While the focus of international tax news in 2024 is on the application of the new Pillar 2 rules (aimed at limiting tax competition between different countries by applying a minimum tax rate of 15% on the profits of multinationals worldwide), the OECD (Organisation for Economic Cooperation and Development) published its report on Pillar 1, Amount B, on 19 February 2024.
As a reminder, Pillar 1 is divided into two amounts:
– Amount A, which provides for new rules for allocating the right to tax group profits, irrespective of any physical presence;
– Amount B, which provides for new rules to simplify and rationalise transfer pricing, and in particular the arm’s length principle, for so-called ‘ routine ’ marketing and distribution activities.
In view of its potential application from 1. January 2025, it is necessary to review these international tax developments.
1. Pillar 1 B amount: what is at stake?
The OECD Report is based on the observation that marketing and distribution activities account for a significant proportion of the activities of multinational groups, but also for a significant proportion of the disputes between tax authorities and taxpayers when comparables and the transfer pricing policy applied are called into question.
With the potential introduction of the rules referred to in Pillar 1, Amount B, the objective is threefold:
– To ease the compliance burden on taxpayers by simplifying and rationalising the application of the arm’s length principle,
– To provide legal certainty,
– Reduce the risk of the arm’s length principle being called into question in the event of a tax audit.
2. Pillar 1 B amount: which activities are concerned?
Unlike Pillar 2 or even Pillar 1 amount A, Pillar 1 amount B will apply to all groups, without distinction or threshold conditions, as long as the activity carried out by the group falls within the scope of this new system.
The activities concerned by Pillar 1 Amount B are as follows:
– Wholesale distribution and marketing of goods to unrelated parties (so-called ‘ B-to-B ’ relationships)
– The activities of intermediaries (commercial agents and commission agents) involved in the wholesale distribution of goods to unrelated parties.
By way of example, the OECD, in its report dated 19 February 2024, provides a non-exhaustive list of distribution functions:
– The function of purchasing from a related enterprise and reselling to an unrelated party,
– canvassing for customers
– warehousing,
– Invoicing,
– Promotional or advertising activities.
As a result, retail sales activities are excluded in principle, unless they represent less than 20% of the company’s distribution and marketing total net revenues.
In addition, the OECD Report also set out a non-exhaustive list of excluded activities, such as manufacturing, R&D, financing, the sale of non-tangible goods, services or the sale of goods meeting the definition of ‘commodities’, such as minerals or agricultural products.
Lastly, even if the company carries out a distribution and marketing activity, the latter must still be considered a ‘reference’ activity, commonly referred to as a ‘ routine ’ function. In other words, a simple distribution and marketing activity, without a high degree of integration (modification of the goods sold) or without the presence of specific risks borne by the distributor, falls within the scope of this new system.
3. Pillar 1 amount B: Rules to simplify the arm’s length principle
The transactional net margin method has been chosen as the most appropriate method for activities falling within the scope of Pillar 1 Amount B.
The OECD recognises the possibility of applying the comparable uncontrolled price method, provided that internal comparables are used.
Using a standardised pricing matrix with 15 pre-identified operating margin levels between 1.5% and 5.5%, distributors identified in this way will be able to self-determine the arm’s length price applicable to their transaction, without having to carry out benchmark studies.
To determine the arm’s length price applicable to the taxpayer under the matrix, two criteria apply:
1. A business sector criterion, based on the products distributed,
2. A factor intensity criterion based on two ratios, namely operating net asset intensity (the ratio of operating net assets to net income) and operating expense intensity (the ratio of operating expenses to net income).
The matrix data will be updated by the OECD every 5 years.
4. Pillar 1 Amount B: How is it implemented?
The application of Pillar 1 Amount B is left to the discretion of the jurisdictions, for initial application from 1 January 2025.
In addition, courts choosing to apply the simplification will also have two options:
– Impose the use of the simplified approach by taxpayers and their tax administrations,
– Allow taxpayers to choose whether or not to apply the simplified approach.
To date, France has not communicated whether it intends to apply Pillar 1 Amount B from 1 January 2025, or whether, if it does, this measure will be compulsory or simply an option for taxpayers.
