Changes in the application of the arm’s length principle for marketing and distribution companies

The Report contains a matrix of profit margins that can be applied in setting transfer prices for marketing or distribution entities that meet the specified qualitative and quantitative criteria for applying the simplified approach. Although there are more criteria, in general, the simplified approach will primarily apply to marketing and distribution entities with limited functions that do not have a “unique and valuable” contribution and do not bear economically significant risks in relation to the sale of goods (i.e. buy-sell distributors, agents, commissionaires, etc.). Excluded is, inter alia, the distribution of intangibles, services and commodities.

In the matrix, each entity will be able to find its arm’s length profit margin, which will be within a certain range divided by industry and intensity level of net assets and operating expenses. The resulting margin will then be subject to subsequent adjustments in the next two steps. The margin calculated in this way can then be considered to be in line with the arm’s length principle without the need to prove its arm’s length nature by a separate benchmarking analysis. Therefore, this represents the main simplification in establishing transfer prices for marketing/distribution activities.

The Report should be incorporated into the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations from 1 January 2025, with individual countries having the option to decide whether or not to use Part B. The OECD will publish a list of countries that have decided to implement it during 2024. Countries can introduce Part B either as a requirement or as an option for taxpayers. The exception is members of the OECD/G20 Inclusive Framework group of countries, which will apply the simplified approach on a mandatory basis in the case of so-called low capacity tax jurisdictions (a list of low capacity jurisdictions will also be published by the OECD during 2024).

Countries that choose not to implement Part B will continue to use the existing transfer pricing methods under the OECD Guidelines. Thus, although the Report aims to reduce administrative burdens and create a more predictable tax environment, there may be cases where the simplified approach will bring complications in the area of international dispute resolution (e.g. in the case of cross-border sales of goods between a manufacturer and a related distributor, where one country (applying Amount B) will assess the profit margin of the distributor according to the matrix set out in the Report and the other country (not applying Amount B) will assess the profit margin of the same distributor according to the benchmarking analysis prepared, with the two countries coming to different conclusions as to whether the arm’s length principle has been respected).

Multinational companies that have local distribution units in several countries will also have to monitor which of these countries have applied the simplified approach and which have not. They will then need to adjust the group transfer pricing methodology accordingly, which in this case may be more complicated than it has been until now (i.e., different for distributors from states that apply Part B and for distributors from states that do not).

In practice, the scope and structure of a transfer pricing documentation for marketing/distribution companies will also change. In particular, they will have to pay attention in their documentation to an analysis of the qualitative and quantitative conditions that are critical to the application of the simplified approach (including a detailed functional and risk analysis). The second part of the documentation will then establish the targeted profit margin either:

• By means of a benchmarking analysis, if the entity does not meet the conditions for the simplified

approach; or

• At the level of Amount B, if the entity meets the conditions for the simplified approach.

As can be seen from the above, the Report will therefore on the one hand bring simplification in the application of the arm’s length principle for the valuation of marketing and distribution activities, but on the other hand it may bring new challenges and complications for some distribution companiesor multinational groups.

Our specialists are available to provide further information.

Author: Vít Fritzsche, Tax Manager