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Arbitration Divide Reflects Some Countries’ Fear of the Unknown

Posted on Dec. 9, 2020

Developing countries’ opposition to mandatory binding arbitration in mutual agreement procedure disputes often has more to do with suspicion of the unknown than with protecting sovereignty, according to an OECD official.

Speaking during a December 8 webcast held by New York University School of Law, Sandra Knaepen, head of the OECD’s MAP unit, acknowledged that some developing countries oppose the concept of resolving MAP cases through mandatory binding arbitration in principle. But for others, the aversion toward arbitration reflects their experience with bilateral investment treaties and general wariness of an unfamiliar process, she said.

“They don't really know a lot about how it works and how it goes, so it's the fear of the unknown partly, plus they have had bad experiences with nontax arbitration,” Knaepen said. “There are, of course, some other jurisdictions that at this moment just have the policy not to go for arbitration; some say that it has to do with constitutional issues. But I think that for several of them, it's more like, 'no, we're not doing it because we don't know whether it works and whether we need it.'"

As recognized by the commentary on article 25 of the U.N. model tax convention and the OECD’s recent consultation document on action 14 of the base erosion and profit-shifting project, arbitration as a MAP resolution mechanism remains a divisive issue. Although some countries — including the United States and many other developed countries — support arbitration as a way to guarantee certainty to taxpayers, others have cited the limitation on their national sovereignty and potential bias of MAP arbitrators as the basis for their opposition.

Elizabeth Stevens of Caplin & Drysdale suggested that the term itself may have become an obstacle to agreement. She asked, “Given that some developing countries in particular had such negative experiences with nontax arbitration, if we could develop mandatory binding dispute resolution without using the ‘arbitration’ word, would it be possible to get past some of the concerns about sovereignty and fairness and uncertainty about the process?”

Knaepen said it’s possible that countries will come to accept mandatory binding resolution mechanisms, noting an openness by some countries to considering such procedures in the context of pillar 1 of the OECD inclusive framework’s ongoing work on revised international tax rules. However, their agreement may depend on the specifics, according to Knaepen. “Some jurisdictions say that they would feel that they would be willing to go to such a procedure — a mandatory binding solution — but that they would feel more comfortable if the [arbitration] panels would consist of government officials so that it feels more like it's still their own decision, and not somebody else taking the decision for them,” she said.

COVID-Related Guidance

Regarding the OECD’s work on new transfer pricing guidance addressing issues created by the COVID-19 pandemic, Knaepen said a draft version of the guidance has been submitted to the inclusive framework for approval and will likely be released in late 2020 or early 2021. Like other OECD officials, Knaepen said the new guidance will focus on a narrow range of issues that the OECD transfer pricing guidelines currently do not address in detail.

“It contains information on what you can find in the transfer pricing guidelines, and a little bit of extra guidance on how now to deal with these specific issues,” Knaepen said. “Comparability analysis for 2020, of course, is one of the topics that is very relevant, but also [losses] and the allocation of COVID-specific costs.”

According to John Hughes, director of the IRS’s advance pricing and mutual agreement program, the IRS is facing an increasing number of questions regarding the COVID-19 pandemic’s transfer pricing consequences from taxpayers that have an existing advance pricing agreement or are in the process of negotiating one. For taxpayers still in the negotiation phase, APMA will work with the relevant treaty partner to develop a method that avoids the potential complications that the 2020 pandemic may cause for standard transfer pricing approaches, according to Hughes.

“There typically is a good deal of flexibility that we can exercise with our competent authority counterparts — perhaps shortening terms, perhaps lengthening terms — in order to put 2020 results in a certain context so that they don't distort, kind of overall, tests and things,” Hughes said. However, he warned that the situation may be more difficult for taxpayers that have already executed an APA.

“If we are to approach our competent authority counterpart in order to review results that maybe are out of some range or something in the APA, we're going to need data — good, cold, hard data. It's not going to work with a kind of generalized claim of difficulty or the challenge presented by 2020,” Hughes said. “We need to know exactly what happened with your business, and exactly what is the assistance that you're seeking.”

APMA’s foreign counterparts are likely to take a similar position, Hughes added. “I think I speak on behalf of all competent authorities: None of us are looking to reopen APAs and just have a whole new work stream for 2021, so anything that the taxpayers can do to facilitate that will be helpful,” he said.

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