What happens when the tie-breaker rules do not work, and there is a dispute?

  • QUESTION POSTED BY: Student
  • TOPIC: Residency & Treaties
  • PROGRAMME: Postgraduate Diploma in International Taxation
  • TOPIC: Introduction to Treaties (WEEK 18)
  • LECTURER: Renier van Rensburg

FULL WRITTEN ANSWER

When tie-breaker rules fail to resolve a dispute regarding tax residency or other issues, and both countries involved still claim taxing rights, the situation typically escalates. Here’s what happens:

1. Mutual Agreement Procedure (MAP):

  • Initiation of MAP: If tie-breaker rules within a double taxation agreement (DTA) or tax treaty don’t resolve the dispute, the affected taxpayer can request the competent authorities of the involved countries to initiate a Mutual Agreement Procedure (MAP). This process is intended to provide a resolution by negotiation between the tax authorities of the countries involved.
  • Bilateral Negotiation: The competent authorities of the two countries will negotiate to reach a mutually acceptable solution, ensuring that the taxpayer does not face double taxation. However, MAP does not always guarantee a resolution, and it may take considerable time.

2. Arbitration (if available):

  • Mandatory Arbitration Clause: Some modern tax treaties include mandatory arbitration clauses that come into play if the competent authorities cannot reach an agreement within a specified period under MAP. Arbitration involves an independent panel making a binding decision.
  • Binding Decision: The decision made by the arbitration panel is typically binding on both countries, ensuring the taxpayer does not suffer from double taxation.

3. Unresolved Dispute:

  • Unilateral Measures: If MAP or arbitration doesn’t resolve the dispute, and no binding arbitration clause exists, the countries may unilaterally proceed with their tax assessments. This could result in double taxation for the taxpayer.
  • Domestic Litigation: The taxpayer may have to pursue legal remedies within one or both countries’ judicial systems, which could involve challenging the tax authorities’ decisions in domestic courts. However, this can be complex and costly, and outcomes may vary depending on the jurisdiction.

4. Impact on Taxpayer:

  • Double Taxation: Without a resolution, the taxpayer might be taxed on the same income in both jurisdictions, leading to double taxation, which tax treaties are designed to prevent.
  • Compliance and Administrative Burden: The taxpayer may face increased compliance costs and administrative burdens, as they might need to keep extensive records and potentially engage in prolonged legal or administrative procedures.

5. Policy Implications:

  • Future Treaty Negotiations: Unresolved disputes and the inadequacy of tie-breaker rules can prompt countries to renegotiate their tax treaties or adopt new rules to better handle such situations in the future.

In essence, when tie-breaker rules do not resolve a dispute, the resolution process typically moves to negotiation (MAP), and potentially arbitration, or could result in prolonged disputes that may require domestic legal action. The taxpayer may face the risk of double taxation until a resolution is achieved.

Transcript of the Video

What happens when the tiebreaker rules do not work? And there is a dispute. So I’m going to start with this answer, and maybe I’ll remember to finish with this answer as well. And that is, I think, in those situations, it’s appropriate to also get a very good consultant. What I mean by that is an adviser to understand the countries that are at players who have dealt with us in the past, because you need hands-on experience, because as you’ll see, if you start going into the detail, there’s a few things that usually can happen. 

The first thing is that you are into the world of what they call mutual agreement procedures, a map. Now, if the tie-breaker rules within a double or DTA or tax treaty don’t resolve the dispute, the affected taxpayer can request the competent authorities, as they say, of the involved countries to initiate the map. 

In certain jurisdictions, there have been very few maps even successfully done internally or in the country to do this cross-country. And to end up with a map is very difficult and challenging. The other one is that the competent authorities of the two countries will negotiate to reach a mutually acceptable solution. And that’s referred to loosely as bilateral negotiations, ensuring that the taxpayer does not face double taxation. So very important to appreciate that many times. This is the first point of call after you, as I say, again, have involved a consultant or tax adviser with practical hands-on experience. The second option, if it is available in the jurisdiction, is arbitration. Now, there’s a mandatory arbitration clause in certain of the modern tax treaties, which include this arbitration clause that comes into play. The competent authorities cannot reach an agreement within a specified period under the map. Now, arbitration involves an independent panel, which has to make a binding decision. 

And the binding decision then made by the arbitration panel is typically binding on both countries, ensuring that the taxpayer does not suffer from double taxation, meaning that the one country goes with the outcome of x and the other country they install revolt reserve and refers back to and results back to what the original issue was, which means that you still back in your arbitration, in your so-called the difference. In terms of the tiebreaker rules. Then you also have an option which is called the unresolved dispute. That’s if the map arbitration doesn’t resolve the dispute, then there are no binding, and there is no binding arbitration clause. The countries may unilaterally to proceed with the attack. This does actually, unfortunately result in double taxation in most jurisdictions. And then you have to look at the legal remedies within the domestic litigation rules of the specific judicial systems in those countries. That’s the best way to look at it. 

Now, unfortunately, the impact on a taxpayer from all of this is double taxation, and then your compliance and administrative burden, which could involve in numerous and a very prolonged legal or administrative procedure that needs to be followed. 

One thing I would add, just to assist taxpayers and companies, in general, is to consider looking at future treaty negotiations and that stood latest on the table of the relevant government, or where you see that you’ve got sufficient involvement or know the right people as a company or companies, and to consider involving the the various dispensations or legal authorities or competent authorities to include this in future treaty negotiations. 

So as one can see, it’s not a very easy situation to get yourself out of. In many instances, the mapped and arbitration rules are not very easy to follow in jurisdictions. Therefore, one ends up with double taxation, which brings me to the point that is very careful when you start looking at involving other countries or deciding to do business day from a commercial point of view. Because it may not be worth it because of these situations if you start doing investigations as part of your investment case before you invest in a specific jurisdiction. But if these are the remedies available, and always try, and if I can handle for that, try and involve a local consultant or adviser that has been successful in dealing with matters of this sort.