OECD announces new approach for transfer pricing of distribution activities

A new approach to supporting the profit achieved by distributors in a multinational enterprise has been announced by the Organisation for Economic Co-operation and Development (OECD). This offers the chance of simplification, but how much it eases the compliance burden on business will depend both on which tax authorities take up the new rules, and how tax authorities in counterparty territories view the simplification offered.

The OECD announced a new set of rules for a Simplified and Streamlined Approach (‘SSA’) for rewarding baseline business-to-business distribution activities. The new rules come from the OECD’s work on Base Erosion and Profit Shifting, specifically Pillar One which looks at where profits are recognised within multinational enterprises for transfer pricing purposes.

For fiscal years starting on or after 1 January 2025, jurisdictions will be able to offer the SSA’s formulaic approach either as a safe harbour or as a prescriptive requirement. The OECD is including the SSA in its Transfer Pricing Guidelines, so where it is adopted, it could apply to all businesses that fall within transfer pricing rules. 

The SSA aims to make transfer pricing for distribution activities more straightforward by replacing specific comparables data that is typically used to benchmark an arm’s length operating margin with a formulaic approach based on the distributor’s industry and functional intensity, and using a matrix of prices determined by the OECD.

Qualifying baseline distribution activities are those where product is bought from related parties and sold on to third party customers which are not the end users. These should be comparatively routine activities, and be the sole activity of an entity or a discreet part of those activities whose results can be streamed. Retail sales are excluded if its associated revenue is at least 20% of total revenue. Similarly, services, sale of digital products, the sale of commodities and the contribution of unique and valuable intangibles are also excluded.

Whilst the SSA has clear benefits, its effectiveness will depend not only on how many jurisdictions adopt rules but how other tax authorities adapt to them. If specific benchmarking is still required by territories on the other side of connected party transactions, or if there are lengthy disputes over the characterisation of the distribution activities and whether they fall within the rules, then those benefits will be lost. The OECD can reduce this risk by making best practice clear in its guidance as we move towards the introduction of the SSA.