Scheduled to take effect on 1 January, 2025, the Simplified and Streamlined Approach (SSA) is a crucial component of the OECD's ambitious initiative to reform the international tax system. The OECD has integrated the SSA into its General Transfer Pricing Guidelines, and countries adhering to these guidelines can now adopt the SSA.

To appreciate its significance, we are delving into the origin and context behind this new approach.

The OECD's two-pillar solution

The SSA is part of a broader reform effort known as the OECD's two-pillar solution, designed to address Base Erosion and Profit Shifting (BEPS). This initiative gained momentum from the OECD’s 2015 report, " Addressing the Tax Challenges of the Digital Economy," which sought to tackle tax challenges posed by digitalisation. The two-pillar solution enjoys support from both OECD members and a broader coalition of around 140 countries under the Inclusive Framework.

Pillar One, which includes the SSA, focuses on the allocation of profits among multinational enterprises (MNEs). Set to be introduced in 2025, Pillar One is divided into three sections: Amount A, Amount B, and Amount C.

Breakdown of Pillar One

Amount A aims to reallocate excess profits of the largest MNEs (with revenues of at least €20 billion and profits over 10%) to market jurisdictions meeting specific criteria. However, this component is still in development.

Amount B, the focus of this article, is more comprehensive. It affects all entities within the transfer pricing rules by establishing a standardised formula – the Simplified and Streamlined Approach – for remunerating baseline distribution activities. This formulaic approach is intended to simplify compliance, reducing the need for businesses and tax authorities alike to conduct complex benchmarking analyses.

Amount C is also under development and will potentially offer mechanisms to remunerate additional local activities and resolve disputes.

Pillar Two: The global minimum tax

Alongside Pillar One, Pillar Two introduces a global minimum tax rate of 15%, targeting businesses with revenues of at least €750 million in at least two of the last four years. This provision is already live as of 1 January, 2024.

The Simplified and Streamlined Approach (SSA)

The SSA, developed as Amount B of Pillar One, introduces a formulaic return to determine the remuneration for baseline distribution activities on a territory-by-territory basis. Its goal is to ease compliance burdens by eliminating the need for businesses to perform individualised benchmarking analyses for these activities. Instead, the SSA offers a standardised, formula-based approach.

Notably, the SSA is included in the OECD’s Transfer Pricing Guidelines, potentially impacting all businesses subject to these rules. Jurisdictions can choose to implement the SSA as a mandatory requirement or offer it as an optional safe harbour, with the latter offering flexibility for businesses.

Implications for businesses and tax authorities

Together, the two-pillar approach is designed to create a more predictable and stable international tax framework. By introducing standardised approaches and minimum tax rates, the OECD aims to bolster confidence among businesses and tax authorities alike, facilitating smoother operations and reducing the risk of tax disputes.

As we move closer to the implementation of the SSA in 2025, businesses need to stay informed and prepared for these changes. The adoption of the SSA could significantly streamline compliance processes and reduce administrative burdens. However, it could also give rise to uncertainty around the appropriate application of a new set of rules by both businesses and taxpayers.

How does the SSA work?

Scope of the SSA

The SSA encompasses transactions where goods are purchased from associated enterprises for wholesale distribution to unrelated parties who are not end consumers. It also includes sales agency and commissionaire transactions that facilitate wholesale distribution.

To qualify under the SSA, transactions must be reliably priced using a one-sided transfer pricing method with the distributor as the tested party. The SSA uses the Transactional Net Margin Method (TNMM), utilising return on sales as the net profit measure. In rare cases, the Comparable Uncontrolled Price (CUP) method may be more appropriate, provided the necessary internal comparable data is readily available.

The SSA replaces the standard benchmarking process with a "pricing matrix," offering arm's-length return-on-sales values based on industry classifications and quantitative characteristics. If the SSA is used, taxpayers must also cover how the SSA has been applied in their in their transfer pricing local file documentation.

Qualitative and quantitative scoping criteria

The SSA is grounded in both qualitative and quantitative criteria. It targets core, routine marketing and distribution functions, termed "baseline marketing and distribution activities," where the distributor neither makes unique, valuable contributions nor assumes significant economic risks. The OECD is developing additional optional qualitative criteria that jurisdictions may adopt.

Quantitatively, the SSA focuses on the ratio of operating expenses to sales. The tested party's annual operating expenses must fall between 3% and an upper limit of 20-30% of annual net revenues.

Exceptions to the SSA

Certain transactions are excluded from the SSA:

• Distribution of non-tangible goods and services (e.g., software).
• Marketing and distribution of commodities.
• Retail activities.

Additionally, the tested party must not engage in non-distribution activities such as manufacturing, research and development, or specific service activities. A de minimis threshold of 20% is applied, beyond which these activities must be separately evaluated and priced. Where possible, results may be streamed between baseline distribution and non-distribution activities.

Applying the pricing matrix

The pricing matrix is central to the SSA, offering arm's-length results based on global financial data of companies engaged in baseline marketing and distribution activities. This matrix will be updated every five years by the OECD.

The matrix categorises industries into three groups based on their association with different return levels:

Group 1: Lower returns (e.g., household consumables, construction).
Group 2: Neutral returns (e.g., IT hardware, pharmaceuticals).
Group 3: Higher returns (e.g., medical machinery, industrial machinery).

For companies operating in multiple industries, financial data should be segmented by industry grouping if any group exceeds 20% of sales. The matrix also incorporates two intensity factors:

1. Net operating asset intensity: Net operating assets divided by net revenue. 
2. Operating expense intensity: Operating expenses divided by net revenues.

These factors produce fifteen potential return-on-sales values, ranging from 1.5% to 5.5%. The SSA assesses the distributor's reported return on sales against the pricing matrix. Deviations beyond 0.5% of the identified data point necessitate adjustments.

It is important to note that the SSA is intended as a mechanism to test results, and so businesses should consider how best to embed their transfer pricing policy into their systems to enable a result within the target range.

Other adjustment mechanisms

The SSA includes a cap-and-collar mechanism to adjust a distributor's Earnings Before Interest and Tax (EBIT). If the distributor's return on operating expenses ratio falls outside prescribed limits, EBIT must be adjusted accordingly.

Additionally, the OECD has now listed the qualifying countries where the pricing matrix value may be adjusted based on each country’s sovereign debt rating. This list will be reviewed every five years.

The takeaway

The OECD's Simplified and Streamlined Approach (SSA) signifies a major shift towards more standardised transfer pricing support. By offering a formula-based approach to pricing routine distribution activities, the SSA has the potential to significantly reduce compliance burdens for businesses and tax authorities alike. Effective from the start of 2025, the SSA could foster greater predictability and stability within the international tax landscape.

Look out for part two of this article in which RSM’s specialists discuss documentation requirements, options for adoption, and actionable next steps for businesses.

For more information on the Simplified and Streamlined Approach, watch our latest webinar discussing it.

For any other information regarding transfer pricing or if you would like to get in touch, visit our transfer pricing page.