Multinationals Should Consider Adding ‘Competent Authority Processes’ to Their Tax Strategies | Skadden, Arps, Slate, Meagher & Flom LLP
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- Transfer pricing uncertainty has increased with US tax reforms and an OECD proposal establishing a new approach to determining the jurisdiction where income is recognized.
- The “competent authority procedures” created by standard tax treaties provide cost-effective ways to resolve tax disputes and plan for the future.
- A procedure (MAP) allows taxpayers to engage in negotiations between multiple jurisdictions to resolve transfer pricing and double taxation issues.
- Through another (APA), companies can get pre-approval of transfer pricing policies – clearances that can span years.
As the global tax landscape evolves, multinational enterprises (MNEs) in many jurisdictions find themselves increasingly subject to double taxation or conflicting transfer pricing rules. Fortunately, long-standing tax treaties provide administrative procedures for resolving disputes and obtaining guidance for the future – processes that have been underutilized and even overlooked, but are now important options for taxpayers. as accepted rules and interpretations change.
A host of new cross-border business-to-business issues have been raised by recent U.S. tax reforms, including the Tax Cuts and Jobs Act of 2017 (the largest overhaul of U.S. tax law affecting corporate income abroad for more than 30 years) and the wave of 2021 Proposals. Meanwhile, the Organization for Economic Co-operation and Development (OECD) has gained broad international support for reforms to address digital economy and nexus – that is to say., where income must be recognized when the taxpayer has little or no physical presence in the jurisdictions from which it derives its income. These reforms would force multinational companies to review their transfer pricing systems. (See our customer alert of June 16, 2021 “Is tax competition dead?”)
Due to these developments and the financial anomalies resulting from the COVID-19 pandemic, multinational companies are facing more controversies regarding international taxes and transfer pricing issues and are finding it more difficult to plan. It is therefore increasingly important to consider the “Competent Authority” Mutual Agreement Process (MAP) and Advance Pricing Agreements (APA) as alternative means of avoiding and resolving disputes.
Competent Authority Process Overview
The term “competent authority” derives from widely adopted model tax treaties, which generally establish the AAP and APA processes.
The MAP allows companies to seek relief from double taxation and taxation inconsistent with the terms of the treaty by initiating negotiations between governments that are party to a treaty. Each country has its own set of internal procedures for implementing the process.
Taxpayers are not directly involved in negotiations between tax authorities. Instead, they initiate the process through the competent authority of their home jurisdiction, providing the necessary factual and legal information. U.S.-based parent companies with international subsidiaries submit a request to the Internal Revenue Service and each subsidiary applies to the relevant foreign tax authority.
In addition to resolving transfer pricing disputes, the PAA process can be used to resolve double taxation arising from other treaty issues, such as foreign tax credits, permanent establishment and withholding tax.
While MAPs come after an assessment, an APP looks to the future, establishing a formal agreement between a taxpayer and one or more tax authorities to determine the transfer pricing methodology for future business-to-business transactions. Like the PAA, the APP procedure begins with a request from taxpayers to the relevant competent authorities and can be multilateral. APA approvals generally last for five years or more, with the possibility of renewal and rollback (authorizations for previous years when declarations have already been filed).
Benefits include efficient resolution with multiple jurisdictions
Competent authority processes offer many advantages over traditional methods of resolving international tax disputes, such as domestic tax administrative appeals and litigation.
First, the competent authority process is effective and efficient. Because the MAP is bilateral or multilateral, involving the tax authorities of the relevant jurisdictions, taxpayers can resolve transfer pricing adjustments in multiple jurisdictions simultaneously on consistent terms. In contrast, dispute resolution channels in a single jurisdiction generally do not provide relief from double taxation because actions taken in one jurisdiction may not be available in another, or different results may be obtained.
Additionally, companies have a high success rate with the MAP process, making it a better alternative to litigation. For example, in 2020, of the 209 transfer pricing AAP cases resolved by the IRS, 105 reached an agreement that completely eliminated double taxation, 14 resulted in the IRS unilaterally granting ‘double tax relief and 25 have been withdrawn by the taxpayer, according to OECD data.
Taxpayers also have the option of managing their transfer pricing arrangements proactively through bilateral or multilateral APAs, which provide initial certainty of methodology and avoid the risk of double taxation.
Second, competent authority procedures tend to be amicable, less costly and less time-consuming than administrative appeals or litigation. The cost of submitting the claim and providing the necessary information, although considerable, is usually a fraction of the cost of depositions, experts, etc., in the event of a dispute.
Third, where appropriate, competent authorities may take into account the OECD guidelines when interpreting applicable domestic law. Depending on the facts at hand, this can provide common ground where national laws or interpretations of the rules are in conflict.
Fourth, the competent authority process is flexible. Taxpayers can usually submit a PAA request after an unsuccessful review or alternative dispute resolution. Additionally, businesses can request that the terms of a MAP resolution be extended to subsequent tax years where a return has been filed but not yet verified.
Finally, the results are not judicial decisions, so the parties are not bound by the determinations proposed by the competent authorities, and these do not constitute a precedent for future litigation. Thus, if a proposed amicable settlement is not satisfactory to the taxpayer, the latter can take legal action. And, if beneficial APA pre-approval cannot be obtained, the taxpayer can simply wait for an assessment and deal with the matter then.
Considerations to weigh
The decision to pursue a PAA or an APA involves many factors, including the importance and complexity of the issues and the sophistication and experience of the relevant tax authorities. Similarly, commercial considerations may make the competent authority process less attractive. For example, some MNEs may be reluctant to disclose details of their activities and transactions to certain authorities.
Overall, however, the competent authority process provides an effective remedy for the relief of double taxation, and multinational enterprises should consider these avenues as alternatives to domestic avenues for resolving tax disputes.