Corporate Tax- USA

Procedure

In the past year the United States has concluded two double taxation agreements that contain mandatory arbitration clauses. The first, the new Protocol to the US-Germany Treaty, was signed on June 1 2006. In addition, on November 27 2006 the United States and Belgium signed a new Income Tax Treaty and Protocol to replace the Income Tax Treaty 1970 currently in force. These are the only US treaty arrangements with mandatory arbitration provisions incorporated in the mutual agreement procedure (MAP) articles (disregarding the limited arbitration on factual issues contained in the US-Canada treaty). No mention of the arbitration clause was incorporated into the new US Model Tax Convention adopted on November 15 2006. Inserting an arbitration clause in the model treaty would convey a message that this is a new official US position. The US approach towards arbitration has changed, but it is too early to conclude that such a procedure will be made general practice with respect to all future treaties.

New Arbitration Provisions

The basic goal of any type of binding arbitration is to ensure that the taxpayer will not suffer double taxation or undue delay because of the inability of treaty partners to resolve the substance of a cross-border dispute. It also provides for a fair apportionment of revenues between two contracting states, which is not always possible to achieve in the usual MAP process.

Both US provisions are very similar. They provide for the 'baseball' or 'last best offer' type of arbitration - that is, the arbitration committee will have limited influence on the contents of the final agreement. Arbitrators will have to choose between resolution proposals submitted to them by the competent authorities. This could positively affect the work of the competent authorities. When faced with the unavoidable arbitration, ideally both parties will try to resolve the case at the negotiation stage of the process. In addition, once arbitration has been initiated efforts will be intensified to reach the most reasonable solution. The work will have to be done within the specified deadline as the consequence of missing the deadline will be fatal to the lax competent authority. Once the time limit for submitting a proposal has passed, the other proposal (if timely submitted) automatically becomes binding.

What could prove to be important for taxpayers is the fact that both the German protocol (Article 17.4) and the Belgian treaty (Article 28.7) apply the arbitration procedure retroactively to cases pending as of the date when the protocol and the treaty enter into force. Thus, cases currently under consideration by the competent authorities are potential candidates for arbitration. Although arbitration would not begin until two years after the agreements enter into force, the inevitability of its initiation should push the competent authorities towards better cooperation. According to the new provisions, the arbitration committee chooses between two opposing positions. Although the winner might be better off compared to the hypothetical MAP resolution (where it would be more likely that both parties have to adjust their initial positions in order to reach a compromise), the other party would suffer a loss considerably greater compared to the concessions that would have to be given in the MAP negotiations. This threat might have a positive influence on the work progress of both competent authorities.

The arbitration clause is designed to improve and speed up the dispute resolution process. Both documents leave some leeway for the competent authorities to delay the arbitration. The two-year period for the initiation of the procedure begins after the 'commencement date', which in all MAP cases arising after the protocol and the treaty enter into force is defined as the earliest date on which the information necessary to undertake substantive consideration for a mutual agreement is received by both competent authorities. Depending on the interpretation of the word 'substantive', the starting point of the two-year period may be effectively postponed. In addition, the competent authorities may agree on a different date for the initiation of the arbitration procedure.

National Modifications

In each case the rules and procedures that will govern the arbitration process are subject to modification by the contracting states.

Under the Belgian treaty, arbitration will apply to all cases arising under the convention. The German protocol differs in this respect, as it provides for a list of articles which may be covered by possible arbitration. However, the competent authorities can agree on a case-by-case basis to submit to arbitration any case to which Article 25 (MAP) of the German treaty applies.

Both the taxpayer and the competent authorities will have the power to terminate the proceeding after its initiation: the taxpayer by withdrawing a request for MAP and the competent authorities by reaching a mutual agreement to resolve the case. Neither the German protocol nor the Belgian treaty provides for any taxpayer participation during the process.

Procedure

The arbitration panel will consist of three arbitrators: two representatives of the countries involved (national members) and a neutral chair. Each country will elect one person to sit on the board and these members will appoint a third arbitrator (who cannot be a citizen of either country) to serve as chair of the board. In the event that the competent authorities violate the 60-day period in which to appoint a chair, the power to elect a chair automatically vests with the secretariat at the Centre for Tax Policy and Administration of the Organization for Economic Cooperation and Development (OECD). A member chosen by the OECD also cannot be a citizen of either contracting state. This rule will effectively encourage timely elections on the part of the competent authorities and prevent delays in the selection process.

Under the German protocol, within 90 days of the appointment of the chair the contracting states may submit a proposed resolution. In addition, within 180 days of the appointment of the chair each competent authority can submit a written reply to points raised by the proposed resolution of the other contracting state. These periods were shortened in the US-Belgium treaty and are 60 and 120 days respectively. The board will have six months from the day on which the chair is elected to deliver a binding decision.

In making its determination, the arbitration board will apply, as necessary and in descending order of priority:

• the provisions of the convention;
• any agreed commentaries or explanations of the contracting states concerning the convention;
• the laws of the contracting states to the extent they are consistent with each other; and
• any OECD commentary, guidelines or reports regarding relevant analogous portions of the OECD Model Tax Convention

No precedential value will be attributed to the board's decision. The determination will not state a rationale. This, coupled with the confidentiality of the whole process (there is no possibility of publication), could produce different treatment of similar cases depending on the persons appointed to the board. However, this result does not diverge from the treatment under EU and OECD rules. Both the EU Arbitration Convention and the OECD 2006 proposals do not afford any precedential value to the decisions of arbitration committees.

A taxpayer must take affirmative action to accept the determination of the board. The formal acceptance must be submitted to the competent authority that first received the case within 30 days of the taxpayer's receipt of the determination. If the taxpayer does not accept, fails to advise the competent authority or does so after the expiration of the 30-day period, the determination of the board will be considered "not to have been accepted". Such cases will subsequently be barred from being the subject of arbitration proceedings. Consequently, a taxpayer will have the last word. If the solution chosen by the board is unsatisfactory, the taxpayer will be able to reject the determination at the risk of further uncertainty.

The taxpayer's rights and participation in the process differ significantly under the US arbitration model compared with the rights and participation of the taxpayer under the OECD arbitration procedure (the 2006 proposals). Under the rules drafted by the OECD a taxpayer can actively participate in the proceedings (eg, submitting its position in writing; making oral statements after obtaining the board's permission). Once the decision is delivered, it is binding on the taxpayer. No possibility exists to challenge the arbitration decision in the national courts, as this right must be waived before the arbitration process can begin. The US arbitration model does not provide for any taxpayer participation. However, once the decision is delivered a taxpayer is free to accept or reject it and, if the determination is rejected, a national judicial path is still available.

International Law Office