It's an Amount B World

It’s been more than two months since the OECD’s self-imposed deadline to produce final text for the Pillar One Amount A multilateral agreement, and the organization has seemed to drop the pretense that it’s still just a few details away from completion.

Whatever political divides have prevented it from crossing the finish line seem to be deceptively stubborn, and countries are probably tired of compromising.

That leaves Amount A in limbo. It’s a shame after the amount of work that’s gone into it, but some obstacles cannot be scaled.

But Pillar One is not done for–there’s still Amount B. And not only has that process produced a final product (of a sort), but it’s already having an impact on international taxation around the world, according to practitioners.

It’s just not quite what the designers envisioned, and how it ends up working in practice will be hard to predict.

Amount A and Amount B don’t actually have much in common, despite being part of the same overall Pillar. Their connection is one of political calculation, not policy. While Amount A creates a new taxing right for market jurisdictions based on sales, to potentially capture online transactions made without a physical presence, Amount B’s goal is to massage the existing rules of transfer pricing to assist countries in the pricing of select routine distribution and marketing activities. It’s meant to reduce conflicts between taxpayers and tax authorities on activities that ought to be fairly uncontroversial, by creating a formulaic distribution based on sales, either as a mandatory requirement or a safe harbor.

The formula includes factors such as earnings and return on sales, as well as “operating expense intensity”--the ratio of operating expenses to net revenue. (In this context “net revenue” means total sales minus “any sales returns, allowances, and discounts.”)

This was grouped with Amount A on the logic that this added certainty would give both multinational corporations and developing countries more of a reason to support the overall project. (And whether or not the two should be bound together as a take-it-or-leave-it whole is allegedly the biggest remaining sticking point in the Amount A text.)

In the meantime, though, a final Amount B report released in February has already been added to the OECD’s transfer pricing guidelines. Even if it wasn’t, it would be hard for tax authorities to ignore–this is a new formula for calculating the arm’s-length price of distribution activities, blessed by the global standard-setter.

According to some, it’s already showing up in some competent authority proceedings.

“We’ve started to see that already in some cases, where competent authorities are expressly asking how the Amount B framework would apply in a case, even if there has been no adoption of Amount B on either side,” said Thomas Bettge of KPMG LLP in a recent podcast.

Speaking in the same podcast, Jessie Coleman of KPMG said she expected to see countries apply the formula on an “ad-hoc basis,” even if they don’t formally adopt the policy.

“We have a set of numbers that put out a point for a routine distribution function, and I think it’s going to be hard for taxing authorities not to look to those numbers when they look to benchmark functions that are similar,” Coleman said.

There’s been so much focus on the mandatory-or-not question for Amount B, that the system is already seeping into global taxes has been a bit under-discussed. Whether or not it becomes part of a future global tax treaty–which would mean its principles are added to existing double tax agreements–these concepts could become part of transfer pricing adjustments. (Not to mention, future tax treaty negotiations.)

Presumably, one of the reasons that the U.S. has been so adamant about making Amount B mandatory is that they’re worried countries will only use it when it benefits them. If the formula can increase the amount of the taxable income in the jurisdiction, apply it–if not, then come up with a reason that it’s out of scope, something that still includes a degree of subjective analysis. (Or, they could try the opposite: never use the formula as the first step, but when a result through another method comes in low, ask the taxpayer “why is your result out of sync with the Amount B formula?)

I’m still trying to wrap my head around the implications if Amount B becomes a silent force in transfer pricing, rather than an outright policy or designated safe harbor. Could it potentially lead to more disputes, as not all countries use it?

Another complicating factor is that Amount B is supposed to apply differently for different jurisdictions. There’s an “operating expense cross-check” that only applies for certain jurisdictions, generally low-income and developing countries. There’s also an adjustment for jurisdictions where there may be little data about comparable transactions, also generally applying to developing countries. (Additionally, the Inclusive Framework members agreed to respect Amount B results for low-capacity countries.)

In a formal system, this can make sense, even if it’s somewhat novel. But if Amount B is mostly used in an informal, below-the-radar sense, will these distinctions continue to apply?

And, maybe the biggest question, if countries get used to this kind of calculation, will it spread beyond the activities currently designated for Amount B? The lines of the new policy are fairly well-defined, but one of the unspoken ideas behind the project is that if countries get acclimated to it, they may be willing to look at where else it could apply. Businesses hope it could apply to intangible products as well as tangible ones, or services. It’s not a replacement for the truly sticky issues in international taxes, which can’t be defined as “routine,” but it could end up becoming the grease that will make the rest of the system run more smoothly.

Or, it could gum up the works even more.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

A message from Exactera:

At Exactera, we believe that tax compliance is more than just obligatory documentation. Approached strategically, compliance can be an ongoing tool that reveals valuable insights about a business’ performance. Our AI-driven transfer pricing software, revolutionary income tax provision solution, and R&D tax credit services empower tax professionals to go beyond mere data gathering and number crunching. Our analytics show a company’s tax position impacts the bottom line. Tax departments that embrace our technology become a value-added part of the business. At Exactera, we turn tax data into business intelligence. Unleash the power of compliance. See how at exactera.com.

Sign up for the Emperor Subscription

Thanks for reading! Don’t forget, you can sign up here for a paid Emperor Subscription, to get extra bonus content, including interviews with newsmakers in the tax field and deep dives on various international tax topics.

The Emperor Subscription will also give you access to past content, such as interviews with former OECD tax chief Pascal Saint-Amans, Tax Foundation CEO Daniel Bunn, and former U.S. Treasury official Jason Yen.

On Friday I talk to Zach Moller, an economics and budget expert and director of Third Way's economic program. We discuss how corporate taxes play into the 2024 presidential race and the 2025 expected tax overhaul.

The transactions are handled by Stripe, a safe and secure payment processing platform. Electronic receipt and invoice available. (If anyone has any difficulties subscribing, please let me know.)

You can sign up here for $8/month or an $80 annual payment. Please consider subscribing!

LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• I'm writing this shortly after the first (and maybe only) presidential debate between former President Donald Trump and Vice President Kamala Harris. The two didn't shy away from tax policy, sparring over issues like the Democratic proposal to expand the child tax credit and the 2017 Tax Cuts and Jobs Act. Corporate tax policy got less attention, and there was virtually nothing on international--unless you count Trump's proposal to enact drastic tariffs on imports from China and the rest of the world. While the former president has long championed stronger protectionist policies--it's maybe one of the few issues he seems to have real convictions on--he's increasingly pitching it as a revenue measure, rather than a way to bolster domestic production. Last night, he said that due to his proposed tariffs "other countries are going to finally, after 75 years, pay us back for all that we've done for the world." Of course, most experts vehemently dispute the notion that it would bring in trillions of dollars in revenue without harming American consumers. (It's true that tariffs were the U.S. government's primary revenue source for most of the 19th century--but the government looked a lot different back then!) On the other hand, he had a point when he noted that the Biden Administration has retained many of the tariffs that he put into place from 2017-2020. Both parties have become more protectionist in the past decade and that's a trend that will probably continue no matter who wins in November. The lines between tax and trade policy have become blurry, as I've written in the past, and it's something we international tax folks are going to have to wrap our heads around.
• In a bit of a blast from the past, the Court of Justice of the European Union caught many off-guard by ruling against Ireland and Apple Inc. in a decision released Tuesday, claiming that an arrangement sanctioned by the country’s tax authority from 1991 to 2014 constituted illegal state aid. The EU’s state aid investigations have lost some of their notoriety–in part because of some losses in court, and in part because the TCJA’s 2017 deemed repatriation took back much of the disputed income from Europe, making the whole thing seem less consequential. This decision could re-ignite some interest if it means that other cases could move forward. The U.S. has adamantly opposed the proceedings while it has been praised by tax justice advocates on both sides of the Atlantic. To me, what was always most interesting about it was how it pitted national sovereignty over taxes with the European Union’s mandate to create a single economy without distortions–getting to the heart of the question, just what does the EU want to be? This should be an interesting area to follow.
• Last week, U.S. Secretary of the Treasury Janet Yellen announced that the Treasury Department had raised nearly $1.3 billion in new tax revenue from two initiatives to hike enforcement on high-wealth taxpayers, through funding from the 2022 Inflation Reduction Act. The two initiatives targeted taxpayers who neglected to file returns for several years, and taxpayers who have not paid recognized tax debt. While the announcement didn't mention international issues in particular, these cases often involve foreign taxpayers or taxpayers with significant overseas assets.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Every week, a new character from the Golden Age of Superheroes who's fallen out of use.

The Hood, first appearing in Cat-Man Comics #5 in 1941. A renegade FBI agent who decided he needed to take justice into his own hands, The Hood doesn't have superpowers but he does have a skin-tight yellow body-suit and inconvenient-looking blue hood/cape. Later in the U.S. Army, his rank/name seems to change by issue.

Contact the author at amparkerdc@gmail.com.