Introduction and position of tax arbitration hitherto
Traditionally, states have been reluctant to consent to binding international arbitration. However, over the last couple of years, due to sustained corporate lobbying, the mandatory dispute resolution of tax disputes under Mutually Agreement Procedure (MAP) articles in Double Tax Agreements (DTAs) has been adopted by the developed nations. The MAP enables the competent tax authorities to implement and negotiate solutions in instances where the taxpayer considers that the acts of either or both of the contracting states will amount to violation of taxation provisions as per the DTA and consults to rule out double taxation. However, the implementation faces various political, institutional and legal challenges and has been criticized on various factors like huge litigation costs, lack of good faith and most importantly because of states’ unwillingness to cooperate as it threatens the sovereignty of the state.
The dispute resolution has been based on non-binding protocols and bilateral double-tax treaties concurred in the Organisation for Economic Co-operation and Development (OECD) and also to some scale, the United Nations (UN) Model Tax Convention. Double-Tax Treaties (DTTs) have a MAP which is based on Article 25 of either OECD or UN Model tax Convention which enables the taxpayers to call into question the actions of the States resulting in taxation not in consonance with the agreement. The paradigm has slowly shifted to developing nations accepting mandatory arbitration which was incorporated in the MAP provisions of the OECD Model Tax Convention in 2008.
Multilateral Instrument to Prevent Base Erosion and Profit Shifting (BEPS) and Arbitration of tax disputes
The rise of international dispute resolution is connected to the issue of tax avoidance and steps taken to counter the tax planning. The corporate lobbying gained momentum and was significant in getting OECD to inculcate binding arbitration in 2008 in Article 25(5) of the Model Tax Treaty. Similarly, UN Model Convention was also altered in 2011 to imbibe an optional dispute resolution provision. The MAP arbitration in Article 25 has been condemned on various parameters like lack of transparency, long span of the process, uncertainty in resolving disputes and the limited access.
Base Erosion and Profit Shifting (BEPS) entails tax planning blueprints used by corporations to exploit loopholes in the tax rules to escape the payment of income tax majorly by transporting surplus to low or no-tax jurisdictions where there is meagre business activity. The BEPS project was launched in 2013 by OECD and the G20 under which jurisdictions agreed to 15 actions for reduction of tax avoidance and improving the tax regime. Ultimately, the Multilateral Instrument to prevent BEPS (MLI) was endorsed in 2017. The 15 actions address several issues like challenges of the digital economy, hybrid mismatches, treaty abuse etc. with the ultimate aim to tax the income at the source state. Nations which endorse the inclusive framework are expected to execute the Action Items set out by OECD and meet the minimum standards, out of which the fourth standard specifically pertains to arbitration and treaty disputes. The issues that may fall under the MAP dispute resolution include deduction of taxes, transfer price adjustments, application of anti-abuse and domestic anti-avoidance provisions and allocation of surplus to permanent establishments. As of January 2025, 104 nations have signed the MLI to prevent BEPS and Lebanon has expressed its intention to sign the instrument.
The MLI and BEPS Action 14 which focuses on bolstering the efficiency and effectiveness of the MAP provisions were brought into picture to address the challenges. BEPS Action 14 encompasses a commitment to provide accurate and timely reporting of MAP statistics and resolving disputes in a time-bound manner. However, only those cases could be submitted to MLI where taxes have been actually charged. The mandatory binding dispute resolution provisions of MLI in Articles 18 and 26 are only applicable if both the contracting states decide their bilateral DTA is a covered tax issue. The states that opt-in, usually made reservations thereby limiting the horizon of MLI mandatory arbitration clause. Additionally, the taxpayer has the recourse to dismiss the outcome reached upon and even the contracting states can refuse to implement the decision if they have agreed upon a different alternative. All these instances precluded the effective use of MAP arbitration and arbitration could be accessed under a tiny fraction of over 3,000 bilateral tax treaties.
Miscellaneous conventions and the road to Two-Pillar Solution
The European Commission has also suggested displacing the pro-tem arbitration panels with a more structured and centralised investment court system for resolving international investment issues, influenced in many ways by the World Trade Organisation’s (WTO) Appellate Body. Finally, In October 2021, the mandatory binding arbitration was ingrained by 138 nations of Inclusive framework as part of the building block of Two-Pillar solution. This was introduced keeping in view the tax challenges of the digital economy regardless of a vigorous friction existing from developing nations to taxpayer-initiated dispute resolution outside the purview of OECD Framework. The Two Pillar Solution is an arrangement reached upon by OECD in the backdrop of US’s reluctance to ratify international convention for binding arbitration and to escalate the tax bases of States bringing in and importing the digital goods and services online. Pillar One focuses at settling apprehensions between the home nations and market nations of large multinational corporations by acceding to a new taxing right for market nations known as ‘Amount A’ in reciprocation for a debarment on use of digital service taxes and identical taxes with a binding arbitration procedure. The other legal element is domestic transfer pricing rule known as ‘Amount B’ which will be coordinated with OECD’s Transfer Pricing Guidelines and will standardize the remuneration. Pillar Two targets to address the concerns arising out of corporate income tax competition. It strives to stimulate nations to introduce a threshold degree of corporate income taxation for multinational corporations, albeit without such rates being determined under a binding agreement/treaty. The primary objective was the protection of states from tax competition and profit shifting. The future of Two Pillar solution, however, is uncertain yet, as the political viability and other factors need to be taken into consideration. [1]
Legal and Policy challenges
The MAP provisions, as discussed in some respects in the above paragraphs, suffers from various legal and policy challenges. The foremost challenge is that the taxpayers are at liberty to exit the MAP arbitration and pursue solutions under domestic laws. The taxpayers are not even bound by the decision once it has been arbitrated by the competent authorities. Parallelly, the jurisdictions can also abstain a matter from being arbitrated by assenting to an outcome before or after arbitration has initiated. Jurisdictions usually have less liberty with respect to Amount A but the multinational can outrightly turn down the arbitration decision. This one-sided prejudicial allegiance is often open to abuse by the taxpayers and affects the lawfulness of the procedure. Secondly, the process of tax arbitration is not transparent. While maintaining strong confidentiality is necessary, the default in discussing arbitration in Amount A arbitration is flabbergasting. The incapacity to make results and analyses of cases public goes directly against the harmonious exercise of rules and procedures by the domestic authorities. Moreover, withholding arbitration decisions from going public will result in larger states having the capability to repudiate the outcomes unilaterally, thereby coercing smaller states to concur to some other decision. Thirdly, states’ reluctance to cede decision-making to the arbitrators is another roadblock. The arbitrators are experienced professionals who come to a decision bases on the instruments, provisions and procedures. Hence, the faith has to be restored in order to ensure an effective tax arbitration regime. Lastly, the sovereignty concerns of developed and developing nations has been a major concern too. If the dispute resolution outcomes are arbitrated against several nations specifically the developing ones, considerations pertaining loss of sovereignty are most likely to assume greater political prominence.
India’s position on Arbitration in Tax Treaties and BEPS implementation
India has entered into approximately 100 Double Tax Avoidance Agreements (DTAAs) with other nations. These agreements include provisions on MAP pointing out how India and its agreement partners would settle, at the prompt of the taxpayer, issues that lead to ‘taxation not in consonance with the agreement’. The recommendation of adding mandatory binding arbitration as a determinant to resolving MAP cases has been opposed mostly by India and other developing nations. India voiced its reservations in imbibing the recommendation as it takes a hit on the sovereignty of the developing nations and also curbs the ability of the nations to tax the non-residents and foreign companies as per the domestic laws.
India has made qualified reservation with respect to Article 16(1) of MLI by conforming to the minimum standard as required under BEPS Action Plan 14 by allowing the access to MAP arbitration in the resident state. India is taking measures to eliminate tax collection when MAP proceedings are pending. India has strictly abstained from adopting Part VI of the MLI which pertains to inclusion of mandatory arbitration clause in the tax treaties. OECD in its recommendations on India’s stance on MAP process suggested India to publish exhaustive MAP guidance and adhere to OECD Transfer Pricing guidelines.
Conclusion and Way Forward
Two Pillar Solution and binding mandatory arbitration would go a long way when contrasted with the conventional MAP Arbitration process in the international tax regime. With the advent of digital economy and increasing complexities in the international trade system, the optimal approach to resolving tax disputes for the developing nations would be the incorporation of mandatory arbitration provision in treaties. This can also be looked at from the viewpoint that if the tax treaties don’t opt for the mandatory arbitration clause, it would instill terror in the mind of the investors who would be reluctant in approaching the domestic laws of the contracting jurisdiction. However, the issues related to transparency, loss of sovereignty and the capability of smaller nations can’t be ignored. The focus of the dispute resolution process should evidently be on the public interest over the corporate interests. Hence, the role of mandatory dispute resolution process warrants close attention. The BEPS Action Plans need to be structured in a manner that takes into view the concerns of the smaller nations. Especially, the implementation of Action Plan 14 should be enhanced with clear guidelines and peer review for effective and efficient dispute resolution mechanism. The concerns related to loss of sovereignty and smaller & developing nations can be addressed by reassuring the nations about the multiple shields of protection laid down by OECD. The process of MAP arbitration is not an automatic one and comes into picture only when the parties to the dispute aren’t able to solve the disputes within a span of two years from the date of commencement of MAP proceedings. Moreover, the chair of the Arbitral Tribunal can be chosen at the free will of the respective parties who can ensure that the Chair is not a nation or residence of either parties. The parties also have the capacity to rescind the proceedings in some cases. All these shields of protection guarantee that the sovereignty of the nations is not jeopardized at any cost. The symmetrical availability of mandatory binding arbitration coupled with competent legal capacity and transparency will ultimately make for a good solution for interrelationship between the developing and smaller nations and the multinational corporations.
[1] Chris Noonan | ‘Swimming Against the Tide? The Arbitration of International Tax Disputes’ | 2023| Volume 14| Indian Journal of International Economic Law | https://repository.nls.ac.in/ijiel/vol14/iss1/3/) | April 10th, 2025
Author(s)
Vanika Kansal
Student at Campus Law Centre, DU