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When OECD’s Transfer Pricing Reform Can Help—And When it Can’t

Jan. 23, 2023, 9:45 AM

In December 2022, OECD released a public consultation document with the goal of simplifying some transfer pricing rules. The document, known as Amount B, includes discussions about scope, methodology, and implementation measures. It aims to present a fixed return for in-country baseline marketing and distribution activities in hopes of eliminating disputes about those scenarios.

Unlike Amount A, which is only relevant to a limited number of huge multinational corporations, Amount B is expected to apply to all businesses and thus has a more far-reaching impact. In this article, we will examine to what extent the Amount B proposal could actually be applied in the transfer pricing practice, based on our experience from managing global transfer pricing engagements.

When Amount B Could Not Help

Obviously, the Organization for Economic Cooperation and Development is trying to strike a balance between sticking to the arm’s length principle (which requires sufficiently reasonable examination for any real-life case application) and simplifying and streamlining procedures (which otherwise would defeat the ultimate purpose of Amount B). With multiple goals on the agenda at the same time, the application of Amount B could face quite a few limitations. Moreover, local revenue authorities often have different views on the benchmarking details, making it more difficult to apply a single approach in different jurisdictions.

In addition to the special exclusion cases mentioned in the consultation document, based on our observation, Amount B may not be applicable in some common scenarios such as the following.

When authorities prefer using local comparable companies. Similar to other OECD initiatives, the success of Amount B depends on the acceptance of different revenue authorities, particularly the non-OECD jurisdictions. Some revenue authorities prefer to use local comparable companies to benchmark the local profit margin; some would even prefer to use local private companies whose financial information could not be publicly verified.

Unless those jurisdictions were willing to change the local practice, the use of local country or private comparables naturally would become a hurdle to apply Amount B.

When a distributor performs more functions than baseline activities. The consultation document lists a long set of scoping criteria now under evaluation. If the distributor performs more functions—such as those other than distribution and those that incur higher marketing, advertising, or other operating expenses—it would not fall under Amount B’s scope.

While such scoping assessment technically is reasonable and necessary, in practice, controversies don’t often involve the distributors that perfectly fit with OECD’s Amount B scope with limited functions and risks. Instead, they involve distributors with somewhat incremental functions. For the local distributors with more functions, the revenue authorities may hold the view that the return based on the transactional net margin method is insufficient and needs a more complex analysis with higher return expectation for remunerating the incremental activities.

Unless OECD can provide a wider tolerance range of qualified distributors, we expect that revenue authorities will continue with the existing approach as long as they have evidence showing local distributors have an incremental function.

When third party transactions coexist. Sometime,s a distributor will purchase from both related and unrelated party suppliers for resales. Understandably, the revenue authority would have strong interest in examining the purchase if the third-party transaction would be used as benchmark and if a simplified fixed return for intercompany transactions could not be applied immediately.

When Amount B Could Help

While it is unlikely that the Amount B proposal could provide global consensus on profit returns for in-country distributors, we believe OECD’s work could still provide certain benefits if properly leveraged under the following circumstances.

When setting the expectation of baseline distribution return. Years ago, OECD provided guidance on low-value-adding intra-group services suggesting a 5% profit markup. Even though some revenue authorities won’t agree to adopt the markup without benchmarking support, OECD’s comment is still helpful as a reference source to set the common expectation, and transfer pricing practitioners and taxpayers can have a second look when the benchmarking result substantially deviates from 5%.

Similarly, OECD’s work on Amount B also could be used as a common source of reference for the baseline distribution return, even if an additional benchmarking study may still be required. If a distributor has more functions, Amount B could serve as the base return, with additional analysis to determine what would be the required add-on return.

When standardizing the benchmarking search criteria. Large multinational corporations preparing global transfer pricing documents covering multiple jurisdictions may be frustrated by the different jurisdictions having different preferences and requirements in the detailed benchmarking search practice, even with all the general OECD transactional net margin methods.

For example, some jurisdictions would reject the use of loss-making comparables (either in written or verbal guidance), while others would require the completion of benchmarking before intercompany transactions take place. Some would require the use of the latest comparable financials in the same year as the tested period. Others would require a single year of comparable financials, and still others would require a three-year average. The different operational details would make it difficult to align a benchmarking result, not to mention using a local database or private comparables in certain jurisdictions.

Conclusion

The consultation document provides the common benchmarking search criteria being considered for the purposes of Amount B. Even not immediately agreeing on the fixed return as Amount B, if the revenue authorities could share more commonality based on OECD’s benchmarking search criteria or be more flexible, this could help streamline the application of transactional net margin method benchmarking.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Victor Zhang is a transfer pricing partner and Season Guo is a transfer pricing senior manager with Deloitte Hong Kong. The authors’ views are their own, but not Deloitte’s official position, nor do they constitute advice to any companies.

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