[This guest blog by Micah Burch, Senior Lecturer at Sydney Law School, draws on our joint research for the project, “Fostering a Common Culture in Cross-Border Dispute Resolution: Australia, Japan and the Asia-Pacific“, supported by the Commonwealth through the Australia-Japan Foundation which is part of the Department of Foreign Affairs and Trade. We have subsequently co-authored a related paper entitled “Novel Treaty-Based Approaches to Resolving International Investment and Tax Disputes in the Asia-Pacific Region” (October 4, 2011) Sydney Law School Research Paper No. 11/66, available here.]
Much was made (in tax treaty circles, at least) three years ago when, after decades of mounting discussion, the Organisation for Economic Co-operation and Development (OECD) included in its model tax treaty a provision requiring arbitration. The controversial provision (Article 25(5) of the OECD Model Tax Convention on Income and on Capital (2003)) takes the substantial step of requiring states to arbitrate tax disputes arising under the treaty if they remain unresolved after two years of negotiation between the two competent authorities. While arbitration is a generally accepted facet of international commercial dispute resolution worldwide, including now throughout Asia, dispute resolution under bilateral tax treaties has been relatively undeveloped. But there are now signs of change.
Under the standard ‘mutual agreement procedure’ (MAP) found in most current tax treaties, appropriately made taxpayer claims that they are being taxed not in accordance with the treaty (i.e., that they are being double taxed in one way or another) require that the two competent authorities “endeavour” to resolve the dispute through bilateral negotiation. The major perceived weaknesses of the MAP are, inter alia, that it better serves the competent authorities than taxpayers, does not require resolution of the dispute, and is cumbersome and wasteful. Indeed, it was pressure from the international business community that was in large part the impetus for the OECD’s work in this regard.
The growing acceptance of the arbitration provision in tax treaties is at odds with a long-held and deeply engrained resistance to ceding fiscal sovereignty, especially over tax policy matters. The OECD’s own early view on mandatory arbitration in the tax area was that it “would represent an unacceptable surrender of fiscal sovereignty.” Perhaps it is for this reason that the model tax treaty arbitration provision differs from other commercial arbitration in that there is greater control given to the competent authorities (at the expense of the affected taxpayer). The competent authorities appoint the arbitrators, determine the questions to be resolved, and otherwise have significant control over the arbitral procedure. In short, to the extent possible, even the arbitration provision itself addresses sensitive concerns regarding fiscal sovereignty.
Thus, the existence of this provision, and its early adoption in tax treaties particularly between states with close relationships (e.g., Australia – New Zealand, United States – Canada), can be explained by the widely held view that the arbitration provision’s real effect will be upon the competent authorities’ negotiations pursuant to the MAP in which the arbitration is embedded. The theory is that states are so averse to submitting to arbitration (especially in the admittedly rare case involving tax policy rather than transfer pricing) that they will earnestly endeavor to resolve international tax disputes through negotiation in the two years allowed pursuant to the relevant treaty’s MAP.
If the provision’s primary effect is to improve MAP outcomes without actual resort to arbitration (as appears likely to be the case), it could indeed facilitate the resolution of a specialized but important class of international tax disputes. (The overwhelming majority of cases submitted for resolution under MAPs involve transfer pricing disputes.) Perhaps more importantly, however, the mechanism might also suggest an alternative way forward in the seemingly stalled discussions about a ‘top-down’ Asia-Pacific community (however defined). The emerging dispute resolution paradigm for tax treaty arbitrations points to an interesting hybrid model for the many sovereign states that make up this particular regional community.
Japan, which has gradually become familiar with using arbitration to resolve commercial disputes, has begun to embrace international tax arbitration in its recent, and important, treaties. Without little fanfare, in August 2010 Japan signed its first double tax treaty to include mandatory arbitration, with the Netherlands. The Hong Kong – Japan tax treaty, signed in November of last year, also includes the provision. At the time of this post Japan is negotiating amendments to its tax treaty with the United States, and it is believed that mandatory arbitration under the MAP is being discussed. Such actions can be interpreted as Japan signaling to its trading partners (and their tax-resident multinational enterprises) that it is committed to resolving international tax disputes, even at the cost of potentially putting jealously guarded tax sovereignty on the line. Such willingness to potentially cede even a very limited aspect of fiscal sovereignty would seem to be necessary for the creation of a robust regional arrangement.
Australia, for its part, also recognizes the importance of a modern treaty network to its aspirations of becoming a regional hub for multinational companies and does not want to discourage growing Asian economies from competing for its resources. To date, Australia’s only tax treaty to include an arbitration provision is the Australia – New Zealand treaty signed in 2009, and it is too early to tell how Australia will approach tax treaty dispute resolution going forward with its Asian and other trading partners. In the grander scheme of things, Australia’s ambivalence towards tying its own hands when resolving trade and especially investment disputes may suggest a broader more skeptical attitude nowadays towards arbitration of international disputes where firms are concerned.
As the web of bilateral tax treaties between the states of the Asia-Pacific inevitably grows, the inclusion of the ‘hammer’ of mandatory arbitration would refocus the emphasis on bilateral negotiation between the two competent taxing authorities in resolving international tax disputes pursuant to the MAP. The growingnumber of transfer pricing (and other) disputes arising under MAPs – evident also from the latest Annual Report of Japan’s National Tax Agency (2010, p40) – and the growing acceptance of the model arbitration provision in tax treaties (particularly between states with close relationships) mean that there will be more and more occasions for disputes to arise. They will increasingly highlight the importance of the sovereignty concerns underlying international tax arbitration.
Dispute resolution in this area can be an indicator and determinant of the cohesion of any meaningful Asia-Pacific community. Such a community will be forced to take account of the glorious variety of (sometimes still quite neurotic) attitudes toward sovereignty exhibited by the regional powers. Tax treaty arbitration provides one interesting avenue for doing so.