Tax Arbitration: The preferred solution

Tax arbitration is an intricate area of law. It is therefore vital for us to understand what tax arbitration entails, its consequences for taxpayer rights, and the effects it has on the legal sector.

Author: Maité Camilo, lawyer and LLM Candidate at IE Law School (Master in Global Taxation)

On November 20, 2018, relevant figures from the national and international tax field gathered at IE Law School’s LawAhead Hub to discuss the “Current Approaches to Tax Arbitration.” On this occasion, IE Law School hosted Patricia A. Brown[1] and Violeta Ruiz Almendral[2] who guided the debates.

In 2015, the Organization for Economic Co-operation and Development (OECD) released their Final Report[3] on Action 14 – Making Dispute Resolution Mechanisms More Effective – as part of the G20 Base Erosion and Profit Shifting (BEPS) Project. This Final Report highlights the following: “eliminating opportunities for cross-border tax avoidance and evasion and the effective and efficient prevention of double taxation are critical to building an international tax system that supports economic growth and a resilient global economy.”[4] Nevertheless, these measures should not result in punishing compliant taxpayers with further uncertainty and unintended double taxation.[5] Therefore, supporting taxpayer rights by ensuring that profits are taxed where value is created – prescribed as BEPS Project’s fundamental initiative – similarly requires improving dispute resolution mechanisms between the competent authorities.

Article 25 of the OECD Model Tax Convention on Income and on Capital (OECD Model Tax Convention)[6] grants taxpayers the opportunity to entrust the corresponding competent authorities with resolving tax disputes which have arisen from the interpretation and application of the convention by means of the MAP, irrespective of the remedies available under domestic law. However, in the event that the authorities do not reach an agreement within two years, the unresolved issue may be submitted to arbitration at the request of the taxpayer.

2017 MAP statistics from the OECD (covering 85 jurisdictions and almost all MAP cases worldwide) show an overall increase of 35% in the MAP cases being closed,[7] despite a significant increase seen with newer cases being opened (transfer pricing cases are up 25%, while other cases are up 50%). The foregoing may be a consequence of the awareness and expectations from taxpayers about the MAP.

In this taxpayer rights context, it is fundamental to discuss the influence and current approaches that the tax arbitration clause of Article 25 of the OECD Model Tax Convention may have exercised in the resolution of cross-border tax disputes, especially given the increase in resolved cases within prior years.

The arbitration clause introduced in Article 25 of the Model Tax Convention of 2008 serves a dual purpose: On one hand, it is a means of ensuring that issues concerning the application and interpretation of tax conventions are resolved, which, in turn, provides legal certainty to taxpayers. However, on the other hand, it motivates the corresponding competent authorities to reach timely and efficient agreements within the two-year timeframe, in order to avoid the need to rely on a third party to reach an agreement for them.

According to the OECD, tax revenues represented over 34% of member countries’ GDP in 2017.[8] Consequently, tax administrations may not champion tax disputes, especially when the results may cause a decline in tax revenues. Tax arbitration – and to some extent, the desire to avoid tax arbitration all together – presents itself as a viable instrument for reaching an agreement and to ensure tax certainty to taxpayers.

From the perspective of the United States, however, the competent authority was very much against arbitration and, according to Patricia A. Brown, was relatively slow to adopt mandatory binding arbitration for the resolution of tax treaty disputes.”[9] This approach was justified on gounds of legitimate concerns about the “independent opinion” model, which happens to be the predominant form of arbitration.[10] This particular model served as an incentive for the competent authorities to take unreasonable positions, provided the panel could reach any result it wants. Therefore, there is a possibility that the panel will only be able to reach a consensus, by agreeing on a result that is between the positions of the two competent authorities.[11]

In this regard, the US adopted what is known as “baseball arbitration” or, “last best offer.” Under this model, the panel’s decision-making capacity is restricted to choosing between the positions presented by the competent authorities. Therefore, the “last best offer” was likely preferred over other forms of arbitration with the hope that it would ensure that the tax administrations will be more reasonable in their negotiations.[12]

In general, there is still concern and skepticism regarding the adoption of an arbitration clause as an actual means to guarantee taxpayer rights. However, although the decision of an arbitration panel is binding vis-à-vis competent authorities, taxpayers have the option of opting out and pursuing the remedies provided in domestic law.

As a final note, the need for tax arbitration has proven to be unquestionable since there is a need for experts to resolve tax treaty controversies when competent authorities cannot reach an agreement on their own.

Maité Camilo is a lawyer in the Dominican Republic and is currently an LLM Candidate at IE Law School (Master in Global Taxation) in Madrid. She has prior experience having worked at Ernst & Young’s International Tax Services Department.

Note: The views expressed by the author of this paper are completely personal and do not represent the position of any affiliated institution.

[1] Director of the Graduate Program in Taxation, University of Miami School of Law, United States of America (USA)
[2] Lawyer of the Spanish Constitutional Court and professor at Carlos III University
[3] As part of the G20/OECD tax certainty agenda, the adoption of the Report implies that countries shall commit themselves to a minimum standard re their approach to dispute resolutions. The minimum standard will: (a) ensure that treaty obligations related to the mutual agreement procedure are fully implemented in good faith and that Mutual Agreement Procedure (MAP) cases are resolved in a timely manner; (b) ensure de implementation of administrative processes that promote the prevention and timely resolution of treaty-related disputes; and, (c) ensure that taxpayers can access the MAP when eligible.
[4] OECD (2015), Making Dispute Resolution Mechanisms More Effective, Action 14 – 2015 Final Report, OECD/G20 BEPS Project, OECD Publishing, Paris 
[5] Ibid.
[6] OECD (2017), Model Tax Convention on Income and on Capital: Condensed Version 2017, OECD Publishing. 
[7] The average time to close MAP cases on 2017 was of 22.2 months
[8] OECD (2018), Revenue Statistics 2018, OECD Publishing, Paris, Table 1.1 
[9] BROWN, Patricia A., “Development of the “North American Model” for Arbitration of Tax Treaty Disputes.”
[10] Ibid
[11] Ibid
[12] Ibid