Tax Notes chief correspondent Stephanie Soong discusses the latest developments surrounding amount B under pillar 1 of the OECD’s two-pillar corporate tax reform plan.
This transcript has been edited for length and clarity.
David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: To B, or not?
We’re back into the realm of the OECD’s two-pillar project for updating international taxation. Specifically, we’ll be talking about updates to the pillar 1 amount B. We last talked about this subject in August of last year, which we’ll link to in the show notes. But a few things have happened since then.
Here to talk about where things stand now is Tax Notes chief correspondent Stephanie Soong. Stephanie, welcome back to the podcast.
Stephanie Soong: Great to be here, as always. Thank you.
David D. Stewart: Let’s start off with the big picture of what’s happening in the OECD project these days.
Stephanie Soong: There’s lots of stuff happening or are about to happen. Let’s start with pillar 2.
Countries around the world are moving to adopt pillar 2. This is the part of the project that deals with global minimum taxation, ensuring that large multinationals are subject to a 15 percent effect tax rate no matter where they operate. Already we’ve got several EU member states — Japan, South Korea, and Vietnam — and a few others actually implementing the rules. Others are either announcing they’re going to implement the rules or they’re consulting, or they’ve got draft legislation. I most recently covered Thailand. They just started a public consultation on a plan to implement pillar 2, and they expect the rules to start taking effect in 2025.
A lot happening on the pillar 2 front, but the real action seems to be gearing up in pillar 1. You might remember me talking about amount A of pillar 1. It’s a taxing right for market jurisdictions over a portion of the residual profits that the largest, most profitable MNEs make off sales to consumers in those jurisdictions. In exchange for that taxing right, jurisdictions agree to withdraw DSTs [digital services taxes] and other similar unilateral measures. That’s where things seem to be heating up.
David D. Stewart: What is going on there? We’ll be talking about, specifically, amount B in just a minute, but what is going on with pillar 1 in general? Because we do have this looming threat that a bunch of countries are going to implement digital services taxes. Are they waiting on those? What’s happening?
Stephanie Soong: Amount A needs a multilateral convention [MLC] to implement, which the inclusive framework on BEPS is working to finalize by the end of March so that countries can start signing the MLC in June. There was a moratorium on new DSTs while this is being finalized, but that hasn’t been renewed as far as I know.
Canada is the biggest threat, I guess you’d say, if you were a U.S. politician. Canada is gearing up with its digital services tax with legislation going through Parliament. I’ve mentioned before that the U.S. needs to ratify the MLC in order to get the critical mass needed to make it go into effect. But judging by U.S. lawmakers’ comments during the recent [House] Ways and Means taxation subcommittee hearing on pillar 1, their opinion is divided on whether we should even be at the table still. There’s an uphill battle, I think, for getting the U.S. to sign this thing.
While the MLC is being finalized, the U.S., Austria, Italy, Spain, the U.K., France, and Turkey have renewed their unilateral measures compromise to the end of June. This compromise means that countries that have DSTs will give MNEs who pay DSTs a credit against future amount A liabilities and the U.S. agrees that it won’t take any trade actions against them. Right now, I’m just waiting to see what happens coming out of that. There’s some leftover work on amount B, too, which we’ll get to.
David D. Stewart: Let’s turn to amount B. First of all, what is amount B?
Stephanie Soong: Amount B is a key feature of pillar 1, and it’s supposed to provide a simplified and streamlined approach to applying the arms-length principle to baseline distribution activities. Now, a baseline distributor is a wholesale distributor of tangible products other than commodities that does minimal or any retail distribution or non-distribution activities. Now, baseline activities are what people call core distribution functions. These include buying goods for resale, providing after-sale services, warehousing, performing logistics, invoicing collections — your basic mundane, unsexy activities. They’re the furthest removed from the kinds of things that create unique and valuable intangibles that are associated with unique risks.
The best way I can describe amount B is like the warp pipe in the Mario Brothers video games. When you go through the pipe, you can skip through playing part of the stage and get to the end instantly. So like that.
David D. Stewart: This speaks to me. I recognize this as a good analogy.
Stephanie Soong: Like that warp pipe, you don’t have to go through the steps of applying the transactional net margin method, or the TNMM, like doing comparable searches, all those things. Just a quick reminder, the TNMM generally gauges entity-level profitability.
The idea behind amount A is to just basically save everybody time and effort and would decrease disputes between taxpayers and tax authorities over transfer pricing methods, prices, all that sort of stuff. The concept seems simple enough, but the mechanics of the approach itself are very complicated.
David D. Stewart: How does this work? What is this simplified, streamlined approach?
Stephanie Soong: OK, so before you start, there has to be a qualifying transaction. That means wholesale distribution. Then you apply filters to kick out everyone besides baseline distributors. Now, the first filter is a one-sided method like the TNMM. It has to be the best method, and this kicks out distributors that make unique and valuable contributions. The second filter is a quantitative filter. The distributor’s ratio of operating expenses to sales has to fall within a range. This measures functional intensity. It basically kicks out companies that do too much besides core distribution. Then there are other specific exclusions like no digital goods or services, no commodities, no significant non-distribution activities like manufacturing or R&D, unless it can be reliably separated.
Now, you got a distributor in scope. Now you got to apply the reports pricing approach. First you use a pricing matrix — that’s another report — to find the right return on sales, which is EBIT, earning before interest in tax, divided by revenue, you find a distributor’s industry group and factor intensity group.
Then there’s a return on sales for each group combination, ranging from 1.5 percent to 5.5 percent, and then the distributor’s return can be plus or minus 0.5 percent of the return in the matrix. OK, the second step, you cross-check your result with what they call a cap and collar. I don’t know why they call it that.
Anyway, so you compare the distributor’s EBIT to its operating expenses, and if the ratio is too high, you adjust the return, so it’s a lower bound of the range. If the ratio is too low, you adjust the return so it’s at the upper bound of the range. The idea here is to make sure the distributor’s returns and its operating expenses aren’t just out of whack. Then if the distributor is in a qualifying jurisdiction, which means a country doesn’t have domestic comparables, there’s another step that adjusts the return upward. That’s pretty much amount B in a nutshell.
David D. Stewart: Are countries that are involved in the inclusive framework, are they required to adopt this along with all the other parts of these two pillars?
Stephanie Soong: Amount B is optional, which means jurisdictions can choose to apply the simplified approach either by allowing tested parties in their jurisdiction to apply their approach or make them apply it. I also might want to note that actually in the report they try to get away from calling it amount B, they actually say it’s formally amount B, and they instead call it simplified and streamlined approach, which is kind of a mouthful. I’m just going to call it amount B, just a caveat there.
In other words, as I said, amount B is optional. Countries can adopt it, but countries can choose to make it mandatory for distributors in their jurisdictions. Any amount B outcome is nonbinding in the counterparty jurisdiction if that jurisdiction doesn’t adopt the approach. That means if one treaty partner adopts amount B and the other doesn’t, any mutual agreement procedure dispute involving an in-scope distributor will be resolved by applying the general provisions of the OECD transfer pricing guidelines.
Amount B doesn’t carry any weight in MAP. However, inclusive framework members have agreed to respect the outcome if a low-capacity jurisdiction applies their approach. They promise to take reasonable steps to avoid double taxation. The final report says that inclusive framework will agree on a list of low-capacity jurisdictions by March 31, which is coming up soon.
David D. Stewart: Have we heard from individual member countries? Are they adopting this amount B idea?
Stephanie Soong: Yeah, it’s too early to say which countries are definitely going to adopt and who isn’t. But the OECD will eventually publish a list of jurisdictions that adopt the approach.
But right away, New Zealand announced that it would not implement the approach, and Australia didn’t outrightly say they wouldn’t adopt, but they did say they support optionality, and they already have transfer pricing simplifications in place for inbound distributors. It’s like a lukewarm response, but they tell me they’re going to come up with their formal response in due course, whatever that means. OK.
Then, well, India. I might note that India had a lot of reservations about the approach. You can see them in the footnotes of the report. India said they couldn’t support the work if another qualitative criterion for ensuring the approach applies only to baseline distributors isn’t incorporated in the scoping criteria.
In these negotiations, the countries were in basically two different camps. One saying that you only need a quantitative filter to identify your baseline distributors, but other countries wanted to add a qualitative filter, which I guess from a transfer pricing perspective — I’m told that it’s not ideal because then it takes the simplification out of the method. I guess the inclusive framework is working on this optional qualitative filter, so maybe India might sign on if that happens. We’ll see.
Meanwhile, the United States wants the approach to be mandatory, and a Treasury official recently said that U.S. negotiators are working on a phase 2, which is a mandatory amount B, so more details come on that.
David D. Stewart: What’s next for amount B? What are we looking for to come in the near future?
Stephanie Soong: I forgot to mention the report was incorporated into the OECD transfer pricing guidelines as an annex to Chapter 4, which is about special considerations for baseline distribution activities. There are conforming changes to the commentary on article 25 of the OECD model tax convention, which I believe still need approval from the OECD council.
We’re waiting on that. The OECD said that they’re going to be doing further work on the interdependence of amount A and amount B under pillar 1 before the amount A multilateral convention is signed and enters into force. That would be also very interesting because there really wasn’t outrightly clear what the connection was between amount A and amount B in pillar 1. That would be interesting to find out more about that.
The business reaction to this, Business at OECD criticized this approach in saying it fails to provide tax publication and certainty because of its optionality and narrow scope. However, it also said that understands that countries might think about expanding the amount B project to apply beyond just baseline distribution transactions. Maybe it could be expanded, we’ll see. There’s a lot happening. I think amount B is not really the end of the story of this final report.
David D. Stewart: Are there any other OECD issues that we should be watching for in the coming months?
Stephanie Soong: I’m so narrowly focused on just the two pillars. I really wish I could tell you look out for this and that and the other thing. But the OECD does do other things besides pillars, but what I’m watching for really is the pillar 1 and multilateral convention treaty text. I want to see what happens with amount B, whether there’s actually going to be another version of amount B that’s mandatory. I’m looking at DSTs.
I’m trying to see which countries are actually going to go ahead with their own digital services taxes, see what the U.S. response is. We’ll see what the U.S. says about signing the pillar 1 MLC. It’s a lot of stuff that I’m looking for, so there’s a lot to come and it’s been keeping me really busy.
David D. Stewart: I assume they’re going to keep you busy for a good while to come. Stephanie, thank you for updating us on all of this.
Stephanie Soong: Oh, you’re welcome. Thanks for having me again.
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