On December 18, 2024, the U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued Notice 2025-04 to announce their intent to propose regulations that, for purposes of Internal Revenue Code (IRC) section 482, provide a safe harbor method for pricing controlled transactions involving baseline marketing and distribution activities. This method, known as the "simplified and streamlined approach" (SSA), would largely adopt the SSA as advanced by the Organisation for Economic Cooperation and Development (OECD)/Group of 20 (G20) Inclusive Framework (IF) on Base Erosion and Profit Shifting (BEPS) as part of Pillar One, Amount B, in February 2024 (as supplemented). The SSA provides a simplified way to compute an arm's length return for routine distributors and, incidentally, suppliers to such distributors. The Notice also provides that U.S. taxpayers may apply the SSA in accordance with the Notice beginning in 2025. 

The SSA would join a short list of safe harbor provisions provided in the context of section 482, including the safe haven interest rate in Treas. Reg. § 1.482-2(a)(2)(iii) and the services cost method in Treas. Reg. § 1.482-9(b). However, unlike these other safe harbors, the SSA is based upon data from comparables. The SSA is a specific and mechanical application of the comparable profits method in the U.S. transfer pricing regulations or the transactional net margin method in the OECD Transfer Pricing Guidelines, producing results based on factors such as industry grouping, operating asset intensity, and operating expense intensity that are intended to approximate arm's length results. (A larger discussion of the SSA scope and methodology can be found here in the March 2024 issue of our Monthly Tax Roundup.)

The Notice proposes to adopt the SSA because it "reflects a carefully balanced tradeoff between reliability and administrability." Without the SSA, the burdens of transfer pricing compliance and administration for routine marketing and distribution activities can impose a relatively high cost on taxpayers and tax administrations. The SSA may ameliorate these costs, but only for taxpayers that are willing to adopt a potentially less-precise transfer pricing analysis than could be achieved under an individualized approach. Treasury and the IRS hope the loss of precision will be minimal, however, due to the sophistication of the SSA and its sensitivity to material factual differences between comparables and tested parties. 

If a taxpayer elects to use the SSA for "in-scope" and "qualifying" transactions, the IRS will, with certain exceptions, treat the SSA as the best method. The SSA will not be considered the best method if any party (i.e., the parties to the transactions or either taxing authority) demonstrates that the comparable uncontrolled price method is more reliable. In addition, the IRS may still audit the taxpayer regarding whether a transaction is in-scope, whether the taxpayer's election is valid, and whether the taxpayer's income allocations are properly calculated under the SSA. If a taxpayer uses the SSA without meeting the requirements of the Notice, the IRS will treat it as an unspecified method.

The Notice does not bind the tax authorities of other countries, and in general IF jurisdictions have taken a political commitment to respect outcomes under the SSA only where the SSA is applied by certain low- and middle-income jurisdictions (so-called "covered jurisdictions") to local distributors. Accordingly, a U.S. taxpayer that elects to apply the SSA may risk double taxation to the extent the counterparty jurisdiction has not adopted the SSA for transactions involving the U.S. While the Notice signals a U.S. commitment to adopt the SSA more broadly than required, ultimately the utility of the SSA will depend on broad adoption.   

Taxpayers should consider providing comments on the provisions discussed in the Notice on or before March 7, 2025. The Notice welcomes comments generally and also raises specific areas for comment:

• Under the Notice, taxpayers may elect to use the SSA. The Notice asks for comment regarding whether the proposed regulations should also allow the IRS to impose the SSA on taxpayers, and if the election should be limited to circumstances where the non-U.S. counterparty is in a jurisdiction that also recognizes the SSA. The Notice recognizes that the SSA will not provide protection in a Mutual Agreement Procedure   if the other jurisdiction does not recognize the SSA.
• The Notice would allow the SSA to be elected on a transaction-by-transaction basis for the taxable year for which the election is filed, but further notes that Treasury and IRS are considering whether to include a requirement of consistency such that the SSA would be applied in a different manner. The Notice requests comment on possible requirements of consistency, such as a requirement that elections must cover all (or certain categories) of in-scope transactions or cover multiple years.
• The Notice limits in-scope transactions to those with distributors with a ratio of annual operating expenses to annual net revenue between three percent and an upper band of 20-30 percent (depending on the jurisdiction). The Notice requested comment on whether 30 percent is the appropriate upper boundary.

Taxpayers who are considering the SSA should continue to monitor legal and policy developments, in particular announcements by other IF members regarding adoption of the SSA. In the meantime, taxpayers may elect to use the SSA for in-scope transactions involving U.S. distributors and suppliers as described in the Notice for tax years starting on or after January 1, 2025. Such taxpayers should review the Notice carefully, particularly regarding the types of documentation required to avoid penalties under IRC section 6662. Nevertheless, taxpayers with routine marketing and distribution activities may find that the SSA ultimately reduces their overall compliance burdens and provides helpful clarity on how the IRS will view their transfer pricing analyses. Moreover, taxpayers with pending disputes involving routine marketing and distribution activities in which the U.S. is involved may consider the utility of the SSA in providing a reference to help resolve disputes even in tax years prior to 2025.

For more information, please contact:

Brian S. Gleicher, bgleicher@milchev.com, 202-626-1589

Rocco V. Femia, rfemia@milchev.com, 202-626-5823

Jaclyn Roeing, jroeing@milchev.com, 202-626-5929

The information contained in this communication is not intended as legal advice or as an opinion on specific facts. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information, please contact one of the senders or your existing Miller & Chevalier lawyer contact. The invitation to contact the firm and its lawyers is not to be construed as a solicitation for legal work. Any new lawyer-client relationship will be confirmed in writing.

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