International Tax Arbitration n13 11

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PRIVATE AND PUBLIC DISPUTE RESOLUTIONIN INTERNATIONAL TAXATION

Charl es R. I r ish

ABSTRACT

An inevitable byproduct of the globalization of economic

activities has been the increased attention to international disputeresolution. International arbitration, mediation, conciliation aswell as traditional cross border litigation proceedings are nowrelatively common. One subset of international disputes that hasnot received much attention, however, is the resolution ofinternational tax disputes.

This essay is intended to shed some light on international taxdispute resolution. The essay is divided into three principal parts.

After this introduction, Tt he firstnext part describes how privateand public international tax disputes arise and explains briefly howthey are commonly resolved. The second major part of the essay

then focuses specifically on a relatively new area of internationaltax dispute resolution: arbitration of international tax disputes.The second part describes and compares the most important formsof international tax dispute resolution arbitration now in use,including specifically the EUs arbitration rules, the OECDs

Model Arbitration Rules, and the arbitration provisions included in some of the more recent bilateral tax treaties to which the U .S . is a party. The third part of the essay concludes with an analysis of the

Senior Director, East Asian Legal Studies Center, Volkmn-Bascom Professor of Law (emeritus),

University of Wisconsin Law School, Madison, USA. The author can be reached [email protected].

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existing arbitration rules and suggestions for how they can beimproved.

K EYWORDS :

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. P RIVATE AND P UBLIC INTERNATIONAL T AX DISPUTES : G ENERALLY

A. The Natur e of the Disputes

International tax disputes arise in two general contexts. The first is probably the most common dispute and involves a taxpayer or taxpayers onone side and the government or governments on the other side. In thesedisputes, the government typically claims taxes are owed and the taxpayerresists the imposition of taxes. The second type of dispute involves two ormore government arguing over the allocation of tax revenues derived fromtrade and investment transactions between their territories. In the secondtype of dispute, private taxpayers may have little or no direct role, althoughthey may play important roles in attempting to influence the positions ofgovernments in the intergovernmental negotiations. In both types ofdisputes, the amounts involved usually are very substantial and reachhundreds of millions or even billions of U .S. dollars. 1

B. D isputes Between Taxpayers and the Government

International tax disputes between taxpayers and the government can be divided into two categories: disputes in which the taxpayers claim thereis international double taxation and disputes which could result in doublenon-taxation.

Under the basic jurisdictional rules of international taxation, mostcountries with an income tax impose that tax on the global income ofresident individuals and business enterprises under the residence principle,

but they also tax foreign individuals and non-resident business enterpriseson income that arises within their territory under the source principle. As aconsequence, the fundamental structure of international taxation anticipatesthe risk of double taxation as the countries involved in international

business often impose their taxes on the global income of their residentsand the domestic source income of foreigners. Because double taxation ofinternational income flows would kill off a great amount of international

business and investment, it is not surprising that many of the internationaltax rules are aimed at reducing the risk of double taxation.

1 For the tax years 1989 to 2005, GlaxoSmithKline PLC, the British pharmaceuticals giant, agreedto pay the U .S. IRS US$3.4 billion to settle a transfer pricing controversy. See Michael J.. Mcintyre,Comments on the OECD Proposal for Secret and Mandatory Arbitration of International Tax

Dsiputes , 7(9) FLORID A. TAX R EV.IEW 622 (2006), at footnotenote 10, quoting Robert GuyMatthews and Jeanne Whalen :, "Glaxo to Settle Tax Dispute With IRS Over U.S. Unit for $ 3.4Billion ," Wall Street Journal, Sept. 12, 2006 at A3.

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Of all the international tax disputes, the most commonly encountered problems involve transfer pricing controversies. This is especially so withthe globally integrated economy where so many transfers of goods, servicesand intangible property are between parents and subsidiaries or betweenother affiliated enterprises. Transfer pricing refers to the price ch arged ontransfers of goods, services and intangible property between related entities.Thus, for example, if Am Corp is a U .S. based holding company withsubsidiary operations in the U .S., Taiwan, and several other jurisdictions,the prices charged on transfers of anything of value among the subsidiariesand between Am Corp and its subsidiaries would be transfer prices. Theessence of transfer prices is that they are set not by the market place, butare within the discretion of the multinational enterprises.

It is generally accepted that transfer pricing controversies are one ofthe most common and most serious issues facing multinational enterprisesand at any given time a majority of the largest multinational enterprises areinvolved in very substantial transfer pricing disputes somewhere in theworld .2. Despite the enormous efforts at establishing uniformity in transfer

pricing rules, 3 the issues inevitably are so complex and dependent on somany subjective variables that transfer pricing disputes remain the most

serious tax controversies facing multinational enterprises.4

Example 1illustrates how Am Corp could become involved in an international taxdispute related to transfer pricing.

Example 1 In 2008, Am Corp licensed patents and copyrights to

Taiwan Sub, Am Corps wholly owned subsidiary in Taiwan.Under the licensing agreement, Taiwan Sub agreed to payroyalties of US$10 million per year. In the year 2009, accordingto the licensing agreement, Taiwan Sub paid Am Corp US$10million. In 2010, on reviewing Taiwan Subs income taxaccounts for 2009, Taiwan s National Tax Administrationdetermined that the royalties paid by Taiwan Sub to Am Corpwere excessive and that the proper amount of royalties in 2009should have been only US$4 million. As a result, in computing

2 See OECD, TRANSFER PRICING GUIDELINES FOR MULTINATIONAL E NTERPRISES AND TAXADMINISTRATIONS (2010).[pincite] at http://www.oecd.org/document/34/0,3746,en_2649_33753_1915490_1_1_1_1,00.html (visitedAugust 20, 2011). 3 The OECD and the UN both have developed extensive guidelines for the computation of transfer

prices in international business. See, e . g ., iI d. Most major economies, including Taiwan and theU.S., have their own transfer pricing rules that mirror or are similar to the OECD or UN Guidelines.4 Yitzhak. Hadari, Compulsory Arbitration in International Transfer Pricing and Other DoubleTaxation Disputes , available at http://ssrn.com/abstract=1483621 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1483621 (last visited 27 Oct . 20ober ,, 201109 ). [Please kindly provide the cited material.]

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Taiwan Subs Taiwan income tax liabilities, Taiwans NationalTax Administration disallowed US$6 million of Taiwan Substax deduction for the royalties paid to Am Corp.

For the year 2009, Am Corp properly reported royaltyincome of US$10 millio n that is first subject to Taiwanswithholding tax on outbound royalty payments and then againin the U .S.. Even though Am Corp is taxed in both Taiwan andthe U .S., double taxation is avoided because Am Corp can claimthe Taiwan withholding tax paid as a credit against its U .S. taxliability. However, because Taiwan Sub is now taxed in Taiwanon the US$6 million that was disallowed as deduction by theTaiwans National Tax Administration and Am Corp is taxed onroyalty income of US$10 million, not US$4 million, the US$6million is threatened with double income taxation because it isnow being taxed in Taiwan in the hands of Taiwan Sub and italso is taxed in Taiwan and the U .S. in the hands of Am Corp.

Because of the prevalence of intra-firm transfers of goods, services andintangible property in international transactions and the very considerable

difficulties associated with computing accurate transfer prices, transfer pricing disputes arising under national income tax laws are the mostfrequent type of international tax dispute. Less common, but stilltroublesome disputes arise from inconsistent characterizations ofinternational remittances. Example 2 illustrates a situation that creates athreat of double taxation when the source country characterizes aremittance as interest income and the recipient country treats the remittanceas services income.

Example 2In 2009, U .S. Bank (USB) entered into an agreement to

provide loan guarantees, lines of credits and other services forits British Banking Sub (BBS), its wholly owned subsidiaryin London. In 2010, BBS paid USB US$12 million for thevarious services under the agreement. The UK Department ofInland Revenue determined that the US$12 million paymentswere in the nature of interest, which has its source in the UKand hence is taxable to USB in the UK. The U .S. InternationalRevenue Service, however, determined that the paymentsconstituted services income and had their source where theservices were performed in the U .S., not the UK.

In this case, USB would be taxed on the US$12 million payment in the UK and also taxable in the U .S.. Unlike thesituation in Example 1, however, the U .S. would not allow USB

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to offset the UK tax through the U .S. foreign tax credit becausethe credit is only allowed for foreign source income, asdetermined under U .S. tax rules. Because the U .S. hasconcluded that the payments were US source services income,no foreign tax credit would be available to eliminate the threatof double taxation.

Other less common instances creating threats of double taxation are: Conflicting determinations of the residency of taxpayers, such as where

the U .S. asserts that a taxpayer is a resident of the U .S. while Canadaclaims that the taxpayer is a Canadian resident.

Inconsistent determinations on the legal status of a taxpayer as aconduit or pass-through entity (i.e., a partnership) or a separate entity(i.e., a traditional corporation).

Different views on the status of a tax as an income tax that qualifies forthe foreign tax credit (e.g., Brazil imposes a withholding tax on interest

paid to U .S. lenders, but the U .S. determines that the tax is not properlycharacterized as an income tax and thus does not qualify for the U .S. foreign tax credit).

The other category of international tax disputes involving private parties is where the controversy could result in double non-taxation. Thesecases are less common than double taxation controversies, but the growingimportance of sovereign wealth funds and large pension funds as foreigninvestors makes these cases increasingly relevant. Example 3 illustrates onesuch case.

Example 3TIAA-CREF is one of the largest financial services

companies in the US with assets of about US$400 billion. Theincome of TIAA-CREF is tax exempt in the U .S. because it isqualified as a tax exempt pension fund. Taiwan, however, hasmuch more limited tax exemptions for foreign institutions soTIAA- CREFs investments in Taiwan are potentially subject towithholding taxes. TIAA- CREF may seek to persuade Taiwans

National Tax Administration to extend tax exempt status toforeign pension funds and other exempt institutions where thehome country of the pension funds grants a reciprocalexemption for tax exempt Taiwanese pension funds withinvestments in that country. 5

5 The U .S. tax law is actually generous in unconditionally granting tax exempt status to sovereignwealth funds and other governmental entities irrespective of the tax treatment of U .S. sovereignwealth funds and governmental entities in the other countries. See Internal Revenue Code of 1986 , 892.

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If this situation arose between countries with a bilateralincome tax treaty, such as the U .S. and Denmark, TIAA-CREFwould look to the Mutual Agreement Procedure (MAP) in thetax treaty to make use of the Competent Authority Procedure.Under Article 26 of the U .S./Danish Tax Treaty, TIAA-CREFwould try to persuade the U .S. Competent Authority (a

bureaucrat within the U .S. Treasury) to persuade the DanishCompetent Authority that it is a qualified pension fund that fitswithin the definition in the U .S./Danish income tax treaty. If theU.S. Competent Authority agrees to help TIAA-CREF and theDanish Competent Authority then agrees with the U .S. Competent Authority that TIAA-CREF is included within thedefinition of a qualified pension fund in the bilateral tax treaty,TIAA- CREFs pass ive investment income from Denmarkwould be taxed in neither Denmark nor the U .S..

C. Di sputes Between Governments

International tax disputes between governments center on the

allocation of tax revenues between the various territories. Most of thedisputes take the form of bilateral negotiations that result in the conclusionof bilateral tax treaties, while others are more subtle and may even be sosubtle that one side does not understand that there is a controversy.Example 4 illustrates intergovernmental tax negotiations and Example 5describes a subtle controversy.

Example 4 The U .S. Government is sporadically involved in income

tax treaty negotiations with Sub-Saharan African countries .6 . One of the issues in the tax treaty negotiations is the rate of thesource based withholding tax on royalties for patents,copyrights and trademarks used in one country and paid toenterprises resident in the other country. In other words, thenegotiations will decide the maximum rate of tax that the U .S. Government can impose on royalties paid by U .S. enterprises toAfrican enterprises and, because the negotiations imposereciprocal obligations, the U .S. rate also will determine themaximum rate that the African governments can impose onroyalties paid by African enterprises to U .S. enterprises.Technological flows between the U .S. and Sub-Saharan Africa

6 Allison D . Christians, Tax Treaties for Investment and Aid to Sub-Saharan Africa , 71(2) BROOK .LYN L.R EV.. 639,, at 641 (2005).


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are not reciprocal, but instead it is much more common for U .S. enterprises to license technology to Africa than for Africanenterprises to license technology to the U .S.. As a consequence,royalties between the U .S. and Africa will flow largely one-wayfrom Africa to the U .S. so that if the source based withholdingtax is set at zero percent the African governments will obtainvirtually no revenues from U .S./Africa technology flows andthe U .S. will be able to impose the full rate of its corporate tax(35 percent % of net income) on the technology flows. On theother hand, if the source based withholding tax is set at 20

percent% , the African governments will receive 20 percent% ofthe gross income from the technology flows and the U .S. willhave only the residue revenues after allowing a credit for theAfrican withholding taxes. 7

Example 5In the 1990s, the U .S. adopted aggressive transfer pricing

rules with heavy penalties for non-compliance. Even though theU.S., Korean and many other governments have adopted

detailed rules to determine transfer prices, the reality is thatthere is an exceptionally high level of uncertainty in manytransfer prices. The combination of aggressive transfer pricingrules, severe penalties for non-compliance, and a high level ofuncertainty about what was acceptable caused multinationalenterprises with operations in the U .S. to adjust their transfer

prices so that they minimized the risks of confrontation with theU.S. tax authorities. The result was that the multinationalenterprises tended to overstate their U .S. income, because of thegreater risk of audit and severe penalties, and understate theirincome in other jurisdictions where the risks of audit werelower and the penalties less harsh. 8

. R ESOLUTION OF I NTERNATIONAL T AX DISPUTES : ANO VERVIEW

A. Resoluti on of Di sputes Between Taxpayers and the Government

7 For a more detailed discussion of this problem, see Charles RC . Irish, International

IncomeDouble Taxation Agreements and IncomeLess Texation at SourceDeveloped Countries ,23(2) I NTL &AND COMP . L.Q. 292 (1974). [material][pincite] 8 For a more detailed discussion of this problem, see Charles R . Irish, The Other Harmful TaxCompetition , 24 T AX NOTES I NTERNA TIONA L 901 (2001). [material][pincite]

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International tax disputes between taxpayers and the governments areresolved either prospectively through advanced government rulings on thetax consequences of a proposed transaction, most notably advanced pricingagreements (APAs) , or after the fact through negotiations with nationaltax authorities, under the mutual agreement procedures in bilateral taxtreaties, and in a few instances through voluntary or binding arbitration alsounder the mutual agreement procedures in bilateral tax treaties.

Taiwan, the U .S., Korea, Japan, China and many other countries have procedures for the issuance of advanced pricing agreements (APAs) intransfer pricing controversies. 9 In some cases, taxpayers are able to obtainAPAs in transfer pricing cases involving both customs duties and incometaxes. 10 It also is very common for bilateral or multilateral APAs to beconcluded so a taxpayer is able to secure commitments on the taxconsequences of future transactions from all interested taxadministrations. 11 For example, in June, 2009, the State Administration ofTaxation of China ( "SAT ") and the Danish Tax Authorities ( "DTA ")completed negotiations for two bilateral advance pricing agreementsinvolving a leading Danish technology company and two of its Chinesesubsidiaries. The APAs, which covered almost all types of related party

transactions, are the first of their kind between China and a Europeancountry. 12 In 2011, China and Denmark concluded a third bilateraladvanced pricing agreement, although Denmark remains the only Europeancountry to have APAs with China. 13

International tax disputes not settled in advance through APAs or otheradvance rulings typically begin with negotiations with national taxauthorities. In Example 1 , above, Am Corp would complain to the Taiwan

9 Deloitte, Strategy Matrix for Global Transfer Pricing : Planning for Methods, Documentation, Penalties and Other Issues 2008 , available athttp://www.iasplus.com/dttpubs/0807transferpricing.pdfh ttp://www.iasplus.com/dttpubs/0807transf

erpricing.pdf (last visited Oct.August 20, 2011).10 See http://www.pwccn.com/home/eng/tp_apa_cn_kr_jan2008.htmlh ttp://www.pwccn.com/home/eng/tp

_apa_cn_kr_jan2008.html (last visited Oct. 20 November ,, 201109 ). [the link doesn t exist] 11 See OECD, Guidelines for Conducting Advanced Pricing Arrangements Uu nder the Mutual

Agreement Procedure s (MAP APAs) , available athttp://www.oecd.org/dataoecd/10/10/38008392.pdfh ttp://www.oecd.org/dataoecd/10/10/38008392.

pdf (last visited (Oct.August 20, 2011).12 Price Waterhouse Coopers [hereinafter PWC], Pricing Knowledge Network, PKN Stop PressChina China Cconcludes the Nnegotiations of the Ff irst European Bbilateral Advance Pricing

Arrangement with Denmark , available at http://www.publications.pwc.com/ArchiveIssue.aspx?IsIssue=ISSUE&PubId=354&IssueId=5105 http://www.publications.pwc.com/DisplayFile.aspx?Attachmentid=2292&Mailinstanceid=12074 (last visited Oct.August 20, 2011).13 PWC, PKN Third Bilateral APA Concluded Bbetween Denmark and China , available at http://www.pwccn.com/webmedia/doc/634438150496233653_cn_dm_tp_apa_jun2011.pdfh ttp://www.pwccn.com/webmedia/doc/634438150496233653_cn_dm_tp_apa_jun2011.pdf (last visitedOct.August 20, 2011).

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National Tax Administration that, because US$6 million was disallowed asa deduction for Taiwan Sub, it should only be taxed in Taiwan on US$4million. Am Corp would make the same argument to the US InternalRevenue Service. If the Taiwan National Tax Administration and the USInternal Revenue Service do not agree t o reduce Am Corps Taiwan sourceincome by the amount of Taiwan Subs disallowed deduction, Am Corpwould have to undertake negotiations with the Taiwan National TaxAdministration and the U .S. Internal Revenue Service. Given the absenceof formal diplomatic relations between Taiwan and the U .S. and the lack ofa bilateral income tax treaty, there is no formal mechanism for workingwith both governments simultaneously, so Am Corp will have to undertakecumbersome negotiations with both governments and provide its owncoordination between the two governments.

If Example 1 involved two countries with a bilateral income tax treaty,such as the treaty between the U .S. and Korea, 14 Am Corp could make useof the Mutual Agreement Procedure in Article 27 of that treaty. 15 UnderArticle 27, the Korean and U .S. tax agencies are obliged to work togetherto resolve inconsistent applications of the tax laws that result in doubletaxation that is inconsistent with the Korea/U .S. tax treaty. Article 27 does

not, however, impose a binding obligation on either the Korean NationalTax Service of the U .S. Internal Revenue Service to reach an agreementeliminating the risk of double taxation.

The mutual agreement procedures in more recently concluded bilateraltax treaties often contain mechanisms for compulsory arbitration. TheEuropean Union arbitration convention of 1995 has adopted arbitration as asolution for double taxation that arises due to transfer pricing disputes. 16 An arbitration provision with a broader scope now is included in Article 25of the 2008 OECD Model Income Tax Convention. Under Article 25(5), ifthe competent authorities fail to resolve a controversy submitted to themwithin two years, any unresolved issues must be submitted to arbitration ifthe taxpayers request it. 17 Recent amendments to bilateral tax treaties alsocontain arbitration provisions for resolving tax disputes. Many of thesevarious arbitration regimes are discussed in greater detail in the next part ofthis paper.

14 KoreaU nited .States. - Republic ofS. Korea Income Tax Convention, available /US I ncome TaxTreaty at http://www.irs.gov/pub/irs-trty/korea.pdfh ttp://www.irs.gov/pub/irs-trty/korea.pdf (lastvisited Oct. 20, 2011on multiple occasions ).15 Id.16 Hadari, supra note 44,Compulsory Arbitration in International Transfer Pricing and Other

Double Taxation Disputes , at 4. at http://ssrn.com/abstract=1483621 (visited 27 October, 2009) at

p. 4. 17 OECD, Model Tax Convention on Income and on Capital (July 18, 2008), at 17, available athttp://www.oecd.org/dataoecd/14/32/41147804.pdfArticle 25(5) 2008 OECD Model Income TaxTreaty at p. 17.

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B. Resolut ion of Dd isputes Bb etween Gg overnments .

In some cases, governments conclude specific revenue sharingagreements. The Isle of Man and the UK Finance Ministry, for example,have an agreement that divides the revenues from value added taxes

between the UK and the island. 18 Bilateral income tax treaties are, however,the most common way of allocating revenues between governments. Thereare hundreds of tax treaties in effect around the world. The U .S., forexample, has about 58 income tax treaties that affect tax relations withmost major economies in the world (except Taiwan). 19 Korea also has anextensive tax treaty network with over 60 bilateral income tax treatiescurrently in force, including a relatively old treaty (1979) with the U .S. thathas been the object of renegotiation for several years. 20 Income tax treaties

provide detailed rules on the taxation of income that arises between the twocontracting parties. Most of the tax treaties are modeled after the OECDmodel income tax treaties 21 and they are structured to avoid double taxation,

principally by limiting the power of the source country to imposes taxes onincome that arises within with their territory and then requiring theresidence to either grant a credit for the source based taxes or to exempt the

income subject to the source based withholding taxes.When governments have unilaterally adopted aggressive tactics to gaingreater shares of tax revenues, such as with the U .S. aggressive transfer

pricing rules illustrated in Example 5, other governments sometimes haveresponded with their own aggressive rules and practices so as to rebalanceallocation of revenues. Faced with the loss of revenues because of the U .S. transfer pricing rules described in Example 5, for example, the CanadianGovernment introduced its own tougher transfer pricing rules to limit theinstances when companies tilted their transfer prices towards the U .S..22

. INTERNATIONAL T AX ARBITRATION R ULES

18 Andrew Bounds, Isle of Man Ff aces 50 million Pp ound Tt ax Cclawback , FINANCIAL TIMES (U.S. EDITION ), Oct. 21, 2009, at p. 4 (US edition, October 21, 2009) .[Please kindly provide thecited material.] 19 Department of the Treasury, U.S. Tax Treaties , Publication 901 (Rev. April 2011), Cat. No.46849F, at p. 55- 56, available at http://www.irs.gov/pub/irs-

pdf/p901.pdfh ttp://www.irs.gov/pub/irs-pdf/p901.pdf (last visited Oct.August 202, 2011).20 Linex Systems, See http://www.linexlegal.com/content.php?content_id=76581h ttp://www.linexlegal.com/content.php?content_id=76581 (last visited 2 Oct. 20November , 201109 ).21 See OECD, OECD Model Tax Convention on Income and on Capital: An Overview of Available

Products ,http://www.oecd.org/document/37/0,3343,en_2649_33747_1913957_1_1_1_1,00.htmlh ttp://www.

oecd.org/document/37/0,3343,en_2649_33747_1913957_1_1_1_1,00.html (last visited 2 Oct.20November , 20111109 ).22 C. Irish, supra note 8, at The Other Harmful Tax Competition , 24 T AX NOTES I NTERNATIONAL 901 (2001) .[pincite]

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A. An I ntr oduction to the M utual Agreement Procedure .

As mentioned above, the principal purpose of bilateral income taxtreaties is to allocate revenues from international business between twocountries. Included in the provisions of typical income tax treaties is anarticle establishing a Mutual Agreement Procedure (MAP). The

purpose of MAP is to offer taxpayers a diplomatic remedy when they feelthat their tax consequences are not consistent with the terms of the taxtreaty. Under the U .S. tax treaty with Korea, for example, if a U .S. Corporation (USC) thinks that its operations in Korea are being taxed tooheavily, it may ask the U .S. Competent Authority to contact the KoreanCompetent Authority to deal with its complaint. If the U .S. CompetentAuthority determines that the claim of USC has merit, it will contact theKorean Competent Authority and seek an adjustment to USCs taxaccounts in Korea. If the Korean Competent Authority agrees with the U .S. Competent Authority, an adjustment to USCs Korean tax burden willfollow.

The key elements of the traditional MAP are as follows: The competent authority receiving the initial complaint is under no

obligation to accept the complaint. In the U .S., some courts haverefused to compel the U .S. Competent Authority to accept a complaintapparently on the ground that the decision to accept a complaint iswithin the complete discretion of the U .S. Competent Authority. 23 Inother countries, however, the courts have referred taxpayers to themutual agreement procedure in lieu of domestic litigation. 24

Contacts under the MAP are purely between the governments. Thetaxpayer raising the complaint is not a party to the negotiations and hasno right to appear or make submissions to the competent authorities.

The government to government negotiations are confidential, even tothe taxpayer raising the complaint. Written documents exchanged

between the competent authorities also are not available to the taxpayerinvolved.

There generally are no specific time limits within which the competentauthorities have to act.

There is no obligation on the part of either competent authority to reachan agreement that avoids double taxation. 25

23 Hadari, supra note 16, at 6. Compulsory Arbitration in International Transfer Pricing and Other Double Taxation Disputes , at http://ssrn.com/abstract=1483621 (visited 27 October, 2009) at p. 6. 24 Id. at p. 7, referring to a decision of the Israeli District Court.25 A good i llustration of competent authorities not reaching an agreement is a tax case involving the

noted musician Pierre Boulez. The issue in the case was whether certain payments received byPierre Boulez under a contract with CBS constituted royalties or compensation for personalservices. Had the payments been characterized as royalties, they would have been exempt from U.S.tax. Had they been compensation for personal services, they would have been subject to U.S. tax.

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Except for the taxpayer making the complaint, the outcome of thecompetent authority negotiations is confidential. The results are not

publicly reported.

B. The EU Arbitr ation Convention

The EU Arbitration Convention (Arbitration Convention) , whichfirst became effective in 1995, establishes a procedure to resolve disputeswhere double taxation occurs between related enterprises of different EUMember States as a result of a transfer pricing adjustment in one MemberState. Article 7 of the Arbitration Convention provides that if thecompetent authorities of two members states fail to reach agreement on atransfer pricing dispute within two years after the complaint is firstsubmitted to one of the competent authorities, they must establish anadvisory commission that will deliver an opinion on eliminating the doubletaxation. 26 The advisory commissions are composed of two representativesfrom the competent authorities of each party and an even number of expertsand independent persons picked from a list of experts. 27 The enterprisescomplaining about the transfer pricing adjustment have the right to make

submissions and to appear during the arbitration process.28

The advisorycommission then is obligated to give an opinion on the elimination ofdouble taxation within six months of getting the case and the competentauthorities have an additional six months to decide the case. 29 If thecompetent authorities fail to decide the case within the additional sixmonths, the opinion of the advisory commission prevails. 30 The competentauthorities may agree to publish the decision, but only if the affectedenterprises agree to publication. 31

The key elements of the EU Arbitration Convention are as follows: The convention only applies to transfer pricing controversies within

EU member states.

Under the MAP of the U.S.-German tax treaty, the German competent authority concluded that payments were royalties, while the American competent authority decided the payments werecompensation. The end result was that Boulexz was taxed twice on the income.26 Article 7 Theof the Convention for the Elimination of Double Taxation in Connection with theAdjustment of Profits of Associated Enterprises , art. 7, available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:41990A0436:en:HTMLh ttp://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:41990A0436:en:HTML (last visitedOct.August 201, 2011).27 Id. . art.Article 9(1).28 Id . art.Article 10(2) .29 Id. art.Article 12(1).30 Id. Article 12(1). 31 Id . Article art. 12(2).

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The competent authorities are only obligated to accept a complaint ifthey determine that the complaint is well founded 32 and it is not clearwhether a competent authoritys refusal to accept a complaint is subjectto judicial review in the home country of the competent authority.

Because each case is referred to and settled by international procedures, irrespective of the remedies provided by the domesticlaws of the C ontracting States concerned, the domestic andinternational procedures are not mutually exclusive and do not competeas the mutual agreement is only binding on the Contracting States, noton the national courts. The affected enterprises are therefore placed in atactical position of having optional parallel proceedings. Theenterprises can choose one or the other, or a combination of both. Inthe latter case, the enterprises can choose to call for the discontinuationof the international procedure if it is satisfied with the elimination ofdouble taxation afforded by a decision of the national courts. 33

During the initial stage when the negotiations are between the twocompetent authorities there is no indication that the enterprises have aright to be involved. Once the process moves into the arbitration phase,however, the enterprises have the right to make submissions and to

appear before the advisory commission. The two year time limit that triggers the arbitration process can beextended by mutual agreement of the competent authorities and withthe agreement of the associated enterprises concerned. 34

The members of the advisory commission are obligated to treat thearbitration process as secret.

Unless the competent authorities reach an agreement within six monthafter the decision of the advisory commission, the decision of theadvisory commission is binding on all parties. Some have suggestedthat the complainant, who is not technically a party in the MAParbitration process, may choose not to accept the arbitration decisionand instead litigate the issue in domestic courts. 35

Once a decision is rendered, the competent authorities may publish thedecision but publication is permissible only if the affected enterprisesagree.

32 Id . art.Article 6(2).33 Jean-Philippe. Chetcuti, The EU Tax Arbitration Convention , at 6.6, at http://www.inter-lawyer.com/lex-e-scripta/articles/eu-tax-arb-conv.htm#_Toc518052897h ttp://www.inter-lawyer.com/lex-e-scripta/articles/eu-tax-arb-conv.htm#_Toc518052897 (last visited Oct.August 201, 2011).34 Id. atArticle 7.4(4) .35 Hadari, supra note 4, Compulsory Arbitration in International Transfer Pricing and Other

Double Taxation Disputes , at http://ssrn.com/abstract=1483621 (visited 27 October, 2009) at p. 7; J. Chetcuti, supra note 33T he EU Tax Arbitration Convention at 6.6 at http://www.inter-lawyer.com/lex-e-scripta/articles/eu-tax-arb-conv.htm#_Toc518052897 (visited August 21, 2011) .

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C. The OECD M odel I ncome Tax Conventi on

The OECD Fiscal Affairs Committee and its current successor theCenter for Tax Policy and Administration have undertaken extensivestudies of the role of tax treaties in avoiding double taxation and preventingfiscal evasion. Among the most prominent outcomes of these studies arevarious iterations of a model bilateral income tax convention. Most taxtreaties in force today strongly resemble these model conventions as theyhave evolved over the years since the first model was published in 1958.

The 2008 OECD Model Income Tax Convention is the latest version ofthe OECD models. Paragraphs 1 through 4 of Article 25 of that modelcontain the traditional MAP as discussed above. Article 25, Paragraph 5added arbitration as a new element to the MAP in the 2008 Model. UnderArticle 25(5), if the competent authorities are unable to reach an agreementto resolve the complaint within two years after it is submitted to them, anyunresolved issues are to be submitted to arbitration if the complainant sorequests. 36 The complainant requesting the arbitration can make writtensubmissions during the arbitration process and, with the assent of thearbitrators, present his case orally during the arbitration proceedings. 37 The

arbitration decision is binding on the competent authorities, although thecomplainant can refuse to accept the decision and litigate the issue on localcourts. 38 The arbitrators are treated as the authorized representatives of thecompetent authorities and are subject to the same strict confidentialityrequirements as the competent authorities. 39 The arbitration decision may

be published, but only with the consent of both competent authorities andthe complainant. Even then, only the basic elements of the decision should

be published and the name of the complainant should not be disclosed. 40 Among the key features of the arbitration provisions in the 2008

OECD Model Income Tax Convention are the following: As under the traditional MAP, the competent authorities are only

obligated to accept a complaint if they determine that the complaint iswell founded. 41 It has been suggested that in some jurisdictions thedecision of the competent authority to accept or reject a complaint may

36 Supra note 17, at 16.OECD, Articles of the Model Income Tax Treaty (as they read on July 18,2008) at p. 16. 37 OECD, The 2008 Update to the OECD Model Tax Convention , at p. 99, available at http://www.oecd.org/dataoecd/20/34/41032078.pdf (last visited Oct. 20, 2011) .38 Supra note 17, at 16.OECD, Articles of the Model Income Tax Treaty (as they read on July 18,

2008) at p. 16. 39 Supra note 37, Update at p. 105.40 Id .Update at p. 108-09.41 Supra note 17, Id art.Article 6(2).

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be subject to judicial review, with the standard of review similar to thatapplied to administrative decisions generally. 42

MAP Arbitration is generally available for any tax disputes thatinvolve the underlying tax treaty; it is not limited to the resolution oftransfer pricing disputes as under the EU Arbitration Convention.

The complainant requesting the arbitration can make writtensubmissions during the arbitration process and, with the assent of thearbitrators, present his case orally during the arbitration proceedings. 43

The arbitration process is an integral part of the MAP. As a result,arbitration only is available when the competent authorities have leftunresolved issues. If the competent authorities have agreed on all of theissues, arbitration is not allowed even if taxpayer disagrees with thedecision. 44

The OECD Model arbitration agreement takes as the starting point theindependent opinion approach to deciding a case. The OECDrecognizes, however, that use of other methods, such as the last bestoffer method, may be suitable in some circumstances. 45

The arbitration decision is binding on the competent authorities, butapparently not on the taxpayer who can decline to accept the arbitration

decision and pursue the dispute in domestic courts.46

The costs of the arbitration process are borne by the competentauthorities, although any expenses incurred by the complainant inmaking written submissions or oral presentations should be borne bythe complainant. 47

Although an arbitration decisions under Article 25(5) is not intended toserve as formal precedent, the OECD has recognized that having thedecision available to the public would make the process moretransparent and it might influence the course of subsequent disputesand it could contribute to greater uniformity of tax lawadministration. 48 As a consequence, arbitration decisions under Article25(5) may be published, but only if the complainant agrees. In addition,if the decision is published, it should be done in such a fashion as tomaintain the confidentiality of the complainant. 49

D. D ispute Resolution Under U.S. I ncome Tax Tr eaties

42 Hadari, supra note 4, Compulsory Arbitration in International Transfer Pricing and Other Double Taxation Disputes , at http://ssrn.com/abstract=1483621 (visited 27 October, 2009) at p. 7.43 OECD, The 2008 Update to the OECD M odel Convention atSupra note 37 p. 99 .44 Commentary to the 2008 OECD Model Income Tax TreatySupra note 17, at p. 373.45 Id. at p. 102.46 Id . art.Article 25(5 ). of the 2008 OECD Model Income Tax Treaty. 47 The 2008 Update to the 2008 OECD Model Income Tax TreatySupra note 37, at pp. 99- 100.48 Id. at p. 108.49 Id. at p. 109.

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The U .S. Model Income Tax Treaty does not include the option ofarbitration to resolve international tax disputes. 50 Nonetheless, some of themajor treaties to which the U .S. is a party have been amended to addarbitration provisions to the MAP. The amendments to the U .S. tax treatieswith Germany, Canada and Belgium offer good illustrations of the U .S. arbitration rules governing international tax disputes. The German protocol,which became effective in December, 2007, provides that arbitration is notfully mandatory in that the competent authorities by mutual agreement maydecide not to arbitrate a particular matter. The protocol also provides forfull secrecy of the proceedings and does not require the arbitrators to

prepare a report. Instead, the arbitrators simply pick between the settlement proposals made by the two parties in what is known as last best offer orbaseball arbitration . As with the results of traditional MAP proceeding,the outcome of the arbitration is disclosed only to the concerned taxpayerand its representatives, again under a requirement of confidentiality. Onlyenumerated issues, including transfer-pricing disputes, are subject toarbitration. The Canadian and Belgian arbitration provisions follow theGerman provisions in all material aspects.

The key elements of the arbitration provisions under U .S. treaties with

Germany, Canada and Belgium are as follows:51

50 See Article 25(5) of the United States Model Income Tax Convention of November 15,2006Treaty , art. 25(5), http://www.irs.gov/pub/irs-trty/model006.pdf available at p. 38 at http://www.irs.gov/pub/irs-trty/model006.pdfh ttp://www.irs.gov/pub/irs-trty/model006.pdf (lastvisited Oct.August 203, 2011).51 The details of the arbitrations provisions in the U .S. treaties with Germany, Canada and Belgiumcan be obtained form the following sources: Protocol Amending the U .S.-German/German TaxTreaty , effective December, 2007 at http://www.irs.gov/pub/irs-trty/germanprot06.pdfh ttp://www.irs.gov/pub/irs-trty/germanprot06.pdf ; id. ,Technical Explanationof the U .S./-German/German Protocol [the last material cited is not as same as the present one.] athttp://www.irs.gov/pub/irs-trty/germanprot06.pdf ; U.S./Germany Tax Treaty Modified to IncludeMandatory Arbitration in Certain Circumstances,Announcement on Mandatory Arbitration in U.S.-

/German Tax Treaty, at http://www.irs.gov/businesses/international/article/0,,id=181003,00.htmlh ttp://www.irs.gov/businesses/international/article/0,,id=181003,00.html ; Protocol to U .S.-/Canada Tax Treaty 2007 , a t http://www.treasury.gov/resource-center/tax-

policy/treaties/Documents/CanadaProtocol07.pdfh ttp://www.treasury.gov/resource -center/tax - policy/treaties/Documents/CanadaProtocol07.pdf ; Technical Explanation of the U .S.-/Canad ian Protocol , at http://www.treasury.gov/resource-center/tax-

policy/treaties/Documents/tecanada08.pdfh ttp://www.treasury.gov/resource-center/tax- policy/treaties/Documents/tecanada08.pdf ; Convention between the Government of the UnitedStates of America and the Government of the Kingdom of Belgium for the Avoidance of DoubleTaxation and the Prevention of Fiscal Evasion With Respect to Taxes on Income,U.S/.-Belgium Tax Treaty 2006, at http://www.irs.gov/pub/irs-trty/belgiumtt06.pdfh ttp://www.irs.gov/pub/irs-trty/belgiumtt06.pdf ; 2006 Protocol to U .S.-/Belgium Tax Treaty , at http://www.irs.gov/pub/irs-trty/belgiumprot06.pdf; 2007 Technical

Explanation of the U .S.-/Beglgium Tax Treaty , at http://www.irs.gov/pub/irs-trty/belgiumte07.pdfh ttp://www.irs.gov/pub/irs-trty/belgiumte07.pdf ; U.S.-/Belgium Tax TreatyMutual Agreement Procedure Arbitration Processes Announcement on Arbitration 2009 , at http://www.irs.gov/businesses/small/international/article/0,,id=205324,00.htmlh ttp://www.irs.gov/

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In general, arbitration is mandatory if the competent authorities cannotreach agreement, but the competent still may mutually agree that a

particular matter is not suitable for arbitration. Arbitration is only available for disputes involving specific provisions

of the underlying tax treaty, including transfer pricing disputes, but thecompetent authorities may agree to arbitrate any controversy covered

by the traditional MAP. When a complaint is accepted for arbitration, each competent authority

is to appoint one arbitrator and the two arbitrators then are to appoint athird arbitrator who is to act as chair of the arbitration commission.

The arbitration process requires that each competent authority preparea proposed resolution of the controversy, with the arbitrationcommission then selecting one of the proposed resolutions. In otherwords, the arbitration decision is reached using the last best offermethod.

The arbitration decision is binding on the competent authorities. Thecomplainants have the option whether to accept the arbitration decisionof litigate the issue in domestic courts.

The fees and expenses of the arbitration process costs of the arbitration process are to be borne equally by the competent authorities. The proceedings and the arbitration decision are to be regarded asconfidential with no public disclosure.

E. Questions and Concerns About Tax Treaty Arbi tr ation

The introduction of arbitration proceedings to resolve international taxdisputes between taxpayers and governments is generally regarded as a stepin the right direction. It certainly has been endorsed as an appropriatereform by the OECD and the International Chamber of Commerce. The use

of last best offer or baseball arbitration rules to resolve controversies seemsespecially noteworthy because it encourages both sides to adopt morereasonable positions in controversies often fraught with great uncertainties.The last best offer approach seems especially attractive for transfer pricingcases because of the wide range of possibilities typically available asdefensible transfer prices.

There are, however, two major questions about the new tax arbitrationrules: (i) Are the traditional MAPs so deficient as to require the

businesses/small/international/article/0,,id=205324,00.html ; U.S.-/Belgium Tax Treaty ArbitrationGuidelines 2009 , at http://www.irs.gov/businesses/international/article/0,,id=209577,00.htmlh ttp://www.irs.gov/businesses/international/article/0,,id=209577,00.html (all sites were last visited on Oct.August 205, 2011).

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introduction of a more formalized system of dispute resolution? and (ii)Are the new tax arbitration rules designed to serve the public interest?

F . I s I nternational Tax Arbitr ation Necessary?

Because of the secrecy surrounding the MAP generally, little is knownabout its effectiveness. It appears that no study has been done on theefficacy of the MAP process as currently implemented and such a studywould be difficult or impossible to conduct, given the confidentiality rulesembedded in the MAP practices. 52 The arbitration provisions were added tothe OECD Model Tax Convention only after a great amount of study andlobbying involving two major private sector institutions - theInternational Fiscal Association (IFA) and the International Chamber ofCommerce (ICC) and there is no evidence that existing MAP processeswere serious deficient.

The scant evidence that does exist suggests that there is not asignificant void waiting to be filled by the arbitration rules. The OECDreport explaining the proposed tax arbitratio n rules said that in the rarecases where the competent authorities are unable to reach agreement, the

unresolved issues will, at the request of the person who presented the case, be resolved through an arbitration process. 53 When the EU ArbitrationConvention was renewed in 2005, the EU reported that in the ten yearssince its inception the tax arbitration process had been used only twice witha third case pending. 54

So, there is a serious question about whether the tax arbitration processis necessary. There also is the possibility that some modest measures, suchas allowing greater participation by taxpayers from the beginning of thecompetent authority process, could remove any significant deficiencies inthe MAP processes.

G. I s I nternational Tax Ar bitr ation in the Publi c I nterest?

An even more serious question is whether the new tax arbitration rulesare in the public interest. Those who have looked at this question with an

52 Allison. Christians, Your Own Personal Tax Law: Dispute Resolution Uunder the OECD ModelTax Convention , 17() WILLAMETTE J. I NTL L. & DISPUTE R ES.olution 172, 180 (2009) at p.180.[material] 53 OECD, Proposals for Improving Mechanisms for the Resolution of Tax Treaty Disputes, PublicDiscussion Draft, February 2006 (2006), at 6, 45, 91, http://www.oecd.org/dataoecd/5/20/36054823.pdfhttp://www.oecd.org/dataoecd/5/20/36054823.pd

f (last visited Oct. 20, 2011). (hereinafter "OECD Proposal") at 6, 91, 45, quoted in M. Mcintyre,Comments on the OECD Proposal for Secret and Mandatory Arbitration of International Tax

Dsiputes, 7 Florida Tax Review 622 (2006) at 623. 54 OECD Report. [material]

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objective mind have suggested that the tax arbitration rules are betterdesigned to serve the international business community than serve the

public interest. 55 The number one criticism of the tax arbitration process isthe secrecy surrounding it. Both the EU Arbitration Convention and theOECD Model Income Tax Convention allow for limited publication of thearbitration results, but even the barebones publication of the outcome can

be blocked by the taxpayers who initiated the competent authority proceedings and it seems likely that taxpayers will often use this privilegeto block publication.

The result is that the international business community now can bypassthe domestic administrative and judicial procedures normally available forresolving tax disputes and instead move into a secret forum outside thescrutiny of the taxpaying public. This possibility seems like a bad idea forat least three reasons: As the OECD itself has recognized, publication of the arbitration

decisions improves the transparency of the taxing process and mayinfluence the settlement or avoidance of future disputes. Allowing fullsecrecy of the process means that the process will not be transparentand the possibility of informal precedential value of the decisions will

be lost. Secrecy in the arbitration process creates the opportunity for corruptionor other improper influences by the taxpayers on the competentauthorities.

The lack of transparency risks development of a two tiered tax systemwhere a limited group of taxpayers who communicate amongthemselves have a better understanding of the dangers and theloopholes in a particular tax system. In the 1970s, the confidentiality of

private letter rulings in the US was discontinued precisely because ofthis reason the confidentiality of the rulings enabled the U .S. Treasury to adopt tax policies favorable to a particular industry(principally the oil industry) well outside Congressional or publicoversight.In defense of rigorous confidentiality is the fact that outcomes of most

arbitration cases are secret. But most arbitration cases involve private parties dealing with issues of private controversies, which is very differentfrom the resolution of public tax issues with major revenue (and possibly

precedential) consequences. 56

55 See, e . g ., A. Christians, Your Own Personal Tax Law: Dispute Resolution under the OECD Model Tax Convention, 17 Willamette J. Intl L. & Dispute Resolution supra note 52, at172

(2009) ; M. Mciintyre, supra note 1,Comments on the OECD Proposal for Secret and Mandatory Arbitration of International Tax Dsiputes , 7 FLORIDA TAX R EVIEW 622 (2006). [pincite]. 56 A. Christians, Your Own Personal Tax Law: Dispute Resolution under the OECD Model TaxConvention, 17 Willamette J. Intl L. & Dispute Resolution 172 (2009); M. Mcintyre, Comments

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If the use of international tax arbitration is to continue, as appearslikely given the strong support of the international business community,two adjustments need to be made. First, taxpayer participation in thecompetent authority process should be allowed from the beginning of the

process. Second, the arbitration process and decisions should be made public. Some have argued against greater participation by private partiesdue to concerns that the private parties will overwhelm the competentauthorities. That certainly is a risk, especially where multinationalenterprises are working with tax administrations in smaller, less developedcountries, but the risk is likely to be minimized if the process itself issubject to greater transparency. There also is the argument thatconfidentiality is necessary to maintain business secrets of the taxpayers,

but in other areas, such as with private letter rulings in the U .S., theconfidentiality of sensitive business information is maintained even thoughthe tax issues involved in the ruling are discussed and resolved in arelatively thorough fashion.

on the OECD Proposal for Secret and Mandatory Arbitration of International Tax Dsiputes, 7F lor ida Tax Review 622 (2006).Id.

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R EFERENCES

Books

OECD (2010), TRANSFER PRICING GUIDELINES FOR MULTINATIONALE NTERPRISES AND TAX ADMINISTRATIONS .

Articles

Mcintyre, Michael J. (2006), Comments on the OECD Proposal for Secret

and Mandatory Arbitration of International Tax Dsiputes , 7(9)FLORIDA TAX R EVIEW 622.Christians, Allison D. (2005), Tax Treaties for Investment and Aid to Sub-

Saharan Africa , 71(2) B ROOKLYN LAW R EVIEW 639, 641.Irish, Charles R. (1974), International Double Taxation Agreements and

Income Texation at Source , 23(2) I NTERNATIONAL AND COMPARATIVELAW QUARTERLY 292.

Irish, Charles R. (2001), The Other Harmful Tax Competition , 24 T AX NOTES I NTERNATIONL 901.

Christians, Allison D. (2009), Your Own Personal Tax Law: Dispute Resolution Under the OECD Model Tax Convention , 17() THEWILLAMETTE JOURNAL OF I NTERNATIONAL LAW AND DISPUTER ESOLUTION 172.

Websites

Hadari, Yitzhak, Compulsory Arbitration in International Transfer Pricingand Other Double Taxation Disputes , available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1483621.

Deloitte, Strategy Matrix for Global Transfer Pricing: Planning for Methods, Documentation, Penalties and Other Issues 2008 , available athttp://www.iasplus.com/dttpubs/0807transferpricing.pdf.

http://www.pwccn.com/home/eng/tp_apa_cn_kr_jan2008.html.(Fn10)OECD, Guidelines for Conducting Advanced Pricing Arrangements Underthe Mutual Agreement Procedure (MAP APAs) , available athttp://www.oecd.org/dataoecd/10/10/38008392.pdf.

Price Waterhouse Coopers, Pricing Knowledge Network, PKN Stop PressChina China Concludes the Negotiations of the First European

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