International Tax Dispute Resolution
2001 Dr Jean-Philippe Chetcuti. All Rights Reserved.
chapter reviews the historical development of different methods of international
tax dispute resolution, looking at the workings of the mutual agreement
procedure, its strengths and weaknesses, and at the reasons for the infiltration
or for the lack of it of arbitration as a more conclusive and effective method
of dispute resolution.
The mutual agreement procedure
The rise of the mutual agreement procedure
League of Nations Model DTC
the First and the Second World Wars, a number of countries displayed an
inclination towards the signing of bilateral double taxation agreements.
Although the necessity for rules governing the resolution of
international tax conflicts was not felt immediately at the outset of the rapid
developments in the international tax scene, nonetheless, the very first DTCs
ever to be concluded still contained rules for final decisions to be made by
bodies beyond the control of the competent authorities.
The 1924 Model Double Taxation Agreement of the League of Nations
provided for the setting up of a technical committee to decide double taxation
The UK-Ireland 1926 DTC
UK-Ireland agreement of 14 April 1926 concerning income taxes provided for the
delivery of binding judgments by a tribunal:
question that may arise between the parties of this Agreement as to the
interpretation of this Agreement or as to any matter arising out of or
incidental to the Agreement shall be determined by such tribunal as may be
agreed between them and the determination of such tribunal shall, as between
them, be final.”
1927, the League of Nations published a model treaty for mutual assistance in
tax matters. In 1928, it published a model DTC which not only provided for
a mutual agreement procedure but also envisaged the creation of a commission to
settle disputes among the taxing jurisdictions regarding the interpretation or
application of the convention. If
no solution could be reached by mutual agreement, then each of the contracting
states was entitled to submit the matter for resolution to the then Permanent
Czechoslovakia-Rumania 1934 DTC
the DTC of 20 June 1934, in connection with succession duties, entered into by
Czechoslovakia and Rumania, contemplated a similar mode of dispute resolution; a
board was formed by the Fiscal Committee within the League of Nations to hear
both parties, jointly if deemed necessary or advisable, and to bind the parties
with its opinion.
the passage of time proved that it was necessary to find solutions for problems
arising in other different areas relating to a DTC.
Not only could the aim of the DTC be frustrated by cases of taxation of a
taxpayer in both countries, but also, for instance, by difficulties in the
interpretation of the provisions of the convention, by cases of double taxation
not covered by the convention, or by changes in the internal regulations of the
Contracting States in the area covered by the convention.
If the importance of such convention was not to be undermined, such
matters had to be promptly resolved by efficient methods of co-operation, this
necessitating close co-operation between the Contracting States to achieve
mutual agreement. The practice
developed for the finance ministries of the Contracting States to engage in
negotiations with the aim of securing agreement and solving disputes on the
interpretation of the convention. This
method was also adopted concretely when a taxpayer called for negotiations on
the interpretation of the convention.
OECD 1963 Draft DTC
rules for a mutual agreement procedure started appearing in DTCs, authorising
the competent authorities to enter negotiations with the aim of obtaining
agreement to solve individual cases in which the intentions of the convention
had not been fulfilled. As this method developed further, conventions started laying
down special rules governing the conduct of the negotiations between the
competent authorities and before long, the mutual agreement procedure had
crystallised in the foremost method of solving disputes arising from the
implementation and interpretation of the DTCs, so much so that it was adopted by
the OECD Draft DTC on Income and on Capital adopted by the Council in 1963.
Nonetheless the mandates of the convention were limited as they only
contemplated the appointment of commissions to serve as consultative bodies for
each particular dispute and stopped short of providing them with any
A European DTC
1968, the EC Commission suggested conducting negotiations to work out an
arrangement for actual disputes to be submitted to a standing committee of the
national tax authorities. Unfortunately,
due to insurmountable political obstacles, discussions on a Pre-Draft for a
had to be abandoned.
Revision of the Mutual Agreement Procedure
levelled at the 1963 OECD Draft Model Convention regarding the role of the
taxpayer in the mutual agreement procedure, and the marked lack of a procedure
which would lead up to a mutual agreement, led the working groups of the
Committee on Fiscal Affairs in 1971 to commence work to revise and develop the
said Draft DTC in the light of the experience of the existing conventions.
This escalated in the proposal and adoption by the Council, in 1977, of
amendments to Article 25 containing the existing provisions of the mutual
The competent authorities would be authorised to resolve by mutual
agreement difficulties or doubts regarding the interpretation or application of
the convention and also to eliminate cases of double taxation which are not
covered by the convention.
According to the Commentary on Article 25 of the 1977 Model DTC,
“Article 25 represents the maximum that Contracting States are prepared to
They agreed to seek a solution but did not want to commit themselves to
find a joint solution to eliminate the double taxation.
basis of the original procedures was left intact; however, a new paragraph (4)
was added to it. The provisions
envisage the possibility of the formation of a joint commission for an oral
exchange of views; when it seems advisable in order to reach agreement to have
an exchange of opinions, this exchange may be conducted via the commission
consisting of representatives of the competent authorities of the Contracting
The OECD Model Convention leaves it to the competent authorities to
determine the composition of and the procedural rules to regulate this joint
commission. In the event that a commission is actually formed, then the
Contracting States are duty bound to give taxpayers promoting the case before
the joint commission the following rights:
the right to make representations in writing or orally, either in person
or through a representative;
the right to be assisted by counsel
to facilitate the reaching of an agreement, the Contracting States are bound to
entrust the chairmanship of each delegation to a judge or high official chosen
first and foremost on the basis of his special experience.
Possibly, also, the Contracting States may be ready to subject themselves
to an obligation to reach an agreement at the end of the procedure.
Furthermore, the competent authorities may agree to seek the opinion of
an impartial third party, or an advisory opinion from independent arbitrators,
but the final decision still remains with the contracting states.
It appears, though, that such possibilities have not been used so far.
The weaknesses of the competent authority procedure
mutual agreement procedure, also known as the ‘competent authority
procedure’ can boast of having benefited international business and has earned
a reputation as the best method of resolving instances of double taxation.
Nonetheless, it presents certain undeniable defects:
Though DTCs generally encourage the competent tax authorities to reach an
agreement which eliminates double taxation, this is in no way imposed on them
compulsorily and therefore there still remains the possibility that double
taxation will persist after the application of the mutual agreement procedure.
DTCs fail to lay down time limits or procedural rules for the mutual
agreement procedure, and specify no method for their implementation (even though
many conventions stipulate that competent authority agreements will be
implemented notwithstanding national time limits).
The affected taxpayers are normally excluded from the competent authority
deliberations or, in any event, have no official or guaranteed status in such
Procedural rules followed by the competent authorities differ
significantly from those applicable to domestic examination and appeals.
Procrastination in reaching a conclusion of competent authority
proceedings can be very long, and is of concern to businesses.
Even if the competent authorities agree to eliminate double taxation, the
taxpayer may not be neutral as to how this is achieved. The competent authority
decision may not conform to national or treaty law, and may be influenced by
extraneous factors such as other pending competent authority cases.
these reasons, an international movement gained momentum with the view that
binding and compulsory arbitration could tackle the weaknesses of the competent
authority procedure. An arbitral award fixing the applicable transfer price is
infallibly reached, adopting an impartial, predictable and transparent process
which specifically includes proper taxpayer involvement, and which applies law
rather than compromise.
Proposals for arbitration
Lindencrona and Mattsson’s proposal for an arbitral procedure
the Ninth Conference of the Law of the World,
Lindencrona and Mattsson suggested compulsory arbitration in front of an
international institute for arbitration in tax disputes in Stockholm as a
logical step following the failure by the parties of a DTC to settle an
international tax dispute.
The justification given for this curtailment of States’ tax
jurisdiction is that the parties to a DTC would have already consented to
particular limitations of their taxing jurisdiction and should therefore not
object of a further limitation intended to ensure that a solution is found to
disputes on the interpretation of the DTC.
and Mattsson, together with Francke, also featured at the 1981 Berlin Annual
Congress of the IFA dealing with the mutual agreement procedure in tax treaties.
They presented a Cahiers proposing an arbitral procedure for the
settlement of all international tax disputes and not restricted to those arising
from transfer pricing.
They proposed a model clause to be included in future tax treaties,
worded as follows:
one of the Contracting States is of the opinion that one of its residents has,
due to a difference of opinion between the Contracting States as to the
interpretation of application of this Convention, not been taxed according to
this Convention it shall, if a solution has not been found by other means, call
for arbitration for settlement of this dispute.
arbitration procedure is initiated by a request for arbitration to the
International Institute for Arbitration in Tax Disputes in Stockholm and shall
follow the rules of that institute.
award shall be binding on the Contracting States.”
the further development of the mutual agreement procedure in mind, the authors
of this proposal advocated arbitration as a remedy to be resorted to only after
all other measures have been exhausted without success.
Besides the principle of the exhaustion of domestic remedies, a
prerequisite for the commencement of the arbitration would be that, in the
opinion of the arbitration institute, the arbitral award would be capable of
implementation. If not, the application for arbitration would be rejected.
and Mattsson believed that an International Institute for Arbitration in Tax
Disputes would be necessary to solve administrative and technical problems
arising from and after the appointment of an arbitration commission.
An arbitration institute would ideally be founded by the United Nations
to give it supranational status and would be responsible for the laying down of
a uniform procedure, a system which would treat different cases uniformly.
The Institute would draw up a list of suitable arbitrators from different
countries and assume the role of a forum open for all interested countries, thus
imparting stability to the arbitral procedure and saving the individual
Contracting States the trouble of devising rules for particular arbitral
procedures. The suggested rules
regulated the appointment and the composition of the arbitral commission and the
manner of initiation of the arbitral procedure, thus doing away with the problem
of determining the applicable law.
taxpayer would have no independent right of initiation, as this, they argued,
would undermine the mutual agreement procedure currently practiced between
states and would also require the present rules to be extensively amended.
Nonetheless, taxpayers should be given the opportunity to be heard in
person and to present to the arbitral commission any supporting documentation
relevant to their cause. It was
proposed that the direct expenses of the arbitral procedure should be borne
equally by the states involved irrespective of the outcome.
Awards should generally be published and final.
the Swedish national reporters for the first topic, Lindencrona and Mattsson
were the only national reporters who advocated without reservation in favour of
mandatory arbitration of tax disputes if the contracting states could not reach
a solution in their dispute themselves.
the other hand, in its Report on Transfer Pricing, Corresponding Adjustments and
the Mutual Agreement Procedure, the OECD Committee on Fiscal Affairs reviewed
the Draft Directive and concluded that it could not, for the time being at
least, recommend the adoption of a compulsory arbitration procedure to supersede
or supplement the mutual agreement procedure.
Carl S. Shoup’s proposal
opinion on arbitration of transfer pricing disputes involving multinational
enterprises was that it should be voluntary but binding.
Thus any country or any taxpayer choosing to employ this arbitral remedy
should commit itself to its continued use for a term of three to five years and
would have to bind itself to abide by the board’s award and waive any right of
right of initiative before the proposed permanent board of arbitration would lie
with either one of the tax administrations concerned or with one of the
associated companies. Arguing in
favour of the right of initiative of the taxpaying company, Shoup acknowledged
that a taxpayer might not be happy with the transfer price agreed upon between
the two countries’ tax authorities. Such
an agreement might still affect the company’s legal position as it is in the
fiscal interest of the taxpayer for a lower transfer price to be established if
the importing company operates in a lower tax jurisdiction and for a higher
transfer price to be agreed if it is the exporting company that operates in the
lower tax jurisdiction. Therefore
if the arbitration board was to command respect, it should not seek to
compromise; rather, its awards should be
based on strict principles.
was contrary to the rule of the exhaustion of domestic remedies and all in
favour of allowing taxpayers to appeal at once to the arbitration board the
decision of which would overrule any interim or eventual decision of the
domestic courts. Otherwise, by the
time the taxpayer has exhausted his rights of domestic appeal, the dispute would
have dragged on for so many years that an agreement with the other country could
become significantly difficult.
Lindencrona and Mattsson, Shoup overlooks the possibility of taxpayers using the
two systems and opting for the most favourable result.
To prevent abuse of the arbitral system, the former make it a
precondition for the commencement of the arbitral procedure that all domestic
legal remedies available in either state have been resorted to. Otherwise, the procedure would only be initiated if the
taxpayer declared in writing that he would accept the arbitral award.
The ICC – all for arbitration
1959, the International Chamber of Commerce (ICC) has played an important role
in the promotion of arbitration as an appropriate and efficient method for the
resolution of taxation disputes, culminating in the publication of a position
paper in 1984 describing the shortcomings of the mutual agreement procedure and
calling both for reforms of the mutual agreement procedure and for the
introduction of an arbitration procedure.
However, since then, little significant progress has been registered in
this regard and the acceptance of proper arbitration provisions is still not as
widespread as is desirable.
regards the mutual agreement procedure, the ICC, representing taxpaying
companies, has called for the better protection of the rights of the taxpayer.
Thus the taxpayer should have the right to demand the initiation of the
mutual agreement procedure, to submit any materials to the competent authority
and also the right to be heard and to reject any unsatisfactory mutual
agreement. A mutual agreement
should be implemented in all cases, even if taxation incompatible with the
treaty has been confirmed by a judicial decision.
the event that no satisfactory agreement is reached by the competent authorities
which is compatible with the treaty or if the problem is not resolved within one
year, the taxpayer should be able to compel the said authorities to submit the
case to an arbitral commission. This
should be composed by one member chosen by each state, who in turn chooses an
independent chairman. The arbitral
award should always be based on the treaty and not on a compromise reached by
the parties. The taxpayer should
have the right to present his views to the arbitration commission and put
forward his arguments before meetings of the commission.
The award should be implemented in all cases.
The costs of the procedure should be borne by the states.
its 1999 action programme, the ICC reiterated its commitment to “encourage
governments to accept compulsory arbitration in international tax conflicts.”
The ICC recommends the negotiation and adoption by all governments of
bilateral or multilateral tax conventions for the compulsory and binding
arbitration of tax controversies, using the OECD as the most appropriate forum
for the purpose. Its recommendation
is based on its broad experience in commercial arbitration as a cost-effective
and equitable form of dispute resolution with significant advantages to
businesses and government and with a significant chance of enhancing global
economic growth and development through elimination of unintended instances of
The OECD – ‘an unacceptable surrender of fiscal sovereignty’
number of members composing the BIAC, the Business and Industry Advisory
Committee to the OECD, are also members of the tax commission of the ICC and
have actively pursued the idea of an arbitral procedure. However, as reflected
in the 1984 OECD report entitled “Transfer Pricing and Multinational
Enterprises – Three Taxation Issues”, the government representatives were,
for the time being, unwilling to recommend the adoption of a compulsory
arbitration procedure to supersede the mutual agreement procedure.
They were of the opinion that “the need for such compulsory arbitration
has not been demonstrated by evidence available and the adoption of such
procedure would represent an unacceptable surrender of fiscal sovereignty.”
the years, the views of the Committee on Fiscal Affairs of the OECD regarding
international tax arbitration have evolved.
Arbitration is not expressly contemplated in the OECD Model Convention
but the 1995 “Transfer Pricing Guidelines”
note that developments since 1984 call for the reconsideration of the matter.
The Committee on Fiscal Affairs has committed itself to the further
analysis of the topic in view of incorporating the conclusions thereof in the
favour of arbitration we have the Commentary to the OECD Model Convention
which depicts arbitration as the answer to the significant problem of the
failure of the competent authorities to eliminate double taxation.
Current use of arbitration
The draft German-Swedish Income
1985, amidst opposition from other states to an arbitration procedure, Germany
and Sweden drafted an income tax treaty
which included an arbitration clause. Thus, in addition to the mechanism contemplated in the
European Convention for the Peaceful Settlement of Disputes,
the Contracting States have the option to agree to refer the dispute to a Court
of Arbitration, whose decision will be binding between the Contracting States.
contemplated Court of Arbitration is composed of judges of the courts of the
Contracting States or of third countries or of international organizations and
follows internationally recognised arbitral procedures.
Awards have to be based upon the treaties of the Contracting States and
on general international law so that a decision ex
aequo et bono is inadmissible.
The parties have the right to completely present their case and to
propose their own motions.
the use of the drafted arbitration clause is completely voluntary.
Much more would be achieved if the use of an arbitral procedure had been
mandatory. Moreover, the
imposition of a time-limit within which the competent authorities have to reach
a mutual agreement was desirable; their failure to agree within, say, a year,
would have triggered an arbitration procedure.
Another perceived fault is the composition of the arbitral court of
judges who do not have a reputation for international tax expertise.
The USA-Germany Treaty
1979 OECD Report on Transfer Pricing failed to persuade either the OECD
Members or the MSs of the EC to set up a unitary institution entrusted with the
tasks of settling double taxation disputes.
Rather, some OECD Members set out to publish their own unilateral
transfer pricing rules.
Others worked on finding solutions on a bilateral level; the United
States drafted the first model convention
which contemplated the possible triggering of an arbitral procedure
in the event that mutual agreement negotiations between tax authorities
fail to secure relief from double taxation.
Apart from the use of an arbitration panel, the solution offered by the
United States resembled the OECD Model Convention.
procedure was implemented in the DTC between Germany and the United States.
Furthermore, the USA-Germany Treaty, unlike other treaties such as the
also included an arbitration clause.
The arbitration procedures are to be agreed [upon] by the two Contracting
States, and established by exchanges of notes through diplomatic channels. Notes
were exchanged at the time of the signing of the Convention which specify a set
of procedures to be used in the implementation of paragraph 5. Changes in these
procedures may be made through future exchanges of diplomatic notes. The agreed
rules of the procedure are as follows:
Exhaustion of the mutual agreement procedure
diplomatic notes, which marked the conclusion of the treaty, detailed the rules
for the arbitral procedure, laying down that arbitration cannot be used from the
outset. Before, every effort must be done to secure a solution by
This does not means that a Contracting State is obliged to compromise if
it feels strongly about its legal position.
In the event that the Contracting States fail to find a solution they may
then revert to the arbitral procedure.
Abuse of arbitration provision
the matter of the relation between national procedure and the arbitral
procedure, the USA-Germany DTC makes it impossible for a taxpayer to use both
the national courts and the mutual agreement procedure and then choose the best
outcome. Before the opening of the arbitral procedure, the taxpayer
has to bind himself in writing to be bound by the arbitrators’ award.
If the taxpayer denies his consent to the procedure, no arbitration will
take place and the taxpayer thus bears the risk of a negative outcome.
The position of the taxpayer - confidentiality
meaningful feature of modern doctrine on arbitration which applies to this
procedure is confidentiality which is highly beneficial to the taxpayers.
The arbitral board is bound by the confidentiality and disclosure
provisions applicable in both Contracting States and the convention. Should
problems of conflict arise, the most restrictive condition prevails.
regards the publication of the awards, despite the silence of the notes on the
matter, it is hoped that such publication will be carried out in the light of
the principles of confidentiality.
Locus standi of the taxpayer
taxpayers are afforded the opportunity to present their views to the arbitration
board. The same provision applies to the mutual agreement procedure.
international public arbitration, arbitration of tax disputes is a procedure to
which the parties are the Contracting States, unlike the state-taxpayer
relationship typical of domestic tax disputes.
However, the very purpose of the arbitration is to prevent the arbitrary
taxation of taxpayers and to give effect to the relative law and the treaty. Thus the notes give taxpayers some rights such as the right
to be heard and to confidentiality.
Law not compromise
award is based, rather than on the tax policy or domestic tax law of either
Contracting State, on the convention, on the domestic laws of both Contracting
States and on the principles of international law.
costs of arbitration are to be borne by the Contracting States which may,
however, require that a taxpayer agrees to bear the state’s share of the
costs. However, this can only take
place in exceptional cases.
Competent authorities who believe that they have a weak case are not
compelled to resort to arbitration under the USA-Germany DTC, despite any
insistence to that effect by the taxpayer.
Some argue, however, for allowing taxpayer to risk arbitration and assume
the responsibility for the resultant costs thereof.
the counter-argument goes, the possibility of burdening the taxpayer with the
costs brings with it the risk that the competent authority will expect the
taxpayer to meet the costs. As far
as the taxpayer is concerned, if no mutual agreement is reached within a
specified time limit, the competent authorities should be compelled to invoke
the arbitration procedure and bear the costs therefor.
Binding force and the law of precedent
the USA-German DTC, the awards of the arbitral board are binding on both
Contracting States with respect to that case and also upon the taxpayer.
Awards have no precedential effect as this, coupled with the absence of
the possibility to appeal, would mean that an award which tackles a particular
legal question will have closed any possible discussion on the issue forever.
This does not mean that such decisions will not ordinarily be taken into
account in subsequent competent authority cases involving the same taxpayer(s),
the same issue(s), substantially similar facts, and also in other cases where
while it is encouraging that an arbitration clause has been included in certain
US DTCs, the fact that arbitration is not compulsory is a major drawback.
The Arbitration Convention
1990, the states of the then European Community concluded a multilateral
convention providing for the use of compulsory arbitration in international
taxation disputes concerning transfer pricing.
The “Arbitration Convention”
represents a valuable precedent which merits consideration in framing the
appropriate terms for international arbitration provisions in general. For this reason, the next chapter is dedicated solely to the