On 17 July 2023, the OECD/IF published the public consultation document for Pillar One, Amount B. The objective of this consultation document is to simplify the pricing of baseline marketing and distribution activities, to increase tax certainty for businesses, and to minimise conflicts between taxpayers and tax administrations. Unlike Pillar Two, there is no revenue threshold applicable for the application of Pillar One, Amount B. The public consultation document can be accessed here.
Summary of the Pillar One Amount B consultation document
The consultation document, which does not yet represent consensus of the OECD/IF, introduces a streamlined approach for certain qualifying transactions, referred to as ‘in-country baseline marketing and distribution activities’. The streamlined approach uses a pricing matrix to replace the need for specific benchmark studies. A Global Pricing Matrix is used as the default option, with a mechanism to account for regional differences in respect of certain qualifying jurisdictions, resulting in a Modified Pricing Matrix.
It is explicitly stated that the simplified approach should provide results consistent with the arm’s length principle. It is not intended to replace the arm’s length principle, but only to provide a pragmatic and efficient application of the arm’s length principle in day-to-day practice for both buy-sell and agency arrangements.
Although the proposal touches on several issues that still need to be resolved, in this blog we will focus on just one specific issue: the use of secret comparables.
Data availability
Both the Standard and the Modified Pricing Matrix are constructed using data from publicly available databases. This is the same data that multinationals use to create individual benchmark studies to support their intercompany transactions. Transfer pricing professionals are well aware that any individual benchmark study can be challenged by tax authorities and may result in lengthy disputes. An important benefit of using a Pricing Matrix could be the elimination of such disputes in respect of qualifying transactions.
However, the OECD/IF also introduces the possibility for individual countries to create a specific local dataset to create a Local Pricing Matrix if the public dataset does not provide sufficient local coverage. But if a local tax administration can add data to create a local dataset that is not based on publicly available data, does this mean that the OECD/IF facilitates the use of secret comparables? This raises some interesting questions.
Public data versus secret data
For secret comparables to be acceptable, there should at least be a mechanism to have the comparables assessed by a neutral party to avoid opportunistic behaviour by tax administrations seeking to increase their tax base. Within the overall framework of the Simplified Approach, this would mean that the proposed secret comparables should be tested and accepted by the OECD/IF before they can be used as the basis for a local data set. The OECD/IF should be able to maintain a consistent approach to accepting or rejecting potential comparables without being unduly influenced by local country interests. The OECD/IF’s review of the local dataset is therefore explicitly mentioned in the public consultation document. However, it would be helpful if the OECD/IF would provide more insight into how they would seek to enforce such a verification process to address concerns about the objectivity of the data. Although the specific data would remain secret to the public, this could certainly improve the quality of the data used to construct a Pricing Matrix.
Global dataset versus local data set
So far so good. If we can solve (part of) the lack of public data to identify appropriate comparables, we should certainly consider it with an open mind. However, we do not see why there should be separate local data sets and local price matrices alongside the global data set, the Global Pricing Matrix, and the Modified Pricing Matrix. If local countries can provide additional local data that are considered reliable and comparable, the most logical action would be to add the additional information to the existing global dataset to further improve the global Pricing Matrix and the Modified Pricing Matrix. This would further simplify the approach and avoid opportunistic behaviour by individual countries.
If the use of secret comparables were to be facilitated in this way, it could also be argued that all countries should be allowed to provide additional secret comparables to complement the global dataset. Even if the public dataset has sufficient coverage of the country, the addition of verified secret comparables would still further increase the accuracy of a pricing matrix.
The practical problem would be on how to ensure that countries do not take an opportunistic ‘pick and choose’ approach in presenting their secret comparables. This would require the possibility for the OECD/IF, as a gatekeeper, to verify the objectivity of the search criteria used to identify potential secret comparables. However, if the secret comparables were not used to produce a specific local dataset and local pricing matrix, but ‘only’ to complement the public global dataset, there would be less incentive for individual countries to be opportunistic.
Cautiously optimistic
The use of secret comparables has always been a delicate and sensitive issue, and rightly so. If the use of secret comparables would create an undue information asymmetry in favour of a tax authority, the use of such secret comparables should be denied. There is broad international support for not allowing such information asymmetry and we should all encourage this. However, we should also be open to considering solutions that could assist the international tax community (taxpayers and tax authorities alike) in dealing with the lack of (publicly available) data to properly apply the arm’s length principle. This principle is still seen as the conceptual basis for resolving international transfer pricing disputes.
But having an open mind is not the same as being blind to the practical difficulties of operationalising such a controlled use of secret comparables. Yet, given the current state of the technology, these practical difficulties may indeed be overcome if the OECD/IF were to provide adequate support.
We look forward to future developments and hope that countries can agree on a principled approach to the use of secret comparables. Otherwise, this road could lead to additional and more complex transfer pricing disputes.