More on Binding Arbitration of Tax Treaty Disputes: Issues and Anomalies Under the Newly-Negotiated Protocol with France

By David R. Tillinghast, Esq. Baker & McKenzie LLP, New York, NY

To the provisions in the recent Belgian Treaty, the German Protocol, and the Canadian Protocol for the binding arbitration of tax treaty disputes (now all in force but yet to be applied), we can now add the provision in the newly-negotiated Protocol with France. While there are substantial similarities among the agreements in force, there are also a considerable number of differences, and the French Protocol will add to these.

First, let's look at similarities. Like the three previous agreements, the French Protocol contemplates a “baseball” or “best offer” arbitration procedure following rules which, with one important exception to be discussed below, are the same as in the three other agreements. Like the others, the French agreement gives the taxpayer the option to accept or reject the arbitral award, while making the award binding on the Competent Authorities if the taxpayer accepts it. The rules for making the award, for enforcing it, and for assuring confidentiality are essentially the same.

The range of issues subject to arbitral review differs. Under the German Protocol, these are limited to issues arising under Article 4 (as it relates to the residence of an individual); Article 5, Permanent Establishment; Article 7, business profits; Article 9, associated enterprises (transfer pricing); and Article 12, royalties. The range under the Canadian Protocol is quite similar, but with a much narrower range of royalty issues included. The Belgian Treaty does not limit the range of issues subject to arbitration. In this respect the French Protocol resembles the Belgian Treaty. Like the other agreements, it also provides that an issue will not be arbitrated if the Competent Authorities agree that it is not “suitable for arbitration.” (Article 26(5)(b) of the Treaty, as revised by Article X of the Protocol.)

A serious deficiency in the French Protocol, or more precisely in the accompanying Memorandum of Understanding, is in the procedure for the nomination of arbitrators. As in the earlier agreements, each Competent Authority is directed to name one arbitrator, and the two so named are instructed to agree upon a Chair. If within 60 days they cannot agree, they are “regarded as dismissed” and the Competent Authorities then name two new arbitrators, who are presumably supposed to agree on a Chair. However, this is not expressly stated; no time period is specified for reaching agreement; and if the new appointees cannot agree, there is no provision for resolution of the deadlock. The three earlier agreements provide that in the case of such a deadlock, the Chair will be appointed by an official of the Centre for Tax Policy Administration of the OECD. The failure to include such a rule in the French Protocol leaves open the possibility that a recalcitrant Competent Authority can effectively torpedo an arbitration by simply naming arbitrators who will not agree upon the identity of the Chair.

A positive, though somewhat flawed, innovation in the French Protocol is a provision which contemplates that the taxpayer will be permitted to submit to the arbitrators a Position Paper like those submitted by the Competent Authorities, which form the basis for the arbitrators' consideration of the case. Memorandum of Understanding, ¶ (h). In this connection, see my commentary, “Taxpayer Participation in Mandatory Arbitration Under the New German and Canadian Protocols and Belgian Treaty,” 38 Tax Mgmt. Int'l J. 581 (11/9/07).

While this represents a big step forward, and should be adopted for use under the three earlier agreements by appropriate amendment of the Memoranda of Understanding or Notes exchanged by the Competent Authorities thereunder, some bugs need to be worked out. As the provision now stands, the taxpayer's Position Paper is to be submitted within 90 days of the appointment of the Chair, which is only 30 days later than the dates on which the Competent Authorities must submit their Position Papers, but before they are required to submit their Reply Submissions. While it is provided that the arbitrators will forward the taxpayer's Position Paper to the Competent Authorities, there is no indication that the taxpayer will have access to the Position Papers submitted by the Competent Authorities. (Even if it had access, giving the taxpayer only thirty days to review them and submit a Position Paper seems much too tight a schedule.)

In addition, the taxpayer is apparently not permitted to present to the arbitrators a Proposed Resolution which is different from those submitted by the Competent Authorities, since the Memorandum of Understanding continues to specify that the arbitration panel must adopt one or the other of the Proposed Resolutions submitted by the Competent Authorities. Memorandum of Understanding, ¶ (i).

From the beginning, it has been obvious that, in contemplating arbitration, the Competent Authorities have taken care to see that the proceedings remain under their sole control. The procedures which are contemplated by the agreements which the United States has entered into are a far cry from the procedures followed in analogous arbitration proceedings, such as arbitration of investment or commercial disputes, in which the affected private party or parties play an active role. There is merit in giving the affected taxpayer the ability to make a meaningful contribution to the resolution of the dispute. If the Competent Authorities have got it wrong, it will only increase the number of successful outcomes if the taxpayer can effectively persuade the arbitrators that this is so and why. It would be preferable, therefore, if the taxpayer could be afforded access to the Proposed Resolutions submitted by the Competent Authorities and have the ability to submit a different Proposed Resolution which could be adopted by the arbitral panel.

Procedurally, the Competent Authorities are the ones involved in initiating the arbitration. However, the arbitration will not occur unless and until the taxpayer and the other “concerned persons” (if any) submit the agreements not to disclose, which are contemplated by Article 26(6)(d) of the Treaty (as revised by Article X of the Protocol). Presumably, these agreements must be delivered in writing to the two Competent Authorities.

Meeting this requirement could, of course, substantially delay the commencement of the proceeding (and if the taxpayer wants to block arbitration it can do so by simply never submitting the agreement, although it is hard to see when this would be in the taxpayer's interest). Assuming that at least one of the Competent Authorities and the taxpayer are anxious to get on with the arbitration, they will make it a point to get the required agreements in place before the standard two-year period (prior to commencement of arbitration) runs and assure that they are delivered to the other Competent Authority as well.

The deadline for the submission by the taxpayer of a Position Paper is tied to the date on which the Chair of the arbitral panel is appointed. The taxpayer will not ab initio know when this occurs, so it will be necessary for the Competent Authorities (or one of them) to notify it of the event. Given the shortness of time given for the submission by the taxpayer, such notification needs to be given promptly.

This commentary also will appear in the March 2009 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Cole, Gordon and Croker, 940 T.M., Income Tax Treaties -- Administrative and Competent Authority, and in Tax Practice Series, see ¶7140, U.S. Income Tax Treaties.