The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
Siemens AG’s global tax chief said he’s heartened that 25 countries have signed on to arbitration provisions in the OECD’s master treaty as a first step to including those provisions—designed to allow cross-border tax disputes to be resolved more quickly—in their treaties.
“The mere threat of arbitration usually motivates competent authorities to come to an agreement and not escalate the case,” Christian Kaeser, vice president and global head of tax at the company, told Bloomberg BNA June 13. No competent authority wants a disputed case to be decided by an arbitration board, he said.
The 25 countries signing on for arbitration represent more than a third of the 68 countries that signed the Organization for Economic Cooperation and Development treaty June 7, and will lead to introduction of arbitration in over 150 existing tax treaties.
The arbitration clause of the OECD treaty, which allows countries to select among provisions to adopt, says that when governments fail to settle overlapping tax claims on a company after two years, the dispute is taken out of their hands and given to a panel of arbitrators to resolve. The U.S. didn’t sign the OECD treaty, but it began including arbitration provisions in its treaties in 2007, and officials from both the U.S. and its treaty partners have said the clauses spur them to dispose of cases more quickly.
A former OECD official said the 25 countries that signed up for mandatory binding arbitration of tax disputes under the treaty are an encouraging sign. “Arbitration is a great way to ensure that competent authority disputes can be resolved more quickly,” said Jesse Eggert, now a principal in the international tax group of KPMG LLP’s Washington National Tax practice. While with the OECD, Eggert led negotiations with more than 100 jurisdictions to develop the treaty, known as the multilateral instrument (MLI).
Another former official with the organization—Marlies de Ruiter, who led the OECD’s BEPS work on tax treaties—agreed. “Having a stick behind the door makes competent authorities more efficient,” she told Bloomberg BNA June 13. Moreover, there are some disputes competent authorities find impossible to resolve, added de Ruiter, now a partner with Ernst & Young Belastingadviseurs LLP in Rotterdam, Netherlands.
Eggert noted that improving dispute resolution was a key goal of the OECD’s Action Plan on Base Erosion and Profit Shifting, the comprehensive rewrite of the global tax rules designed to curb tax avoidance by multinational companies, which also spawned the MLI. Many of the BEPS measures were predicted to increase the number of disputes by causing countries to adopt tougher tax rules.
Business groups have long been in favor of arbitration.
The United States Council for International Business, which represents 300 multinational companies, law firms, and business associations, “strongly supports mandatory binding arbitration,” its tax counsel, Carol Doran Klein, said June 13. William Sample, chairman of USCIB’s tax committee and corporate vice president worldwide for tax with Microsoft Corp., championed the adoption of arbitration during the BEPS project.
The 25 countries that opted for arbitration June 7 are Andorra, Australia, Austria, Belgium, Canada, Fiji, Finland, France, Germany, Greece, Ireland, Italy, Japan, Liechtenstein, Luxembourg, Malta, the Netherlands, New Zealand, Portugal, Singapore, Slovenia, Spain, Sweden, Switzerland, and the U.K.
The OECD said in “ Frequently Asked Questions on the Multilateral Instrument” posted to its website June 7 that their decision will lead to the introduction of arbitration in over 150 existing bilateral tax treaties.
The U.S. is committed to including arbitration provisions in its bilateral tax treaties but is unlikely to sign the MLI. In-force U.S. bilateral tax treaties with Belgium, Canada, Germany, and France contain an arbitration provision, as do pending U.S. bilateral tax treaties with Switzerland, Spain and Japan.
A senior legal adviser for the OECD said June 9 that 18 of the 25 countries opted for the MLI’s default option of “final offer” arbitration, also known as “baseball arbitration.” The other seven jurisdictions opted for “independent opinion” arbitration, said Gita Kothari, speaking during an OECD web seminar broadcast from Paris. Final-offer arbitration requires the arbitrators to choose between the two governments’ positions, with no possibility of creating a compromise, while the independent-opinion version, as the name suggests, requires a written opinion from the arbitration panel.
Final-offer arbitration is the default rule under the MLI, but countries that have principled objections against that style of arbitration can choose independent-opinion arbitration instead.
De Ruiter said it’s important for the MLI to create a default set of rules in case the countries including an arbitration clause in a bilateral or multilateral tax treaty fail to agree to a specific process.
“There has been some history of mandatory and binding arbitration clauses in treaties not being effective because no rules of procedure were agreed upon after the provision had been included in the treaty, and before the arbitration case arose,” she said.
The seven countries choosing “independent opinion” arbitration are Andorra, Greece, Japan, Malta, Portugal, Slovenia, and Sweden, according to de Ruiter and Eggert.
In the case of baseball or final-offer arbitration, the fact that the arbitrator must choose the solution proposed by one of the governments gives the governments incentive to take more reasonable positions during competent authority negotiations, which in turn helps to ensure that arbitration is only rarely needed, Eggert said. “Those incentives are not as strong with reasoned-opinion arbitration, but at the least, setting a two- or three-year time limit before the arbitration process begins will help prevent disputes from dragging on forever.”
USCIB prefers baseball arbitration because it has a number of important virtues, Doran Klein said. First, it reduces the length of time to a decision and therefore minimizes uncertainty and the cost of arbitration. Second, it greatly encourages competent authorities and taxpayers to make their best arguments during the mutual agreement procedure and results in the resolution of more cases without resorting to arbitration. Third, it raises fewer concerns about surrendering sovereignty because the arbitrators are merely resolving a single dispute and not deciding any legal issue in a way that could set a precedent.
De Ruiter said the 18 countries opting for final-offer arbitration are willing to accept that kind of arbitration as a default if they are unable to agree on a set of procedures with their treaty partners before an arbitration case arises.
This doesn’t necessarily mean that they have chosen or will always use final-offer arbitration, de Ruiter said. The 18 countries may have a strong preference for final-offer arbitration, or it may be that having arbitration in their treaties is more important to them than the form of arbitration, and so they are willing to be led by the other country’s preference when it comes to the default rule.
De Ruiter said five of the 18 countries that accepted final-offer arbitration as a default have indicated that if the treaty partner opts out of that type of arbitration, they “are not willing to automatically accept independent-opinion arbitration as a default.” In that case, the parties will have to bilaterally negotiate their procedures; otherwise, arbitration won’t happen. The five countries are Canada, Finland, Italy, Luxembourg, and Singapore.
The other 13 countries that accepted final-offer arbitration as a default rule haven’t made such a reservation, which means they will accept independent-opinion arbitration as a default rule if the other country has indicated it can’t accept final-offer arbitration, de Ruiter said.
Doran Klein said that if two countries agree to arbitrate, agree on the form or arbitration, and agree on the topics, then when both countries ratify the MLI and it enters into force, they will be bound by that obligation just as they would be by any other treaty obligation. However, she noted, some of the countries “have limited the things that they were willing to arbitrate on.”
Eggert explained the matching process for the MLI arbitration provisions.
If two countries both sign up for the MLI and elect to apply the arbitration provision, arbitration would generally apply for purposes of the tax treaty between them, he said. The details of the arbitration process and the scope of cases covered, however, both depend on the choices each country makes when it signs up.
In particular, parties to the MLI are able to make free-form reservations about the cases covered by the arbitration provision, Eggert said. “Fifteen countries signing up for arbitration formulated one or more carve-outs from the scope of cases covered, some of them quite broad, and taxpayers need to pay attention to those carve-outs to know whether particular types of cases will be subject to arbitration.”
Kothari said Part VI of the MLI, which contains the arbitration provisions, is the only part of the treaty where countries can make free-form reservations, as opposed to choosing to adopt or not to adopt existing provisions.
Eggert said cases on which countries might make free-form reservations include those violating domestic anti-abuse rules or those in which “serious penalties” have been imposed. De Ruiter said other common exclusions are cases where the courts found one of the parties guilty of fraud, cases of willful default or gross negligence, and cases that don’t result in double taxation.
Eggert said countries are able to object to other countries’ free-form reservations, and if they do, “no arbitration will apply between the objecting country and the reserving country.”
Eggert outlined how the bilateral income tax treaty between France and Germany—both of which signed the MLI and opted for final-offer arbitration—would work if both countries ratify the MLI without changing their current positions.
Eggert said the tax treaty would provide for arbitration, “but the scope of that arbitration would be limited by the free-form reservations that each country has made.”
If the two countries involved were instead France and Japan, arbitration wouldn’t apply at all because Japan has objected to France’s reservations, Eggert said.
Kothari said the MLI country provisions can change up until the point of ratification. Even after ratification, it’s possible for jurisdictions to modify their MLI positions to accept more of the treaty.
“They can’t go backwards but they can accept more,” Kothari said. The MLI is a dynamic instrument, meaning jurisdictions could opt in to Part VI on arbitration once they become more comfortable with the process.
Kothari said several government officials at the June 7 signing ceremony called for more countries to adopt the arbitration provisions.
Eggert, too, said he is “hopeful that we will see more countries joining over time, as they learn from the experiences of the countries that have signed up.”
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