Pillar One of Global Tax Reform Faces a Tipping Point in 2025

A make-or-break year is coming for Pillar One, the first half of a two-part global tax overhaul that aims to reallocate corporate profits to address digitalization of the economy and reform rules for transfer pricing, which dictate how multinational corporations value their intercompany transactions.

Pillar One has had its challenges over the past year. Deadlines for final deliverables came and went. The final text of the Multilateral Convention to implement Amount A, slated for release in June, has yet to be published.

Amount B of Pillar One, which aims to simplify transfer pricing compliance and reduce controversy for wholesale distribution transactions, is now part of the OECD’s transfer pricing guidelines. But officials at the Organization for Economic Cooperation and Development are still discussing how to establish a more substantial, mandatory transfer pricing system and incorporate a qualitative scoping criterion to further define whether an intercompany transaction is within the scope of Amount B.

Finalization is also nearing for Amount A, which aims to expand taxation rights to jurisdictions where multinational enterprises have customers but not a traditional physical presence.

Amount A

The reallocation plan in Amount A requires a treaty, or multilateral convention, to take effect. Political considerations have become more pronounced as countries consider whether to ratify this major shift in international tax policy.

The US—the home of the largest share of would-be Amount A taxpayers—holds the deciding vote on whether the treaty goes into effect. The US Senate would need to ratify the convention, a step that has proven politically difficult over the past decade for any tax treaty.

For the US to benefit from inbound Amount A, the full Congress would have to pass legislation implementing the new nexus standards into the federal tax code. The treaty’s future will depend on how President-elect Donald Trump and Congress view these tradeoffs in Amount A.

At the core of the treaty is an agreement for countries like the US to cede taxing jurisdiction to market states in exchange for the removal of digital services taxes, with the goal of stabilizing the international tax framework. The Joint Committee on Taxation has projected that this could result in a net loss of $1.4 billion of income tax revenue annually—a figure that doesn’t include savings to US taxpayers from the relief of digital services tax costs.

Congress must balance this income tax loss with the potential stabilization benefits for US-headquartered multinational corporations, plus the threat of a proliferation of digital services taxes (and perhaps more aggressive audit positions) targeted at US corporations if the treaty fails.

Amount B

Though the US has designated a “robust” and mandatory Amount B as one of its “red lines” for accepting the Amount A treaty, Amount B technically can proceed no matter Amount A’s fate. The Treasury Department just released a notice allowing taxpayers to opt to apply Amount B to in-scope transactions as a safe harbor beginning Jan. 1.

The more narrow and non-binding version of Amount B is already part of the OECD transfer pricing guidelines, and countries can implement (and already have implemented) related guidance and legislation on their own accord. We’ve seen progress in this respect from Ireland, the Netherlands, and now the US.

Of course, piecemeal implementation of Amount B is far from ideal. The resulting patchwork system falls short of the mandatory Amount B originally outlined by the OECD’s Inclusive Framework and doesn’t create the transfer pricing stability that Amount B was meant to provide.

The new Treasury notice states that the proposed regulations in the US will be consistent with the OECD report released in February and won’t “substantially diverge from any aspect of the Report.”

Going further than Ireland and the Netherlands, the US regulations will allow for the use of Amount B for baseline wholesale distributors both in the US and outside the US (where the counterparty is a related US supplier). Initially, the application of Amount B will be a safe harbor that the taxpayer may elect, though the notice states that it’s being considered to permit the IRS to apply Amount B.

Regardless of the extent it’s implemented in the US and globally, we anticipate that the benchmarks established as part of Amount B will seep into transfer pricing practice and disputes in one way or another.

While using Amount B appropriately could streamline some disputes, there is a risk that it could be used inappropriately. Its pricing matrix will likely be used as an unspoken comparable despite language in the guidance not to use it if the respective jurisdictions haven’t opted in. Also, the analysis of marketing and distribution transactions is likely to be influenced by the Amount B scoping criteria.

Some tax administrations might try to misuse the pricing matrix as a floor for transactions outside the scope of Amount B, such as retail sales and digital services transactions.

Similarly, some tax administrations might be tempted to misuse the data availability mechanism, which essentially is an upward risk adjustment, in a way that increases the range of accepted benchmark returns for any and all routine business functions. This draws more taxable income into the market jurisdiction but potentially creates controversies in the counterparty jurisdiction.

The Amount B pricing matrix is based on extensive analysis of relevant data and benchmarks that may inform how tax authorities will proceed and interact with one another. In advance pricing arrangements and mutual agreement procedures, the Amount B matrix could be used to expedite negotiations—and we’ve already heard of tax authorities considering taking this approach.

Likewise, some of the Amount B pricing elements, such as the data availability mechanism and the operating expense cross check, might be adopted for benchmarking exercises for other transactions.

We strongly recommend that taxpayers consider the impact of Amount B on ongoing or upcoming audits, advance pricing arrangements, and mutual agreement procedures, regardless of whether it’s been formally adopted in the relevant jurisdictions. Its underpinning rationale and benchmarking approach will undoubtedly influence the pricing analysis for baseline distribution activity.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Gary Sprague is partner with Baker McKenzie in Palo Alto, Calif., focusing on software, digital services, and high-tech companies.

Imke Gerdes is partner at Baker McKenzie in New York, focusing on international tax law and transfer pricing.

Shane Koball is an economics director for Baker & McKenzie Consulting, specializing in transfer pricing planning and dispute resolution.

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