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 recent political agreement among 130 countries on the Pillar One and Pillar Two proposals (see this post), and the ambitious business taxation reforms recently announced by the European Commission (see here).
The new rules on the horizon are likely to be complex and tax authorities are taking a more assertive approach. So, risks of multiple taxation will inevitably rise and taxpayers will need effective means of preventing and settling disputes. But international rule coordination in this area remains insufficient. The existing rules form a procedural patchwork which is difficult to navigate. When deciding which procedure to follow, taxpayers will need to carefully analyse, and compare and contrast, the scope of each procedure and the protections and remedies it offers.
Existing mechanisms to resolve international tax disputes
The default for taxpayers facing an international tax dispute will often be to appeal to the domestic courts in 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 so as to ensure that there is no double taxation. So, international tax dispute mechanisms will need to be considered.
The scope of each international tax dispute mechanism is limited from a geographical, temporal and substantive perspective. These limitations differ depending on the mechanism pursued. Furthermore, the "EU proceedings" arguably allow multilateral proceedings, while DTA/MLI proceedings are by nature bilateral.
- 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 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).
- Multilateral Instrument (MLI). The MLI also provides 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". While the mutual agreement procedure is required as a minimum standard, arbitration is optional and applies only 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 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 resolution mechanisms in the EU Arbitration Convention and many DTAs. But it contains more legal safeguards for taxpayers if the relevant Member States fail to act timely or in accordance with the provisions of the directive.
Taxpayer protection in international proceedings
These international proceedings are diplomatic in nature. The countries' competent authorities would seek to agree the correct application of the DTA and/or Arbitration Convention without the taxpayer's involvement. Arbitration mechanisms, if provided for, are aimed at "forcing" the authorities to reach such an agreement, but do not change the diplomatic, state-to-state, nature of the proceedings. The taxpayer may request that proceedings are initiated, but it is not a party to them and has, at best, limited 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 international proceedings through domestic processes. In the Netherlands, for instance, a taxpayer can appeal the tax authority's refusal to initiate international proceedings before the domestic courts. However, these kinds of remedies bear no similarity to the due process generally afforded in domestic proceedings.
Outcomes and remedies
Different international proceedings could also lead to different outcomes. Proceedings without mandatory binding arbitration do not guarantee that the countries involved will arrive at an agreement that resolves the dispute. Applicable arbitration provisions may also differ significantly. Some arbitration mechanisms prescribe "baseball arbitration" where the arbitration tribunal "simply" selects one of the solutions presented by the countries involved. Other arbitration mechanisms require that the arbitration tribunal reaches its own conclusion, 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.
International proceedings often allow taxpayers to reject the outcome. But, if the taxpayer cannot effectively restart domestic proceedings because it is unhappy with the outcome, there are few options left.
Concurrent domestic and international proceedings
Taxpayers initiating international proceedings often want to preserve their right to pursue domestic proceedings because, generally, international procedures do not guarantee resolution within a reasonable timeframe and, in international procedures, the taxpayer's legal position is not adequately protected.
It will typically be impermissible to run domestic and international proceedings in parallel - which does make sense, given the amount of resources required for each type of proceeding, but it significantly restricts the effectiveness of taxpayers' legal protections. This issue could be addressed (at least in part) by allowing international and domestic proceedings to be commenced in parallel before suspending one set of proceedings while the other runs its course.
International rules tend to permit this approach and some countries' domestic rules do, too. The Netherlands, for instance, seems to allow the suspension of domestic proceedings pending the resolution of international proceedings, giving taxpayers the option of rejecting the outcome of the international proceedings and re-starting domestic proceedings. The Netherlands also accepts that remedies resulting from international proceedings can effectively overturn decisions by domestic courts.
The domestic laws or practices of many other countries do not, however, seem to provide for this flexibility. Some 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 resolution is not effective). Others do not allow domestic proceedings to be suspended pending international resolution (meaning that domestic time limits may lapse while the international proceedings run their course).
As a result, taxpayers are forced to choose between two evils:
- pursue domestic proceedings which may afford better legal protection, but carry a higher risk of a "multilateral" issue not being effectively resolved (resulting in double taxation)
- pursue international proceedings which offer less legal protection, but have a higher chance of achieving a coherent outcome without double taxation
This forced "choice" may also be seen as problematic in an EU context because the "choice" can restrict effective access to the European Court of Justice on matters that relate to the application of EU law.
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. The reference to mandatory and binding mechanisms for tax certainty in the Statement by the G20/OECD on the political agreement on Pillar One and Pillar Two may be seen as promising. Further, 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. Unfortunately, recent initiatives, including the same OECD's Pillar 1 blueprint, also clearly show the reluctance among many countries to concede jurisdiction on tax matters to an effective, 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.