EU Tax Arbitration Convention - its strengths and its weaknesses
2001 Dr Jean-Philippe Chetcuti. All Rights Reserved.
Taxpayers are now certain that a
procedure will be started and that the double taxation will be eliminated.
Smaller businesses, which do not have the staff to deal with the
frequently demanding and time-consuming area of double taxation cases, will now
be more ready to risk stepping over the border and taking advantage of the
Internal Market. The long term
hopes are that the MSs’ experience with the Convention, which goes only as far
as to lay down a procedural framework, will lead to the development of
substantive rules of Community law on transfer pricing between associated
The fact that the only parties to the
arbitration procedure are the Contracting States,
these being the signatories of the Convention,
does not mean that the taxpayers concerned do not entertain an interest in its
outcome. It is true that the
competent authorities of the Contracting States are bound by the final decision,
but ultimately, the relief or burden embodied in this decision is borne in its
entirety by the taxpayer. For this
reason, the taxpayer has a legitimate interest and its legal position must be
Of course, the taxpayer’s role in the mutual agreement procedure is
justifiably limited but a taxpayer still merits the opportunity to actively
participate in the procedure.
Taxpayer’s right of initiative
Competent authority not to abuse of its rights to
The competent authority may refuse to
initiate the international procedure in cases which do not fall within the scope
of the Convention (such as double taxation arising out of different
interpretations of Convention terms), where the taxpayer’s claims are not
well-founded and in serious penalty cases.
However, the Contracting States are bound by an obligation to perform the
Convention in good faith and therefore should not abuse of these grounds for
non-initiation to deprive the taxpayer of his rights under the Convention.
Right of recourse to remedies provided by domestic law
It would be unfair and unreasonable to
deprive a taxpayer and his competent authority of his rights to seek the
remedies available to him in the domestic courts. In fact, according to the Convention, enterprises “may have
recourse to the remedies available to them under the domestic law of the
Contracting States concerned”.
However, should a taxpayer avail himself of such a right, the two year
time limit within which he is to call for formation of an arbitral commission
starts running from the date of the judgement of the final court of appeal.
The Constitutions of some Contracting
States prevent the competent authority from resolving cases by mutual agreement
where such a solution derogates from the decisions of their judicial bodies.
In such cases, the Convention
precludes the initiation of the arbitral proceedings before the time provided
for appeal has been allowed to expire or any appeal has been withdrawn by the
enterprise before a decision has been delivered.
Right to a reasonable time framework
The length of the Convention proceedings
is restricted. It is no longer
possible for a disagreement to hang in the balance for many years, with all the
extra costs that it entails.
The time framework for the arbitral
procedure should last long enough so as to permit an adequate presentation of
the case, but should be expedient enough to afford the taxpayer a decision
within a reasonable time. These
criteria are present in the Convention: the taxpayer has three years within
which to submit his case; the competent authorities then have two years to
negotiate an agreement; the commission has six months
within which to deliver its opinion and then the competent authorities have
another six months to contemplate whether to accept the arbitral decision or to
agree on an alternative.
Right to require discontinuation of the procedure
The Convention does not expressly
provide the taxpayer with such a right. However,
despite the fact that the taxpayer is strictly speaking not a party to the
proceedings, not only should he have the right of initiative but he should also
have a corresponding right to terminate the proceedings. After all, the aim of
the convention is to provide relief to the taxpayer, so if this aim is reached,
why continue with proceedings to that effect?
Right to independent and impartial jurisdiction
This right depends very much on the
composition of the tax arbitration commission and the nomination of its members
under the Convention. The
independence and impartiality of the commission is fundamentally important for
the taxpayer who is effectively and finally bound by its decision. It is also argued that under the Convention, taxpayers are
protected by the Convention on Human Rights (1950) and the Covenant on Civil and
Political Rights (1981).
The qualifications required from the
independent persons appointed by mutual agreement between the two competent
authorities are that they must be persons of standing, competent and
independent. Moreover, their
Chairman must possess the qualifications required for appointment to the highest
judicial offices in his country or be a jurisconsult of recognised competence.
In addition, there is a right of
eviction of an independent member if such member works for the tax authorities
of an involved Contracting State or if he works or has worked for the affected
enterprise, or if he does not offer sufficient guarantee of objectivity.
Right to appear or to be represented
The Convention expressly provides for
the international principle of fair hearing.
Thus the parties involved must be given the opportunity to be present or
represented. The taxpayer concerned
also has the right to provide information, evidence or documentation.
Implied in Article 10 is the principle of equality of arms which
applies to the affected enterprise too as a semi-party with a separate interest
of its own. It should be given the
opportunity to hear, improve and refute the presentations, arguments and
evidence of the competent authorities. Also
implied is the right of access to information and evidence of the commission.
Right to refuse to provide certain information
The same right given to the competent
authorities is given to the taxpayer to refuse to provide information not
obtainable under domestic law or administrative practice or if it means the
disclosure of any trade, business, industrial or professional secret or trade
process, or information the disclosure of which would be contrary to public
Secrecy and confidentiality
“The members of the advisory
commission shall keep secret all matters which they learn as a result of the
This is one of the strongest features of any arbitral procedure in that
it respects the confidentiality of the parties involved.
The Convention contemplates punitive action for breach of this
Right to require justification from commission
An implied obligation of the commission
is to issue a reasoned opinion and therefore to supplement the opinion with a
justification. This ensures the
accountability and transparency of the commission’s workings.
Taxpayer’s consent to publication
Even if publication of arbitral awards
contributes to the consistency of future awards, it could impinge on the
taxpayer’s right to confidentiality and business secrets.
Therefore, besides the agreement of the competent authorities, the
consent of the taxpayer is required before publication can proceed.
Fair allocation of costs of procedure
The costs of the arbitral procedure are
to be shared equally by the Contracting States while the costs incurred by the
affected enterprises have to be borne by the enterprises themselves.
Some authors have found this unjustified since the advisory commission
has the right to request the parties to appear or be represented before it and
to provide information, evidence or documents to it.
The payment of interest
The Convention remains completely silent
on the issue of interest and does not provide for the accrual of interest on
late tax payments or on tax refunds. The
Convention does not purport to tackle the disparities between the domestic rules
competent authorities of Contracting States, aware of transfer pricing abuses by
MNGs of companies and unwilling to give up their sovereign jurisdictional
authority, may resort to abusive ‘escape routes’ to exclude a particular
case from the scope of the Convention.
Differences in interpretation
Convention does apply to cases of double taxation caused by a conflicting
interpretation of its terms, even if those terms condition the access to the
Convention. On this basis, a
competent authority may refuse to initiate the Convention procedures using
differences in interpretation as an easy excuse to keep a genuine transfer
pricing case under its jurisdiction. The
serious penalty clause too can be applied to such abusive purposes, frustrating
the object and effectiveness of the Convention and violating the international
legal principles of performance in good faith of treaty obligations enshrines in
Article 26 of the Vienna Convention on the Law of Treaties.
the drafters of the Convention, who could have been more articulate in the
formulation and definition of terms, carry part of the blame.
“One of the very first points preliminary to making international
conventions or agreements on double taxation is to define the terms so that
there will be no possibility of misinterpretation.” Another possible solution would be the setting up of an EC
Consultation Board, composed in such a way as to draw on the expertise of all
MSs’ arbitration commissions and which will decide disputes regarding the
meaning of the Convention’s terms.
Convention gives the Contracting State the opportunity, before resorting to the
mutual agreement procedure, to first determine whether the complaint appears to
be justified (“well-founded”)
or abusive. This resembles the
phraseology used by the OECD Model in Article 25(2). However, Hinnekens disagrees that it is “within the scope
of their due discretion whether mutual agreement procedures should be
initiated”. Whilst acknowledging that Contracting States could abuse of
this interpretation to escape its implications, he believes that a Contracting
State may refuse to set in motion the international procedure only on grounds
relating to the Convention. This
restrictive interpretation is in line with the autonomous international right
granted to the taxpaying enterprise to present its case to its competent
authority in view of an international resolution.
This right should be subjected only to the review of the necessary nature
of the procedure and of the good faith of the request.
political decision of the MSs to adopt the convention form rather than the
directive was based on the collective hesitance by the MSs to surrender a
significant part of their fiscal sovereignty.
However, it is legitimate to compare the Convention with the two
directives packaged with it in 1990, the Merger and Parent-Subsidiary
the Directives imposed on MSs the obligation of implementation in their domestic
law, as a consequence of the transformation from directive to convention, the
effective date of the Convention was delayed until the last signatory State
(Portugal) submitted the instrument of ratification to the Secretary-General of
the Council. Unlike the Directives which are not applicable indefinitely,
the Convention was initially concluded for a period of five years, which were
barely sufficient for the implications of its application to become evident. Its extension is surrounded with doubts and uncertainties as
discussed in Chapter 3.
far as three 1995 entrants, Austria, Finland and Sweden were concerned, the
Convention required them to formally sign and ratify the Convention first before
it could enter into force in their territories.
Unlike the two Direct Tax Directives, the Convention does not
automatically apply to new MSs which have not been signatories to the Convention
itself. On the other hand, like all international treaties, the
Convention overrules national laws, whether passed before or after the
ratification of the Convention itself.
significant disadvantage owed to the legal form of the arbitral measure is that,
unlike the case of Directives, the EC Commission is not entitled and obliged to
supervise the correct and timely implementation and compliance of the
Convention’s mandates. Nor is it
possible to submit to the adjudicative jurisdiction of the ECJ unless all MSs
submit to it, which is presently not the case.
the mutual agreement procedure contemplated in the OECD Model, the Convention
procedures are limited to cases of double taxation which may arise following the
adjustment of profits of associated enterprises. Several affected groups, like the ICC, feel that this is
unduly restrictive, as several other issues can and do arise. Thus issues like the classification of an entity, the
characterisation of certain payments as dividends or interest, and other
questions concerning the interpretation of the various countries’ DTCs fall
outside the scope of the Convention.
is hoped, by such groups, that the experiences of the Convention might convince
them of the potential of these procedures in the resolution of a wider range of
international tax disputes.
assessment and reallocation of income to an enterprise of a given Contracting
State as well as the allocation of income between an enterprise of a Contracting
State and its PE is to be based on the domestic laws of the Contracting States
and, were a DTC modelled on the OECD Model has been entered into, on Articles 9
and 7(2) respectively of the OECD Model.
of the Convention refers to the principles set out in Article 4.
Article 4(1) is identical with Article 9(1) of the OECD Model and
Article 4(2) is substantially identical with Article 7(2) of the OECD
Model. However, the mutual agreement procedure, the advisory opinion
and the final decision of the competent authorities will only be based on the
substantive tax principles set out in Article 4 of the Convention and not on the
Contracting States’ domestic law, whether such domestic provisions are
identical with Article 4 or narrower or broader than such article. Killius argues that if Article 4(1) of the Convention is
recognised as the sole substantive test for the Convention procedures,
then the 1979 OECD Report on Transfer Pricing
should provide the competent authorities with the necessary guidance in applying
profit allocation principle laid down in the Convention is the principle of
arm’s length dealing and separate accounting.
The other possible method, not chosen by the Convention is that adopted
by the United States for the purpose of State taxation, namely that of unitary
taxation (formulary apportionment). The
plural form used in Article 1 (“principles”) merely refers to the
applications of the arm’s length principle to the two types of
‘association’ to which the Convention applies.
length pricing is in line with the tax concepts of sovereignty, territoriality
and the separate entity approach as well as the fairness and equity expected of
the allocation of the multinational tax base, both to taxpayers and to the tax
essence, arm’s length pricing means that:
of associated enterprises, and of branches and their head offices, should be
determined as if they were dealing wholly independently from each other.
drafters chose a definition of the principle identical with, but without
reference to, that found in the bilateral treaties. This is largely due to the lack of such treaties between some
MSs, and more potentially so, between the prospective MSs, as well as the often
inconsistent wording of Articles 7(2) and 9.
Convention does not specify the arm’s length method to be applied.
This creates a choice among the transaction-oriented methods
and profit-oriented approaches. It is argued that this lack of specificity was intentional on
the part of the drafters as they “did not fancy venturing into this
mine-field”. For them, “any
method is valid as long as it is based on the fiction of independence of the
associated enterprises involved, rather than on blind formula apportionment of
the total group profit among the individual companies in the group.”
is understandable, in the light of the ECJ’s inexperience in the field of
arbitration, that the Contracting State were unwilling to entrust the ECJ with
the substantive review of the arbitral decision under the Convention.
However, the MSs deserve criticism for refusing to submit to the ECJ
issues related to the correct practical application and implementation of the
Convention’s rules. The practical
application and the correct interpretation of the Convention’s provisions is
now left to the arbitrary discretion of each MS.
When the Convention becomes part of the domestic law of the MS, the
judicial authorities of that MS assume unrestricted authority to regulate their
country’s efforts to comply with the Convention.
The problem with this is that judicial decisions will differ from one MS
to the other and the desirable uniformity of interpretation will not be
Lack of post-award controls
is unclear whether the post-award controls against violation of due process and
excess of arbitrator’s authority are afforded to the taxpayer under the New
York Convention on the Recognition and Enforcement of Foreign Arbitral Awards,
the Convention for the Protection of Human Rights and the International Covenant
on Civil and Political Rights. If
not, the Convention should be revised to ensure the possibility of re-opening
cases on the basis of serious procedural defects and of new facts following the
Various authorities on the subject have
expressed themselves on the need for review of the Convention.
Dirk Schelpe formulates eleven recommendations for revising the
As regards the improvement of the efficiency and uniformity of its
procedures and principles, he suggests the following measures:
the designation in the Convention of an authority (the ECJ) responsible
for reviewing the commissions’ decisions if the Contracting States consider
them unreasonable and to supervise and control the interpretation and
application of the Convention by the MSs;
the examination of the prospect of providing the possibility to re-open a
case on the basis of new facts occurring after the delivery of the
the setting up of a group of delegates of commissioners from the
Contracting States to enable the sharing of experience and the possible solution
of substantive issues in possible disputes.
recommends the extension of the scope of application of the Convention in the
to cover PEs of third country enterprises based in the EC;
to include other conflicts concerning double taxation, particularly
regarding the recharacterisation of payments and the interpretation of bilateral
to include more expressly conflicts involving local income taxes;
to cater more specifically to multiparty proceedings involving more than
two enterprises and more than two Contracting States in a single procedure.
the following proposals concern the contractual effectiveness of the Convention:
The Convention, amendments and extensions thereto should become effective
as soon as a limited number of Contracting States has ratified it; and
The prohibition of unilateral withdrawal from the proceedings once these
To expedite the workings of the arbitral
commission which has a mere six months to do the job, it might be considered
useful to establish an optional set
of standard rules of procedure which could be adopted flexibly by the commission
on a case by case basis. The
competent authorities could agree on this at the outset of an arbitration
procedure and should be allowed to apply other rules or to adapt them to the
particular cases. This proposal has
a potential as a time saving measure for future consideration. Possible areas for additional rules of procedure could
“The cost of the arbitration procedure; the
costs to be covered, the remuneration of the independent members of the advisory
The determination of the competent authority
which takes the initiative to set up the advisory commission.
The form the opinion of the advisory commission
is going to take.
A common policy with respect to publication of
the decision of the competent authorities.
The language regime”
It is clear that the Convention presents
many advantages compared with the other existing procedures. Admittedly, its principal significance lies not in the
substantive principles which it incorporates.
After all, the arm’s length principle on which the Convention is based
is identical with that provided in the OECD-based DTCs existing between MSs.
Rather, its innovation lies in the mandatory arbitral system which it
introduces to the world of international tax disputes.
The Convention procedures are effective in that they guarantee the
elimination of double taxation arising out of cross-border transfer pricing.
Moreover, its multilateral legal form is more suited than bilateral
treaties in the area of transfer pricing which often involves more than two
affected enterprises. The major and
fundamental setback of the EC Tax Arbitration Convention is the fact that it is
currently inoperative, awaiting ratification by the last MS.
It is, however, clear that the elimination
of double taxation issues caused by transfer pricing disputes currently is in
deadlock. The Convention is
therefore not yet passé but certainly in an impasse.”