Amount B in life sciences and healthcare: an industry perspective

Amount B is intended to simplify transfer pricing rules relating to distribution activities, thus reducing cost and administrative load, and benefiting taxpayers and tax administrations. This article discusses the applicability of amount B to the life sciences and healthcare (LSHC) industry and highlights associated challenges stemming from the LSHC industry’s characteristics.

The OECD published the final report on amount B on February 19 2024 (the OECD Report on Amount B), which was preceded by two consultation papers from the end of 2022 and mid-2023. The concept of amount B, originally developed in the context of the OECD’s pillar one, is that it is intended to simplify and streamline transfer pricing approaches for simple – referred to as “baseline” – sales and marketing activities performed within multinational groups. Thereby, the number of potential related transfer pricing disputes and the risk of resulting double taxation should be mitigated.

In particular, the OECD Report on Amount B presents a new process for pricing baseline marketing and distribution activities, which will be treated as providing outcomes consistent with the arm’s-length principle in countries that opt to apply amount B. All companies, regardless of size, are in the scope of amount B if they meet certain criteria for suitable distribution activities. To capture differences in industries, amount B introduces, inter alia, industry groupings and takes into account factor intensity to derive an arm’s-length profitability for baseline distribution activities.

The latest guidance on amount B was issued by the OECD/G20 Inclusive Framework on BEPS on June 17 2024, including definitions of “qualifying jurisdictions” within the meaning of sections 5.2 and 5.3 of the amount B guidance and “covered jurisdictions” within scope of the political commitment on amount B.

However, further guidance on the application of amount B, as well as details on the respective national implementation of amount B, is still outstanding. Hence, it is unclear whether the concept of amount B will indeed lead to the envisioned simplification. Aspects that are subject to discussion include the scope of application regarding the definition of “wholesale” activities, process- and data-related questions for the price setting and outcome testing approach, and the determination of operating asset/operating expense intensities, as well as questions in relation to tax procedural aspects given the different options for national implementation (see Heidecke and Al-Anaswah, IWB Nr. 10, 2024; in German).

In addition, the treatment of potential industry specifics in relation to the application of amount B is still to be clarified. Concerning the LSHC industry, distribution activities are characterised by features that may require special consideration for the determination of arm’s-length transfer prices.

For instance, in the pharmaceutical subsector, challenges with regard to determining arm’s-length distribution returns for local pharmaceutical distribution entities based on database searches could require specific benchmarking approaches. Furthermore, the function of local pharmaceutical distributors may include regulatory activities, something not typically seen in other industries.

Another example concerns the medical technology subsector, where business models may feature complementary offerings, such as the distribution of medical devices and the provision of corresponding after-sales services. This also requires special consideration when determining arm’s-length transfer prices.

In the following, such aspects specific to the LSHC industry are outlined and discussed against the background of the OECD’s amount B concept.

With regard to patent-protected prescription pharmaceuticals, local pharmaceutical distribution companies within multinational groups generally perform two key functions:

• They can be responsible for the physical distribution of the products and perform related logistic and warehousing activities; or

• They may perform marketing activities in relation to the distributed pharmaceutical products.

These marketing activities differ from marketing and promotion conducted in other industries. They are typically not aimed at end customers – i.e., patients – but at doctors and hospitals. As such, the local distributor may employ specially trained sales personnel visiting and informing doctors about the pharmaceutical products, issuing product information and respective publications, and participating in expert congresses.

In many cases, these marketing measures are performed within the overall framework of the group marketing strategy developed centrally, often at the level of the parent company. As such, the main strategic marketing decisions are often not taken at the level of the local distributor but centrally. Hence, the local marketing activities are typically associated with limited risks. Moreover, the local distribution entity does not typically develop or employ any significant intangible assets in relation to the marketing activities.

In addition to the distribution and marketing activities described above, local pharmaceutical distribution companies may also perform activities related to obtaining regulatory licences. In this regard, different set-ups are possible concerning the allocation of respective functions and risks between the local distributor and the parent company/intangibles-owning group company.

In the following, special considerations are outlined that may apply when determining arm’s-length returns for pharmaceutical distributors in light of the above-mentioned specificities. These considerations, in turn, are relevant for the question of whether such industry specifics are appropriately reflected by the OECD Report on Amount B.

In practice, the transactional net margin method (TNMM) is often considered the most appropriate method to determine arm’s-length product prices for the intercompany sale of products to the local pharmaceutical distribution entity such that arm’s-length prices are determined by reference to appropriate operating profit margins generated at the local level.

When applying the TNMM by means of benchmarking analyses, a typical challenge is that the number of comparable companies is limited. Generally, unrelated pharmaceutical distributors perform a comparable distribution function; they physically transport pharmaceuticals to hospitals, doctors, and pharmacies, and perform the related logistics and warehousing activities. However, in some cases it could also be relevant to control for significant marketing activities at the level of comparable companies.

It should therefore be ensured that benchmarking studies for distribution activities should lead to ranges of operating profit margins that also entail an appropriate profit element for marketing activities performed by local distribution entities, if applicable. As such, suitable adjustment calculations could be required to account for an additional return for such marketing functions (see the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022; e.g., note 1.39).

To account for the challenges when benchmarking pharmaceutical distributors as explained above, the so-called synthetic approach to determine the arm’s-length remuneration of local distribution entities for prescription-only, patent-protected products is sometimes applied.

According to this approach, in a first step, the arm’s-length operating profit margin for pure distribution and sales activities is determined by means of a distribution benchmark study for wholesale pharmaceutical activities. In a second step, a service benchmarking study is performed to reflect the marketing functions at the level of the local pharmaceutical distribution entity.

As described above, pharmaceutical marketing is characterised by sales personnel informing and educating the medical community; activities largely bound by an overarching marketing strategy developed centrally. In particular, typically no significant local marketing IP is generated in performing such activities. As such, local pharmaceutical marketing activities could be considered as service activities, often performed to the benefit of the group parent company. The related profit element could therefore be determined by means of a service benchmarking study, determining arm’s-length net cost-plus markups.

In a subsequent step, the net cost-plus markup resulting from this service benchmarking study is converted into a company-specific operating profit element by multiplication of the net cost-plus markup by the ratio of marketing costs to revenues at the level of the tested party. This company-specific operating profit margin element is added to the operating profit margin for distribution activities obtained in the first step to determine a combined appropriate return for the functions performed by the local pharmaceutical distributor vis-à-vis the group parent company.

Pharmaceutical distributors could generally fall within the scope of application of amount B if the general conditions for application are fulfilled; i.e., if the transactions are qualifying transactions in the sense of paragraphs 10–12 of the OECD Report on Amount B and the scoping criteria laid out in paragraphs 13 and 14 of the OECD Report on Amount B are fulfilled.

In the “Commentary” in section 3.3 of the OECD Report on Amount B, these scoping criteria are further discussed; in particular, with regard to whether a one-sided transfer pricing method could be applied. With potential relevance for the pharmaceutical industry, it is mentioned in paragraph 21 that “a regulatory license that is required to access a market, for example, may be an intangible” and that “[i]n assessing the impact of contributions made to obtain the license, it is important to consider the contributions of both the distributor and other group members”.

Thus, in practice, pharmaceutical companies will have to carefully analyse the functions performed locally versus centrally with respect to obtaining regulatory licences to assess whether the scoping criteria – in particular, the applicability of one-sided methods – are fulfilled such that amount B applies. As a result, uncertainty remains concerning the applicability of amount B for transactions with pharmaceutical distributors that perform regulatory activities.

For these pharmaceutical distributors whose transactions fall within the scope of amount B, the question remains as to what extent the returns provided in the pricing matrix, which are derived from a global data set, appropriately capture the functional profile of pharmaceutical distributors as outlined above. The simplified calculation of the arm's-length return under amount B results from a global database study, where, based on the applied search strategy, companies performing baseline marketing and distribution are identified (see OECD Report on Amount B, Appendix A, and Heidecke and Al-Anaswah, IWB Nr. 10, 2024).

Naturally, this simplified approach does not (and is not intended to) leave room for industry-specific adjustment calculations respectively benchmarking approaches such as the synthetic approach as described above. Therefore, especially for the pharmaceutical subsector, it remains to be seen whether amount B will indeed lead to a targeted reduction of transfer pricing disputes; in particular, if one country applies amount B, but the other country continues to rely on the general arm’s-length analysis.

The medical technology sector is characterised by many companies having business models under which they earn revenues from multiple, complementary offerings.

For medical devices, for instance, revenues may come from selling products and offering services such as maintenance to keep the products working. For diagnostic devices, companies may provide both the testing devices and the necessary reagents/tests.

Profitability may vary significantly between these offerings: selling the device might bring low or no profit, but services are usually profitable. Diagnostic devices can be given for free or rented cheaply, while money is made from selling the reagents and tests.

These characteristics may create challenges for the application of amount B.

According to the OECD Report on Amount B, a qualifying transaction will be out of scope of amount B if “[t]he tested party carries out non-distribution activities in addition to the qualifying transaction, unless the qualifying transaction can be adequately evaluated on a separate basis and can be reliably priced separately from the non-distribution activities” (see paragraph 13).

Moreover, paragraph 34 states: “A tested party may undertake a combination of distribution and non-distribution activities for which it does not establish separate prices, and in practice treats these activities as a bundled transaction. For example, a distributor of products might also provide services that are separate to the distribution transaction, but where it only charges one price for the combined supply of products and services as a bundled transaction. Given that these separate (in this case, distribution and service) activities are not separately transacted for with related or unrelated parties and priced at arm’s length, the distribution activity might not be able to be adequately evaluated separately or reliably priced separately, given the absence of separate revenue streams for the bundled transaction.”

Further relevant guidance can be found in paragraph 37, which states: “One further example of where both adequate separate evaluation and reliable separate pricing is challenging is where an MNE [multinational enterprise] group bundles the provision of goods and services, where it may be difficult to unbundle these activities and consequently quantify the revenue and profits attributable to each activity.”

In practice, for medical technology companies, it may, in principle, be possible to evaluate the profitability of their product and spare parts/reagents/service offerings separately. However, given the complementary nature of the offerings, from an economic perspective, a separate evaluation may not give meaningful results, reflecting that companies may not consider and steer their offerings separately for transfer pricing purposes.

As for the application of amount B, this may lead to distorted results. For instance, consider a distribution entity selling medical devices and providing associated services for these products. Assume that the distribution activities on a standalone basis would fall under the scope of amount B and that they can, in principle, be evaluated separately.

The arrangement with the external customer may be such that selling the medical device up front is not profitable for the group as a whole, whereas the subsequent service business is.

Assume, further, that up until now the arm’s-length nature of the transfer prices applied to the distribution entity has been supported by using the TNMM on a whole-of-entity level.

According to the amount B concept, the distribution entity would receive a (significantly) positive return in line with the matrix of returns for its buy-sell activities. However, the service transaction, due to its nature, would not be covered by the scope of amount B. As a result, a (significantly) higher overall profitability attributed to the distribution entity may result in case the distributor’s profitability from the service business is not, or cannot be, reduced otherwise.

The guidance given by the OECD so far has not explicitly covered such cases of complementary offerings, which, based on the authors’ experience, are the rule rather than an exception for medical technology groups.

In practice, the question of who can determine whether amount B is applicable since, for example, an integrated business model exists will therefore be highly relevant and can be decisive in profit allocation. This is especially true with respect to countries that will implement amount B mandatorily.

The publication of the OECD Report on Amount B left a lot of points open and the recently issued guidance has not (yet) fully clarified these issues. With regard to LSHC companies in particular, a number of questions remain as to whether, or to what extent, the amount B simplification rules apply. This article has highlighted that this may be the case for pharmaceutical distributors due to their potential variety of functions performed and for medical technology distributors because of frequently observed complementary offerings of, for example, products and associated services.

It remains to be seen how the tax authorities will interpret the rules, and taxpayers are advised to carefully document their reasons if they do not consider amount B to be applicable.

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