Pillar One - Amount B

5. Determining the return under the simplified and streamlined approach

1. The methodology and guidance included throughout Section 5, including the design elements described in 5.1, 5.2 and 5.3, and the defined terms relied upon in these elements, are specific to the application of the simplified and streamlined approach. As with all other design elements of the simplified and streamlined approach, neither the inclusion of the operating expense cross-check, nor the data availability mechanism, nor any individual features within those design elements should be construed as implying that they would be included in the application of a most appropriate method determined under the remainder of these Guidelines for any transaction.

5.1. Pricing matrix

2. Application of the relevant benchmarking search criteria as well as additional screening and manual review to reflect the scoping criteria has led to the development of a global dataset of companies involved in baseline marketing and distribution activities. The financial information derived from that global dataset has in part formed the basis for the approximation of arm’s length results which has been translated into a pricing matrix.1

3. The approximation of arm’s length results has been presented as matrix segments according to the following factors: net operating asset intensity (OAS), operating expense intensity (OES) and industry groupings.

4. For the purposes of the simplified and streamlined approach, return on sales has been applied as the net profit indicator for the purpose of establishing pricing outcomes for in-scope transactions.

Table 5.1. Pricing Matrix (return on sales %) derived from the global dataset

Industry Grouping	Industry Grouping 1	Industry Grouping 2	Industry Grouping 3
Factor Intensity
(A) OAS 45% or more, any level of OES	3.50%	5.00%	5.50%
(B) OAS 30% to 44.99%, any level of OES	3.00%	3.75%	4.50%
(C) OAS 15% to 29.99%, any level of OES	2.50%	3.00%	4.50%
(D) OAS less than 15%, OES 10% or more	1.75%	2.00%	3.00%
(E) OAS less than 15%, OES less than 10%	1.50%	1.75%	2.25%

5. In order to determine the return for a tested party involved in in-scope transactions for the relevant fiscal year, a tax administration and relevant taxpayer2 will apply the following 3-step process:

a. Step 1 - determine the relevant industry grouping(s) of the tested party from the three possible groupings (i.e. industry grouping 1, 2, 3) and identify the applicable vertical column(s) of return on sales in the pricing matrix in table 5.1 that correspond to that industry grouping. In the case that the products distributed fall into more than one industry grouping, the proportion of sales falling into each industry grouping should be calculated. In the case that at least 80% of sales fall into a single industry grouping and so 20% of sales or less fall into different industry grouping(s), the latter will not be determinative for setting the matrix return and instead the return will be set by reference only to the relevant matrix cell for the industry grouping where the majority of sales fall. In the case that more than 20% of sales are from products which fall into a second and/or third industry grouping, a weighted average return should be calculated.

b. Step 2 - determine the relevant factor intensity classification of the tested party3 from the five possible classifications (i.e. factor intensity classification A, B, C, D, and E) and identify the applicable horizontal row of return on sales in the pricing matrix in table 5.1 that correspond to that factor intensity classification. The factor intensity classification of the tested party should be calculated based on a weighted average of the three preceding fiscal years.4

c. Step 3 - identify the range from the pricing matrix segment that corresponds to the intersection of the industry grouping(s) and the factor intensity classification of the tested party. If needed, the weighted average return should be calculated by multiplying each return from the relevant cells of the matrix by the proportion of sales to be priced by reference to that cell and totalling these proportional returns to give a single weighted average return rate applicable to all sales by that distributor. In this way, the weighting of factor intensity classifications relies only on the proportion of sales assigned to each industry grouping and does not require a calculation that recognises the operating expenses and assets that are specific to each industry grouping.

6. The return derived from application of step 3 in Section 5.1 will produce a range equal to the return on sales percentage5 derived from the pricing matrix (Table 5.1) plus or minus 0.5%. Any point within that acceptable range can be relied upon for the purpose of demonstrating compliance with Section 5.1 and will form the basis for any subsequent adjustments that may apply in accordance with Section 5.2 and 5.3 below.

7. For the purposes of the simplified and streamlined approach, relevant taxpayers will apply and test the actual outcome of in-scope transactions to demonstrate the conditions of these transactions were consistent with the simplified and streamlined approach on an ex post basis (i.e. the arm’s length outcome-testing approach). Such test typically takes place as part of the process for establishing the tax return at year-end.6

8. In asserting the application of the simplified and streamlined approach to in-scope transactions, tax administrations should bear in mind the guidance in paragraph 3.60 of these Guidelines regarding controlled transactions that are within the range. Moreover, when the margin reported by a relevant taxpayer falls outside the range resulting from the appropriate application of the simplified and streamlined approach by a tax administration, tax administrations should use the return on sales percentage derived from the pricing matrix (table 5.1) to adjust the margin of the controlled transaction.

5.2. Operating expense cross-check

9. For the purposes of the simplified and streamlined approach, an operating expense cross-check is applied as a guardrail within which the primary return on sales net profit indicator is applied. Where the application of the return on sales net profit indicator produces a result outside of the pre-defined operating expense cap-and-collar range specified in table 5.2 below, the profitability of the tested party will be adjusted in accordance with paragraph 52(d).

Table 5.2. Operating expense cap-and-collar range

	Operating expense cap-and-collar range
Factor intensity	Default cap rates	Alternative cap rates for qualifying jurisdictions	Collar rate
High OAS (A)	70%	80%	10%
Medium OAS (B+C)	60%	70%
Low OAS (D+E)	40%	45%

10. The operating expense cross-check applies to all in-scope transactions and requires a tax administration and relevant taxpayer to apply the following 4-step process:

11. Step 1 - a tax administration and taxpayer will determine the return on sales for the tested party in accordance with the guidance in Section 5.1 and compute an equivalent return on operating expense derived from that return.

12. Step 2 – the tax administration and taxpayer will determine the applicable operating expense cap-and-collar range derived from table 5.2. The applicable cap rate is determined by reference to: (i) the factor intensity classification of the tested party7, and (ii) whether the tested party is subject to the default cap rates8 or alternative cap rates9 for qualifying jurisdictions within the meaning of Section 5.2.

13. Step 3 - the tax administration and taxpayer will compare the equivalent return on operating expense of the tested party against the operating expense cap-and-collar determined in Step 2.

14. Step 4 - where the equivalent return on operating expense of the tested party determined in Step 1 falls within the operating expense cap-and-collar range, no further adjustment is required to the return on sales calculated in Section 5.1. However, where the equivalent return on operating expense of the tested party determined in Step 1 exceeds the operating expense cap, the return on sales of the tested party will be adjusted downwards until it results in an equivalent return on operating expense equal to the operating expense cap. Conversely, where the equivalent return on operating expense of the tested party falls below the operating expense collar, the return on sales of the tested party will be adjusted upwards until it results in an equivalent return on operating expense equal to the operating expense collar.

5.3. Data availability mechanism for qualifying jurisdictions

15. The data availability mechanism is intended to account for cases where there is no or insufficient data in the global dataset for a particular tested party jurisdiction and that jurisdiction is a qualifying jurisdiction within the meaning of Section 5.3.10

16. Where a tested party is located in a qualifying jurisdiction, an adjustment will be made to the return initially determined under Section 5.1 and Section 5.2 where applicable. A relevant taxpayer in an aforementioned qualifying jurisdiction will earn an adjusted return in accordance with the following formula:

17. Adjusted return on sales = ROS^TP + (NRA^J x OAS^TP)

18.  Where –

19. ROS^TP is the return on sales percentage of the tested party calculated in accordance with Section 5.1 and Section 5.2 where applicable.

20. NRA^J is the net risk adjustment percentage of the qualifying jurisdiction derived from table 5.3 below, where the applicable category is determined by reference to the sovereign credit rating11 of the qualifying jurisdiction of the tested party applicable on the first day of the relevant fiscal year.12

21. OAS^TP is the net operating asset intensity percentage of the tested party for the relevant fiscal year but will not exceed 85% for the purpose of computing the adjusted return on sales of the tested party.

Table 5.3. Net risk adjustment percentage to be applied to the OAS of a Tested Party in qualifying jurisdictions

Sovereign Credit Rating Category		Net risk adjustment %13
Investment grade	BBB+	0.0%
	BBB	0.0%
	BBB-	0.3%
Non-investment grade	BB+	0.7%
	BB	1.2%
	BB-	1.8%
	B+	2.8%
	B	3.8%
	B-	4.9%
	CCC+	5.9%
	CCC	7.5%
	CCC- (or lower)	8.6%

5.4. Periodic updates

30. In order to simplify compliance burdens associated with administering the simplified and streamlined approach, the analysis supporting the determination of the ranges referenced in Section 5.1 and operating expense cap-and-collar rates in Section 5.2 will be updated every five years unless there is a significant change in market conditions that warrants an interim update.

31. The financial data and other datapoints referenced in Section 5.1 and Section 5.3 will be reviewed annually and updated where necessary.

Notes

← 1.  See Appendix A for further details.

← 2.  With reference to the implementation options outlined in paragraph 7 of this guidance, “relevant taxpayer” refers to: (i) taxpayers who elect to apply the simplified and streamlined approach in a jurisdiction of residence that permits such election, and (ii) taxpayers who are otherwise obligated to apply the simplified and streamlined approach in the jurisdiction of residence.

← 3.  For the purpose of calculating the net operating assets of the tested party for relevant years and mitigating the risk of distortive credit terms, an accounts payable days guardrail of 90 days applies, such that the value of creditors used in the respective calculations shall not exceed cost of goods sold / 365 * 90. An illustrative example, example 6, on the practical application of the accounts payable days guardrail is included in Appendix B.

← 4.  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.

← 5.  In the case where more than 20% of sales are from products which fall outside of a single industry grouping, the return derived from step 3 will produce a range equal to the weighted average return determined in accordance with paragraph 5.  plus or minus 0.5%.

← 6.  See paragraph 3.70 of these Guidelines.

← 7.  This should correspond to the factor intensity classification of the tested party as determined in accordance with paragraph 47(b) in Section 5.1.

← 8.  Default cap rates apply for the purpose of step 2 unless the tested party is located in a qualifying jurisdiction within the meaning of Section 5.2.

← 9.  Alternative cap rates apply for the purpose of step 2 where the tested party is located in a qualifying jurisdiction within the meaning of Section 5.2.

← 10.  See paragraph 1.167 of these Guidelines.

← 11.  Where there exists multiple and varying sovereign credit ratings for a qualifying jurisdiction from the recognised independent ratings agencies, the determination of the applicable net risk adjustment percentage from table 5.3 should be based on the sovereign credit rating for that qualifying jurisdiction that was issued or re-affirmed nearest to the first day of the relevant fiscal year.

← 12.  Where there exists no sovereign credit rating for a qualifying jurisdiction from the recognised independent ratings agencies, the applicable net risk adjustment percentage will equal the average net risk adjustment percentage for all non-investment grades derived from table 5.3.

← 13.  The methodology applied to calculate the net risk adjustment percentages in this table comprises determining the five-year average sovereign debt default spread for each credit rating grade (sourced from data compiled by Aswath Damodaran, NYU Stern School of Business) less a double counting adjustment that seeks to approximate for the existing country risk present in the global dataset.