Bloomberg BNA’s Premier International Tax Library is a comprehensive global tax resource. Trust Bloomberg BNA's Premier International Tax Library for the guidance you need on...
By David Ernick, Esq.
PricewaterhouseCoopers LLP, Washington, DC
The OECD Mutual Agreement Procedure Statistics for 20131 (MAP Statistics), released on November 25, 2014, show a dramatic surge in the inventory of mutual agreement procedure (MAP) cases among OECD member countries. The MAP Statistics confirm that the potential for double taxation is increasing. This is reflected most starkly in the inventory at the end of 2013 of 4,566 MAP cases. That represents a 12% increase in open cases from 2012 and a 94% increase from 2006. The unprecedented levels of MAP cases and growing concerns that the OECD Base Erosion and Profit Shifting (BEPS) project could lead to more cross-border tax disputes and double taxation highlight the urgent need for BEPS Action 14 to succeed in making dispute resolution mechanisms more effective, particularly by recommending and facilitating far more widespread adoption and use of mandatory binding arbitration.
The BEPS Action Plan recognized the need for certainty and predictability and that, while the project would work to prevent so-called "double non-taxation," it was imperative that double taxation which could impede cross-border trade and investment also be avoided. Action 14 explicitly highlighted the importance of arbitration and promised to improve dispute resolution mechanisms by working to:[d]evelop solutions to address obstacles that prevent countries from solving treaty-related disputes under MAP, including the absence of arbitration provisions in most treaties and the fact that access to MAP and arbitration may be denied in certain cases.
Consequently, it was disappointing to many observers that the December 18, 2014 report, BEPS Action 14: Make Dispute Resolution Mechanisms More Effective (Discussion Draft), stated that "there is no consensus on moving towards universal mandatory binding MAP arbitration." Instead, the Discussion Draft proposed a three-pronged approach for resolving treaty-related disputes through MAP proceedings, consisting of: (1) political commitments to effectively eliminate taxation not in accordance with the OECD Model Convention on Income and on Capital; (2) measures to improve access to MAP proceedings, and new and improved procedures aimed at making MAP proceedings effective and efficient; and (3) a monitoring mechanism to check the proper implementation of the political commitment. The political commitment and the proposals to improve MAP proceedings are grounded in four principles which are the framework of the Discussion Draft:
Before analyzing how mandatory binding arbitration can improve MAP proceedings and advance the goal of preventing double taxation, it is important to bear in mind that a fundamental purpose of income tax treaties is the fostering of bilateral trade and investment between the treaty partners by minimizing artificial tax barriers. One of the predominant ways this is achieved is by providing greater certainty. One way tax treaties improve that certainty is by allowing a resident of one country a minimum threshold of economic activity in another country before the resident is subject to net income taxation on business profits generated in the host country.
An equally important means of removing artificial tax barriers is to provide for relief of double taxation. That is accomplished mostly by setting out an agreed allocation of taxing rights between the two treaty partners. One way that allocation is established is by agreeing on rules for determining residence of a taxpayer, and then setting out a procedure for resolving cases where a taxpayer may be considered to be a resident of both countries. Another way is by establishing categories of income and assigning the primary right to tax that income to one country, usually the "source" country, and giving the "residence" country a residual right to tax that income, and relieving double taxation through a commitment by the residence country to provide a credit against its tax for the source country taxes (or an exemption from residence country tax for income sourced in the other country). In addition to mitigating double taxation, tax treaties strive to prevent excessive taxation, by reducing or eliminating withholding taxes imposed at source. Tax treaties also aim to prevent taxpayers from being subject to discriminatory taxation in the host jurisdiction.
In sum, all of these measures reflect the fact that tax treaties are designed to eliminate or reduce impediments to cross-border trade and investment. Tax treaties increase certainty for taxpayers with respect to their potential tax liability in a foreign jurisdiction, provide an agreed upon allocation of taxing rights, reduce the potential for double taxation, and protect against taxpayers being subjected to excessive or discriminatory taxation in the treaty partner jurisdiction.
The goal of tax treaties to reduce double taxation cannot be achieved if the treaty is not implemented effectively. That requires that when disputes arise regarding the interpretation or application of the treaty, the Competent Authorities of the treaty partners are able to resolve them effectively, and in a timely manner. Many of the comment letters received on the Discussion Draft noted that the process for resolving cross-border tax disputes is in desperate need of improvement in order to accomplish the basic goal of preventing double taxation. The record high inventory of MAP cases combined with aggressive audit tactics as a means to increase tax revenues in a BEPS environment and unilateral domestic law changes mean that extreme pressure will be placed on the MAP process.
The U.S. experience with "final offer" or "baseball" mandatory binding arbitration shows that it can be an effective tool to relieve that pressure. The United States initially experimented with "voluntary" binding arbitration procedures in treaties with Germany, Canada, Mexico, and the Netherlands, but it was not a satisfactory experience. Although it may have provided some limited amount of assistance in resolving disputes, it did not significantly improve resolution of cases.
Consequently, the United States moved to mandatory binding arbitration, which is in effect in treaties with four countries (Belgium, Canada, France, and Germany) and has been agreed to in treaties with three other countries (Japan, Spain, and Switzerland) that have not yet been ratified. Under this so-called "baseball-style" arbitration, the Competent Authorities have two years to resolve a particular case, after which time they must present it to an arbitration panel for resolution, unless they both agree that it is not appropriate for resolution by arbitration. In "baseball" arbitration, the arbitration panel has to choose the position of one of the Competent Authorities to resolve the case, rather than develop its own independent resolution of the dispute. Because the arbitration panel cannot "split the difference" between the two positions, both Competent Authorities are incentivized to set forth reasonable positions. In fact, the experience has been that not many cases actually go to arbitration, because both sides are encouraged to narrow their differences as the expiration of the two-year period looms closer. For cases that are resolved by the arbitration panel, its decision is adopted by the Competent Authorities as their own resolution of the case. IRS and Treasury officials have stated publicly that mandatory binding arbitration has been a significant help in resolving MAP cases, and business has been a strong supporter as well.
With this experience as background, many of the comment letters received urged the OECD to redouble its efforts to achieve a consensus recommendation for mandatory binding arbitration. Although the Discussion Draft noted that it would not be fruitful to recommend measures that would not be "fully used or implemented," that should not be an impediment to endorsing mandatory binding arbitration in the final guidance on improving dispute resolution mechanisms. The OECD generally is only a standard-setting body, meaning that its purpose is limited to making recommendations – it has no enforcement power, unlike, for example, the WTO in the trade arena. It generally only makes recommendations and does not get involved in implementation or enforcement. Most of its recommendations involving tax are in fact never "fully" used or implemented, but that is not the point. By merely establishing the standard, the OECD encourages uniform implementation over time, as member countries and others move closer to the standard over the years, in order to recognize the mutual benefits from having a uniform set of rules.
If the OECD is not able to achieve a consensus recommendation on mandatory binding arbitration, is there anything the United States could do unilaterally to encourage more widespread adoption? In an earlier commentary, I argued that the United States could offer a single-issue protocol providing for mandatory binding arbitration to any country willing to sign. In addition to that approach, the United States could more assertively lead the way to more widespread adoption of mandatory binding arbitration by moving it from its list of preferred provisions in treaty negotiations to a mandatory provision. Currently, there are several "deal-breaker" issues which the United States will not compromise on in negotiating tax treaties. For example, if a potential treaty partner does not impose significant income tax and there is only a slight possibility of double taxation, a tax treaty is not appropriate.2 Other U.S. treaty positions that are non-negotiable include the following:
The U.S. Treasury Department's Office of Tax Policy (OTP) is primarily responsible for the negotiation of income tax treaties. OTP has a small staff and receives many requests for tax treaty negotiations from countries around the world. The negotiation of an income tax treaty requires a significant commitment of time and effort on the part of the staff of OTP, and indeed the complexity of the negotiations themselves is a significant constraint on the size of the U.S. treaty network. In other words, the "demand" for tax treaties with the United States is much greater than the "supply."
Making mandatory binding arbitration a prerequisite to sitting down at the negotiating table with the United States likely could be done with little to no reduction in requests for treaty negotiations. It also could strengthen the negotiating hand of OTP, as there would be no need during negotiations to trade any other provisions for arbitration with those countries averse to but not completely against arbitration. It could even lead to more widespread adoption of mandatory binding arbitration provisions in treaties to which the United States is not a party. Businesses always consider the investment climate before entering or expanding into new markets, with tax being an important consideration – even more so in the potentially turbulent post-BEPS environment. In that regard, a country's internal tax rules as well as its network of tax treaties are significant factors to evaluate. But, more and more, it is recognized that signing a tax treaty is one thing, but effectively administering that treaty is another. Countries averse to mandatory binding arbitration because they are not willing to have the soundness of their positions examined by a neutral arbitrator may be viewed as less attractive for business investment as cross-border tax disputes multiply in the coming years.
This commentary also will appear in the April 2015 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Gleicher, 892 T.M., Transfer Pricing: Competent Authority Consideration, Suringa, 904 T.M., U.S. Income Tax Treaties -- U.S. Competent Authority Functions and Procedures, and in Tax Practice Series, see ¶3600, Section 482 — Allocations of Income and Deductions Between Related Taxpayers, and ¶7160, U.S. Income Tax Treaties.
Copyright©2015 by The Bureau of National Affairs, Inc.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to email@example.com.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to firstname.lastname@example.org.
Put me on standing order
Notify me when new releases are available (no standing order will be created)