Understanding Mutual Agreement Procedure in Double Taxation Avoidance Agreements

1. Bombay Chartered Accountants’ SocietyStudy Course on Double Taxation Avoidance AgreementsArticle 25 - Mutual Agreement Procedure 25th January 2014 Presented by CA Anil D. Doshi

2. Contents Background Treaty provisions – Article 25 OECD MC OECD Amendments 2008 MAP – Treaty Model Differences Mechanics of MAP MAP – Some Aspects Categories of Disputes Practical issues under MAP Statutory Regime – MAPs in India MAP – India US DTAA

3. Background Need & Importance of Resolving International Tax Disputes Major concern for business and government Disputes have increased in number and complexity … this trend will continue Need a more effective procedure to resolve disputes

4. Background International Tax Dispute Redressal Mechanisms • Before Dispute Arises • Advance Pricing Agreements (Transfer Pricing) • Authority for Advanced Ruling • After Dispute Arises • Mutual Agreement Procedures (MAP) • Arbitration – Compulsory or Optional • International Litigation – International Court of Justice European Court of Justice (ECJ)

5. …Background - MAP If taxation not in accordance with tax treaty, taxpayer may need to litigate in one or both of contracting states. Inbuilt mechanism for tax treaty dispute resolution on bilateral basis (also unilateral?). Resolution of disputes through Competent Authorities (‘CA’) of Contracting States (‘CS’). Remedy under MAP is available irrespective of remedies available in domestic tax laws. Potential of a negotiated settlement (may agree to disagree) • Mandatory resolution if arbitration clause exist.

6. Art. 25 – OECD MC “1. Where a person considersthat the actionsof one or bothof the Contracting States result or will resultfor him in taxation not in accordance with the provisions of this Convention, he may, irrespective of the remedies provided by the domestic law of those States, present his case to the competent authority of the Contracting State of which he is a residentor, if his case comes under paragraph 1 of Article 24, to that of the Contracting State of which he is a national. The case must be presented within three yearsfrom the firstnotification of the action resulting in taxation not in accordance with the provisions of the Convention.

7. …Art. 25 – OECD MC • Article 25 (1) – Indian Treaties • Who can seek initialization of MAP • The word ‘Person’ is used • Austria, Belgium, Egypt, Finland, Germany, Greece, Hungary, Ireland, Israel, Japan, Jordan, Kazakhstan, Kyrgyzstan, Malta, Namibia, Philippines, Portugal, Qatar, Russia, South Africa, Sri Lanka, Sweden, Trinidad and Tobago, Turkmenistan and USA. • The word ‘Resident’ is used • Australia, Belarus, Brazil, Canada, Kenya, France, Malaysia, Spain, Switzerland, UK, etc.

8. …Art. 25 – OECD MC • Article 25 (1) – Indian Treaties… • Time Limit initialization of MAP • Generally OECD model followed i.e. 3 yrs • Period of 2 yrs. • Belgium, Canada, Italy, UAE. • Period of 5 yrs. • Brazil • No maximum period prescribed • Libya, Turkey, UK • Bangladesh – The case must be presented within 3 yrs from the date of the assessment or of the withholding of tax at source, whichever is later. • OECD Report on ‘Transfer Pricing, Corresponding Adjustment and Mutual Agreement Procedure’ [Nov 82] • MAP can be invoked as soon as an adjustment, even if tentatively, is proposed.

9. …Art. 25 – OECD MC 2.The competent authority shall endeavour, if the objection appears to it to be justifiedand if it is not itself able to arrive at a satisfactory solution, to resolve the case by mutual agreement with the competent authority of the other Contracting State, with a view to the avoidance of taxation which is not in accordance with the Convention. Any agreement reached shall be implemented notwithstanding any time limits in the domestic law of the Contracting States.

10. …Art. 25 – OECD MC • OECD Report Feb 2007 – ‘Improving the Resolution of Tax Treaty Disputes’ • Outlined several duties and responsibilities of the CA under MAP • Second Sentence – ‘..shall be implemented notwithstanding any time limits in the domestic law..’ • Article 25 (2) – Indian Treaties… • Second Sentence omitted – Canada, Egypt, Italy, Libya, Philippines, Switzerland, Thailand • USA – use the phrase ‘any time limit or other procedural limitations in the domestic law’

11. …Art. 25 – OECD MC 3.The competent authorities of the Contracting States shall endeavourto resolve by mutual agreement any difficulties or doubtsarising as to the interpretation or applicationof the Convention. They may also consult together for the elimination of double taxationin cases not provided for in the Convention.

12. …Art. 25 – OECD MC • Art 25(3) Second Sentence – ‘… also consult together for the elimination of double taxationin cases not provided for in the Convention.’ • Taxation of same income in the hands of different persons e.g. Firm vs Partners • Situation where TP adjustment between two PEs (one in each contracting state) of a third country resident results in double taxation • Second sentence absent in case of India’s DTAAs with Australia, Belgium, Canada, Ukraine, UK.

13. …Art. 25 – OECD MC OECD MC 4. The competent authorities of the Contracting States may communicatewith each other directly, including through a joint commissionconsisting of themselves or their representatives, for the purpose of reaching an agreement in the sense of the preceding paragraphs. UN MC 4. The competent authorities of the Contracting States may communicatewith each other directly, including through a joint commissionconsisting of themselves or their representatives, for the purpose of reaching an agreement in the sense of the preceding paragraphs. The Competent authorities, through consultations, shall develop appropriate bilateral procedures, conditions, methods and techniques for the implementation of the mutual agreement procedure provided for in this article. In addition, a competent authority may device appropriate unilateral procedures, conditions, methods and techniques to facilitate the abovementioned bilateral actions and the implementation of the mutual agreement procedure.

14. …Art. 25 – OECD MC • Article 25(4) of Revised UN MC 2011 The competent authorities of the Contracting States may communicate with each other directly, including through a joint commission consisting of themselves or their representatives, for the purpose of reaching an agreement in the sense of the preceding paragraphs. The competent authorities, through consultations, may develop appropriate bilateral procedures, conditions, methods and techniques for the implementation of the mutual agreement procedure provided for in this Article. • Article 25(4) • Most Indian Treaties include the wordings of OECD model or variations thereof and not extended version of UN Model. • UN Model version included – DTAAs with Sri Lanka, Thailand, Trinidad and Tobago & USA.

15. …Art. 25 – OECD MC 5. Where, a) under paragraph 1, a person has presented a case to the competent authority of a Contracting State on the basis that the actions of one or both of the Contracting States have resultedfor that person in taxation not in accordance with the provisions of this Convention, and b) the competent authorities are unable to reach an agreement to resolve that case pursuant to paragraph 2 within two yearsfrom the presentation of the case to the competent authority of the other Contracting State, any unresolved issuesarising from the case shall be submitted to arbitration if the person so requests.

16. …Art. 25 – OECD MC …..5. These unresolved issues shall not, however, be submitted to arbitration if a decision on these issues has already been rendered by a court or administrative tribunal of either State. Unless a person directly affected by the case does not accept the mutual agreement that implements the arbitration decision, that decision shall be binding on both Contracting Statesand shall be implemented notwithstanding any time limitsin the domestic laws of these States. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of this paragraph.”

17. MAP – Art 25(5) Arbitration Amendment in 2008 Issues not resolved by CAs themselves Taxpayer’s choice to request for arbitration Arbitration can be invoked only for actual cases [not for probabilities] Can be invoked only after 2 year from reference to host country CA Results of arbitration are binding on CAs only if accepted by taxpayer Consensus on suspension of collection of tax during MAP process No arbitration, if domestic court in either CS rules on the same issue CS need to agree on bilateral mechanics of Arbitration process.

18. Best Practices for MAP • Both the OECD and the UN give guidance as to “best practices” in structuring MA • UN Guide to Mutual Agreement Under Tax Treaties (“UN”), http://www.un.org/esa/ffd/tax/gmap/Guide_MAP.pdf • OECD Manual on Effective Mutual Agreement Procedures(“MEMAP”), http://www.oecd.org/ctp/38061910.pdf • CAs should make every effort to resolve cases on a principled basis, UN para 49 • Audit settlements which involve the waiver of MAP access should be avoided, UN para 80

19. Best Practices • Competent Authority function should be independent of Audit function, UN para 62 • Guidelines and procedures should be developed and publicized for taxpayer presentation of MAP cases, UN para 92 • Use of position papers and response papers to clarify area of disagreement, UN para 169 • Resolving and publishing issues of interpretation under Article 25(3), MEMAP BP 1 • Liberal interpretation of time limits and advising of treatyrights, MEMAP BP 9

20. Best Practices • Avoiding exclusion from MAP relief due to late adjustments or late notification, MEMAP BP 10 • Consideration of MAP assistance for cases described as “tax avoidance”, MEMAP BP 11 • Taxpayer presentations to competent authorities, MEMAP BP 13 • Independence and resources of a competent authority, MEMAP BP 23 • Implementing and promoting ACAP and bilateral APA programs, MEMAP BP 25.

21. MAP – Treaty Model Differences UN and OECD MC are similar except that: • UN model additionally commits the CA to jointly or unilaterally develop procedures for implementing MAP • In Alternative B of Article 25(5) in the revised UN Model 2011 Mandatory Arbitration is provided with following differences: • First, arbitration may be initiated if the competent authorities are unable to reach an agreement on a case within three years from the presentation of that case rather than within two years as per OECD Model. • Second, OECD Model provides that arbitration must be requested by the person who initiated the case, paragraph 5 of UN Model provides that arbitration must be requested by the competent authority of one of the Contracting States. • Third, paragraph 5 of UN Model, unlike the corresponding provision of the OECD Model Convention, allows the competent authorities to depart from the arbitration decision if they agree to do so within six months after the decision has been communicated to them.

22. MAP – Treaty Model Differences • US Model differs from the UN / OECD in the following ways: • Any agreement reached between the CAs to be implemented notwithstanding any time limits as well as procedural limitations • Time period of 3 years not prescribed for taxpayer to present the case • Even for the cases involving issues related to Art. 24(1), MAP can be initiated with CA of the country of which he is resident. • For CA initiated MAP, US model illustrates the matters that could be included in such MAPs. • Competent Authority (CA) • India: Officer Authorised by Central Government – Rule 44G / 44H • Other Countries: Ministry of Finance or Apex tax authority or Tax Commissioners or Directors as their representatives

23. Mechanics of MAP Tax Dispute Applicant approaches CA in the country of Residence / Nationality (Home Country) Yes No Dispute Capable of Unilateral Resolution? Should be resolved by Consultation Should be resolved by CA of Country of Residence MAP

24. MAP Overview • Mutual Agreement Procedure ('MAP') is an alternate mechanism incorporated into many tax treaties for the resolution of international tax disputes • Scope limited to issues pertaining to tax treaties and does not extend to domestic tax laws • Resolution of disputes through the intervention of the Competent Authorities ('CAs') of each state who evolve a mutually acceptable solution • Possibility of dispute resolution through a negotiated settlement • Relief through MAP possible irrespective of remedies available under domestic tax laws • Issues which can be tackled through MAP – • Disputes where taxpayer contends that he is being taxed in a manner not in accordance with the tax treaty • Issues relating to interpretation of terms appearing in the tax treaty • Elimination of double taxation in cases not covered by tax treaties

25. MAP Procedure Process typically requires 2 to 3 years for completion.

26. MAP - Points to consider • Treaties typically incorporate a time-limit for initiation of MAP procedures - - Under most of India's tax treaties, MAP procedures are required to be initiated within three years of Revenue action leading to the MAP application • MAP solution binding on the tax payer only if - - Taxpayer gives express acceptance of the MAP solution; and - Taxpayer withdraws any appeals pending before any appellate authority/Court in respect of the matter covered by the MAP solution • MAP solutions typically binding on tax authorities only in respect of the particular case - However, MAP cases involving interpretation of tax treaties may have persuasive valuein other cases

27. Corresponding or Correlative Adjustment • What is Correlative Adjustment? - Under the Transfer Pricing legislation, every country has a power to re-determine the transaction price between the associated enterprises, if the same is not an ALP. The correlative adjustment arises in the other country on account of the primary adjustment made under the TP regulations. - E.g. A Ltd. in India enters into an agreement with K Ltd of Australia. The Indian revenue authorities consider that the price agreed between A Ltd. and K Ltd. is not an ALP and hence the price is adjusted. The issue that arises is consequent to adjustment made by revenue authorities in the assessment of A Ltd. whether K Ltd. is entitled for the adjustment in Australia.

28. Whether corresponding adjustments are mandatory? • The corresponding adjustments by the other country are not mandatory consequent to primary adjustments made by one country • The other country can resort to corresponding adjustment if the same is in accordance with provisions of its domestic legislation • The right to carry the corresponding adjustment in the other country primarily arises due to provisions of Article 9(2) of the OECD Model • If the countries have inserted the provisions of Article 9(2) in the double tax treaty, then those countries can make a corresponding adjustment provided the other country accepts the principle and quantum.

29. MAP vis-à-vis Domestic Appeal Process

30. MAP – Pros & Cons Pros • MAP request can be pursued parallel with domestic appellate proceedings • MAP decision is not binding on the taxpayer • Time span of 2 to 3 years - Significantly lesser compared to appeal process under domestic tax laws • More scope for negotiation/compromise than domestic appeal process • Possibility of avoiding double tax impact through correlative relief • Possibility of suspension of collection of taxes, subject to conditions (For India-USA, India-UK, India- Denmark MAP procedures) • Greater chance of reaching finality as decision of CA is binding on tax officer Cons • Not incumbent upon CA to reach resolution – may agree to disagree on matters involved • Grant of an opportunity for "personal hearing" before CA is not mandatory • Where facts are inaccurate, erroneous or incomplete CA may reject the MAP application. • Confidentiality of information provided or exchanged in MAP

31. MAP – Some Aspects Who can apply for MAP? • Taxpayer initiated MAP vs. CA initiated MAP? Who is Competent Authority? What is its role? In what situations can MAP be invoked? • Interpretation? • Application? • Transfer pricing? What is the time limit within which one has to apply for MAP? • Possibility or probability of action Vs. Actual Action? • First notification [how to establish]? Whether Mutual Agreements under MAP are published?

32. …MAP – Some Aspects What is the procedure involved in MAP? • Application procedure and form? • Representation by taxpayer? • Payment of taxes – before, during or after MAP application? Whether CA may refuse to refer a specific case to MAP? • Refusal as there is no prospect of success, because: • The taxpayer has not provided sufficient information; • The case concerns only an issue under domestic law (e.g. allowability of expenditure under Indian Income Tax Act, 1961). • Time limits have lapsed under the Treaty or national law • No double taxation has occurred • The amount involved is negligible • Taxpayer is guilty of tax evasion or tax fraud

33. …MAP – Some Aspects What is the time frame for settlement of disputes under MAP? • Indian Experience so far? • OECD Countries - 25.46 months in the 2012 reporting period. What is the participation of the taxpayer in the MAP ? • Without arbitration cases • Arbitration cases Can there be multilateral MAP involving more than two countries – triangular cases? Is MAP binding on the revenue authorities and the taxpayer? • Can taxpayer reject MAP result?

34. …MAP – Some Aspects Can MAP results be implemented after expiry of the domestic time limits prescribed for altering a tax assessment? • What about procedural aspects? Whether taxpayer can defer acceptance of MAP results if dispute is pending in the Competent Court of either Contracting States? Can the taxpayer file an appeal after MAP? • Cable News Network LP vs. ADIT [2010-TIOL-20, ITAT Del] – Appeal can be filed against the Order of the Assessing Officer giving effect to MAP Resolution. Can taxpayer pursue domestic law remedy and MAP simultaneously?

35. …MAP – Some Aspects Can MAP override domestic court decisions? Is there any alternative mechanism available when no solution is reached under MAP? • In cases where treaty provides for arbitration clause • Treaty do not provide for arbitration clause What are the shortcomings of MAP? What are the advantages of MAP? Confidentiality of information provided or exchanged in MAP? Can MAP be invoked where action of authority does not result into double taxation? Can MAP orders be revised?

36. …MAP – Some Aspects MAP and Transfer pricing • Can MAP be initiated for transfer pricing cases? • For what type of TP cases: • Quantum of adjustment? • Quality of adjustments – such as factual position? • Corresponding adjustments • Can advance pricing agreements be executed through MAP?

37. Categories of disputes… Case / Taxpayer Specific Disputes General Interpretive or Application Related Elimination of Double Taxation not provided in Treaty • Elimination of Double Taxation in cases not provided in Treaty • E.g. Determination of Residential status for Dual Tax Residency cases Not resolved under Tie breaker Rules [Individuals + Corporates] • Includes specific cases of Taxation not in accordance with Treaty • Scope only limited to Treaty and Not Domestic Tax Laws • Includes issues relating to interpretation or application of terms under Treaties • General in Nature and are initiated suo moto by CA Broad categories of disputes that could be resolved under MAP:

38. …Categories of disputes Common disputes currently resolved under MAP in India: • Existence of Permanent Establishment (PE) • Attribution of income, expenses, deductions, credits, etc. to PE • E-Commerce transactions • Categorisation of income [e.g.. royalty / FTC Vs. Business Income] • Common meaning of terms • Application of domestic laws to penalties, fines, interest inconsistent with treaty Transfer Pricing issues

39. Advance Pricing Agreement [APA] Scheme • Finance Act 2012 inserted sections 92CC and 92CD in the Act, to bring certainty in transfer pricing issues between associated enterprise • Notification No. 36/2012 issued by CBDT detailing procedural aspects of APAs dated 30th August 2012 • APAs were introduced in the tax law from 1st July 2012 • Relevant rules prescribed under Rules 10F to 10T and Rule 44GA

40. APA Scheme • APA scheme envisages three types of APAs • Unilateral APA An agreement between CBDT and the applicant determining the ALP or TPM for the transfer pricing issues in an international transaction • Bilateral APA An agreement between two CA’s through MAP negotiation for the transfer pricing issues in an international transactions • Multilateral APA An agreement between more than two CA’s through MAP negotiation for the transfer pricing issues in an international transactions

41. APA Scheme • The bilateral/multilateral APA would be possible only when • Tax treaty exists between India and other countries participating and containing an article on MAP • Tax Treaty contains provision similar to OECD Article 9(2) on Associated Enterprise • A corresponding APA program exists in that other country • The applicant may accept/reject the arrangement agreed by the CA’s within 30 days

42. Practical issues under MAP Some practical issues faced in India: • Success of MAP as alternate dispute resolution • Repetitive procedures for subsequent years • eFunds Corporation vs ADIT, IT [2010] 42 SOT 165 (Delhi) • MAP Proceedings Order for one of the year and Article 27 of Indo-US DTAA had important bearing on the issue being considered and had to be given effect to on priority. • Time limit under domestic tax law provisions for tax officer to give effect to MAP order • Time limit for filing of MAP application under certain treaties • MAP resolution limited to the determination of principle issues, leaves income computation to tax officers • Availability of tax credit in respect of taxes under a MAP settlement • Issues resolved under MAP contradictory to subsequent decision of court • Stay of demand – only possible where MAP negotiation US or UK or Denmark

43. Keys Practical Challenges / Lessons • Limited time-frame and opportunity as depends on the number of times CAs meet • No prescribed time limit within which MAP cases are to be resolved • CA team on Indian side frequently rotated • MAP hard to resolve unless true and full disclosure of facts made • Findings of Indian tax Courts have a significant bearing on proceedings

44. MAP- Indian Statutory Regime

45. MAP- Indian Statutory Regime • Instruction No. 12 dated 1-11-2002 regarding Procedure in respect of Mutual Agreement Procedure for Double Taxation Avoidance Conventions • Visakhapatnam Port Trust (144 ITR 146 ) (A.P.) • MAP available in addition to and not in substitution of the domestic remedies • New MoUs • MoU with U. K. • Instruction No. 3 dated 19-03-2004 • MoU with USA • Instruction No. 2 dated 28-04-2003 & Instruction No. 10/2007 dated 23-10-2007 • Mckinsey & Company Inc. vs UoI [2010] 192 Taxman 421 (Bom) • MoU with Denmark • Instruction No. 7/2008 dated 24-06-2008

46. OECD MAP Statistics for 2012

47. MAP Example: Indo - US DTAA Article 27 • Stipulates a time limit of three years for all references • Encompasses elimination of double taxation in cases not provided for in DTAA • Provision for joint commissions or representatives Article 3(1)(h): Competent Authority • India: Central Government in the Ministry of Finance (Department of Revenue) or their authorised representative • USA: Assistant Commissioner (International) and for interpretative issues in concurrence with Associate Chief Counsel (International) of the Internal Revenue Service.

48. MAP Example: Indo - US DTAA India - U.S. Competent Authority Agreement • Suspends tax assessment and collection for taxable years that are the subject of mutual agreement procedure cases under DTAA between USA and India • Security to be provided for the additional tax demand subject to mutual agreement procedure • Resolve or close the case within two years • Taxes covered include tax on assessment, reassessment, withholding tax, advance tax, interest and penalty.

49. MAP Example: Indo - US DTAA Indo US Technical Explanation • Clarifies that remedies available under domestic laws need not be exhausted • Three years time limit runs from the receipt of formal notification • Recourse can be taken to US Model for list of examples • Competent Authorities entitled to consult each other • Communication between Competent Authorities can be direct or through representatives

50. Recent Developments • First MAP in India was refused by the tax payer in 2009 • First MAP was signed with USA on transfer pricing dispute in 2010. • In India, most references related to Transfer Pricing Disputes.