The wholesale and retail industry continues to stand on the brink of a paradigm shift, largely influenced by critical factors such as digitalisation-driven new pricing strategies and targeted marketing, AI-induced personalised shopping experiences, and robust online marketplace platforms. Simultaneously, multinational firms in the wholesale and retail industry are grappling with numerous disruptive social, economic, and legislative forces such as inflation, shifting consumer preferences towards sustainable products, a shrinking labour force, and regulatory obligations such as carbon border taxes and the German Supply Chain Act.
Consequently, multinational firms in the wholesale and retail industry increasingly find themselves at a crossroads where they must navigate challenges to remain profitable and at the same time invest in new technology and business models to keep pace with rapid digitalisation and competition (see Deloitte’s 2024 US Retail Industry Outlook).
As competition in the retail sector is fierce, distributors are always on the lookout for new ways to engage customers and increase profitability. With the advancement of AI in the retail space, firms have been enabled to offer tailored experiences to consumers through AI-supported algorithms that use browsing histories, shopping patterns, consumer ratings, and preferences to make personalised recommendations, and through tools such as virtual try-ons and 24/7 AI chatbots providing customer service.
Since the application of AI and digital technology has expanded to enrich the in-person retail experience of consumers, multinational firms active as retailers are increasingly spending on smart displays, interactive signage, augmented reality, and virtual reality product trials (see Deloitte’s Future of the Store).
As digital transformation continues, growing geopolitical challenges increasingly put a strain on multinational firms in the consumer goods industry as they expose vulnerabilities in supply chains. As a consequence, firms in the wholesale and retail industry are concentrating on supply chain diversification and aiming to reduce their dependence on suppliers and consumers in certain regions, while improving supply chain efficiency to minimise vulnerabilities (see Deloitte’s 2024 US Retail Industry Outlook).
As multinational enterprises deal with these challenges, it becomes crucial for tax departments that their transfer pricing systems allow them to steer through these difficult periods. Therefore, this article considers amount B, its possible impact on the profit allocation of companies operating in the wholesale and retail distribution sector, and the question of its effectiveness in addressing these challenges.
Arm’s-length remunerations of distribution activities: a key source for dispute
Being an essential part of value chains within the wholesale and retail industry, sales entities have always been in the spotlight of tax authorities’ attention. Considering the industry trends outlined above, tax authorities around the globe increasingly take the view that the value contribution of sales activities is changing, potentially with new intangibles being created by the sales entities, making an adjustment of applicable remuneration necessary.
This assessment adds another layer to the debate around the characterisation of sales and marketing activities and the appropriate profit level attributable to these activities. In practice, this debate is fiercely led by tax practitioners and tax authorities, resulting in sometimes long-lasting and cost-intensive tax audit processes.
In practice – especially with regard to routine sales support activities, such as sales and marketing services, agent activities, and commissionaire activities – tax authorities often challenge the appropriateness of the transfer pricing method. Often, such activities are remunerated on a cost-plus basis, whereas in the context of tax audits, tax authorities view revenue-based methods as most appropriate. These tax audits might entail lengthy fact-finding processes, including interviews with key sales and marketing personnel, to defend the cost-based remuneration.
As regards the markup, although some tax authorities have expressed their view that sales, marketing, and distribution activities go beyond low-value-adding services, due to the lack of unambiguous guidance, the likelihood of disputes remains high.
Similar disputes may arise in tax audits of typical sales entities, whose functional and risk profiles go beyond those of a sales and marketing services provider without being fully entrepreneurial; e.g., limited risk distributors. While such activities are usually remunerated using a revenue-based transfer pricing method, disputes in tax audits may arise from a discussion around the creation of (non-routine) marketing intangibles through these sales entities.
Disputes may also arise for a third group of sales entities, whose functional and risk profiles qualify as entrepreneurial or strategic in nature. Disputes may concern the identification and qualification of the significant value contributions of such sales entities to the overall value chain, and whether a two-sided transfer pricing method should be applied.
In light of the above, in-house transfer pricing teams are evaluating potential opportunities for an increased level of tax certainty that might come along with the implementation and application of amount B into transfer pricing regulations.
Global regulatory developments that led to amount B
In a report issued in October 2020, the OECD announced its intention to introduce amount B, a simplified and streamlined approach to setting transfer prices for baseline marketing and distribution activities to enhance tax certainty and to relieve compliance burdens for taxpayers and tax administrations alike, particularly those in low-capacity jurisdictions facing limited resources.
Amount B was initially part of pillar one, which, in turn, is part of the OECD’s two-pillar approach. Pillar one specifies that enterprises with an annual profit surpassing €20 billion and a profitability of above 10% must pay a portion of their taxes in jurisdictions where consumers and users are located, as opposed to those in which the legal entities reside. Amount B represents a margin that is applied as a remuneration for routine marketing and distribution activities.
While the implementation of pillar one is unclear, amount B was further developed and a final report was issued by the OECD in February 2024. The guidance on amount B will be incorporated into the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022 as an Annex to Chapter IV ("Special considerations for baseline distribution activities”). Thus, the implementation of amount B is independent of pillar one, and the size and profitability of enterprises.
Jurisdictions have three options to implement the approach on a discretionary basis from January 1 2025: no implementation, mandatory application, or optional application, the latter implying that amount B would become a safe harbour rule similar to the OECD’s simplified approach for low-value-adding services. In any case, there is no binding effect on the jurisdiction of the counterparty to a transaction. The exception is if one of the jurisdictions involved is considered a covered jurisdiction; in which case, even the jurisdiction that chose not to implement amount B would still need to adhere to the guidance if a bilateral tax treaty is in place.
Overview of amount B’s mechanism
Amount B targets transactions in which one side, the distributor, performs baseline – or routine – marketing and distribution activities. The OECD defined several exclusion criteria (see the OECD report dated February 19 2024, Pillar One – Amount B: Inclusive Framework on BEPS, for a detailed description of all the exclusion criteria). The distributor needs to be involved in the wholesale of goods and act as a buy-sell entity, sales agent, or commissionaire. Distributors with average net retail revenues – i.e., revenues with end consumers exceeding 20% – are not in scope of amount B. Furthermore, only transactions that can be reliably priced using a one-sided method and in which the tested party is the distributor are in scope of amount B.
This implies, among others, that the distributor may not contribute unique and valuable intangibles and may not assume significant risks. Furthermore, distributors with very low or very high operating expenses as a share of revenue are excluded. Lastly, if the distributor performs activities not related to the transaction in scope, these other activities need to be clearly separated.
If a transaction falls in the scope of amount B, the distributor should earn a stylised operating margin (defined by the OECD as EBIT divided by revenues) specified by the OECD in the pricing matrix. The acceptable operating margin depends firstly on the industry and secondly on the factor intensity (operating assets and operating expenses).
Of special relevance for the consumer industry are the first and second industry groupings covering industries such as perishable foods, household consumables, cosmetics, consumer electronics, and a broad variety of consumer goods. For example, if a distributor sells groceries (industry group one), has a low operating asset intensity score (the ratio of net operating assets to net revenue, or OAS), and a low operating expense intensity score (the ratio of operating expenses to net revenue), the distributor should earn an operating margin of 1.5%, accepting a deviation of +/- 0.5%. Similarly, if a distributor sells industrial machinery (industry group three) and has a high operating asset intensity, the distributor should earn an operating margin of 5.5%, accepting a deviation of +/- 0.5%.
Next to the pricing matrix, two additional steps are required. The first step is a cross-check of the resulting return on operating expenses. The acceptable ratio of EBIT to operating expenses lies between 10% (collar rate) and cap rates depending on the operating asset intensity and the jurisdiction involved. The cap rates vary between 40% (low OAS) and 80% (high OAS and qualifying jurisdiction). If the actual return lies below the collar rate or above the cap rate, the operating margin needs to be adjusted. The cross-check and the method is similar to the Berry ratio, which was often used for low-profile distribution activities but has become less prevalent over the past few years. The second step is a risk adjustment to the operating margins depending on the distributor’s jurisdiction.
Effectiveness of amount B in assisting the wholesale and retail industry
While amount B theoretically seems to be a simplification and less expensive method of pricing baseline marketing and distribution activities, several challenges may arise in practice.
In the consumer industry, distributors often perform both wholesale and retail activities. If the retail sector represents more than 20% of revenues, a segmentation of the distributor’s profit and loss statement and the balance sheet will be needed to calculate the relevant margins and ratios. This is also the case if the distributor, apart from selling tangible goods, performs services; e.g., after-sales services. Segmentation of financials is often a key challenge for companies and this criterion consequently creates an additional burden for the industry.
Distributors in the consumer industry often perform substantial marketing activities, and, as such, may be out of scope of the simplified approach due to having operating expenses that are too high. Consequently, for each distributor within a group, an annual analysis is needed to assess whether the respective distributor is in scope of amount B. If the answer is no, a separate economic analysis – e.g., based on a database – would be required.
There may be situations in which companies currently apply operating margins based on database searches, the results of which may differ from the OECD’s pricing matrix. This could lead to the following scenarios for a group:
Scenario one – distributors within scope of the simplified approach and in a jurisdiction that implemented amount B on a mandatory basis need to earn different operating margins due to each distributor’s different factor intensity (stage one), operating expense ratio (stage two), and jurisdiction (stage three); or
Scenario two – distributors not in scope of the simplified approach or in a jurisdiction that did not implement amount B need to perform separate economic analyses, which may lead to operating margins different from those in the OECD’s pricing matrix.
Both scenarios create a challenge for the group from an operational transfer pricing perspective, as both types of distributors need to be monitored and steered separately.
Summarising the above, although amount B provides for opportunities to effectively address some of the challenges the consumer goods industry is facing, the implementation and processing of amount B principles triggers various questions on the ‘how’. As a significant level of uncertainty remains, tax departments are well advised to analyse the potential impact on their companies well ahead of January 1 2025.
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