Overview. As discussed in prior blog posts, Amount A is a proposed new taxing right over a share of residual profit of MNE groups that fall within its defined scope. The calculation and allocation of Amount A will be determined through a formula that is not based on the Arm's Length Principle (ALP). The formula will apply to the tax base of a group (or segment where relevant) and will involve three components: Step 1: a profitability threshold to isolate the residual profit potentially subject to reallocation; Step 2: a reallocation percentage to identify an appropriate share of residual profit that can be allocated to market jurisdictions under Amount A (the "allocable tax base"); and Step 3: an allocation key to distribute the allocable tax base amongst the eligible market jurisdictions (i.e. where nexus is established for Amount A). This three-step formula to determining the Amount A quantum could be delivered through two approaches: a profit-based approach or a profit margin-based approach. A profit-based approach would start the calculation with the Amount A tax base determined as a profit amount (e.g. an absolute profit of EUR 10 million) whereas a profit-margin approach would start the calculation with the Amount A tax base determined as a profit margin (e.g. a PBT to revenue of 15%). Both approaches would apply the three steps of the allocation formula similarly, and hence would deliver the same quantum of Amount A taxable in each market jurisdiction.
According to the OECD, it will be necessary to determine whether the formula should incorporate any differentiation mechanism. That is, whether the different components of the formula should apply similarly in all circumstances, or whether some variations (for example the profitability threshold under step 1 and/or the reallocation percentage under step 2) should sometimes be applied to increase (or decrease) the quantum of profit reallocated to market jurisdictions for certain business activities.
An important question arises whether the interactions between Amount A and existing taxing rights of market jurisdictions could, in some instances, result in a market jurisdiction being able to tax twice the residual profit of an MNE group; once under its existing taxing rights, and again through Amount A (the issue of "double counting"). The marketing and distribution profits safe harbor described below is an approach that seeks to address these issues related to double counting. The premise of the marketing and distribution safe harbor is that Amount A should be allocated to a market jurisdiction that is not allocated residual profits under the existing profit allocation rules but should not be allocated to a market jurisdiction where (for its in-scope activities) an MNE Group already leaves sufficient residual profit in the market. Under the safe harbor, where an MNE group has a taxable presence in a market jurisdiction conducting marketing and distribution activities connected to locally sourced in-scope revenue, the group would determine the profits allocated to the market jurisdiction under existing profit allocation rules for the performance of these marketing and distribution activities. The MNE group would then compare this with the "safe harbor return", which would be the sum of two components: (1) Amount A, as computed under the Amount A formula; and (2) a fixed return for in-country routine marketing and distribution activities, which could include a regional and industry uplift. The safe harbor return represents the cap, by reference to which the quantum of Amount A allocated to a market jurisdiction would be adjusted.
A domestic business exemption would exclude from the scope of Amount A profits derived by an Automated Digital Services (ADS) or Consumer Facing Business (CFB) in a market jurisdiction which can be seen as autonomous from the rest of the group, i.e., sale of goods or services that are developed, manufactured and sold in a single jurisdiction, as in this scenario residual profit is typically already allocated to the market.
The formula to determine the quantum of Amount A. Amount A represents a simplified proxy of the portion of the residual profit of a business that can reasonably be associated with the sustained and significant participation of that business in the economy of a market jurisdiction. To isolate the residual profit of a business (group or segment where relevant) potentially subject to reallocation under Amount A, the formula includes a profitability threshold. The threshold is based on a simplified convention (i.e. a fixed percentage) and will apply to the Amount A tax base after the deduction of any available losses carried forward. One reason for introducing and using a fixed threshold, rather than a variable percentage based on facts and circumstances or related transfer pricing analysis, is to reduce complexity. This threshold will not alter the allocation of profit derived from routine activities under the current transfer pricing rules but will simplify the identification and calculation of the residual profit subject to the new taxing right. To facilitate administration and compliance, the profitability of an MNE group (or segment) would be assessed through an Amount A PBT to revenue ratio (i.e. a percentage). The determination of this figure will not rest on any MNE-specific economic assessment nor necessarily correspond with the underlying transfer pricing arrangements.
Under Pillar One, only a portion of the residual profit of a group (or segment where relevant) is attributable to Amount A. This is because MNE groups perform a variety of activities unrelated to Amount A that generate residual profit, and hence a substantial portion of the group's residual profit should continue to be allocated under existing rules to factors such as trade intangibles, capital and risk, etc. The formulaic calculation of Amount A thus requires an additional step: the reallocation percentage. For simplicity, the share of residual profit that is attributable to the market jurisdiction will be determined by a simplifying convention (i.e. proxy) not based on the particular circumstances of the MNE group or the ALP. Such a convention could be residual profit multiplied by a fixed percentage.
Once the calculation of the allocable tax base for Amount A is completed, that profit needs to be allocated to the various eligible market jurisdictions based on an allocation key. The allocation is based on in-scope revenue derived from each eligible market jurisdiction. The application of this allocation key will require a clear definition of revenue. Under accounting standards, revenues are typically booked on a gross basis, net of certain types of taxes. The application of the revenue-based allocation key will differ depending on whether the formula is implemented through a profit-based or a profit margin approach. Under a profit-based approach, the allocable tax base (a profit amount, i.e. PBT) could be multiplied by the ratio of locally sourced in-scope revenue to total revenue of a MNE group (or segment where relevant) used in computing the tax base, including revenue from ineligible market jurisdictions (where no nexus would be established for Amount A purposes) and potentially out of scope revenue. Under a profit-margin approach, the allocable tax base (a profit ratio, i.e. PBT/revenue) could be multiplied by locally sourced in-scope revenue. Both of these approaches would ensure that Amount A profits attributable to revenue sourced in ineligible market jurisdictions are not allocated to other eligible market jurisdictions, and remain instead taxed under the existing profit allocation system.
Potential differentiation mechanisms. The OECD has considered whether the different components of the formula described above should apply similarly in all circumstances, or whether some variations are necessary to increase (or decrease) the amount of profit reallocated to market jurisdictions in some cases (the "differentiation mechanisms"). Such variations could have a significant impact to the general application of the Amount A rules. A differentiation mechanism could potentially be introduced to (1) account for different degrees of digitalization between in-scope business activities and increase the quantum of profit reallocated for certain types of business activities ("digital differentiation"); or (2) account for substantial variations in profitability between different market jurisdictions and increase the quantum of profit reallocated to market jurisdictions where the profitability is significantly higher than the average profitability of the segment ("jurisdictional differentiation"). OECD members have different views on whether some form of "digital differentiation" is necessary in the design of the Amount A formula. Further, some OECD members believe that where ADS or CFB businesses make remote sales in a jurisdiction by using digital means to connect with customers, this jurisdiction should also receive an allocation of routine profits form the remote performance of marketing and distribution activities. Under this view, once the new nexus threshold under Amount A is reached, it is unfair to deny market jurisdictions taxing rights over businesses that thanks to digitalisation are able to participate in the economic life of their jurisdiction remotely.
The OECD identified the need to explore the rationale and technical feasibility of jurisdictional or regional segmentation as a way to account for variations in profitability across regions. For businesses that do not operate on a regional basis, regional segmentation would be technically challenging because, like segmenting between ADS, CFB and out-of-scope activities, it would require that potentially significant portions of central costs are apportioned among different regions using allocation keys. The OECD also believes that regional or jurisdictional differentiation is mainly a question for CFB businesses and not for ADS businesses. Conceptually, incorporating jurisdictional differentiation within the Amount A model is particularly challenging, because it is inconsistent with the overall approach which is to calculate the profits allocable to a market jurisdiction on a group or segment basis.
The issue of double counting. Interactions between Amount A and the existing taxing rights of market jurisdictions on business profit, including withholding taxes, is conceptually challenging and an area where OECD members have expressed different views. An important issue identified by the OECD is whether some of these interactions (i.e. between Amount A and existing ALP-based profit allocation rules) could result in duplicative taxation of the same profit of an MNE group in a particular market jurisdiction, which could be inconsistent with the policy intention of Pillar One. The concern is that the market jurisdiction may get to tax the same item of residual profit twice: once through an existing taxable presence under transfer pricing rules and again through Amount A. The issue of double counting is expected to be addressed, at least partially, through the mechanism to eliminate double taxation. The elimination of double taxation process is an important element in dealing with any potential double counting in the market jurisdiction. This is because where an entity is allocated significant residual profit in a market jurisdiction under existing profit allocation rules, this entity may be identified as a "paying entity" within the group for the purpose of eliminating double taxation. Identifying this entity as a "paying entity" for amount A purposes will, in turn, result in a "netting-off" effect: the residual profit allocated under existing rules to the market jurisdiction will, in effect, be reduced by the method used to relieve double taxation from Amount A (including Amount A allocated to other market jurisdictions).
The marketing and distribution profits safe harbor. The "marketing and distribution profits safe harbor" would start from the premise that Amount A should be allocated to a market jurisdiction that is not allocated residual profits under existing profit allocation rules, but where a group already allocates and actually earns residual profit in the market on in-scope revenue then there should be no Amount A allocation. This would mean an MNE group would have to compute Amount A under the above rules, but would not allocate it to a market jurisdiction to the extent that it already allocates and earns residual profit in that jurisdiction. The marketing and distribution profit safe harbor seeks to deliver this outcome. The safe harbor would cap the allocation of Amount A to market jurisdictions that already have taxing rights over a group's profits under existing taxing rules. A safe harbor would be determined by combining the residual profit that an MNE group would be expected to allocate to a market jurisdiction with an additional fixed return intended to compensate the local marketing and distribution presence. All MNE groups would calculate Amount A and would then either benefit from the safe harbor or pay Amount A through the new Amount A system. Under the marketing and distribution profits safe harbor, the formula for calculating Amount A would remain unchanged. However, it would be necessary to determine a fixed return for in-country routine marketing and distribution activities. The fixed return would not necessarily seek to replicate an arm's length return nor would it limit the profits allocable to marketing and distribution activities. Jurisdictions that are entitled to a higher return for the performance of marketing and distribution activities under the ALP would continue to be entitled to that return. Instead, this fixed return would act as a test to identify situations when allocating Amount A to a market jurisdiction would give rise to double counting. The fixed return could be computed in a variety of ways, but, according to the OECD, the simplest approach would be to agree a single fixed return on sales that would be applied to in-scope locally sourced revenue. Although the fixed return would not seek to be consistent with the ALP, it could be agreed that the fixed return could vary by region or industry (but probably not based on functions).
The domestic business exemption. The OECD has also considered the development of a "domestic business exemption" to reduce the instances of double counting. There are two potential types of domestic business exemptions. The first, and simplest, would exclude from the scope of Amount A large, domestically-focused business with a minimal level of foreign income. This would be implemented through the exemption of groups whose foreign source in-scope revenue falls below an agreed threshold from the scope of Amount A. The second, and more complex exemption, would seek to exclude from Amount A part of a group's business that is primarily or solely carried on in a single jurisdiction. The "domestic business exemption" would address some instances of double counting by excluding from Amount A profits derived from the sale of goods and services that are developed, manufactured and sold in a single jurisdiction. According to the OECD, it would likely be necessary to develop a quantitative threshold to identify "domestic businesses" eligible for the exemption as those that retained over a given percentage (e.g. 90%) of the total profits derived from a market, or alternatively as those that derive only revenue sourced in their domestic market and have no or only limited transactions with related parties in other jurisdictions.
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