The key role of the mutual agreement and the arbitration procedures in the resolution of international tax disputes

September 2021 | EXPERT BRIEFING | CORPORATE TAX

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Traditionally, the resolution of tax disputes has taken place exclusively through national courts. However, in the specific field of international taxation, where disputes involve cross-border transactions, the use of domestic judicial resources does not guarantee elimination of international double taxation which usually arises in these cases, as no judge has jurisdiction in both jurisdictions involved in the conflict.

In view of this situation, the mutual agreement procedure (MAP) and, lately, arbitration, have emerged through bilateral and multilateral tax treaties as alternatives to the domestic judicial system for resolving international tax disputes.

In the MAP, the competent authorities of two or more tax administrations try to reach a solution when the actions of one or both administrations have led to taxation that does not comply with the Double Tax Convention signed between the two contracting states, or to double taxation.

The problem with the MAP is that it does not guarantee a solution to the tax dispute because there is no obligation under the article of the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention regulating the MAP for the competent authorities to reach an agreement, but only to use their best endeavours to reach an agreement. And it is precisely because there is a possibility that tax administrations may not reach a solution (as has been well observed over the years) that the mechanism of arbitration has been created and sponsored heavily by the OECD.

Arbitration consists of appointing a third party, neutral to both competent authorities, that will have the last word to decide on a tax dispute. Arbitration can be panel arbitration – in which a panel of experts reaches a solution to the dispute (in principle, closer to the European tradition) – or ‘baseball’ arbitration (fostered by US authorities), in which the arbitrator decides between the two offers proposed by conflicting parties.

The success of arbitration consists mainly in the compulsion to avoid it, since the competent authorities will lose the capacity to decide if they fail to reach agreement within two years under the MAP.

Main advantages of alternative mechanisms

The MAP and arbitration are very effective mechanisms for eliminating international double taxation. Moreover, they offer the advantage of being able to resolve disputes more quickly than the domestic judicial remedy, which involves lengthy procedures due to the heavy workload of judges in many Western jurisdictions.

Another advantage of these alternative mechanisms over the domestic judicial route is that the process is carried out by experts in international taxation, unlike the courts, as judges are not necessarily experts in this field.

For which cases are these alternative mechanisms of interest?

The MAP and arbitration are interesting mechanisms for resolving conflicts related to discrepancies in the application and interpretation of Double Tax Conventions that give rise to cases of international double taxation, both juridical and economic. This includes the characterisation of income, the potential existence of permanent establishments, the existence or absence of economic substance in holding companies, and on the application of the beneficial owner clause.

They are also useful mechanisms for resolving disputes arising from the characterisation and valuation of related-party transactions or over the determination of the tax residence of a natural or legal person – all of which are very common nowadays.

Regulation

The MAP is regulated under Article 25 of the OECD Model Tax Convention, but, since it does not guarantee a solution, it evolved toward creating an additional mechanism to resolve conflict, which is arbitration.

The first precedent of arbitration can be found within the European Union (EU) in the 1990 Convention on the resolution of transfer pricing disputes (i.e., the Convention 90/436/EEC on the elimination of double taxation in connection with the adjustment of profits of associated enterprises, known as the ‘EU Arbitration Convention’). Subsequently, the OECD carried out work to strengthen MAPs and regulate arbitration in the first decade of this century.

In the area of bilateral tax treaties, it is now increasingly common to find arbitration clauses along with the MAP.

In the EU, in addition to the EU Arbitration Convention, there is a 2017 Directive on resolution mechanisms for tax disputes beyond the field of transfer pricing, which regulates the MAP and arbitration on interpretation discrepancies in double tax treaties between EU tax authorities.

At the OECD level, we have Action 14 of the OECD base erosion and profit shifting (BEPS) plan, which aims to make tax dispute resolution mechanisms more effective, and the Multilateral Instrument (MLI) derived from Action 15 of the OECD BEPS Plan, which has also led to general use of arbitration by its signatories.

A step forward will come with Pillar One – which aims to ensure a fairer distribution of profits and taxing rights among countries with respect to the largest multinationals – and the disputes arising from its application. Pillar One contains a mandatory and binding system for resolving such disputes through both mechanisms: the MAP and arbitration.

Final comment

Today, there is no doubt that the MAP and arbitration play a growing key role in resolving international tax disputes. Proof of this is their reinforcement at international level. Multinational groups and international investors generally should bear it in mind as an expeditious and effective way of resolving and avoiding international double taxation.

Eduardo Gracia is a partner at Ashurst LLP. He can be contacted on +34 91 364 9854 or by email: eduardo.gracia@ashurst.com.

Eduardo Gracia

Ashurst LLP