250 | 1,150 | 5,000 |
(6) | Operating Expenses | 300 | 1,000 | 1,700 | 1,000 | 3,500 |
(7) | Internal | 300 | 1,000 | 1,200 | 1,000 | - |
(8) | Intercompany Charges | - | - | 500 | - | - |
(9) | EBIT | 200 | 600 | 550 | 150 | 1,500 |
(10) | Tax Rate | 25% | 25% | 15% | 25% | 21.3% |
(11) | Tax Cost | 50 | 150 | 82.5 | 37.5 | 320 |
(12) | NPI/Other Ratios: |
|
|
|
|
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(13) | Royalty Rate (on Third-Party Revenue) | 5% |
|
|
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(14) | MOTC |
| 10% |
|
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(15) | Berry Ratio |
|
|
| 1.15 |
|
(16) | EBIT Margin (on Third-Party Revenue) |
|
|
| 1.5% | 15% |
Note: All figures shown in bold denote NPIs or pricing terms (e.g., royalty rate) directly specified or targeted under the company’s transfer pricing policy that is designed and implemented to comply with the arm’s-length principle. | ||||||
Table 9 shows how amount B’s implementation affects the covered group in this example, assuming the jurisdiction of the LRD adopts amount B and makes it mandatory for taxpayers. The LRD is assumed to fall within Industry Grouping 3 and Factor Intensity Category A in relation to the pricing matrix. Also, all other scoping criteria for amount B are assumed to be met in relation to the LRD. Under amount B, the LRD in the example is required to have a mandated level of profit consistent with the ROS target specified in the pricing matrix for Industry Grouping 3 and Factory Intensity Category A: 5.5 percent.
| (A) | (B) | (C) | (D) | (E) | |
|---|---|---|---|---|---|---|
(1) | Third-Party Revenue | - | - | - | 10,000 | 10,000 |
(2) | Intercompany Revenue | 500 | 6,600 | 8,450 | - | - |
(3) | Total Revenue | 500 | 6,600 | 8,450 | 10,000 | 10,000 |
(4) | COGS | - | 5,000 | 6,600 | 8,450 | 5,000 |
(5) | Gross Profit | 500 | 1,600 | 1,850 | 1,550 | 5,000 |
(6) | Operating Expenses | 300 | 1,000 | 1,700 | 1,000 | 3,500 |
(7) | Internal | 300 | 1,000 | 1,200 | 1,000 | - |
(8) | Intercompany Charges | - | - | 500 | - | - |
(9) | EBIT | 200 | 600 | 150 | 550 | 1,500 |
(10) | Tax Rate | 25% | 25% | 15% | 25% | 24% |
(11) | Tax Cost | 50 | 150 | 22.5 | 137.5 | 360 |
(12) | NPI/Other Ratios: |
|
|
|
|
|
(13) | Royalty Rate (on Third-Party Revenue) | 5% |
|
|
|
|
(14) | MOTC |
| 10% |
|
|
|
(15) | Berry Ratio |
|
|
| 1.55 |
|
(16) | EBIT Margin (on Third-Party Revenue) |
|
|
| 5.5% | 15% |
The adoption of amount B (in mandatory form) by the LRD jurisdiction does not affect the IP Co. or contract manufacturer jurisdictions — neither of the entities within those jurisdictions transact with the LRD. As such, the profits reported in those jurisdictions as shown in Table 9 remain unchanged. The jurisdiction that does get affected is the principal jurisdiction. As long as the principal jurisdiction adopts or respects the transfer pricing outcome from a counterparty jurisdiction’s adoption of amount B, the taxpayer in the example will not face the risk of controversy and the threat of double taxation from the LRD jurisdiction’s adoption of amount B.
It will however have to report higher profits in the LRD jurisdiction — $550 million instead of $150 million — and correspondingly lower profits in the principal jurisdiction. Given the assumed jurisdiction level tax rates, this change in profit allocation will result in $40 million in additional tax cost for the company — $360 million instead of $320 million — and a higher ETR of 24 percent instead of 21.3 percent. If the principal jurisdiction were to choose to not adopt amount B and to not respect outcomes determined under amount B by an adopting counterparty jurisdiction, the taxpayer in the example faces the added risks and costs of double taxation.
Recommended Actions and Key Takeaways
Multinational taxpayers will need to consider concrete practical scenarios involving the application of amount B to explore effective solutions for tax reporting and compliance. In many instances, instead of providing the simplification and certainty that was the amount B stated objective and promise, the compliance landscape that taxpayers will need to navigate will become more fragmented and uncertain. Modeling different scenarios and their implications will be key for taxpayers to come up with a coherent and efficient compliance and documentation approach. Modeling will also be critical for taxpayers to understand and deal with the amount B knock-on effects on different group entities through the value chain.
A proactive approach will serve taxpayers well. Some examples of immediate actions companies should consider include:
assessing supply chain footprint in terms of distribution operations that may come within the amount B scope;
evaluating scoping criteria in jurisdictions in which entities are potentially in-scope, reviewing functional analysis and transfer pricing policies associated with entities that are potentially in-scope;
monitoring individual jurisdiction adoption and implementation of amount B, including whether the jurisdiction has opted in, made amount B mandatory, or has provided a safe harbor (or remained silent);
modeling consequences of amount B under different permutations of its adoption (safe harbor, mandatory, opt-in, opt-out) and assess effects;
revisiting compliance and documentation approach to ensure that the approach is coherent and efficient in the new environment;
analyzing and addressing the amount B knock-on affects on different group entities within a company’s value chain; and
evaluating existing APAs and pending APA requests to determine how they will apply and coexist where amount B may be a factor.12
FOOTNOTES
1 See OECD, “Pillar One — Amount B: Inclusive Framework on BEPS,” at footnotes 4, 7, 8, 9, 11, and 12 (Feb. 2024).
2 See Department of Inland Revenue of New Zealand, “OECD/G20 Inclusive Framework Two-Pillars Solution” (last updated June 25, 2024).
3 Stephanie Soong, “Amount B Won’t Change Australia’s Inbound Distributor Approach,” Tax Notes Int’l, Mar. 11, 2024, p. 1543.
4 See Soong and Anna Paez, “Gaps Remain on U.S. Red Line for Mandatory Amount B,” Tax Notes Int’l, July 1, 2024, p. 101.
5 Stephanie Soong, “OECD Aiming to Publish Amount B Country Opt-In List in Autumn,” Tax Notes Today International, July 12, 2024.
6 For a summary of the operating rules under the amount B report, see “OECD Releases Guidance Relating to Pillar Two GloBE and Pillar One Amount B,” PwC Tax Policy Alert, June 19, 2024; “A Closer Look at the Simplified and Streamlined Approach,” PwC Tax Policy Bulletin, Mar. 14, 2024; and “OECD Releases Pillar One Amount B,” PwC Tax Policy Alert, July 19, 2023.
7 See OECD, “Pillar One — Amount B: Inclusive Framework on BEPS,” at Introduction, para. 4 (2024).
8 See OECD, “Pillar One — Amount B: Inclusive Framework on BEPS,” at para. 81 (2024).
9 For simplicity, all examples in this article assume that the financial results shown are the same for book (i.e., statutory reporting) and tax purposes.
10 The pricing matrix allows for a range of plus/minus 0.5 percent around this value such that the taxpayer could target 4.5 percent for the routine distributor under the simplified and streamlined approach. For simplicity, the examples in the article consider single-point ROS targets under amount B.
11 New Zealand has, for example, publicly announced its intent not to adopt amount B. See supra note 2; see also “Pillar One: New Zealand Will Not Adopt ‘Amount B,’” PwC New Zealand Tax Insights (last visited July 24, 2024).
12 Copyright 2024 PwC. All rights reserved. PwC refers to the U.S. member firm or one of its subsidiaries or affiliates and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only and should not be used as a substitute for consultation with professional advisers.
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