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OECD Proposal to Improve the Resolution of Tax Treaty Disputes

Presented by:
Jeffrey Owens, Director of the Centre for Tax Policy & Administration, OECD.
The views expressed in this article are those of the author and do not commit the OECD nor its Member countries.
The article will be published in European Taxation, Issue 6, 2007.
© Copyright IBFD

International

Jeffrey Owens

OECD Proposal to Improve the Resolution of Tax Treaty Disputes

1. Introduction

As more people work abroad and more cross-border trade and investment take place, there are inevitably more cross-border tax issues and more risk of friction in the form of double taxation. Left unresolved, double taxation can be a major impediment to cross-border activity. Over the last 50 years, the OECD has led the way in the development of the network of more than 2,500 bilateral tax treaties designed to reduce this friction. The application of these tax treaties may, however, lead to disputes. The OECD has just agreed recommendations that will significantly improve the way in which these disputes are resolved.

2. OECD Report on Improving Tax Treaty Dispute Resolution

2.1. Introductory remarks

The Report, "Improving the Resolution of Tax Treaty Disputes",¹ was approved by the Committee on Fiscal Affairs on 30 January 2007. It addresses various issues arising from the mutual agreement procedure (MAP), which is the mechanism provided by tax treaties to resolve disputes between the countries that sign these tax treaties.

1 OECD, "Improving the Resolution of Tax Treaty Disputes" (Paris: 2007)

When disputes arise between governments as to how their tax treaty applies to a taxpayer, the MAP allows the tax authorities to meet to attempt to resolve differences and to ensure the correct application of the tax treaty. The MAP has worked reasonably well in the past, but both the number of cross-border disputes and the complexity of the cases involved has increased, and unresolved issues have become more frequent. For example, statistics produced by two Member countries of the OECD for 2005 and 2006 indicate that between 9% and 20% of the negotiated mutual agreement cases completed during these years did not result in full relief from double taxation. Some of the reasons that there was less than a full solution to these cases were the withdrawal of the case by the taxpayer, disagreement on what constitutes a permanent establishment (PE), disagreement on the interpretation of a treaty provision and disagreement on the valuation of intangibles or services.

2.2. New arbitration procedures

The most important feature of the new OECD Report is a change to the OECD Model Convention (hereinafter: the OECD Model), which is the basis on which many tax treaties are negotiated, to provide for the arbitration of issues that remain unresolved after two years of negotiation under a MAP. Whilst the change is in line with the approach put forward in the EC Arbitration Convention, which provides for the arbitration of unresolved transfer pricing cases between members of the European Union, the change's scope is broader, as it is not restricted to transfer pricing issues.

To implement these provisions, a new Para. 5 will be added to Art. 25 of the OECD Model. (See Box I.)

Box I

New Art. 25(5)

Where,

1. under paragraph 1, a person has presented a case to the competent authority of a Contracting State on the basis that the actions of one or both of the Contracting States have resulted for that person in taxation not in accordance with the provisions of this Convention, and



2. the competent authorities are unable to reach an agreement to resolve that case pursuant to paragraph 2 within two years from the presentation of the case to the competent authority of the other Contracting State, any unresolved issues arising from the case shall be submitted to arbitration if the person so requests. These unresolved issues shall not, however, be submitted to arbitration if a decision on these issues has already been rendered by a court or administrative tribunal of either State. Unless a person directly affected by the case does not accept the mutual agreement that implements the arbitration decision, that decision shall be binding on both Contracting States and shall be implemented notwithstanding any time limits in the domestic laws of these States. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of this paragraph.

The new arbitration process is an integrated part of the MAP. As the unresolved issues to be arbitrated are issues on which the competent authorities disagree, the arbitration procedure is, therefore, a government-to-government process. The taxpayer is, however, the party that invokes the arbitration procedure. The revised commentaries to Art. 25 of the OECD Model include a sample mutual agreement that governments may wish to adopt to specify the manner in which they intend to apply the arbitration provision, although governments are free to adopt different procedures. Whilst this sample agreement calls for the governments to appoint the arbitrators and to submit the questions for decision to the arbitral panel, it allows the taxpayer to make its own submission and to make an oral presentation to the panel with the panel's permission. The taxpayer has the option at the end of the process to accept the arbitral panel's decision or, instead, to opt to pursue other available domestic law remedies.

Confidentiality is provided for under the sample agreement. To ensure the confidentiality of the information relating to the arbitration case, each arbitrator is designated to be the authorized representative of the competent authority that appointed the arbitrator.

Under the sample agreement, the arbitrators are to adopt the procedural and evidentiary rules that they deem to be necessary to answer the questions set out in the terms of reference, which have been submitted to them by the competent authorities. Unless the competent authorities agree otherwise, any information that was not available to both competent authorities before the request for arbitration is received is not taken into account for purposes of the decision.

All of the issues covered by Art. 25(1) of a tax treaty based on the OECD Model could be subject to arbitration, including cases relating to the existence of a PE and the profits attributable to the PE. The OECD proposal does not, however, cover cases described in Art. 25(3), for example cases of double taxation not specifically covered by the tax treaty, unless the bilateral treaty partners agreed to expand the arbitration provision to cover these issues.

Under Para. 18 of the sample agreement, the arbitration decision is final, unless the decision is found to be unenforceable by the courts of one of the contracting states because of a violation of Art. 25(5) of the tax treaty or of any procedural rule included in the terms of reference, or in the competent authority agreement that may "reasonably have affected the decision". In that event, the request for arbitration is deemed not to have been made and the arbitration process is considered not to have occurred.

Para. 19 of the sample agreement provides that the competent authorities will implement the arbitration decision within six months of the date the decision is communicated to them by reaching a mutual agreement on the case that led to the arbitration.

Business participants had expressed concern regarding the aspect of the initial proposal published in early 2006 that would have required taxpayers to waive their rights to domestic legal remedies in order to bring unresolved issues to arbitration. In response to these comments, an important change was made to the initial proposal and the final OECD Report provides that the taxpayer is not required to waive rights to domestic remedies as a condition for requesting arbitration.

The inclusion of the arbitration provision in a bilateral tax treaty should not mean that all difficult cases result in arbitration. The existence of the possibility of the arbitration of unresolved issues should, however, encourage the competent authorities to come to an agreement without the need to use the process. To put it another way, "the best arbitration is no arbitration".

2.3. Other features of the Report

These include:

• Additional guidance, to be included in the Commentary on the OECD Model, on how the current MAP should work. This deals with issues such as time limits for making a MAP request, the suspension of collection of tax during the process, the suspension or remission of interest, and penalties and the relationship between domestic law and the MAP.
• The development of an online Manual on Effective Mutual Agreement Procedure (MEMAP). The online manual, which will be updated periodically to reflect new developments, explains the various stages of the MAP, discusses issues relating to that procedure, and contains 25 "best practice" recommendations for tax authorities and taxpayers to make MAP operate more effectively. (See Box II.)
  
  

  Box II – Best practices for MAPs
  
  Best Practice No. 1: Resolving and publishing issues of interpretation or application
  
  Best Practice No. 2: Robust use of Article 25(3) power to relieve double taxation
  
  Best Practice No. 3: Principled approach to resolution of cases
  
  Best Practice No. 4: Transparency and simplicity of procedures for accessing and using the MAP
  
  Best Practice No. 5: Providing complete, accurate, and timely information to the competent authorities
  
  Best Practice No. 6: Allowing electronic submissions
  
  Best Practice No. 7: Allowing early resolution of cases
  
  Best Practice No. 8: Earlier notification of a potential case
  
  Best Practice No. 9: Liberal interpretation of time limits and advising of treaty rights
  
  Best Practice No. 10: Avoiding exclusion from MAP relief due to late adjustments or late notification
  
  Best Practice No. 11: Consideration of MAP assistance for cases described as "tax avoidance"
  
  Best Practice No. 12: Countries eliminate or minimize "exceptions" to MAP
  
  Best Practice No. 13: Taxpayer presentations to competent authorities
  
  Best Practice No. 14: Cooperation and transparency
  
  Best Practice No. 15: Face-to-face meetings between competent authorities
  
  Best Practice No. 16: Bilateral process improvements
  
  Best Practice No. 17: Decision summaries
  
  Best Practice No. 18: Recommendation for MAP cases beyond two years
  
  Best Practice No. 19: Avoid blocking MAP access via audit settlements or unilateral [advance pricing agreements] APAs
  
  Best Practice No. 20: Interest relief
  
  Best Practice No. 21: Suspension of collections during MAP
  
  Best Practice No. 22: Readily available access to a competent authority
  
  Best Practice No. 23: Independence and resources of a competent authority
  
  Best Practice No. 24: Performance indicators for the competent authority function and staff
  
  Best Practice No. 25: Implementing and promoting [Accelerated Competent Authority Procedure] ACAP and bilateral APA programs
  

  
  
• The development of a reporting framework for MAP cases, which will be used to collect and publish statistical information on the number of MAP cases in the Member countries of the OECD.

3. Conclusions

The approach chosen to implement the arbitration proposals, by means of the MAP protocol, means that countries wishing to use the provision can do so by voluntarily introducing the arrangement through a mutual agreement, without necessarily having to engage in a renegotiation of their bilateral tax treaties. It is to be hoped that many governments will quickly avail themselves of this option as an interim step towards the introduction of the new provision into their tax treaties.

The implementation of arbitration provisions into the tax treaties between countries will be a significant step in reducing impediments to a more efficient dispute resolution process. This, in turn, should save both time and money for business and governments. The governments of the Member countries of the OECD now need to take the lead in this process.