Episode 19: Practical challenges when implementing Amount B, with Robin Hart

The following transcript has been lightly edited for clarity. Robin can be contacted at rhart@crai.com.

Intro: Hello and welcome to The LCN Legal Podcast, bringing you expert views and analysis of the legal aspects of transfer pricing compliance. Our focus is always on real world, practical insights that you can apply in your everyday work. In this episode, LCN Legal’s co founder Paul Sutton, talks to Robin Hart. Based in the San Francisco Bay Area, Robin is a Principal in Charles River Associates’ Transfer Pricing Practice, and advises clients on all phases of the transfer pricing lifecycle. He’s very familiar with the issues and latest developments around Amount B, and that’s the focus of this episode: the current state of play, what we know and what we don’t, some practical challenges for MNEs when planning to implement Amount B, and some of the fundamental options when doing so. We hope you enjoy the discussion.

Paul Sutton: Hi, Robin. Thanks very much for joining us.

Robin Hart: Thank you very much, Paul. I appreciate the invitation to join the esteemed list of transfer pricing practitioners who’ve been on the podcast.

PS: Amazing. Thank you. We’re here to talk about Amount B, and perhaps you could kick things off, Robin, with a recap. What’s it all about and how do we get into this situation, as it were?

RH: Yeah, absolutely. As a quick explainer to level set, the goal of Amount B is to find a globally harmonised approach to applying the arm’s length principle to tangible good transactions. So intercompany cross-border sale of goods accounts for more than a third of global trade annually, and that’s a conservative estimate. So that is trillions and trillions of dollars annually. And eliminating transfer pricing disputes on this volume of transactions is certainly a laudable goal, especially as applying the arm’s length principle for straightforward tangible good transactions can be considered low-hanging fruit from a transfer pricing perspective. In February 2024, the OECD released its detailed calculations and approach to applying Amount B. And since then, in June of 2024, there’s been a new release from the OECD that provides additional detail. It’s certainly helpful to taxpayers as they begin to truly assess the impact that Amount B is going to have on their transfer pricing.

So Amount B, or as it is now being called ‘the simplified and streamlined approach’, is applied in a four-step process. Step one is a scoping exercise that looks at both quantitative and qualitative factors relating to a tangible goods transaction. And for distributors that qualify into Amount B, there’s then a three-step calculation to determine what the target return on sales should be for that entity.

These are what I call the three dimensions of identifying the target return on sales. So the first dimension is to find a point in a three-by-five matrix that the distributor fits within. Where one axis is a selection of product types, and the other axis is the factor intensity of the distributor, where the asset-to-sales ratio is the most important metric. Depending on the product mix of the company, averaging might be required in this step. The second dimension is applying the operating-expense-to-sales ratio crosscheck. And the third dimension is what’s called the data availability mechanism, which is essentially a premium return on assets for distributors in countries that have a higher cost of capital due to a lower sovereign credit rating in that jurisdiction.

PS: OK, so we’re talking about a matrix approach for setting a target return for a distributor. We’re talking about wholesale distribution of physical goods. So that’s the focus of it. And the aim is basically to remove the need for benchmarking, if you like, in terms of that that return because instead we’ve got a matrix position to ascertain that. So just before we dive into some of the details, what has been the high-level reaction from the TP community from your perspective? On what we’ve seen so far?

RH: Well, as I said, the OECD have described this as a simplified and streamlined approach. And it’s easy to see why that could be the case from the perspective of a tax authority who might come in 2-3 years after the transaction, or after the fiscal year has closed, and audit the transfer pricing related to this distribution transaction. All the data is available and the calculations, that three-step calculation that I just walked through, can be applied. From a taxpayer perspective or a practitioner’s perspective, it is in fact a somewhat complex process still, and that’s specifically to do with the data availability at the time that the calculation needs to be performed. Now, while some of the scoping steps rely on historical financial information for the distributor in question, applying the three-step calculation process that I mentioned requires the real-time data – or the current year data, I should say – with respect to that distributor and the transactions that it’s engaging in with its related party supplier. And therein lies the complexity.

In addition to that, the calculation needs to be done on local statutory accounts, unless the local government or tax authority gives a waiver and allows the entity to use the parent company financials. And as many taxpayers will recognise, there’s often a lag in the reporting of statutory accounts at the local level, and that’s going to lead to this complexity of actually calculating what the precise target should be. And that is at a single entity level. For a multinational company that could have dozens of these wholesale distributors within the scope of Amount B, this calculation has to happen for all of the distributors. And so the target could very well be different in each of the jurisdictions. And that just adds additional administrative monitoring and complexity relative to the current position.

PS: I guess it’s worth reminding ourselves, one of the original intentions, as I understand it, behind the concept of Amount B is to help so-called low-capacity jurisdictions, which may not have the same ability to analyse fact patterns. Hence the desire to apply a matrix as opposed to benchmarking. But then we’ve got this what looks like incredible complexity in applying these very prescriptive rules based on the current year data. If I’m not wrong, it partly looks at the three previous years. In other words, it’s looking at the asset intensity, for example, over the previous three-year period. It’s actually quite a complex set of calculations that needs to happen after the event in in order to select the outcome for that particular distributor in a particular country.

RH: Yeah, that’s correct, Paul. And when we look at the country-specific elements of the Amount B calculation, there are, by my estimate, six different elements of Amount B that are country-specific. Starting with whether a particular country is going to adopt amount B or not. And if they adopt Amount B, in what form do they do so, either on a mandatory basis or on a safe harbour basis? And when we get to the actual calculations, we have the second and the third steps that I discussed, so the operating-expense-to-sales ratio crosscheck, and we just got recent guidance on that in June. And what you’ll see is some very major economies are going to be the subject of a higher cap with respect to that ratio. So there is not just one ratio crosscheck. For specific countries, there’s a separate ratio crosscheck, and those jurisdictions are going to include China, and India, and Mexico, and Brazil as major economies. And then for the data availability mechanism, which is this premium return on assets concept, we’re going to see countries such as Mexico, and Brazil, again, but not China, potentially subject to that additional uplift from that perspective.

Lastly, when it comes to dispute resolution, there’s an agreement that’s baked into the Amount B concept, that if a smaller tax authority that has fewer resources to analyse transfer pricing fact patterns and also that lacks comparable companies in their jurisdiction, then if that jurisdiction adopts Amount B, then the tax authorities in the developed world will honour that jurisdiction’s adoption of Amount B, even if the developed country doesn’t adopt Amount B itself. So there are certainly different country-specific elements involved, and a lot of them are focused on the developing countries.

PS: In terms of maybe some of the big unknowns out there right now as regards Amount B, we’ve got country-related unknowns. In other words, which countries are going to adopt Amount B, and if they do, is it going to be optional or mandatory? So that’s a big area of unknown. And as I understand it, we’ve got very little view on what that’s going to look like right now. We just got a couple of countries, like Australia and New Zealand, have said we’re definitely not in. But other countries, maybe I’ve missed it, but there’s not much in terms of specific announcements for us to actually start planning in earnest.

RH: Well, that’s very true. The United States government officials on this matter have said that they actually support a universal Amount B, so having it apply across the globe. Other countries are more hesitant. We know that India have certain reservations with respect to Amount B, and those are still being worked out. One thing that India is concerned about (in my recent discussion with a government official) is that they think that this cap on the return to the distributor from this operating-expense-to-sales ratio crosscheck is going to impact distributors in India more frequently, because India is a low labour cost jurisdiction, and so the return may trigger that cap based on the operating-expense-to-sales ratio. So that’s a concern for India and potentially other jurisdictions that have a low labour cost base.

So we are waiting for a lot of guidance from different jurisdictions. My understanding is that for a government to adopt Amount B, it’s going to be legislatively easier than the adoption of Pillar 2, which is obviously ongoing, or indeed the adoption of Amount A of Pillar 1. Maybe at this point, Paul, it’s worth noting that there is no size threshold for the multinational enterprise for Amount B.

So unlike country-by-country reporting, unlike Pillar 2 of course, that’s applied to larger taxpayers, and Amount A of Pillar 1 that just applies to the mega and most profitable taxpayers in the world, Amount B is designed to be applicable to any multinational company, irrespective of size and profitability. Therefore, it is certainly something for people to keep an eye on.

PS: And as I understand it, the intention is still that Amount B, where it applies, applies for accounting periods starting 1st of January 25?

RH: Correct. We haven’t heard anything different in that regard. We understand that a 2024 version of the OECD transfer pricing guidelines is ready to be released with Amount B – or as they call it ‘the simplified and streamlined approach’ – included as an annex to Chapter 4 of those 2024 OECD transfer pricing guidelines, and that’s ready to be released pending any final clarifications. And then we can expect governments, if they opt in, that it would be for accounting periods commencing 1st of January, 2025, as you mentioned.

PS: Right. So what would it mean if a country does not adopt Amount B? What implications does that have? Or is it simply where you don’t have to apply it?

RH: Sure. So of course, in any intercompany transaction, or rather any cross-border intercompany transaction, there are two counterparty jurisdictions. And so really, one needs to look at the adoption from either jurisdiction and then start from there. The other thing to note is that if a country has not adopted Amount B, that is likely signalling that that jurisdiction thinks that they can get a better result by applying the arm’s length principle. In other words, following the existing guidance within the OECD guidelines rather than applying Amount B.

So as a practitioner and as taxpayers, certainly the emphasis should be on considering the perspective of both jurisdictions and whether either have opted in, if it’s mandatory, if it’s a safe harbour.

And then going back to that point about dispute resolution, if the jurisdiction that has adopted Amount B is in one of these developing country jurisdictions, then the developed country is supposed to honour the Amount B outcome.

PS: Right. I suppose if we’re looking at it from a taxpayers’ perspective, where you’ve got a group that has multiple distributors, multiple countries, and we end up with a situation where some of those countries adopt Amount B, others do not, but with substantially similar intercompany transactions for each of the distributors. Then it means, firstly, well, it’s assessing that complexity in terms of non-adopting countries, what do you do about it. But also there’s the issue which is it may lead to a segregated portfolio. In other words, you’re having to treat equivalent distributors in a different way because some are in adopting countries and others are not.

RH: That’s absolutely correct. I’ve seen practitioners put out a decision tree approach to thinking about this issue. We’ve also developed a decision tree approach [at Charles River Associates], and that does factor in the sense that the expectation is that if a country has not adopted Amount B, then they are expecting to be able to get a better result for themselves by the arm’s length principle.

PS: We touched on some of the unknowns from a country perspective. Are there still major areas of unknowns, just from an OECD guidance perspective? In other words, gaps and things that have not been developed yet?

RH: Well, we know that the Indian government, for example, is still advocating for a qualitative activity scoping threshold in addition to the quantitative thresholds already in place. Perhaps that is something that is still being negotiated. But from a taxpayer’s perspective, I think there are enough pieces of the jigsaw puzzle already available to really start thinking about this in detail and seeing how it would impact not only the transfer pricing returns – that’s just the output – but also the processes. Where you come in, Paul, from the intercompany agreements perspective.

PS: Yeah, right. Because one of the really interesting things for us as we start to help clients really crystallise where they want to land on this, is that fundamentally the Amount B tests are applied after the event. Obviously, you’ve got the initial scoping criteria like, is this a wholesale distribution of goods and certain fact patterns that would take a distributor just outside the Amount B regime altogether. But from a taxpayer’s perspective, if they’ve got a portfolio of distributors and one or more are likely to be within Amount B, you’re not actually going to know how that matrix is applied until after the year ends. And yet you need to define in advance what is the nature of the distribution transaction, and also need to think about whether it makes sense to segment or to separate out-of-scope functions into a clearly delineated separate transaction. So this is some of the thought processes that we’re thinking about right now.

RH: Yeah, that makes a lot of sense, Paul. And I think as we’re entering into the second half of 2024 now, and I think that it’s fair to say that there is significant momentum behind the implementation of Amount B, even though we are waiting for specific countries to formally adopt and in which format that they would adopt. Then I think it’s really time for multinational companies to start to work through the implications of this. And so that would involve determining whether their distributors are in scope on an entity-by-entity basis. This may involve some more complex work that has not necessarily occurred in the past, such as segmenting a balance sheet. If you have an entity that is a multifunction entity – in other words, that the wholesale distribution is just one function that that entity performs – the balance sheet needs to be segmented in a way that it might not have needed to be for transfer pricing purposes in years past. So gathering that information as well as looking at the different ratios, thinking about how this process would be operationalised, thinking about – with this narrow target to obtain – how that’s going to impact a year-end adjustment process, what knock-on effect that might have on customs declarations, and so on and so forth.

PS: Can I just ask about that concept of having a segmented balance sheet? Because I think many people will be familiar with the idea of segmenting P&L, but not balance sheet. So is that necessary because of the asset intensity test that are applied. And what does that actually look like?

RH: Yes, that’s absolutely right, Paul. So that’s in the scoping step. So that’s a three-year look back for the entity and segmenting out the balance sheet specific to the distribution transaction. And then also for entities in jurisdictions that are going to be subject to this third step of the calculation, the data availability mechanism, that would include looking at the balance sheet on a current year basis as well. So it’s fairly straightforward and common for entities to identify the accounts receivable, the accounts payable, and the inventory (to use US accounting terminology), related to the distribution transaction. But it’s not typically needed under the current application of the arm’s length principle to bifurcate the fixed assets of the business. (So to determine the property, plant and equipment that is applicable to the distribution activity, versus a service activity that the entity might be performing, for example.) And so that’s going to be a more granular exercise, and that certainly needs to be approached with forethought and rigour.

PS: Interesting. And I guess, again, thinking about it from a transactional, legal and commercial perspective, the transactions affecting an in-scope distributor are not necessarily only the relationship between the principal and the distributor. So if the distributor buys from a related party entity, then that supply arrangement or those supply transactions, and the pricing of those transactions, will obviously affect the outcome of the distributor. So they will be transactions that will need to be documented, structured, thought about in advance, in addition to what I’d describe as the main distribution transaction, which is the appointment of the distributor by the principal. So from a legal perspective, when we’re looking at this kind of fact pattern, it’s separating out the transactions and helping to identify each of them appropriately, as well as separating the out-of-scope activities.

RH: Yeah, that’s absolutely right. And I think, just to think through that balance sheet segmentation through a different lens, you could look at it as a subjective decision point within the framework of Amount B. So if a multinational company determines that its balance sheet cannot reliably be segmented, then the entity would be not within the scope of Amount B. A similar decision point could be around the regulatory environment in which the distributor operates. And if the multinational company determines that the distributor is performing a material amount of regulatory functions, and that’s a differentiator in the market, then the entity would be outside of Amount B. Those are decision points that the multinational company can take regarding the scope of Amount B. But of course, those decisions would be subject to challenge by the tax authorities, so should certainly be thought through.

PS: That’s really interesting. I had a conversation at a recent transfer pricing conference with an in-house tax professional, and that person was saying that for certain distributions transactions, his group was under pressure from various local authorities to actually segment distribution transactions for different types of product and related activity. And so far, they were resisting that because of the complexity. But I guess Amount B is an additional framework on top of that. And it is a binary decision, isn’t it? Are you going to claim that you are out of scope, because you say that you cannot segment the Amount B functions, and basically put yourself out entirely? Or are you going to segment and basically accept that process and that complexity?

RH: Yeah, I think that’s absolutely right. And to the conversation that you had, Amount B does factor in different classes of products. In the matrix. And that’s where an averaging might occur. But equally, one might claim that the entity might fall outside of Amount B based on a couple of other factors. I think that for the most part, if a distributor that otherwise qualifies is excluded from Amount B, that the jurisdiction in which the distributor operates is going to feel that the Amount B target is the floor, and they deserve a higher return for whatever reason it is that disqualifies the entity from Amount B. So the regulatory aspect would be part of that. So the jurisdiction would view that the regulatory component to the business is highly value adding that would lead to a scarcity of that product within the market, and that would lead to a higher return.

PS: Right. Okay. So for those corporates who maybe have not dived into the detail yet because they’ve been hoping to get more clarity as regards country-by-country adoption and also clarity regarding certain other matters from the OECD, what would your high-level advice be to them as to their thought processes at this point in time?

RH: I think that now would be an appropriate time to start modelling this out, thinking through the data requirements, looking at that historically, again, on a local statutory count basis. Looking at the scoping requirements, looking at the three-step calculation to determine the target return on sales for each of the distributors within scope, and getting a sense of what their transfer pricing targets might look like commencing January 1st, 2025, and then building out a plan to operationalise that.

PS: OK, that makes sense. And in terms of how long they have to do this work, presumably they want to do that before the start of the financial period, so before the end of this year, so they’ve got a clear basis on which to decide how to structure their transactions.

RH: That would be my recommendation, yes.

PS: Well, it sounds like this might be a good point in time to pause our conversation, and maybe we’ll be able to get you back, if you don’t mind, Robin, when hopefully we got more clarity from the relevant jurisdictions and possibly when we’ve got more guidance from the OECD. But for now, any key takeaways that you would offer to people listening and what they should be doing right now?

RH: Well, I think one takeaway that I have from this entire process is that it emphasises the complexity of transfer pricing. And if we think about the different stakeholders involved and their different desired outcomes, we have ended up with a fairly intricate calculation that is very specific to certain factors, and different corporates around the world are going to have very different outcomes from applying this framework. And given that the cross-border sale of tangible goods to a related party wholesale distributor is supposedly one of the most straightforward transfer pricing issues that we face, it just goes to show that there is truly not a one-size-fits-all approach in transfer pricing. And while tax authorities are going to have the benefit of hindsight when it comes to auditing the transfer pricing 2-3 years after the transactions have occurred, that process may yet be simplified and streamlined, and disputes may yet be decreased in that regard. But from a company’s perspective in implementing this, particularly perhaps the first couple of cycles, I think that there is going to be a degree of complexity that needs to be overcome. So I would recommend that companies think about how this is going to impact their transfer pricing policies, but also their transfer pricing processes.

And we will wait for additional guidance from the OECD or the release of the 2024 OECD transfer pricing guidelines. We eagerly await more definitive pronouncements from jurisdictions around the world with respect to their adoption of amount B or not.

PS: Absolutely. And just to pick up on some of the points that you made earlier in this conversation, the stakeholders are not just countries, not just tax authorities, but also customs issues, regulatory issues, statutory accounts and so on. So, absolutely, it takes a holistic cross-functional approach to design something that makes sense, that hopefully works. So all I can say is thank you very much, Robin, for spending the time with us. Really appreciated it, and look forward to catching up again, hopefully, when we do have some more country updates to share.

RH: Thank you very much, Paul. It’s been my pleasure.

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