The OECD has announced rules to help distributors fix a standard profit margin for tax purposes in around 145 countries. If you import or export physical goods, you must consider this. The rules are complex, but our firm has developed special software for international distributors.

The OECD has published important new transfer pricing tax rules for “baseline” distribution activities withing multinational groups starting in 2025 (Report on Pillar One – Amount B” published February 19, 2024). 

Background:

Most multinationals sell goods via local subsidiaries in each country – to provide better service using local employees who speak the language and understand the local culture.

The new rules aim to lay down standard taxable profit margins when groups sell those goods to the local market using local subsidiaries as buy-sell distributors, or as supporting agents.

Below is a brief summary.

What distribution activities are covered?

The rules generally apply to wholesale distribution of tangible goods to any type of customer except end-consumers (unless they don’t exceed 20% of revenues over 3 years). This includes buying goods for resale, identification of new customers and managing customer relationships, certain after-sales services, implementing promotional advertising or marketing, warehousing, processing orders, performing logistics, invoicing and collection.

The rules generally do not apply to non-distribution activities such as non-incidental manufacturing, R&D, procurement or financing, nor to commodities or digital goods. Also, annual operating expenditures should be 3%-30% of sales over 3 years. 

Distributors may belong to one of three “industry groupings” depending on their nature and typical profitability.

When and where?

The OECD says countries can choose to apply the simplified and streamlined approach for transactions for fiscal years commencing on or after January 1, 2025. Taxpayers may be required or allowed to elect it. However, members of the Inclusive Framework – 145 countries presently – are committed to respect the outcome at least where the new rules are applied in a “low -capacity” jurisdiction – presumably developing countries (subject to domestic legislation and administrative practices). Many countries may claim to be still developing e.g. India, China, South Africa?

Calculating  the standard profit margin:

Assuming your  activities give rise to qualifying distribution transactions, check which industry group you fall into. Then apply the following steps.

Step 1: Ascertain the standard EBIT profit margin (EBIT = earnings before interest and taxes) on sales from an OECD table . This specifies standard EBIT profit rates on sales ranging from 1.5% to 5.5%, depending on the industry group; and average operating assets to sales over the preceding 3 years.

Operating assets are working capital plus fixed assets including intangible assets, but strip out goodwill and creditors over 90 days.

If more than 20% of sales are from different industry grouping, a weighted average return should be calculated.  

Step 2: Do an operating expense “cross check”.  The OECD provides an operating expense “cap and collar range” table . The operating expenses may range from 10% to 80% of sales.  This might result in a further adjustment to the OECD standard EBIT if your expenses are deemed too high or too low.

Step 3: If you are doing business in a “qualifying jurisdiction” with a sovereign credit rating of BBB+ or less, apply a net risk adjustment factor to assets and profits that may result in an upward adjustment to the step 2 EBIT if you risk selling into such a country. But not more than 85% operating assets to sales.

Ecommerce impact?

The new rules assume you have a local subsidiary company in each country concerned. If you trade over the internet from somewhere else, you may still need to consider these rules if you use a local warehouse, office or agent who can sign for you. Check out income tax, VAT, GST, sales tax, digital service tax and in India the equalization levy, to name a few.

Comments:

On balance, businesses and tax administrations may find the new rules very helpful.  As mentioned, around 145 countries including Israel are expected to embrace the new rules.

The new OECD rules simplify things by laying down standard profit margins for goods distributors for income tax purposes. This should reduce the need for intercompany transfer pricing studies presently required in many countries.

The rules and calculations are complex, but our firm has developed special software to handle this and crunch the numbers – contact us for details.

The new OECD rules should also reduce disputes between taxpayers and income tax administrations.

The OECD did not address customs duties and VAT/GST or sales tax. In the new rules, the above steps may amend profit margins and the cost of goods sold for corporate income tax purposes – but leave sale prices to end customers unchanged. So VAT/GST or sales taxes should remain unchanged, but customs duties would continue to be imposed on the unamended cost of goods sold. 

Taxpayers applying the new rules should generally do so for a minimum of 3 years, unless things change significantly.

The consequences of reorganizing or claiming past losses would depend on domestic tax legislation.

If double taxation occurs because one country applies the new rules and the other doesn’t, regular transfer pricing rules may apply unless otherwise agreed.

Next Steps:

Please contact us to discuss any of the above matters and request details on our software for international distributors. 

As always, consult experienced legal and tax advisors in each country at an early stage in specific cases.

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(c) Leon Harris 29.4.24