Tax rules which were fashioned in a more closed economic environment can discourage international activity. They can create conflict between countries as to the appropriate tax treatment of an international business and between taxpayers and governments.
Unresolved international tax disputes can undermine co-operation and discourage investment, and so become a serious impediment to global development. Clearly we must try and help ensure that such disputes do not arise and, if they do, provide procedures for resolving them.
Much of the work to date at the OECD has been in helping to fashion substantive principles and practices which can lessen the possibilities of tax conflicts. The Model Convention for the Avoidance of Double Taxation and the Transfer Pricing Guidelines are two of the principal contributions which the OECD has made in this area. These instruments form the bases for global co-operation in dealing with these questions.
But, however well the rules are crafted, there will inevitably be situations where disagreements arise; hence, the need to develop procedures through which these conflicts can be resolved.
Two important initiatives have been undertaken by the OECD Committee on Fiscal Affairs in the procedural area. The first is the development of so-called Advance Pricing Agreements (APAs) to deal with potential disputes. One of the most important issues concerning multinational corporations is the allocation of the overall income from the transactions between the various taxing jurisdictions involved. Generally speaking, large multinational groups that produce or distribute goods or services use subsidiaries and parent companies located in different jurisdictions. The group naturally wishes to calculate its tax liabilities in such a way as to concentrate payments in lower tax regimes.
With internal accounting, global firms can shift profits among companies and lessen their overall tax bill, or even avoid tax in some jurisdictions altogether. However, this “transfer pricing” obviously raises a double-edged problem: no tax authority wishes to be short-changed from legitimate tax revenue, and no business wants to be double-taxed by different governments for the same profit.
The Transfer Pricing Guidelines provide a framework to help authorities and businesses to attribute to each jurisdiction in which related companies do business the amount of income which would have been generated if the parties had been acting as quite separate and unrelated businesses. But applying these “arm’s length” standards in concrete situations is difficult and complex, and can still lead to disagreements, even costly and protracted litigation.
This is where the Advance Pricing Agreement procedure comes in. The multilateral APA process allows the taxpayers and the governments involved to reach agreement in principle on the appropriate taxation methods to apply to a particular case before the transaction takes place. The business submits to the tax authorities the economic information necessary to determine the exact nature of the underlying transactions and the tax authorities, using the various approaches developed in the Transfer Pricing Guidelines, can then agree on the appropriate methodology to apply to the case.
The APA does not settle all of the details as to how the transaction will be taxed, but simply establishes the basic framework by which the transactions will be analysed. APA builds trust between the parties: the likelihood of double taxation is greatly diminished and the jurisdictions involved can feel satisfied about their share of the tax revenue likely to be generated from the transactions.
Despite all this, costly disputes inevitably arise, which is why the OECD is working to improve the procedural mechanisms. The present Mutual Agreement Procedure (MAP) is a dispute resolution process laid out in the OECD Model Tax Convention and incorporated in bilateral tax treaties. Under the MAP process, taxpayers who are subject to potential double taxation can ask the countries involved to meet together to try to resolve the dispute over taxing rights.
MAP has worked effectively, but is increasingly being put under strain because of the sharply rising volume and complexity of cases it has to deal with. A review of the dispute resolution process in the tax area is now in progress. It is clear that the MAP process will continue to be the basic mechanism for the resolution of international tax disputes. However, there are a number of areas where the existing procedures can be improved and the work has highlighted situations in which obstacles to the use of the MAP can be eliminated.
In particular, as our consultations with the public have pointed out, it is important to ensure that the MAP process operates in an open and transparent fashion. One key step to improving the transparency of the process was taken in April 2004 by posting Country Profiles on MAP used by OECD countries on the OECD website (see references). Non-OECD countries will be invited to provide their profiles on the website too.
In addition, we are looking in some detail at a range of supplementary dispute resolution techniques, which can help to ensure that international tax disputes are brought to a satisfactory conclusion. These techniques could include the possibility of involving special mediators to help resolve difficult cases and arbitration procedures to help achieve a final and consistent resolution of outstanding cases. A possible structure for such procedures is being developed for use by those countries wishing to adopt arbitration procedures in their bilateral conventions.
The OECD is a consensus organisation and does not generate “hard law” but principles and agreed guidelines. Under this approach, it is unavoidable that differences in interpretation and application will arise. As a result, it is equally important to ensure that there is a well-functioning procedural mechanism to deal with tax disputes when they do arise.
OECD (1999), Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Paris.
OECD (2002), Model Tax Convention on Income and on Capital, Volumes I and II: Update 2002, Paris.
Neighbour, J. (2002), “Transfer pricing: Keeping it at arm’s length”, OECD Observer No 230, January 2002.
©OECD Observer No 243, May 2004