Achieving TP closure: Treaty MAP arbitration
Eddie Morris of Deloitte considers the limited evidence available on the use of the arbitration clause of mutual agreement procedure articles to resolve transfer pricing disputes, and pinpoints areas for improvement.
The number of transfer pricing disputes, as evidenced by the increase in mutual agreement procedure (MAP) cases, appears to be increasing year on year.
Settled MAP cases are outnumbered by new cases being made, and the OECD statistics show that cases on hand are increasing. Settlement times are also on the rise. Competent authority resources remain scarce in many countries and there is an increase in caseloads, plus sizeable or complex issues that are inherently more difficult to resolve than simpler transactional cases.
Against this background, it is a reasonable assumption that more cases will end up utilising the increasingly available arbitration clause in the MAP article to many treaties.
Background and early implementation
The arbitration clause is not, of course, new. It has existed in the Model Tax Convention (MTC) for well over a decade. Its inclusion, in various forms, in more modern treaties has steadily grown. However, the widespread availability of MAP binding arbitration has been relatively recent.
It was the 2015 BEPS multilateral instrument (MLI) that really brought arbitration, as envisaged by the changes to the MTC pre 2010, into many more tax treaties. With this in mind, experience of how arbitration in a MAP has worked has been limited, notwithstanding the long existence of the EU Arbitration Convention for member states.
Recently, however, a small number of cases have been decided using the arbitration clause of the MAP article. This experience has revealed some factors that need to be considered for arbitration to work effectively.
It is expected that there will be more obligatory arbitration panels being convened under the MAP article in tax treaties if disputes are not resolved by the tax administrations within the required timeframe – typically two years after the case has been submitted. Drawing useful conclusions from the limited experience so far can only benefit businesses and tax administrations.
The spread of the arbitration clause into tax treaties gives the prospect of certainty but the road to a conclusion is not always an easy one in practice. Transfer pricing is a practical subject, albeit one that requires a detailed analysis and evidence as to the pricing as if the parties were at arm’s length, turning on the facts and circumstances of a particular case.
Having the necessary legal framework for treaty arbitration is most welcome but the practical mechanics of how arbitration will work in a particular case can prove a hindrance to effective dispute resolution.
Selection of panel members
One of the practical mechanics of the arbitration process that can be time consuming is the selection of independent panel members. This process is in the hands of the tax administrations concerned, both of which must agree on who will be panel members.
Identification and availability is often an issue. In terms of shortening the time taken to convene a panel, a wider pool of potential members would be helpful. Lists of potential members developed at the level of international rather than national bodies might be an effective way forward, as would members of a panel being chosen based on objective criteria by these international bodies to shorten the time taken before the panel sits to hear the case.
Tax administrations consider that all arbitrators must be independent – that is, not arbitrarily in favour of a particular outcome – and it is the desire to ensure this independence that frequently slows down the process. But it is actually objectivity that is required so that a case can be decided on its merits.
This raises the issue of what competence or experience is necessary to sit on an arbitration panel to decide a transfer pricing case. Tax administrations globally have differing views on this question. Rather than leaving the matter completely within the purview of individual tax administrations, a single international list would be helpful.
The necessary experience of the arbitration panellists is best considered in light of the type of arbitration the panel is required to provide.
‘Last best offer’ arbitration, where each tax administration submits a position and the panel picks one, is a simpler process. The members of the panel pick the one that is in their view most in accordance with the arm’s-length principle.
However, where the arbitration panel operates differently and can develop any solution that is in accordance with the arm’s-length principle, then it is possible that a different type of knowledge and experience may be necessary. It might well be the case that this latter sort of experience is scarcer, particularly given the need to take into account that all the independent panelists must be independent and objective. This latter, important requirement will limit the number of potential candidates in many instances.
There are also the necessary considerations of whether the tax administrations should form part of the panel and on what basis the panel decision can be made – majority vote or unanimous agreement. Should there be a chairperson and what should that role be? A chairperson having a casting vote puts a lot of pressure on that individual, as well as on who that individual should be.
To date, all these decisions have been taken by the tax administrations concerned. More clarity would be welcome, as, in appropriate circumstances, would more involvement from the business concerned.
It is the taxpayers who have submitted the MAP and they should be treated as participants in the proceedings, not least because the facts of the case can only come from the business. The level of that participation needs to be addressed to provide more openness.
Arriving at a decision
The panel will need to make its decision based on the information made available to it. This information could derive from documents provided during the original audit that resulted in the MAP and from documents provided by the tax administrations and the business during the pre-arbitration part of the MAP.
The arbitrators might want further information, but they may not be aware of what further information may exist. It seems appropriate for the business to be made aware of what information is being considered by the panel. Many businesses would want the opportunity to provide information themselves.
Going further, some businesses may wish to be allowed to give their view of the application of the arm’s-length principle. It would be helpful if there was a single, internationally agreed set of rules of procedure rather than decisions being left to individual panels. Decisions about how the proceeding should operate should be made by the tax administrations involved, with input from the independent panellists.
It would be helpful to have further clarity on how, and on what basis, any decision is made, but only to the extent that this does not create a barrier to the overall process and resolving double taxation. Subject to that, it would be useful if the panel’s decision made it clear what facts were considered relevant and determinative.
In cases where the panel had to take a view on what would have happened at arm’s length (arm’s-length behaviour) as well as an arm’s-length price (for instance, in business restructuring cases), it would be helpful if the panel decision elaborated on its thinking on what was hypothesised as arm’s length. It might also be helpful if interim thinking was communicated to the business throughout the arbitration process.
A binding arbitration process that can be appropriately and swiftly initiated in practice is the best route to removing double taxation on commercial business profits, even if the process is used in only a limited percentage of MAP cases. Reaching a decision in a timely manner is beneficial to everyone.
Looking beyond this, reaching a decision that will provide certainty is vital. The business and the competent authorities involved look at the process in terms of the elimination of taxation not in accordance with the treaty.
In essence, the competent authorities should, and will, be bound by the panel decision (some processes may allow them to agree a different outcome but it must be one that eliminates double taxation).
The arbitration panel decision should be the decision that provides closure. The business involved needs to accept this closure and to be comfortable that the decision has been reached after a proper consideration of all the relevant facts. Involving the business more in the panel process will provide this reassurance.
Best practice would indicate that any pro forma decision – and, most importantly, the reasoning and factual background for it – is communicated to the business before the decision becomes final, to allow comment. This is even more important where the way in which the panel decision will be enacted in domestic law will need to be interpreted by reference to non-transfer pricing rules.
More focus on these areas can only be a good thing in terms of making arbitration work well. As the need for treaty arbitration increases, perhaps there will be a movement towards the business being actively consulted in the process that they have, after all, initiated.
In an ideal world, all MAPs would be settled without the need for arbitration and this is usually the case. But arbitration needs to be available and to work well – just in case.