ITPJ JANUARY/FEBRUARY 2002 GERMANY Mutual Agreement Procedures and the Role of the Taxpayer Prof. Dr Berndt R. Runge 1. INTRODUCTION taxpayer will therefore increase as the scope for investiga- 1.1. Current situation tion by the tax authorities is restricted or lessened In view of this, German law extends the taxpayer's obliga Worldwide income must be taxed completely in the view tion to assist the authorities in cases r ng to cross-bor- of the tax authorities, both in Germany and in other coun- der transactions related enter- tries throughout the world. However, double taxation must prises in other co on to cooperate more be avoided. e principles There is growing potential for conflict over cross-border equ asibility and activities. Economic relations are becoming increasingly ual c t least in theory, to additional in particu- likely of audit the taxpayers and for national tax 1.2. Establishing the fac to assist the authorities capabilities if c The demands r che GmbH. division in the 2002ir
NUARY/ FEBRUARY 2002 It is surprising how little use has been made of coordinated attain general agreement on clarifying and supplementing audits. The benefits of this instrument are clearly evident. relevant bodies of law and on stopping loopholes. A suc The initial open questions have since been settled. Adher- cessful MAP is a procedure usually based upon an agree ing to the principles of economy in administration, person- ment between two countries which is adopted and trans nel can be deployed as effectively as possible. It also formed into domestic law by the legislature of each lessens the administrative burden on the taxpayer. A suc- country. Thus, competent authorities are authorities autho- cession of audits can be avoided as can the resulting recip- rized by law to enter into a mutual agreement for purposes rocal adjustments, laborious investigations and protracted described in the agreement mutual agreement procedures While the individual is required to meet his or her tax li- 2.1.2. The legal position of the taxpayer is more than exposed to the tax demands of two or more countries with- In the past, the mutual agreement procedure has been out compensation. The taxpayer's compliance costs can be extensively criticized. It generally takes a long time and it reduced, the solution of problems accelerated and in com- are the tax authorities that control the procedure, the tax plex transfer price cases the quality of data on which the payer enjoys no particular legal protection. The taxpayer affected tax authorities base their assessment can be has neither the right to demand a mutual agreement proce- erature(e. g guarantee of tax secrecy, increase in the extent ing treaty principles. The taxpayer has no right to be heard of the taxpayer's disclosure obligations and de facto dou- or to otherwise be involved, and has no right to be ble taxation where definitions have not been reconciled) informed of the decision itself or of the grounds on which are persuasive only insofar as they relate to the lack of any it was taken. Moreover, there is no obligation to disclose binding obligation for the tax authorities involved to reach the agreement. This absence of mandatory problem reso- an agreement in the event of dispute lution is the largest disadvantage of the procedure The provisions in income tax treaties corresponding to However taxpayers generally appreciate that the MAP has those in Art. 26 of the OECD Model Treaty form the legal not been overly formalized and can be easily invoked asis for administrative agreements on coordinated audits. However, frustration occasionally occurs when it is felt Contrary to the view of the OECd and to that of the Ger- that competent authorities do not make a good faith effort man tax authorities (which makes reference only to the to resolve a case in a timely fashion. There is no indication exchange of information article as a legal basis ), a simul- hat the procedure is under-utilized by taxpayers On the taneous audit comprises, in the author's opinion, elements other hand, the question arises from time to time as to of a mutual agreement or consultation procedure in add- whether taxpayers are able to resolve double taxation situ- tion to the exchange of information. The prevention of ations on their own(e.g. in transfer pricing cases without double taxation must form an integral part of an agreement having competent authorities involved). All in all, the on simultaneous audits for the benefit of the taxpayer, cedure seems to work reasonably well. Nevertheless, serv whereas the OECD merely reminds the countries involved ing the taxpayer better would mean a narrowing of the that they should attempt to attain a result that avoids dou- time frame for a case to be resolved ble taxation for the multinational group of enterprises in question 2.1.3. The tax authorities very rarely reject a claim for the nitiation of a mAP 2. INSTRUMENTS FOR SETTLING AND PREVENTING DISPUTES While it must be conceded that the arrangement is unsatis factory from the taxpayer's perspective, it needs to be said 2.1. Mutual agreement procedure hat the German tax authorities follow the request of a tax payer to start a MAP. In the last 30 years less than half a dozen cases are known in which the tax authorities have 2.1.1. An effective tool to solve controversies among tax ment between the taxpayer and the tax authorities is there refused to enter into a MAP. Only in the case of an agree authorities of different jurisdictions a risk of rejection. Most of the German MAPs hithert need for aspecific provide for the avoidance of double conducted have been brought to a satisfactory conclusion ol to cope with the difficulties arising from the dictated by considerations of what is equitable. The rate of application of an applicable tax treaty. Therefore, income success in terms of avoidance of double taxation is well tax treaties include a special kind of procedure known as beyond 90% Nevertheless there is rarely a case that is mutual agreement procedure(hereinafter: MAP), which is resolved in less than one year and in some cases it takes generally modelled on Art. 25 of the OECD Model Treaty. several years. To this extent, the MAP has shown itself to The great advantage of the MAP for both the tax author- be a useful means of settling international disputes over ities and taxpayers is its flexibility and relatively unbur- taxation. Taxpayers should not shrink from applying for a eaucratic nature. Tax authorities are enabled to resolve MAP if double taxation has occurred or is likely to arise oblems in a direct procedure conducted on an informal basis. Not only does the mutual agreement procedure 2. 4. Improvements were realized in the last decades allow taxation contravening treaty provisions to be cor- As early as 1975. the International Fiscal Association rected in an individual case, but it can also be used to(hereinafter: IFA)proposed in its general report on occa E 2002 internat onai Bureau of Fiscal Documentation
P JANUARY FEBRUARY 2002 sion of the IFA Congress on the allocation for tax purposes 2.1.5. The MAP is transparent of expenditure in the case of international arm s-length In 1993 the Federal Ministry of Finance published a leafle transactions, that every effort should be made to rende on the MAP. This leaflet was updated in 1997. It mainly mutual agreement procedures more effective. The rappor- gives guidance to taxpayers on the procedural aspects of teur-general on mutual agreement procedure at the 1981 the map to be observed FA Congress concluded that the mutual agreement proce dure was a suitable means of settling international tax dis- 2.1.6. Ease in applying t for a MAP putes where the provisions of applicable income tax treaties were insufficient. Among other things, national The objective of a MAP is to ascertain the taxpayer's gislatures were called upon to ensure that claim to be taxed in accordance with the provisions of an it should be possible for mutually agreed solutions to applicable income tax treaty. The opening of the MAP the benefit of the taxpayer to be implemented irrespec- requires the taxpayer to make reasonably clear that the tax tive of any time-limits imposed by national law. The payer is faced with a taxation not in accordance with treaty initiation of a mutual agreement procedure should sus- provisions. The MAP will be carried out on behalf of the pend the running of such time-limits interests of the taxpayer. insofar the taxpayer's coopera the interpretation of provisions of an applicable tion is needed. No special type of documentation is income tax treaty as settled by mutual agreement pro- required in order for the competent authority(hereinafter cedure should supersede the definitions set out in the CA)to open a MAP. The opening of a MAP takes the form domestic law of a treaty signatory; and of a written notification to the competent authority of the mutual agreement procedures designed to eliminate other country loopholes should be given statutory force by imple- With respect to transfer pricing MAPs have not necessar- mentation into domestic law ly to be initiated by parent companies. However, German It was further stated that the time taken for a mutual agree- guidelines suggest that for practical reasons MAPs should ment procedure would have to be reduced. In cases where be initiated in the country of the superior taxpayer (i.e. the no agreement could be reached by this procedure between parent company ) As to sister companies, either company the contracting parties, the possibility of referring the dis- may initiate the procedure, although it may be necessary, pute to an arbitration body should be introduced however, to include the country of the parent company. In the author's opinion, it is recommended to initiate the Much time has since elapsed. It must be asked. therefore, MAP in the country in which the tax authorities will most whether there has been any fundamental improvement in likely agree with the arguments of the taxpayer Loss situ mutual agreement procedures since that time. As long ago ations may raise the the question of whether the Ca has as 1987. the International Chamber of Commerce pub- ithority to deal with loss-loss cases; it may be argued that lished a paper on basic issues related to mutual agreement there is no double taxation to be resoived. However,dou procedures, specifying once again the shortcomings of ble taxation may occur because of the availability of loss such procedure and pressing for appropriate action to be carry-overs. Hence, depending on the circumstances, the taken. The OECd had already taken a stand in 1984 in a report on mutual agreement procedures and dealt with the taxpayer may be entitled to request a MAP. issue once again at some length in its 1995 Transfer Pri- 2.1.7. Time limits generally will not hinder a MAP cing Guidelines. While the guidelines address the existing problems in considerable detail, they fail to make any fun- Provided that the applicable treaty itself does not specify a damental progress on the 1984 position, confining them- time limit, claims for competent authority consideration selves as before to mere calls for action are generally accepted within four years after notification detailed auditing of transactions, especially those of inter- in accordance with treaty provisions is the decisive event nationally affiliated enterprises, there has been no signifi- for the time limit to run, the claimant will usually not be While there has been no great improvement in the legal Lime-barred in making its claim. If the CA concludes that cant increase in the number of mutual agreement cases. a transfer pricing adjustment should be withdrawn instead status of the taxpayer, the procedure has nevertheless of being dealt with in a MAP. the issue will be discussed become more transparent in many countries. The call for with the local tax authorities the publication of decisions that could be of benefit to other taxpayers should be upheld, provided that the tax- As soon as a MAP has been opened, any appeal proce- payers interests are protected and, in particular, the tax dures will usually be suspended. In this regard. the MAP is secrecy requirement is observed. Speeding up the proce- not legally but practically linked with a judicial claim dure, though desirable, will invariably come up against Any agreement reached between competent authorities practical difficulties. These are not only the shortage of will be implemented without regard to the stage of any staff in national tax authorities but also the differences in court proceeding under domestic law. However, if an organization and procedure and the need for translations in appeal is still pending, the taxpayer is required to declare most cases the withdrawal of the appeal. A CA agreement may be tion on the Law of Treaties of 23 May 1969. @2002 International Bureau of Fiscal Documentation
JANUARY/FEBRUARY 2002 ITPJ implemented without time limits. Under domestic law, the taxpayer from the outset. However, the assumption tha statute of limitation will not expire before the CA agree- agreement would be reached at the latest one year after ini ment takes effect. The collection of tax may be suspended tiation of the procedure, has failed to apply in most cases during the map Moreover, the utility of a mAP would be increased if it were able to override court decisions in other countries 2.1.8. There is a need for arbitration in the case of a MAP failure Should a MAP fail, the unilateral domestic measures for 2.2. Advance pricing agreements he avoidance of double taxation will by no means come The development of advance pricing agreements(here into effect as an automatic back-up mechanism. Revenue inafter: APAs)by the US Internal Revenue Service and the authorities invariably have recourse to such measures only adoption of APAs by tax authorities in other jurisdictions, if they decide to grant tax relief for reasons of equity. But have lent renewed force to the question as to the scope there should be no call for the enforcement of mutual binding information from the german tax authorities, par agreement despite the telling arguments for and against, as ticularly with respect to transfer pricing, and its coordina this would totally alter the nature of the procedure tion with foreign tax authorities to avoid disputes The possibility should, however, be created for both the tax authorities and the taxpayer to refer the matter to an 2.2.1. Unilateral APAs create benefits only in exo arbitration body if no agreement can be reached. Referring a case to arbitration should involve forfeiting the right to In other countries. the apa is often seen as a suitable legal remedies to ensure that the dispute is settled without instrument for enhancing legal security and reducing the German tax treaty policy is to insert an arbitration clause being le tax authorities. The APA is viewed as in its treaties(e. g. the treaties with the United Sates. Swe den, and-most recently -the revised treaty with austria) uture-oriented, and thus a means of avoiding disputes restricted to isolated problem areas, thus permitting rapid settlement; and 2.1. 9. The taxpayer has an influential impact on the procedure despite the taxpayer's weak legal handled by specialists, thus ensuring that it is properly The OECd holds that APAs can be exceptionally useful. The german administrative practice already complies with in particular when conventional instruments fail or prove most of the demands for improvements. In the author's difficult to apply. However, a number of shortcomings opinion, there is no need for taxpayers to be granted a have also been noted. The OECd gives an express warn- laim in law for the initiation of a MAP. Scarcely a single ing against unilateral APAs in view of the risk of double application for a MAP is turned down by the tax author- taxation. The benefits and drawbacks have also been com pared in the German literature. The general euphoria now The only participants in the CA process are the competent seems to be diminishing authorities. Nevertheless, the taxpayer is required to pro- 2.2.2. There is no legal obligation for the German tax vide the Ca with all aspects of the case, both factual and legal including any type of evidence that may support the authorities to agree to aPas taxpayer's position In straightforward and complex cases Binding information on transfer pricing arrangements can like, the taxpayer is kept informed during the course of be provided by the german tax authorities within the legal he MAP and is not merely notified once it has been con- framework currently in place. In the past, however, the tax cluded. The German tax authorities coordinate their proce- authorities have been very reluctant to do so, as such infor- lure with the taxpayer. The procedure is not used as a pre- mation invariably presupposes investigation by the tax text for taking up tax matters that have nothing to do with authorities themselves and for all practical purposes the case in question implies a partial audit, Without bilateral effect, such infor- A separate legal basis has been created for revoking or ation is generally of only limited value. In certain ci establishing valid tax assessment notices to implement cumstances it can simplify and shorten audits in the coun- mutually agreed decisions and the applicable time limits giving the information, though in most cases the work have also been extended. The comprehensive informa- is merely postponed to a later date. There is a risk that the tional leaflet on the MAP makes the procedure more read- restrictions imposed by the unilateral provision of infor- is always required for implementing a mutually agreed the grounds for dispute in the bilateral relationshp force ily comprehensible for taxpayers. The taxpayer's consent mation relating to cross-border transactions will rei decision. Taxpayers are entitled to reject the result and to attempt to achieve a more favourable outcome by employ- 2.2.3. APAs do not minimize the workload;German tax Ing leg authorities have only limited capacity to handle The result of a MAP will not be disclosed because to do so APAs would be contrary to tax secrecy requirements. If taxes While bilateral or multilateral coordination and agreement have already been paid in the other country. the payment may be of benefit to both the taxpayer and the tax author of taxes in Germany will invariably be deferred during a ities, they do not represent any saving in work, time and MAP in order to avoid imposing a double burden on the expense for either side. In terms of administrative eco- @2002 international Bureau of Fiscal Documentation
JANUARY/FEBRUARY 2002 nomy. the outcome is likely at best to be neutral on both authorities in a foreign jurisdiction indicate that they will sides. The establishment of a bilateral or even multilateral make public the result of an APA. the German tax author agreement implies from the point of view of the German ities will immediately terminate their cooperation ax authorities a substantial extra workload which will have to be handled by staff with the necessary qualifica- 2.2.7. APAs are useful only in bilateral and multilateral tions, including language skills situations It should be noted that the fulfilment of the circumstances The decisive advantage is the security for all concerned on which an agreement was based will also have to be and the avoidance of subsequent disputes in mutual agree demonstrated and verified at a later date. APAs will gener- ment cases. The German tax authorities hold the view that ally require more work than a"conventional" MAP. it may well be expedient to lay down methods and details cause they do not cover known facts, but rather cover in the determination of transfer prices and to cooperate hypothetical future developments, requiring a definition of with foreign tax authorities in doing so. But it remains to subsequent analysis, whether the real events still meet a decisive turn for the better in the field of transfer pricing these critical basic assumptions. Consequently, the deci- Germany regards APAs as a service to the taxpayer, in that payer is within the discretion of the tax authorities in each APAs are"advanced"in the end and thus provide safety to country. e. g. to determine which of the APA requests pre- yet existing transactions or sented to it will be taken up first-against a background of restructuring (contrary to the legal obligation to apply the law to existing facts ). As a consequence of an APA, the ta limited resources. The promotion of APAs will on\a of the law with a view to the processes (e.g. transactions or successful if competent staff is available on a nation authorities would not be able to change their interpretation level. However, the German tax authorities have only lim- ited capacities restructuring )covered by the APA In the authors opinion, the unlimited application of APAs 2.2.4. Treaty provisions like Art. 25 of the OECD Model will not be feasible nor will the tax authorities apply it in Treaty as the legal basis for bilateral or multilateral every case, However, this should not be understood to APAs Bilateral or even multilateral agreements are \ell t an that the German tax authorities have adopted a nega- mes w of the APA procedure. On the contrary, subject achievable by a MAP in accordance with the relevant to personnel constraints, the German tax authorities are applicable income tax treaty. Although bilateral APAs do prepared to discuss APAs with other tax authorities within not differ from MAPS, nevertheless they are future-orien- the framework of MAPs tated, at least in the beginning. In this regard, treaty provi sions like Art. 25(1)of the OECD Model Treaty are the 2.3. Arbitration procedures will remain an exception legal framework for APAs, and not Art. 25(3)of the OECD Model Treaty as the OECD has stated, as the latter In the past, there have been repeated calls for an arbitration provision specifies the rules for a consultation procedure. procedure. At least in part, this requirement has since been met. Among the objectives of German treaty policy is the 2.2.5. The procedure is more or less in the hands of the incorporation of an arbitration procedure in German axpayer; cooperation is the essential factor income tax treaties. The Convention of 23 July 1990 Taxpayers may file a request for an APA. The tax author.(hereinafter: the Convention)on the elimination of double ities will decide on a case-by-case basis whether an APA associated enterprises, in force since 1 January 1995, has xation in connection with the adjustment of profits of will be entertained. Where the tax authorities agree to par- established a binding arbitration procedure in the territory taxpayer provide all relevant data. Due to the fact that an of the European Union. The existence of the Convention APA covers hypothetical future events, the scope of infor- places a much greater pressure than before on the compe mation that the tax authorities regard as necessary in the tent authorities of EU Member States to reach an agree context of an APA but need no be more compre- ment. It provides an appropriate counterweight for the MAP, where the facts are given and the only issue is to unlikely to be applied in practice. Its greatest shortcoming apply the law. If the taxpayer does not comply with a is that it applies, only in relation to EU Member States and request for information deemed relevant by the tax author- only in connection with the adjustment of profits between ities, the tax authorities are free to terminate the aPa pre associated enterprises ess, irrespective of the level the procedure has reached or Nevertheless the pressure on the competent authorities, as he time it has taken so far executed by the existence of an arbitration procedure, will 2.2.6. APAs are covered by both international and minimize the risk that a MAP will fai domestic tax secrecy and may not be published Due to the fact that APAs are a form of MAP, the rules of tax secrecy must be applied in the same manner. If tax