Pillar I: The Marketing and Distribution Safe Harbour (MDSH) as Applicable to Licensed Manufacturers and Centralized Business Models: Does It Fulfil Its Policy Objective?

Abstract

The new Pillar I Amount A system aims to reallocate a portion of in-scope MNEs’ residual profits to market countries. This said, there could be many instances when an MNE already reports residual profits in the market country under the current system, for example, when it operates with a substantial physical presence (which is entrepreneurial in nature) in the market country. In order to avoid the double taxation/double counting of what is known as ‘residual profits’, a Marketing and Distribution Safe Harbour (MDSH) mechanism was first developed in the 2020 Blueprint and redesigned in the 2022 Progress Report. The purpose of this article is to address the question as to whether the MDSH as designed in the Progress Report meets its objective, particularly after briefly describing it as drafted in both reports. The authors analyse whether it does so by testing it against two commonly found MNE business models, i.e., a licensed manufacturer (LM) in the market and a centralized business model with limited risk distributors (LRD) in the market. A technical analysis is undertaken which is then illustrated with numerical case studies. The analysis leads to the conclusion that the MDSH as designed in the Progress Report does not necessarily meet its policy objective of preventing double counting under both the LM and the centralized business models. Thus, one possible policy option is to redraft it and return to the test as originally conceived in the Blueprint. A second possibility is to further reflect on some of the MDSH components, in particular, the manner in which jurisdictional routine and residual profits are calculated with the overall aim of achieving simplicity as well as accuracy. With respect to determining jurisdictional routine profits, our main recommendation is to deem a certain percentage of jurisdictional elimination profits (EPs) to represent routine profits (e.g., 25%). Such a mechanism would be simpler than the existing mechanism to determine jurisdictional routine profits, which seems to be rather complicated. With respect to jurisdictional residual profits, our recommendation is to support the Y% with a facts and circumstances analysis to achieve accurate results (at least, in certain cases). For instance, the Y% will be deemed to be 100% in a country when the MNE group operates with a fully or partly decentralized business model such as a LM (or similar business models such as franchise models). It will be regarded as being 0% in a country when it operates with limited risk sales structures or/and structures that have access to the simplification offered by the Amount B project. In all other cases, the Y% could be considered to be, for example, 25% in a country (which would be a compromise). Moreover, our recommendation with respect to withholding taxes (WHT) (if they are taken into account) is to restrict its scope to selected payments (e.g., royalties or service fees) and to provide a downward adjustment in the residence jurisdiction of the recipient (as opposed to the payors). The effect would be that the EP of the recipient would be reduced, and these profits would then represent the base to provide relief from double taxation. More broadly, if the Amount A project does not achieve fruition, the authors believe that some lessons that can be learned from the Amount A reform, in general, and the MDSH for future alternate reforms. Thus, a few suggestions will be made to policymakers who are considering alternatives to the Amount A project. Pillar I, Amount A, ALP, Transfer Pricing, MDSH, double counting, OECD, business models.