Pillar One - Amount B

3. Transactions in scope

3.1. Qualifying transactions

1. The following controlled transactions are qualifying transactions for the simplified and streamlined approach:

a) Buy-sell marketing and distribution transactions where the distributor purchases goods from one or more associated enterprises for wholesale distribution to unrelated parties; and

b) Sales agency and commissionaire transactions where the sales agent or commissionaire contributes to one or more associated enterprises’ wholesale distribution of goods to unrelated parties.1

2. An accurate delineation of the qualifying transaction should be undertaken in accordance with Chapter I of these Guidelines, considering all five comparability factors and the economically relevant characteristics of the transaction, prior to the application of the scoping criteria.2 A qualifying transaction, as accurately delineated, will be subject to the simplified and streamlined approach when it satisfies the scoping criteria in Section 3.2. Consequently, the information obtained in the accurate delineation of the transaction is to be used to assess whether each of the scoping criteria has been met in order to determine whether a transaction will be subject to the simplified and streamlined approach.

3. The determination of whether a qualifying transaction is within scope is not driven by the adoption of specific labels, but primarily by the functions performed, assets used, and risks assumed by the parties to the qualifying transaction. While this guidance does not attempt to provide an exhaustive list of baseline marketing and distribution activities, it recognises that distributors should perform a set of core distribution functions in relation to in-scope transactions.

3.2. Scoping criteria

4. For a qualifying transaction to be in-scope of the simplified and streamlined approach:

a) The qualifying transaction must exhibit economically relevant characteristics that mean it can be reliably priced using a one-sided transfer pricing method, with the distributor, sales agent or commissionaire being the tested party.3

b) The tested party in the qualifying transaction must not incur annual operating expenses lower than 3% or greater than an upper bound of between 20% and 30% of the tested party’s annual net revenues.4 5

5. For qualifying transactions that do not fall out of scope of the simplified and streamlined approach under paragraph 13, a qualifying transaction will nevertheless be out of scope if:

1. The qualifying transaction involves the distribution of non-tangible goods, services or the marketing, trading, or distribution of commodities; or

2. The 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.6 7

3.3. Commentary

6. This sub-section seeks to clarify and illustrate the application of the scoping criteria to qualifying transactions.

3.3.1. Scoping criterion 13.a - The qualifying transaction must exhibit economically relevant characteristics that mean it can be reliably priced using a one-sided method, with the distributor being the tested party

7. Scoping criterion 13.a limits the application of the simplified and streamlined approach to the set of transactions that can be reliably priced using a one-sided method, with the distributor being the tested party.

8. In evaluating whether a qualifying transaction may be within the scope, determining that a two-sided transfer pricing method should not apply is particularly important. Consequently, the first scoping criterion establishes that any in-scope distributor must exhibit economically relevant characteristics such that the qualifying transaction can be reliably priced using a one sided-method. Section 4 provides that the transactional net margin method is chosen as the most appropriate method to price in-scope transactions under the simplified and streamlined approach, with an exception where the CUP method using internal comparables can be reliably applied and the necessary information is readily available to tax administrations and taxpayers.

9. Chapter II, Part III, Section C.2.2 outlines three key economically relevant characteristics of qualifying transactions that indicate that a one-sided transfer pricing method may not be suitable to apply to establish arm’s length conditions for a qualifying transaction. These should be applied to evaluate whether a qualifying transaction is suitable for the simplified and streamlined approach. The first is where the contributions of each party to the qualifying transaction are “unique and valuable”, including contributions of unique and valuable intangibles (C.2.2.1).8 The second is where the distributor and its counterparties carry out functions, use assets and assume risks in the qualifying transaction with such a degree of integration that their contributions cannot reliably be evaluated in isolation from each other (C.2.2.2). The third is where the distributor and its counterparties share the assumption of one or more economically significant risks to the transaction, or where the various economically significant risks in relation to the transaction are separately assumed by the parties, but those risks are so closely inter-related and/or correlated that the playing out of the risks of each party cannot reliably be isolated (C.2.2.3).

10. The existing examples 1 - 4 in Annex II to Chapter II of these Guidelines provide useful information with respect to the practical application of this scoping criterion.

11. Depending on the accurate delineation of the qualifying transaction, unique and valuable contributions made by a distributor may include, but are not limited to, contributions to the development, enhancement, maintenance, protection, and exploitation of any intangibles that are themselves unique and valuable in the context of the qualifying transaction. Further guidance on the ownership of, and functions, assets, and risks related to intangibles may be found in Chapter VI, Sections B.1 and B.2 of these Guidelines, together with the framework in paragraph 6.34 to be applied for analysing transactions involving intangibles. Moreover, some examples of contributions that may be important are contained in paragraph 6.56 of these Guidelines.9 Unique and valuable contributions of this nature are equally applicable to evaluate intangibles that are self-generated or acquired by a distributor.

12. Another source of guidance that may be relevant in identifying unique and valuable contributions in the accurate delineation of the qualifying transaction is noted in paragraphs 1.169 – 1.171 of these Guidelines. This guidance notes that in certain circumstances, a regulatory license that is required to access a market, for example, may be an intangible whose value in the context of the particular transaction will depend upon several factors, including whether the license is readily available and whether it has the effect of restricting the number of competitors in the market. In 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 in supplying the capabilities necessary to obtain the license. Chapter VI, Section B, including paragraph 6.34, should be considered and applied in assessing these functions and whether they constitute a unique and valuable contribution.

3.3.2. Scoping criterion 13.b – quantitative filter

13. After the application of scoping criterion 13.a, scoping criterion 13.b acts to exclude qualifying transactions from the scope of the simplified and streamlined approach using quantitative filters.

14. These quantitative filters provide a simplified mechanism for the assessment of whether a tested party is in scope, in conjunction with the other scoping criteria.10 The upper bound, for example, acts as a proxy to exclude qualifying transactions from scope where the ratio of operating expenses to sales might indicate that additional functions are performed, suggesting that the pricing methodology of Section 5 of this guidance would have reduced reliability in practice. Consequently, the quantitative filter is applied so that the pricing methodology of Section 5 of this guidance may reliably be applied to establish arm’s length prices for qualifying transactions.

Calculating the quantitative filters in 13.b

15. Given that the values of both operating expenses and net revenues will vary over time, this will inevitably entail certain distributors moving in and out of scope. In order to make qualification for scope more consistent, the calculation of the ratio provided above should be based on a three-year weighted average. The three-year weighted average ratio should be calculated on a year-on-year basis for the purposes of determining whether a qualifying transaction is in-scope. For example, for a qualifying transaction in fiscal year x, the three-year weighted average ratio would be derived by (A) taking the sum of the annual operating expenses for years x-3, x-2, and x-1, then (B) taking the sum of the annual net revenues over the same period, and then dividing (A) by (B) to derive the appropriate percentage.11 12 Where the qualifying transaction has been in place for two years, a two-year weighted average ratio should be used, and where the qualifying transaction has been in place for only one year the ratio should be calculated based on the financial results for that year.

3.3.3. Scoping criterion 14.a – Non-tangible goods and services exclusion and commodities exclusion

Non-tangible goods and services

16. The simplified and streamlined approach applies to tangible goods and does not capture the distribution and marketing of non-tangible goods or services. The simplified and streamlined approach applies to qualifying transactions involving the distribution of tangible goods for which there is broad consistency in the overall supply chain and functional analysis.

Commodities

17. Qualifying transactions involving the trading, marketing or distribution of commodities are excluded from scope. This sub-section articulates the breadth of the exemption and defines the relevant commodities, both using a general principle and listing some specific commodities as examples.

18. The general principle is that the exclusion is broad in nature and encompasses transactions involving the trading, marketing, or distribution of products of a commodity nature, whether or not they have a quoted price, and includes transactions where the commodity has undergone qualifying processing. For the purposes of the simplified and streamlined approach, a commodity may be any of the following:

1. A renewable or non-renewable physical product that is primarily derived from the earth’s crust, land or water. These renewable or non-renewable physical products can be manifested in a solid, liquid or gas state and take various forms such as a hydrocarbon, mineral, mineraloid and agricultural product.

2. A renewable or non-renewable physical product that has undergone qualifying processing.

3. A product that is in accordance with the definition of a commodity provided for in paragraph 2.18 of these Guidelines.

19. The definitions of a hydrocarbon, mineral, mineraloid and agricultural commodity are:

4. Hydrocarbon means any organic compound consisting predominantly of carbon and hydrogen molecules that is in solid, liquid or gaseous form occurring naturally in or on the earth or in the seabed or sub-soil and which was formed by or subjected to a geological process and includes but not limited to crude oil, oil sands, heavy oils and natural gas occurring in a subsurface oil and gas reservoir, deposit, or in a stockpile.

5. Mineral means any inorganic substance that exhibits crystalline characteristics, in solid form, occurring naturally in or on the earth’s crust or in or under water and which was formed by or subjected to a geological process, and includes but not limited to clay, gems, gravel, metal, ore, rock, sand, soil, stone, salt and any such substance occurring in an ore body, ore deposit, or in a stockpile or tailings.

6. Mineraloid means any substance that does not exhibit crystalline characteristics whether in solid, liquid, or gaseous form, occurring naturally in or on the earth or in or under water and which was formed by or subjected to a geological process, and includes but is not limited to amber, coal, obsidian and opals, and any such substance occurring in an ore body, ore deposit, or in a stockpile or tailings.

7. Agricultural means any primary product, raw or processed, that is marketed for consumption and includes but is not limited to animal biproducts such as dairy or fibre, livestock, grains, coffee, tea, fishery, forestry, fruit, and vegetables.

20. The term “qualifying processing” means processing undertaken to bond, concentrate, isolate, purify, refine, blend, separate, raise, harvest, produce or liberate a hydrocarbon, mineral, mineraloids or agricultural product. It includes the processing undertaken to produce all intermediate products obtained from a hydrocarbon, mineral, mineraloids or agricultural product up to and including the following non-exhaustive list of products:

liquefied natural gas, liquefied petroleum gas and other natural gas liquids, diesel, kerosene, gasoline, and hydrogen.

metal oxides, metal hydroxides, anodes, cathodes, cast metals, aluminium, and alloys.

cattle, poultry, swine, sheep, goat, wheat, milk powder, cotton, maize, barley, rice, soybeans, cocoa, corn.

21. To provide additional clarity to the commodity product-based exclusion, a non-exhaustive list of examples of excluded commodities is provided here. Common examples of metals include aluminium, copper, nickel, iron, tin, gold, lead, platinum group metals, silver, manganese, cobalt, molybdenum, lithium carbonate/hydroxide, boric acid, titanium, uranium, and zinc, as well as metal oxides and metal hydroxides. Examples of an anode include copper and graphite anodes. Examples of cathodes are copper, cobalt and nickel cathodes. Common examples of oil and gas products include crude oil, oil sands, heavy oils, natural gas, naphtha, liquefied natural gas, liquefied petroleum gas and other natural gas liquids, diesel, kerosene, gasoline, and hydrogen. Common examples of agricultural products include livestock such as cattle, poultry, swine, sheep, goats, soft commodities such as wheat, cotton, maize, oats, barley, rice, soybeans, cocoa sugar, corn, coffee, and fishery, forestry, fruit, and vegetables.

22. The products listed are typically in the final step of the production process and it is possible that an MNE Group could also sell products that are in an earlier form to this stage i.e. intermediate products. To the extent that intermediate products fulfil the earlier definitions, they would still be captured under the commodity product-based exclusion.

3.3.4. Scoping criterion 14. b - Non-distribution activities separate from the qualifying transaction

23. Distributors that engage in qualifying transactions sometimes engage in non-distribution activities. Where such a tested party performs non-distribution activities, the qualifying transaction may only remain in scope where, based on an accurate delineation of the transaction, it can be adequately evaluated on a separate basis to any non-distribution transactions, and it can be reliably priced separately from any non-distribution transactions under the principles of paragraphs 3.9 – 3.12 of these Guidelines. Illustrations of the application of paragraphs 3.9 – 3.12 in the context of the simplified and streamlined approach are provided in paragraphs 35 to 37.

24. Examples of non-distribution activities include manufacturing, research and development, procurement, financing, or retail distribution performed above the de minimis threshold considered in the Definitions to this guidance. Objective measurements might be used to determine whether the distributor performs these activities. For example,

for manufacturing, the existence of manufacturing inventory (direct labour and/or work-in-process inventory) and/or the existence of manufacturing assets (e.g., property, plant, equipment);

for research and development, the incurrence of research and development expenses, even if reimbursed;

for procurement, the existence of procurement commission income;

for financing, the existence of loan assets on the balance sheet; and

for retail, the sales profile of the distributor (for example, evidence of the sales channels of the distributor and extent of sales made to retail customers), or the holding or leasing of retail storefront property.

25. 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 services) 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. Examples of situations where adequate separate evaluation and reliable separate pricing may be challenging are provided in the subsequent sub-section.

Illustrations of where evaluation of the distribution transaction on a separate basis may be inadequate, or pricing on a separate basis may be unreliable

26. Paragraphs 3.9 – 3.12 of these Guidelines provide examples where transactions are so closely linked or continuous such that they cannot be adequately evaluated on a separate basis. Some examples applied to the context of the simplified and streamlined approach are provided below.

27. Assume that a distributor contributes to the development of manufacturing patents for products that are unrelated to the products distributed. The qualifying transaction would remain in scope provided that the revenues, direct and indirect costs, and assets relevant to the development of the patents can be reliably separated, whether they are attributed or apportioned, from the qualifying transaction so that any remaining revenues, direct and indirect costs, or assets are relevant only to the qualifying distribution transaction.

28. One further example of where both adequate separate evaluation and reliable separate pricing is challenging is where an MNE 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. One example of this is where a distributor provides consumer financing (for example, materially deferred payment terms or financing directly related to the sales of products) alongside the sale of tangible goods. In such situations, separating out the financial results relating to the distribution of tangible goods from the financing could be challenging.13

Guidance relating to the practical allocation of revenues, costs, assets, and liabilities to the distribution activities.

29. Paragraphs 2.83, 2.84, 2.85, 2.86, 2.91 and 2.98, and Sections B.2.2.2 and B.2.3 of Chapter VII provide for the general principles relating to the allocation of revenues, costs, assets, and liabilities with respect to a distribution transaction and other transactions. An allocation of assets for the purposes of pricing the in scope qualifying transaction should follow this guidance and the underlying principles, even where assets may not be specifically mentioned in the guidance.

30. Tax administrations will require various information to assess the reliability of the allocation or apportionment of revenues, costs, assets, and liabilities, and taxpayers should prepare that information under the documentation requirements considered in Section 6. In particular, tax administrations may need to evaluate internal financial reporting, the organisation chart of the entity and the management structure of the entity, over several fiscal years. Tax administrations may also need to review whether the allocation or apportionment of revenues, costs, assets, and liabilities has been performed consistently.

Notes

← 1.  The associated enterprise that engages the sales agent or commissionaire, and which is the counterparty to the sales agent or commissionaire in the potentially qualifying transaction, must sell the goods directly to unrelated parties, i.e. without either it or the sales agent or commissionaire engaging other related parties as intermediaries between it and the unrelated party customers.

← 2.  Refer also to paragraph 1.34 of these Guidelines, which should be taken into account when applying the simplified and streamlined approach.

← 3.  See 2.4, 2.65, 2.66, 2.126, 3.18 and 3.19. Moreover, see Chapter II, Part III, Section B for a discussion regarding the set of economically relevant circumstances under which the transactional net margin method is the most appropriate method. Section 4 of this guidance provides additional discussion on this issue in the context of determination of arm’s length returns under the simplified and streamlined approach.

← 4.  Where the commissionaire or sales agent is not the entity making the sale, the sales of the counterparty of the commissionaire or sales agent (i.e., whichever entity makes the sale to the third-party customer) will be utilised to compute the ratio of operating expenses to sales; however, the net operating expenses of the commissionaire or sales agent are always the sole item included in the numerator of the ratios.

← 5.  Jurisdictions that choose to implement the simplified and streamlined approach will specify the upper bound to apply to this scoping criterion when it is originally implemented, which will be not lower than 20% and not higher than 30%.

← 6.  See paragraphs 3.9 - 3.12 of these Guidelines.

← 7.  Where a tested party in a qualifying transaction carries out non-distribution activities such that scoping criterion 14.b is required to be evaluated, the calculation of any ratios required either to determine whether that qualifying transaction is in scope, or any other ratios that are necessary in the context of the evaluation of the qualifying transaction in this guidance, should be undertaken with regard to the revenues, expenses or assets relevant to the qualifying transaction only.

← 8.  See Glossary, and paragraphs 2.126, 2.130, and 2.131-2.132. This criterion specifically applies to any situation where the contributions of the distributor to the qualifying transaction are unique and valuable.

← 9.  The examples in 6.56 are, for the purposes of the simplified and streamlined approach, of an illustrative nature, and any conclusion that such contributions are unique and valuable should be based on the accurate delineation of the qualifying transaction. Based on the examples provided in 6.56, contributions that may be unique and valuable in the context of qualifying transactions may include the design and control of marketing programmes, the direction of and establishing priorities for creative undertakings relating to the marketing of the products distributed, the control over strategic decisions regarding development programmes for marketing intangibles, or the management and control of associated budgets. Other relevant contributions may also include important decisions regarding the defence and protection of marketing intangibles, such as trademarks or trade names, and important decisions regarding ongoing quality control over functions performed by independent or associated enterprises that may have a material effect on the value of the marketing intangible under consideration.

← 10.  Quantitative scoping filters are used in the context of the simplified and streamlined approach as a simplification measure and do not provide any definitive indication of what functions are performed or the characterisation for distributors that fall out of scope or in general. Where a distributor falls out of scope, this should not be taken as implying any arm’s length price for the controlled transaction, regardless of the scoping criteria used. For the avoidance of doubt, a determination of arm’s length prices in such circumstances should follow the principles articulated in the remainder of these Guidelines. The quantitative filters applied to determine whether a qualifying transaction is within the scope of the simplified and streamlined approach are only used for that purpose, and not, for example, replicated in the pricing methodology used to establish returns for in-scope distributors.

← 11.  When a distributor performs non-distribution activities, and where that distributor remains in scope after applying scoping criterion 14.b, then the ratios described under 13.b should be calculated based on the relevant allocation or apportionment of revenues and operating expenses to the distribution activity only.

← 12.  In calculating each ratio, it is important to determine what are the appropriate operating expenses and what are the appropriate net revenues that should be accounted for. This determination should be made based on an accurate delineation of the transaction and by applying the principles articulated in Chapter II of these Guidelines. Paragraphs 2.99 and 2.100 of these Guidelines may provide some relevant input to making the determination of the appropriate treatment of operating expenses. Moreover, paragraphs 2.96 and 2.97 of these Guidelines provide some relevant input to making the determination of the appropriate treatment of revenues, rebates, and discounts. The treatment of pass-through expenses should be evaluated in calculating the ratio. Under an accurate delineation of the transaction, there may be circumstances where pass-through costs are delineated and should not be taken into account when calculating the ratio. Such a determination should be made in light of the general principles articulated elsewhere in these Guidelines and the facts and circumstances. Moreover, it should be noted that reference to paragraphs 2.96, 2.97, 2.99 and 2.100 of these Guidelines should not be interpreted as modifying existing guidance concerning the most appropriate methods that may be appropriate to evaluate arm’s length remuneration of distributors.

← 13.  Per Section D.8 of Chapter I, and paragraph 1.179, of these Guidelines, MNE group synergies may arise in the context of controlled transactions, for which specific compensation at arm’s length may be justified. These principles are also relevant to consider in this simplified and streamlined approach. For example, where a distributor makes contributions to create such MNE group synergies, or where a non-distribution economic activity undertaken within the same MNE as the distributor leads to similar contributions being made that benefit the distributor, this may lead to challenges in the adequate separate evaluation of the qualifying transaction, on the basis that compensation may need to be imputed with respect to the creation of the synergy.