Arbitration in international taxation, though a historical subject, has begun to find relevance in the context of international tax disputes. Article 25 of OECD Model Convention does not oblige the treaty states to reach an agreement under a Mutual Agreement Procedure (MAP), an alternate dispute resolution mechanism, but only to use their best efforts to resolve a tax dispute. Treaty countries in certain circumstances do reach a stalemate in their MAP negotiations; limitation of MAP therefore logically paves the way for arbitration as an alternate mechanism for resolving cross-border disputes.
Mandatory arbitration has been introduced in the Model Tax Convention (OECD MC) as supplement to MAP, a comprehensive international law on dispute resolution.
MAP and need for ‘arbitration’ MAP provisions in the Model Convention are provided as means for resolving international tax disputes; more specifically, to provide for:
i) a tool for settling questions relating to the interpretation and application of the tax treaty;
ii) a forum for appealing in cases where taxation is not in accordance with the tax treaty; and
iii) a mechanism for eliminating double taxation in cases not provided for in the tax treaty itself.
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Given the impressive growth levels in international trade in the past few decades, the number of MAP cases (reported) may appear minuscule – a rough estimate indicates disproportionate ratio of a few hundreds cases against millions of cross border transaction taking place every year. Statistics of MAP cases indicates that a large majority of MAP cases arise between OECD countries.
The two fundamental questions therefore are – whether MAP is an inefficient mechanism for dispute resolution; and whether supplementary mechanisms such as ‘arbitration’ and ‘mediation or conciliation’ are necessary to improve its effectiveness?
MAP process has an inherent limitation as dispute resolution mechanism which perhaps could be the chief reason for its under-utilisation. Taxpayers may be deterred by a perception that a MAP would be a long drawn process, may not resolve the dispute and may be conducted without sufficient involvement on their part. There are other explanation for under-utilization of MAP in different jurisdictions; for instance, fear that competent authorities could replace MAP for ‘roving enquiries’ into assessment and use MAP process as “joint audit”. Financial cost and administrative burden of pursuing MAP could be material for marginal taxpayers, especially individual and small enterprise.
The fundamental question is what constitutes ‘arbitration’ and whether it should be viewed merely as tool to supplement MAP. In my view, Arbitration’ is a dispute resolution technique in which a third party reviews the case and imposes a decision that is legally binding for both sides; it is therefore, not convincing to describe arbitration as “a tool to ensure that the competent authorities are able to reach an agreed solution”.
Indian landscape
In Indian context, phenomenal rise in cross border disputes over past 5 years and staggering leakage on account of frivolous tax demands have caused serious dent in multinationals’ confidence. The track record of resolution of MAP cases has not been particularly encouraging, and the manner in which the accumulated disputes have been dealt with and decided in last two years could well be a case of hurried resolution.
I tend to believe that the maturing transfer pricing jurisprudence and new tax code introducing internationally accepted anti-avoidance provisions (eg, Controlled Foreign Corporation regime and General Anti-avoidance rules) would add rigors to tax dispute resolution process. The changing landscape thus brings us to debate whether India, as an important treaty economy in international trade, should consider adopting mandatory tax arbitration for speedy dispute resolution.
Global approach to arbitration
The OECD MC and Euro Arbitration Convention include mandatory arbitration provision as a supplement to MAP proceedings. Alternate approaches can be ‘voluntary arbitration’ through bilateral or multilateral participation of treaty countries.
Under a mandatory arbitration provision, the contracting states are obliged to proceed to the arbitration of unresolved MAP’s after specified time. Under a voluntary arbitration procedure, in contrast, the competent authorities must agree on case by case basis to submit a disagreement to arbitration before that disagreement can proceed to arbitration.
The current draft of UN MC does not include a mandatory arbitration provisions, akin to OECD arbitration provision. Report of the Ad Hoc Group of Experts on International Cooperation in Tax Matters had suggested that for effective dispute resolution between treaty countries, it may be appropriate to consider in bilateral negotiations an arbitration provision. Some members of the Group of Experts supported the idea of adding a paragraph providing for arbitration in case the competent authorities cannot conclude MAP proceedings.
Given the expected release of a new version of the UN Model in 2011, questions which shall need to be addressed are 1) placement of arbitration provisions in the UN MC; and
2) time period within which arbitration can be impeached.
Binding nature of Arbitration & domestic law remedies
In theory, arbitration could be either binding or non-binding. Non-binding arbitration is, however, similar to an opinion of an international tax expert who submits determination of tax liability. Non-binding arbitration has limited advantages compared to other supplementary mechanism for dispute resolution. On the other hand, binding arbitration shall be effect of binding the parties to dispute by the arbitral determination, regardless of whether or not the outcome is acceptable to taxpayer.
It is pertinent to understand the inter-play of arbitration provision under the tax treaty vis-à-vis taxpayers’ right to appeal under the domestic law. The OECD arbitration provision does not require taxpayers to waive their right to pursue domestic legal remedies before arbitration can take place; such remedies are only suspended during the arbitration process. This is relevant at the time the UN Model Convention adopts the arbitration provision.
In my view, if for whatever reason double taxation cannot be relieved via arbitration the taxpayer should be permitted to pursue the domestic law remedies.
Limitation for arbitration procedure
Despite several positive attributes and widespread use, arbitration does not provide a definitive answer to all international disputes. Many developing countries are reluctant to resort to international arbitration as most fear that the Government is abdicating its right – an incorrect perception in my view.
The reason is of political nature and sovereignty of states is not compromised in any manner. Often, countries are reluctant to give up their sovereignty, particularly, their tax sovereignty (many of these countries adhere to the Calvo doctrine which severely restrains the creation of third party adjudicative devices for resolving bilateral disputes). Another reason why less matured jurisdictions shirk arbitration is inefficacies of their competent authorities, from technical and administrative standpoint and inability to negotiate /arbiter with competent authorities of developed economies. Financial costs and difficulties in selection of arbitrators are among other reasons.
Future reflections
I have no misgivings about Arbitration being a substantial area of law in itself, and therefore, adopting an independent arbitration clause in the Model Convention is a futuristic approach to resolving cross border tax disputes.
Yet one can’t disagree that international tax arbitration is a young institution and hence should not be allowed to bypass MAP provisions. For practical reasons, purposes at least, arbitrations should take place under the MAP umbrella.
Other developing jurisdictions’ (including India) approach to international arbitration should be relatively of a ‘cautious approval’. The guarded caution is warranted considering that competent authorities of developing nations would still need to gear up before arbitration can be handled without ceding level-playing field to developed jurisdictions.
(The author is a Partner with BMR Legal, and was assisted by Sumit Singhania; views are entirely personal)