In a recent KPMG Private Enterprise Tax article published in Bloomberg, “Could double taxation become the cost of doing business for private companies?”, we addressed the impact of rising cross-border tax reporting requirements on private companies around the world.
In particular, we drew attention to the observable increases in audit activity as a direct result of expanding international trade, increasing disclosure requirements and the rising number of situations where more than one jurisdiction is seeking to tax the same income.
In my view, the available dispute resolution options are not sufficient to adequately deal with the increase in international tax audits where more than one tax authority is involved. This is independent of the potential implementation of Pillar 2 which is likely to increase the need for better dispute resolution mechanism (and in fact, Pillar 2 is intended to include a dispute resolution mechanism).
At present, taxpayers have three main options to handle their international dispute resolution. The first option is to consider the application of international arbitration using an investment treaty. The availability of this option depends, among others, on the existence of an investment treaty between the taxpayer’s country of residence and the country of source and requires the matter in question to fall within the scope of the investment treaty in a way that would allow the taxpayer to invoke its arbitration provision. In practice, this route of action is still very limited.
The second option is for the taxpayer to seek remedy in a domestic court or tribunal. However, a domestic court or tribunal is useful only where a unilateral remedy is sufficient to resolve the double taxation.
This leaves us with the mutual agreement procedure in tax treaties. The main advantage is that this mechanism allows the tax authorities to discuss the double tax dispute directly and come to a resolution that is agreeable for both countries. The main disadvantage, apart from the potential high costs, the limited application of this process (95% of the cases in 2020 originated from only 25 jurisdictions out of 118 jurisdictions reviewed) and the length of process (average length 18 months to three years with many unresolved pre-2016 cases) is that the taxpayer is not a party to the process. The taxpayer (or one of the two tax authority) can initiate the process and present documentation to support its claim but is left completely outside of the process. The two countries then discuss behind closed doors and if they reach an agreement, present it to the taxpayer who can either accept it or reject it and if the latter option is taken, the taxpayer may not have much other options left as the passage of time might have closed other options.
For these large companies, the disputes may represent several billions of dollars, which makes the required investment to challenge the case appropriate and reasonable. These large companies are likely to have also internal resources to handle tax matters and tax disputes at the same time. This is not the situation for smaller private companies, where the options are much more limited, internal resources scarcer and the monetary issues at stake are generally smaller compared to the expected costs. The dispute process itself may lead to expensive and lengthy conflicts with tax authorities in other jurisdictions (with the likelihood for a successful outcome and length of process changing depending on the identity of the jurisdictions involved), and there are few (if any) cost-effective alternatives to turn to.
The need for a more pragmatic approach
In fact, when (and if) the OECD Pillar 2 proposal is implemented, we expect there will be even more international controversy between taxpayers and jurisdictions (and among jurisdictions themselves) regarding the correct and appropriate allocation of cross-border income, which has the potential for increasing double taxation even further. The only possible exception is in the European Union, where mechanisms are already in place to resolve tax disputes between two or more member states.
If appropriate and pragmatic dispute resolution mechanisms are not introduced small to medium sized companies that are planning for significant growth through international expansion may need to accept the possibility of double taxation becoming part of their cost of doing business.
In our next posts we will explore how this change can come about, discussing several options, some of which were raised in past but not followed, either through improving the existing mutual agreement procedure or through alternative means.
Sound tax strategies are now more crucial than ever as private companies around the world face new opportunities and challenges arising from geopolitical shifts, globalization and new business demands. I invite you to visit the KPMG Private Enterprise tax website for further insights on navigating this changing tax landscape.
