Mutual Agreement Procedures: Unravelling the concept and the developments surrounding it – Part 1

  1. Background
  • International double taxation occurs where two countries seek to tax income from the same cross-border transaction or activities. Bilateral tax treaties endeavour to resolve this issue. Most tax treaties are structured on the basis of the OECD Model Convention, the UN Model Convention or some variation of these. These limit the rights of the source state to tax income arising within its territory and require the residence state to allow credit for the source taxes or to exempt income subject to source taxation.
  • The design of sensible tax policies for modern economies require that careful attention be paid to their international ramifications. This is a potentially daunting prospect, since the analysis of tax design in economies entails all of the complications and intricacies that appear in closed economies, with the addition of many others, since multiple, possibly interacting, tax systems are involved. Given the multiplicity of regulations at play, effective dispute resolution framework should be in place to promote a stable tax regime.
  • Mutual Agreement Procedures (‘MAP’) is a mechanism for competent authorities to discuss cross-border taxation of specific transactions or situations with a view to coordinate their approach for the benefits of the taxpayers involved. In a MAP, representatives from each of the contracting states are designated and are referred to as Competent Authorities. This process is available under a tax treaty entered into by two or more countries so that the treaty partners are able to resolve cases involving their taxpayers where there are disputes concerning cross-border transactions in their countries. MAP is ‘a process of discussion between the competent authorities in which they seek to explore the possibilities of a solution to the relevant problem that can be accepted by all concerned’. Explicitly not precedent-setting, it is nevertheless vital to the process that MAP outcomes become binding on the parties, lest the entire process become an exercise in futility.
  • The typical areas covered[1] under a MAP are as follows:
    • Double taxation that could arise from a transfer pricing adjustment: It occurs when a taxpayer is subject to additional tax in one country because of a transfer pricing adjustment to the price of goods or services transferred to or from a related party in the other country
    • Issues pertaining to determination of residential status under the tax treaty/ Issues arising on account of dual residency: It arises when a person is resident of two treaty countries under each country’s domestic law, and each country asserts that the taxpayer is a resident of its jurisdiction for purposes of the tax convention. A request to the competent authorities would initiate discussions between the competent authorities regarding the proper application of the tiebreaker rules contained in the residency article of the convention. The taxpayer should approach the competent authority of the country in which the taxpayer asserts residency and in some cases where it is incorporated.
    • Dispute on the characterisation of income: Because of the complexity involved in the cross border transactions, often a situation arises in which taxpayer is unsure of the characterisation or classification of the item related to a cross-border issue; the taxpayer may approach the competent authority for clarification.
    • Dispute in relation to existence of a Permanent Establishment (PE) in one of the contracting States: A taxpayer subject to tax as a resident in one country on income, including income from carrying on a business in the other treaty country, is taxed in that other treaty country on the business income earned there, despite not having a permanent establishment in that country under the tax convention. The taxpayer may request the competent authority of its country of residence to address the issue of taxation not in accordance with the tax convention with the competent authority of the other country.
  • Structure of the article on Mutual Agreement Procedures
    • Article 25 of the OECD/ UN Model Convention is a very important procedural provision as it provides for the framework of a ‘mutual agreement procedure’ which enables the parties to the convention to better carry out the substantive provisions of the convention which allocate taxing rights. The role of the competent authorities in Article 25 is to ‘endeavour to resolve’ by mutual agreement any difficulties/doubts/disputes arising as to the application of the convention.
  • Article 25 of OECD/UN Model Convention deals with MAP.
    • Article 25(1) provides that MAP can be invoked by person if he considers that the action of one or both the contracting states result or will result in taxation not in accordance with the provisions of the Convention. Further, the case can be presented to the competent authority of the contracting state of which he is national irrespective of remedies provided in the domestic laws and the same should be presented within three years from the first notification of action resulting in taxation not in accordance with the provision of Convention.
    • Article 25(2) states that if the objection of the taxpayer appears to be justified and the competent authority is not able to arrive at the solution the competent authority shall resolve the case by mutual agreement with the competent authority of the other state so as to avoid double taxation. Further, it states that any agreement reached shall be implemented notwithstanding any time limits in domestic laws of the Contracting states.
    • Article 25(3) authorizes the competent authorities to resolve difficulties of interpretation or application of the convention by resorting to MAP. For this purpose, the Convention contemplates a continuous dialogue between the competent authorities of the  state for exchange of views and opinions.
    • Article 25(4) provides that the competent authorities may communicate with each other directly for the purpose of reaching the agreement.
    • Article 25(5) deals with arbitration of unresolved issues in a MAP case. It broadly provides that in cases where the competent authorities are unable to reach an agreement under Article 25(2) within two years, the unresolved issues will, at the request of the person who presented the case, can be solved by arbitration.
      • In UN Model Convention, two alternative versions, Article 25 (Alternative A) & Article 25 (Alternative B) are given. Article 25 (Alternative A) of UN model is similar to Article 25 of the OECD Model Convention with the addition of second sentence in paragraph(4) and exclusion of arbitration clause. Article 25 (Alternative B) of UN model is similar Article 25 of the OECD Model Convention with the addition of second sentence in paragraph(4) and inclusion of arbitration clause in Article 25(5).
  • Certain other issues surrounding MAP :
  • Time limits: Generally, two issues arises on time limits in connection with MAP:
  1. Time limit within which MAP must be initiated: Generally time limits are defined in Article 25(1) of the tax treaty. As per the model tax treaties, the procedure for MAP should be commenced within three years of first notification of action resulting in taxation not in accordance with the Convention.
  2. Question of domestic time limits and implementation of mutual agreements: Second sentence of Article 25(2) states that any agreement shall be implemented not withstanding the time limits under the domestic laws.
  • Binding nature of MAP agreements: The taxpayer may be asked whether he accepts the results of the agreement and if he does then it may be binding on taxpayer as a contract.
  • Applicability of mutual agreement procedures for subsequent years: The MAP of a particular year even if accepted by the taxpayer is not binding on him for later years.

[1] Reference in this regard can also be drawn from Para 8 of the OECD Model commentary as it lists common cases that would fall in purview of MAP

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