The rise of globalisation has not only resulted in an unprecedented increase in cross-border trade, but also in the parallel escalation of disputes in the international tax arena. Disputes usually arise where two different jurisdictions claim the right to tax the same transactions or income, imposing an excessive tax burden on taxpayers. The imposition of double taxation constitutes a significant barrier to the free flow of trade and investment. Where such double taxation disputes remain unresolved, confidence in the certainty, fairness and integrity of the international tax system is undermined.
Traditionally, bilateral tax treaties (of which Australia has entered into more than 40), known as double taxation agreements (DTAs), have attempted to eliminate double taxation, as well as prevent fiscal evasion. Most DTAs worldwide include a formal procedure to facilitate the resolution of disputes between treaty partners, known as the Mutual Agreement Procedure (MAP). This procedure is set out in both Article 25 of the Organisation for Economic Cooperation and Development Model Tax Convention on Income and Capital (OECD Convention), and in Article 25 of the United Nations Model Double Taxation Convention between Developed and Developing Countries (UN Convention). The vast majority of all tax treaties are based on one of these two Conventions.
Under this procedure, treaty country representatives (known as competent authorities) are designated to assist resident taxpayers in resolving disputes between taxing jurisdictions. However, a major problem is that Article 25 does not compel the competent authorities to reach an agreement. Both the OECD Convention and the UN Convention only require these representatives to “endeavour” to resolve the dispute by mutual agreement. This lack of compulsion to resolve disputes has resulted in the unfortunate outcome of a stalemate occurring in certain cases, with companies in these circumstances suffering unrelieved double taxation.
While the MAP is a vital mechanism for resolving tax controversies between treaty partner countries, in the last decade it has experienced increasing pressure, with MAP caseloads more than doubling between 2006 and 2015. Perhaps of greater concern is the inventory of unresolved MAP cases, which has risen by more than 162% from 2352 cases in 2006 to 6176 cases in 2015. There is universal acceptance of an urgent need to improve dispute resolution. Experts are predicting a “tsunami” of international tax disputes, advising that: “…a global consensus must be achieved so that global tax disputes can be resolved in a way that serves the interests of all stakeholders.”
Mandatory arbitration clause: a potential solution
In order to address the problem of unresolved tax disputes between treaty partner countries, the OECD Convention adopted a compulsory arbitration clause in its new Article 25(5) in its 2008 OECD Convention update, to the effect that where:
the competent authorities are unable to reach an agreement to resolve that case …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.
This new arbitration clause ensured the actual resolution of a tax dispute even in situations where the competent authorities could not reach agreement. It also imposed time limits to ensure resolution would be achieved in a timely manner.
While the introduction of this clause constituted a significant change to the OECD Convention, and was acknowledged as advantageous for both taxpayers and tax administrations, the OECD emphasised that its inclusion in tax treaties was discretionary (the UN Convention also included the discretionary option of a mandatory arbitration clause in 2011). Although certain countries amended their tax treaties accordingly (for example, Australia included a new mandatory arbitration clause in its re-negotiated DTA with New Zealand in 2009), most countries opted not to introduce this dispute resolution mechanism that would ensure finality in tax disputes between treaty partners. By 2014, it was reported that only just over five per cent of all double tax treaties contained an arbitration clause.
The OECD/G20 Base Erosion and Profit Shifting Project
In 2013, the OECD/G20 Base Erosion and Profit Shifting (BEPS) 15-point Action Plan was devised to overhaul international tax rules, and address and overcome tax avoidance strategies undertaken to exploit gaps and mismatches in tax rules to artificially shift profits to low tax jurisdictions where there is little or no economic activity. As part of this improvement of the international tax system, Action 14 involved the development of solutions to address obstacles that prevent countries from solving treaty-related disputes under the MAP, including the absence of arbitration provisions in most treaties. The inclusion of such a provision would optimise the international tax system by providing taxpayers with certainty that disputes regarding double taxation would be resolved.
To the dismay of the general business community (see for example the comments of Business Industry Advisory Committee (BIAC) at page 41 of the OECD Comments Received on Public Discussion Draft BEPS Action 14: Make Dispute Resolution Mechanisms More Effective, 19 January 2015), the OECD removed mandatory arbitration from its agreed minimum standards in its final report on Action 14, issued in October 2015, on the grounds that there was a lack of endorsement for this dispute resolution mechanism among all countries associated with the OECD/G20 BEPS Project. The Indian government notoriously opposed the imposition of mandatory arbitration as a dispute resolution tool, in order to maintain its fiscal sovereignty. Indeed, as I have previously commented – the most contentious issue relating to the inclusion of mandatory binding arbitration under the MAP is the surrender of fiscal sovereignty that allegedly accompanies the resolution of disputes by arbitrators. This concept of fiscal sovereignty maintains there should never be any delegation or relinquishment of a country’s power and authority to tax.
This isolationist approach to sovereignty would appear to be out of place in the modern world of the global marketplace, especially as the OECD itself views the arbitration clause in Article 25 as simply an extension of the MAP, historically a generally accepted mechanism included in DTAs, rather than as a new procedure. In contrast to constituting an infringement of sovereignty, arbitration has been described by a former US Competent Authority as being ‘basically a tiebreaker rule for the competent authorities’. (Carol Dunahoo, quoted in Kristen A. Parillo, ‘Competent Authorities Debate Sovereignty and Arbitration’ Tax Notes (15 December 2014), 1224.)
The Multilateral Convention
Despite the lack of consensus among OECD/G20 countries regarding mandatory binding arbitration, over half of the 34 OECD countries (including Australia) expressed interest in committing to this dispute resolution mechanism. It was therefore agreed that a mandatory binding MAP arbitration provision would be developed as part of the negotiation of a Multilateral Convention to allow countries to swiftly modify multiple bilateral DTAs by signing this single instrument.
Negotiations were concluded on the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the Multilateral Convention) in November 2016. The OECD announced that this Multilateral Convention would ‘implement minimum standards to counter treaty abuse and to improve dispute resolution mechanisms while providing flexibility to accommodate specific tax treaty policies.’ However, deferring to the desire of the majority of prospective signatories to preserve national sovereignty in relation to tax matters, binding mandatory arbitration was once again not included as a minimum standard in this Convention, but was instead made an optional provision.
It is noteworthy that only 25 of the 68 signatories to the Multilateral Convention have elected to adopt mandatory arbitration procedures. Australia is one of the minority of countries to include the arbitration provision, albeit with certain conditions (for example, disputes involving the application of general anti-avoidance provisions will be excluded from the scope of arbitration).
Pragmatic motivation for adopting binding mandatory arbitration?
Unresolved tax disputes remain an area of international concern for both taxpayers and tax administrations, as unrelieved double taxation constitutes a barrier to the free flow of trade and investment. Several attempts by international organisations such as the OECD to encourage the use of mandatory arbitration clauses in tax treaties have met with resistance on the grounds of such clauses running counter to fiscal sovereignty. The observation has been made that ‘States’ anxiety over tax sovereignty can be legitimate (although it can also be a smokescreen for less palatable or reputable goals).’
The arbitration of international tax disputes presents significant advantages to both governments and taxpayers. It offers the certainty of the resolution of a tax controversy, even where competent authorities cannot agree, thereby offering a potential solution to double taxation. It would also likely remove the pressure on MAP caseloads, preventing the “tsunami” of international tax disputes referred to above. Countries currently resistant to mandatory binding arbitration in their tax treaties may need to balance their need to shield their tax controversies from independent arbitrators against their need to provide a favourable economic climate for foreign investment.
This is an abbreviated version of an article: M Markham ‘International tax treaty arbitration – fighting an uphill battle in the global arena’ (2017) 28 Australasian Dispute Resolution Journal 162-169, published by Thomson Reuters.
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