The Guidance is intended to ease the compliance burden, particularly for low-capacity jurisdictions with limited resources. This is done by laying down a pricing framework to determine a return on sales (ROS) for in-scope distributors, without requiring the performance of an economic benchmark study.
Notably, amount B will apply to the following ‘qualifying transactions’:
Hence, entities engaged in providing services or intangible goods (including software), are excluded from the scope. However, up to 20 percent of retail sales are permissible for an entity to still qualify as wholesale distributor.
The Guidance presupposes that the transactional net margin method (TNMM), with ROS as a net profit indicator, is the most appropriate method. Whereas this is the de facto standard for distribution models in practice, this presumption helps to limit the extent to which a distributor can contribute intangible assets and assume economically significant risks in the context of the business. As such, this requirement ensures that the application of the simplified and streamlined approach is limited to routine distribution activities.
The Guidance contains a matrix of operating margins (as depicted below). The applicable percentage depends on a three-step process. Starting with identifying the applicable industry grouping for the tested party.
The second step involves the determination of the operational intensity in which a company operates. This is expressed as the ratio of operational expenses to revenues and operating assets to revenues.
In the final step, the pricing matrix percentage is established based on the intersection of the outcomes from steps one and two. Notably, the outcome for the distributor is deemed to be at arm’s length when its operating margin falls within a bandwidth of 0.5 percent point above or below this percentage.
| Industry Grouping | Industry Grouping 1 | Industry Grouping 2 | Industry Grouping 3 |
| Factor Intensity | |||
| [A}] High OAS / Any OES >45% / any level | 3.50% | 5.00% | 5.50% |
| [B] Med/high OAS / any OES 30% - 44.99% / any level | 3.00% | 3.75% | 4.50% |
| [C] Med Low OAS / any OES 15% - 29.99% / any level | 2.50% | 3.00% | 4.50% |
| [D] Low OAS / non-low OES <15% / 10% or higher | 1.75% | 2.00% | 3.00% |
| [E] Low OAS / low OES <15% OAS / <10% OES | 1.50% | 1.75% | 2.25% |
Further, once the right percentage has been determined, two corrections may be applied depending on the level of operating assets; There may be an upward or downward correction if the revenues are deemed excessive in view of the operating assets. Furthermore, a correction may be applied based on the security of investment in the country at hand, assessed based on sovereign creditworthiness ratings.
We applaud this effort by the OECD to provide certainty and simplicity to tax administrations and taxpayers.
Currently, jurisdictions have the option to adopt the Guidance as of the 1st of January 2025. The Guidance may be implemented as an optional or as a mandatory regime for taxpayers. Hence, the success of this legislative endeavor may be tied to sufficient jurisdictions opting to (mandatorily) implement the Guidance. In this regard, it may be beneficial for the OECD to clarify the definition of the term "low-capacity jurisdiction". This would enable the jurisdictions to assess and communicate their intention regarding the ratification of the Guidance at the earliest.
The Guidance allows up to 20 percent of retail activities to remain within the scope of the simplified and streamlined approach. However, any sales of commodities or services require separate analysis, to limit the ‘misuse’ of this Guidance.
However, based on our experience, companies (especially smaller companies that would stand to benefit the most from the implementation of this Guidance) often require more flexibility in their operational scope. As such, it may be worthwhile for the OECD to consider the inclusion of a tolerance for a modest amount of services. Particularly for those that are in line with the goods sold, such as installation, repair, or other after-sales services, as well as a tolerance for a de minimis sale of commodities.
The present scope of the Guidance is limited to companies that buy from affiliates and sell to third parties. To that end, the scope may also be expanded to include routine entities buying from third-party contract manufacturers, which are functionally overseen by affiliates.
Notably, the members of the Inclusive Framework have indicated that an operating margin between 1.50 percent and 5.50 percent may be considered to approach an arm’s length outcome. Accordingly, it would be interesting to see the extent to which this Guidance has reflective value, as the outcomes in line with this Guidance may be met with resistance in jurisdictions that do not formally adopt the Guidance.
Taxpayers are advised to evaluate the impact on their existing profit margins by applying the aforementioned three-step procedure for transactions that fall within the qualifying scope. Would you like further information?
