Policy Proposals  Business Law   Comments on the Public Consultation Document on the Amount B under Pillar One

September 1, 2023
Business Infrastructure Bureau, KEIDANREN

We thank you for the opportunity to submit our comments.

This document is submitted by Keidanren's Business Infrastructure Bureau and is based on the discussions held by the International Tax research project of the 21st Century Public Policy Institute.#1

1 Research project consisting of tax managers from Japanese MNEs, academics and practitioners.

1. General comments

We welcome the release of the new public consultation document on the details of Amount B. Keidanren also supports the objectives of Amount B: that is, to simplify and streamline transfer pricing rules and to contribute to the prevention and resolution of disputes.

However, some of the content presented in the public consultation document continues to raise concerns that taxes may be levied that depart from the reality of the transactions, and that administrative burdens may increase. For these reasons, as explained in section 3(5) under 'Implementation considerations', we firmly advocate for the application of Amount B as a safe harbour that companies may choose whether to apply. Nevertheless, the subsequent points outlined in this opinion are secondary and precautionary claims, posited under the assumption that the application of Amount B may be mandatory.

Based on these perspectives, we express our views below.

2. Transaction in Scope

2.1. Alternative A and Alternative B

Alternative A, a quantitative criterion, is preferable in the sense that it strikes a balance between tax stability and an easy-to-manage system, while also leading to reliable results. However, if the application of Amount B is mandatory, to avoid deviating from the arm's length principle, it may be appropriate to establish, as an exception, qualitative exemption criteria, such as Alternative B, which can be applied only at the taxpayer's discretion in exceptional cases where the activities of local distributors are below baseline contribution. In this case, if the taxpayer proves that a distributor in question meets the exemption criteria, it may choose to exclude the application of Amount B.

2.2. Digital goods and services

The scope of digital products and services should be clarified as there are various possible ways in which digital products can be distributed and digital services can be provided.

The streaming of digital content may be classified as either 'sales' or 'services (including subscriptions)' depending on the type of streaming under the 'wholesale distributions (distributions through electronic distributors)' covered by Amount B. As a baseline contributor for transfer pricing purposes, the functions and risks of both types of wholesale transactions are essentially the same, and in cases where both types of transactions are integrated and mixed, it is not practical to split the transactions for transfer pricing purposes and forcibly separate the financial statements. Therefore, the streaming of digital content in the category of 'wholesale distribution' should be positioned as a covered transaction for Amount B as a whole.

Where the digital business in its entirety is positioned as a covered transaction, it is also necessary to clarify in which industry group the digital business is positioned in the pricing matrix.

In addition, although also related to the segmentation in 2.3 below, in cases where software sales, which include sales of digital products, and maintenance services for such software are provided as a package, the price relating to the digital products may be reduced in order to promote the sales of the package. Where these sales and services are separated and Amount B is applied only to sales of digital products, this may produce the undesirable result of taxing sales of loss-making digital products. Furthermore, it would be unclear whether Amount B can be applied to such sales combined with maintenance services as a package.

2.3. Segmentation (Box 2.3. etc.)

The segmentation approach proposed in the public consultation document is useful for multinational enterprises that can properly demarcate the scope of application of Amount B. However, where various lines of business are inextricably linked, for example in local entities where the manufacturing and sales functions are combined, or where a sales company sells products and provides after-sales services such as maintenance, there may be no income statement by business line. There may also be no balance sheet for calculating asset density. In such cases, segmentation of profits and losses; and, in particular, assets, is not usually carried out and would be difficult to implement. If segmentation were required by the tax authorities, we consider that there is a very high risk of arbitrary implementation.

For this reason, even if Amount B is made mandatory, companies should be able to choose whether to segment, and their chosen approach to segmentation should be respected. Mandatory segmentation or arbitrary categorization by tax authorities should not be enforced.

We also agree with the statement in para 9c, footnote 13 and section 2.3.5. that Amount B is not applicable in the following cases: costs related to non-baseline activities such as manufacturing, research and development are recorded and those costs cannot be segmented.

Furthermore, there is a need for clear guidance concerning the parameters that validate business segmentation, encompassing the methodologies for allocation and computation of sales, expenses, and other pertinent factors. The implementation of segmentation should be structured to prevent subjective evaluations by tax authorities.

2.4. Other scoping issues

The scope of marketing activities in footnote 15 in relation to making a unique and valuable contribution is too broad. From a practical point of view, it is not feasible to assume that all of the activities and functions and risks specified in footnote 15 are subject to two-sided verification such as the profit split method, as this may deviate from the reality of the transaction and functions and risks.

For startup companies that are not yet fully operational or for local distributors facing specific circumstances such as incurring consecutive losses for valid business reasons, it would be appropriate to establish some exclusion criteria. Additionally, considering the practical burden regarding the application of Amount B and the time required for adaptation to the new system, careful consideration needs to be given to the application for small and medium-sized enterprises, including setting thresholds based on transaction amounts.

It should be explicitly stated and mutually agreed upon in each country that if the profit margin of the entire group or entire transactions become negative or falls below the profit margin of Amount B, such transactions will be excluded from the scope of application of Amount B to avoid income creation. Furthermore, in cases of global economic crises or natural disasters such as COVID-19, the OECD/IF should take such circumstances into consideration and provide guidance regarding the application of Amount B.

3. Determining the arm's length return under the simplified and streamlined approach

3.1. Pricing matrix

Regarding the pricing matrix, the presentation of specific profit levels and ranges is appreciated. It is essential to include the figures between 1% and 2% in the matrix as a profit level, given the fact that the scope of Amount B is baseline distribution activities. If the profit level is higher than presented, there is a significant possibility of inappropriate taxation that deviates from commercial reality. In addition, the row "[E]Low OAS/low OES OAS<15% / OES<10%" should be retained to accommodate low levels of OAS (Net operating asset intensity) and OES (Operating expense intensity). If this row were to be eliminated, it would likely result in taxation that deviates from the actual circumstances.

As there are issues regarding the definition and scope related to the assets and their allocation according to transactions, it is imperative to revisit the appropriateness of adopting an intensity criterion based on OAS since Amount B targets baseline distributors. To eliminate complexity and to avoid applying a needlessly elevated profit margin considering the functions and risks of the in-scope entity, it is more advantageous to solely employ OES as a basis for determining the intensity.

3.2. Range

It is appreciated that the prices are stated as ranges instead of fixed values. It is undesirable to adjust sales prices that have been determined by business factors due to tax reasons. In addition, when the range is narrow, companies face a heavy practical burden as it will be uncertain until just before the end of the fiscal year whether they will fall within the range, even if they make price adjustments and other efforts. Therefore, it is essential to provide some allowance regarding the range. The current range of +/-0.5% presented in Table 4.1 should be broadened and it would be appropriate for the range to be at least +/- 1% to 2%. A range narrower than +/-0.5% is unacceptable as it is likely to result in taxation that deviates from the reality of the company's transactions and is also likely to result in a heavy administrative burden associated with price adjustments. Figures on profit margins in the pricing matrix, including information on the Berry ratio, need to be updated and published in a timely manner before the start of the fiscal year, taking into account that companies may realise profit margins within a range by revising transaction prices during the period, or by making price adjustments at the end of the fiscal year.

If the profit margin of the in-scope companies falls outside the range of Amount B, it is envisaged that the necessary income adjustment may be made at the end of the fiscal year or in the following fiscal year by means of cash payment for price adjustments. It is essential to clearly state in the Guidelines that cash payments for price adjustments are permissible. In addition, the cash payments for price adjustments should be deductible in the country of remittance, and the imposition of taxes on deemed cash contributions or withholding tax on the payments for price adjustments should not be permitted. It should be agreed internationally that no such taxation will be imposed in each country.

To simplify and streamline Amount B, income adjustments, cash payments for price adjustments, and other responses made at the end of the fiscal year or in the following fiscal year should be positioned solely as corporate tax measures under transfer pricing rules and should be separate from import prices for customs and value added tax purposes.

3.3. Mechanism to address geographic differences

To address geographical differences in the profit margin, the adjusted price matrix in 4.2.1. is not appropriate, as different treatment among countries would be contrary to the objective of simplifying and streamlining of Amount B. In addition, it is inappropriate to allow only upward adjustments, as this is likely to result in the imposition of taxes that deviate from the actual situation.

The data availability mechanism for qualifying jurisdictions in 4.2.2. is likewise not appropriate. Under current practice, there is no upward adjustment according to credit risk, and such adjustments depart from reality. The basis for upward adjustments based on risks and other factors is unclear, as simple wholesaling only involves very little inventory risk, working capital risk, foreign exchange risk, and other risks. Even if an adjustment is warranted, it would only be in very limited cases, such as in Ukraine, where the country is currently at war and there is an imminent danger to the conduct of local business; or where local borrowing costs are extremely high due to hyperinflation. In such cases, profits should be determined by excluding local entity-specific losses that are not directly related to transfer pricing, such as restructuring-related costs, from in-scope profits and losses.

In addition, the use of qualifying local data sets in 4.2.3. is not supported. Using jurisdiction-specific comparable data not only lacks transparency but may also increase the likelihood of cherry-picking in the target company selection. Even after the process of additional review under the inclusive framework, there remains a possibility that appropriate comparability and economic analysis cannot be ensured in a form that considers proper business characteristics and actual conditions. Furthermore, it is considered that this would run counter to the objectives of Amount B, namely simplicity and streamlining.

3.4. Corroborative mechanism

It is appreciated that the Berry ratio can be applied together with the cap and collar. The figures are closer to the reality of the business and there is a rationale for Berry ratio adjustments where a tested party performs only low functions, such as commissioners and sales agents. However, it is undesirable to complicate the application of Amount B through the Berry ratio corroborative mechanism. The currently proposed range of 1.05 to 1.5 should be maintained at a minimum and not narrowed.

For transactions where gross turnover is difficult to identify, it is recommended that the taxpayer may verify profit margins using Berry-ratio actual figures, as claimed by the taxpayer. There may also be room for considering business characteristics regarding the profit level of the pharmaceutical industry.

3.5. Implementation considerations

For the purposes of simplicity and streamlining, Amount B should be positioned as a safe harbour for taxpayers. If taxpayers are able to justify a more optimal approach based on the arm's length principle, such as having sufficient comparable companies, they should be able to decide not to adopt Amount B, recognising the risk of being challenged by the tax authorities. The rules should also clearly state that companies can apply for an Advance Pricing Arrangement (APA) if they consider that the application of Amount B is not in line with their actual transactions.

Where the tax authorities apply Amount B, it should be clarified that Amount B is a "rebuttable presumption" for the taxpayer. It is also desirable to limit ex post challenges to the taxpayer's interpretation of the scoping rules by the tax authorities in an attempt to apply a higher profit margin, even though the taxpayer has chosen to apply Amount B.

In implementing Amount B, the risk remains that the provisions under the OECD Transfer Pricing Guidelines alone will not prevent challenges by tax authorities, even if a profit margin based on Amount B is secured. Therefore, at a minimum, provisions relating to Amount B need to be explicitly codified by each jurisdiction.

If the application of Amount B is mandatory, adjustments are needed when it is out of range. To avoid double taxation, it is essential to introduce a set of tax certainty measures within Amount B, as discussed below.

With regard to the timetable for the introduction of Amount B, it is necessary to take into consideration the identification of in-scope transactions and local entities, confirmation of commercial distribution and impact calculations, introduction of cash payments for price adjustments, and the amendment and maintenance of contractual documents, among others. After the systems in each country have been finalised, a preparation period of two to three years is required, with application from 2027 or 2028 onward at the earliest.

In relation to the interaction with Amount A, it is worth noting that Amount B may be considered separately from the progress of Amount A. However, when designing Amount A, consideration could also be given to incorporating the Amount B framework into the Marketing and Distribution Profits Safe Harbour (MDSH) for Amount A, and avoiding complex and additional operations based on Return on Depreciation and Payroll (RODP) formula for the jurisdictions concerned.

To ensure consistent application of Amount B, harmonisation of financial data with comparable companies and uniform definitions, it may be useful by allowing taxpayers to calculate Amount B uniformly under global accounting standards, such as IFRS. However, if the application of Amount B is to be extended to small and medium-sized enterprises (SMEs) that use local standards, certain considerations are necessary.

3.6. Other practical issues

We welcome the clarification that bilateral agreements, such as already agreed APAs and applications under the Mutual Agreement Procedure (MAPs), will be given priority.

In addition, it is needed to be clearly stated that future APAs/MAPs are not necessarily bound by the Amount B pricing matrix. Amount B originally omitted the process of benchmarking analysis to calculate customised profit ranges to simplify enforcement. APA/MAP allows for a close examination of the transactions subject to APA/MAP procedures and the calculation of an accurate range that validates the in-scope transaction; the range under APA/MAP is more appropriate to accurately delineate the transaction.

4. Documentation

It is appreciated that, in principle, the information in local files is sufficient for Amount B filing. It should be agreed in an internationally binding form so that countries do not require additional documentation requirements in their domestic laws.

In addition, as companies below a certain size are exempted from documentation for transfer pricing local files, it would be desirable to establish similar exemptions for in-scope transactions under Amount B. Not all enterprises would be required to prepare and maintain documentation.

5. Transitional issues

With regard to the treatment of one-off extraordinary gains or losses in the process of restructuring a business, it needs to be clarified in the Transfer Pricing Guidelines that such gains or losses are not subject to Amount B. In such cases, entities should be permitted to choose to be within the scope of Amount B after making an adjustment to exclude the one-off gain or loss.

6. Tax certainty

The rules for resolving disputes and double taxation should be clarified in cases where Amount B is applicable. Relying on existing APAs and MAPs only, although they are still presented in public consultation documents, may not work as an effective solution, and no remedy will exist if Amount B is applied between countries that do not sign a tax treaty.

Multilateral agreements should be concluded in a form that includes an additional tax certainty process specific to the application of Amount B (for example a process such as the Dispute Resolution Panel in Amount A). If it is difficult to conclude a multilateral agreement, as an alternative, it is essential for international agreement on a uniform start date for the application of Amount B to be applied simultaneously worldwide, in order to prevent double taxation arising from timing differences in the introduction of Amount B.

To ensure simplicity and certainty, which are the main objectives of Amount B, it is appropriate to establish a mechanism to limit disputes in relation to Amount B. Between countries applying Amount B, a subtraction adjustment is required if the country in which the distributor is located makes an adjustment to be included in the range. In such cases, a rule that allows a corresponding adjustment without mutual agreement procedures, regardless of the year in which the relevant subtraction adjustment was made, should be introduced as a global and binding mechanism, for example by specifying it in the multilateral convention. A consultation procedure between the two authorities prior to taxation could also be established. It may also be useful to establish an early and simplified form of advance tax certainty, such as Amount A.