Wednesday, April 12, 2006

Arbitration and Tax Treaty Disputes: Time is approaching

Somewhere in Spain and in the middle of tons of work, the duty to the readers surfaced at last!

The business community and the International Chamber of Commerce, have long been promoting the inclusion of an arbitration provision in tax treaties. Countries, on the other hand, are sceptical to surrender their taxing power to an outside authority. For developing countries, the scepticism may be said to be aggravated by the fact that such countries may be put at a disadvantage in an arbitration proceeding, namely due to resources and expertise related issues.

As maybe some of you are aware, on 1 February 2006, the OECD released a public discussion draft, which includes new proposals for improving mechanisms for the resolution of tax treaty disputes, including finally the long-expected arbitration clause.

For those of you who need to be situated in the debate, this 2006 discussion draft represents in general the follow-up work of the project to improve the effectiveness of the Mutual Agreement Procedure launched back in 2003. A 2004 progress report entitled Improving the Process for Resolving International Tax Disputes included 31 proposals aimed at improving the way that tax treaty disputes are resolved through the Mutual Agreement Procedure and the new 2006 discussion draft includes various draft changes to the OECD Model Tax Convention.

In fact, when countries starting signing tax treaties, they soon realized that problems were not always solved through the allocation of taxing rights. In fact as time went by, those countries realized it was necessary to find solutions for cases of double taxation not covered by the treaty, difficulties in the interpretation or cases resulting from changes in domestic law. As such, there was a neet of a mechanism that would secure an agreement and solve disputes on the interpretation of treaties. The Mutual Agreement Procedure (Article 25 of the OECD Model) was the mechanism adopted in 1963 by the OECD. In short, Art. 25 allows designated representatives (so-called competent authorities) from the governments of the contracting states to interact with the intent to resolve international tax disputes.

But what is a Mutual Agreement Procedure (MAP)?

According to the (also recently released) draft Manual on Effective Mutual Agreement Procedures , the MAP article (Article 25 of the OECD Model) usually sets out three general areas where two Countries shall endeavour to resolve their differences. The first area applies to situations where a taxpayer believes that the actions of one or both of the contracting states has resulted or will result for him in “taxation not in accordance with the provisions of the Convention” (Article 25 (1) and (2)). In addition, the two other areas involve questions of “interpretation or application of the Convention” and the elimination of double taxation in cases not otherwise provided for in a convention (Article 25 (3) first and second sentence respectively).

In short, if a taxpayer considers that the actions of one or both countries’ result or will result in taxation not in accordance with a tax convention (first area), that same taxpayer may request competent authority assistance under the said MAP article (taxpayer-initiated MAP). The cases covered by paragraph 3, rather than offering a treaty obligation are more aimed at facilitating discussion between competent authorities. In fact, the OECD recognizes that there is little experience with cases arising under paragraph 3 of Article 25. Nevertheless, the 2004 report suggested that the appropriate scope (and effectiveness) for paragraph 3 of Article 25 should be examined.

In the 2006 draft, The OECD proposed a system for the mandatory arbitration of tax disputes between two treaty countries when the tax authorities of those countries have been unable to resolve those disputes within a two-year period. The text of the new paragraph 5 reads as follows:

“5. Where, under paragraph 1, a person has presented a case to the competent authority of a Contracting State and 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 any person directly affected by the case is still entitled, under the domestic law of either State, to have courts or administrative tribunals of that State decide the same issues or if a decision on the same issues has already been rendered by such a court or administrative tribunal. The arbitration 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.”

If one looks back to the 2004 Progress Report, two of the most important proposals dealt, in fact, with the use of supplementary dispute resolution mechanisms, in particular the use of an advisory opinion, a joint commission or arbitration to resolve issues that prevent competent authorities from reaching a mutual agreement.

It is here that the problems may start! The problems can be said to be both on the technical aspect of the arbitration rule itself, but also on the policy objectives that it intends to achieve. Is it really necessary?

As we said before MNE and the International Chamber of Commerce (ICC), have long been promoting the inclusion of an arbitration provision in tax treaties. The UN recently commented (5-9 December 2005) on the government side concerns, even suggesting that an attempt could also be made to design an arbitration mechanism adapted to the relations between developed and developing countries.

In that respect, I would like to note that J. Mcintyre (Wayne State University - School of Law) recently posted a paper making a critical analysis of the OECD Proposal. His work “Comments on the OECD Proposal for Secret and Mandatory Arbitration of International Tax Disputes” is a very good platform to understand both the policy issues behind the OECD proposal and consider alternative policy options.

For the ones interested on these issues, I should note that the ICC is hosting on 3 May 2006 a high-level conference on the “Resolution of International Tax Disputes through Arbitration”. According to the programme, the discussions will focus mainly on (i) Recent OECD developments; (ii) EU arbitration convention and the EU Code of Conduct; (iii) ICC model clause; (iv) Design, procedural and enforcement issues of arbitration clauses.

A list of 10 must read BOOKS AND ARTICLES on the subject:
I - Arbitration under tax treaties : improving legal protection in international tax law, Züger, M., Amsterdam: IBFD Publications (2001 )

II - Arbitration in international tax matters, Paris: ICC - International Chamber of Commerce, (1998)

III- Resolution of tax treaty conflicts by arbitration, IFA congress seminar series; Vol. 18e, (1994)

IV- The resolution of transfer pricing disputes through arbitration, Markham, M., Intertax, Vol. 33 (2005), no. 2 ; p. 68-74

V-The EC Arbitration Convention - an overview of the current position, Rousselle, O., European taxation, Vol. 45 (2005), no. 1 ; p. 14-18

VI- Arbitration clauses in international tax treaties could benefit developing states, Morgan, J., Tax notes international, Vol. 31 (2003), no. 7 ; p. 681-691

VII - Tax disputes and international commercial arbitration, Melchionna, L, Diritto e pratica tributaria internazionale, Vol. III (2003), no. 3; p. 769-796

VIII- Income tax treaty arbitration, Park, W. W., Tax Management international journal, Vol. 31 (2002), no. 5 ; p. 219-253

IX- Issues in the implementation of the arbitration of disputes arising under income tax treaties, Tillinghast, D, Bulletin for International Fiscal Documentation,vol. 56, 3 (2002) p. 97

X- International coordination of tax treaty interpretation and application, Van Raad, Intertax, vol. 29, 6-7, (2001)



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