Multinational companies increasingly face situations where two or more countries seek to tax the same profits. Recently enacted and upcoming legislative changes aim to address the perceived undertaxation of multinationals, and to redistribute taxing rights on corporate profits to "market jurisdictions". The origins of these changes include the OECD's BEPS Project, the political agreement among the G7 on radical changes to the taxation of multinationals, and the ambitious business taxation reforms announced by the European Commission. As the new regulations are likely overreaching, complex and untested and tax authorities are taking a more assertive attitude, risks of multiple taxation will inevitably rise.
With these legislative changes, taxpayers will need effective means of preventing and settling disputes. While coordination between the tax rules of many countries has increased considerably in recent years, the coordination of dispute prevention and resolution remains behind. An inventory of existing mechanisms to resolve international tax disputes shows a procedural patchwork. In this article, we look at some of these mechanisms and their key features. The conclusion is simple: when deciding what procedure to follow, taxpayers will need to carefully analyse the pros and cons of each in terms of their scope, the taxpayer's legal position and the remedies they do or don't offer. These pros and cons may differ considerably depending on each situation. And this makes the issue far from simple.
International tax dispute resolution mechanisms
Below we list key existing mechanisms to solve international tax disputes.
The default for taxpayers facing an international tax dispute is to appeal to the domestic courts of the relevant countries. The appeal can be based on the application of domestic law, double taxation agreements or both. A major downside is that there is no guarantee that domestic courts will rule in a consistent manner or that multiple taxation will be addressed..
Double taxation agreements (DTAs)
Many DTAs provide for a mutual agreement procedure, and some for arbitration. For instance, most of the DTAs entered into by the Netherlands after 2008 provide for mandatory and binding arbitration. These procedures can be initiated if taxation is alleged to have contravened the provisions of the DTA (so it is not necessary for double taxation to exist).
The Multilateral Instrument (MLI)
The MLI also provide for a mutual agreement procedure, and for mandatory and binding arbitration for disputes between "MLI countries" with DTAs that have been designated a "Covered Tax Agreement". However, only the mutual agreement procedure is a minimum standard. Arbitration merely applies if both countries have elected this, which few MLI countries have done so far.
EU Arbitration Convention
The EU Arbitration Convention grants taxpayers the right to initiate a mutual agreement procedure. If this does not lead to a solution, taxpayers can initiate mandatory and binding arbitration. However, the EU Arbitration Convention only covers disputes relating to double taxation arising from transfer pricing adjustments or the attribution of profits to permanent establishments between EU member states.
EU Tax Arbitration Directive
This directive, which had to be implemented by EU member states by 30 June 2019, aims to address deficiencies in the EU Arbitration Convention. The directive shares similarities with the dispute mechanisms in the EU Arbitration Convention and many DTAs. However, it contains more legal safeguards for taxpayers if the relevant member states fail to act timely or in compliance with the procedures.
The scope of each of the international tax dispute mechanisms is limited from a geographical, temporal and substantive view. These limitations differ depending on the mechanism pursued. Further, the "EU proceedings" arguably allow multilateral proceedings, while DTA/MLI proceedings are by nature bilateral. It is essential for taxpayers to carefully consider these differences because international tax disputes often involve multiple entities in multiple countries and span multiple years.
Concurrence between domestic and international proceedings
Taxpayers initiating international proceedings often want to preserve their right to pursue domestic proceedings for two reasons. First, a satisfactory outcome of an international procedure within a reasonable period of time is often not guaranteed; for example, because no mandatory and binding arbitration is provided for. Second, the taxpayer's legal position in international procedures is not adequately protected.
Typically, parallel domestic and international proceedings are not allowed. This is logical in view of the amount of the resources each type of proceeding takes. However, it does significantly restrict the effective legal protection of taxpayers. This issue could be partly addressed if domestic proceedings could be finalised before or after the international proceedings. International proceedings typically cater for this, some by suspending the international proceedings pending domestic proceedings and others by allowing domestic proceedings to be suspended pending the international proceedings. The domestic laws and practices of a limited number of countries also allow this flexibility. For instance, the Netherlands seems to allow the suspension of domestic proceedings pending international proceedings, offering the taxpayer the possibility to reject the outcome of the international proceedings and re-start domestic proceedings. Further, the Netherlands accepts that remedies resulting from international proceedings can effectively overturn decisions by domestic courts.
However, the domestic laws or practices of many other countries do not seem to allow this flexibility for two principal reasons. Sometimes, countries do not allow a domestic court decision to be effectively overturned by a remedy that results from subsequent international proceedings (meaning that suspending international proceedings pending domestic proceedings is not effective). On other occasions, countries do not allow domestic proceedings to be suspended pending an international proceedings (meaning that the period to appeal will lapse if international proceedings are finalised before domestic proceedings). Some countries do not allow it for both of these reasons.
As a result, taxpayers are forced to choose between two evils: pursue one or more domestic processes with the accompanying legal protection, but which carries a higher risk that "unilateral" proceedings will not effectively resolve multiple taxation issues. Or pursue an international process that does not offer ideal legal protection, but that generally has a higher possibility of having a coherent outcome; one that does solve multiple taxation issues.
This "forced to choose" issue may also be seen as problematic in an EU context (and from an EU law point of view), because the "choice" can restrict effective access to the European Court of Justice on matters that relate to the application of EU law.
Legal position of taxpayers
The international proceedings described above are nothing like normal legal proceedings, or like commercial or bilateral investment treaty arbitration proceedings. These international proceedings are diplomatic in nature, aimed at the competent authorities of the countries involved reaching an agreement on the correct application of the DTA and/or Arbitration Convention. Arbitration mechanisms, if provided for, are aimed at "forcing" such an agreement, but these do not change the diplomatic, state-to-state, nature of the proceedings. The taxpayer may request that the proceedings be initiated, but it is not a party to it and has few or very limited procedural rights. Some proceedings, especially those that fall under the EU Arbitration Directive, grant certain rights to the taxpayer, such as the right to appeal to domestic courts if the competent authorities fail to take timely action, and the right to request to appear before the arbitration committee. In addition, the taxpayer may attempt to influence the international proceedings by relying on domestic law instruments. For instance, a taxpayer can appeal to the Dutch courts if the Dutch competent authorities refuse to initiate international proceedings. However, these kind of remedies bear no similarity to the due process afforded in domestic proceedings in "rule of law" countries, which offer the proper protections for the taxpayer.
Clearly, taxpayers should take into consideration the lack of legal rights in international proceedings when deciding on which venue to appeal to. Especially if, as described above, pursuing international proceedings will effectively restrict their rights in relation to domestic proceedings.
Outcomes and remedies
Different international proceedings could lead to different outcomes. For instance, proceedings without mandatory and binding arbitration do not guarantee that the countries involved will arrive at an agreement that resolves the dispute. Different processes that provide for arbitration may have different outcomes. Some arbitration mechanisms prescribe "baseball arbitration" where the arbitration tribunal "simply" selects one of the solutions presented by the countries involved. Other arbitration mechanisms result in the arbitration tribunal's advice, which can either be endorsed or rejected by the countries involved, as long as the countries agree to an alternative solution. The different arbitration mechanisms may fit some cases better than others. For example, baseball arbitration is often considered less appropriate for complex, multi-issue matters; it can also reflect a departure from fundamental legal principles.
International proceedings often allow taxpayers to reject the outcome, which is justified for the reasons described above. However, if the taxpayer cannot effectively restart domestic proceedings because it is unhappy with the outcome, there are few options left, and those that remain are often limited.
What this means for taxpayers
It is to be hoped that dispute prevention and resolution will become more effective in addressing the issues we mentioned in this article. For example, by being part of the proposals implementing the legislative changes referred to in the introduction. When it comes to dispute prevention, informal mechanisms like the International Compliance Assurance Programme, ICAP, the EU's initiative on cooperative compliance and the tax certainty mechanisms suggested in the OECD's Pillar 1 Blueprint may help taxpayers to mitigate multiple taxation risks to some extent. However, the OECD's Pillar 1 blueprint also clearly shows the reluctance of many countries to concede jurisdiction on tax matters to an independent and international dispute resolution forum that taxpayers can appeal to and that affords due process.
Hence, if disputes nonetheless arise as expected, taxpayers will probably need to fall back on the existing procedures or on new procedures with similar features and flaws. This means that taxpayers should carefully determine procedural strategies and make informed decisions about the venues to be addressed, taking into account the type of considerations described above. They need to not only consider the dispute in isolation, but also the effects on the wider group and value chain and similar or related positions regarding other years or entities.