Paper review: “How Nations Share”

In the case of international income, it is the disputes and their resolutions, and not the law on the books, that constitute the international tax regime. Yet it is all but impossible for citizens to observe exactly how, or how well, their governments navigate this aspect of economic globalization.

This is Alison Christians’ contention in a thought-provoking paper published in the Indiana Law Journal this summer.  Taking the example of transfer pricing disputes, she suggests a number of issues facing a regime based on bilateral tax negotiations.


Transfer pricing refers to the system for allocating taxable profits between the different countries in which a multinational group operates, treating it as a set of individual companies that trade with each other. Following a tax audit, a revenue authority can choose to adjust the price of transactions within the group.

One of the roles of a tax treaty between two countries is to ensure that these adjustments are coordinated, so that when one country makes an adjustment, the revenue authority on the other side of the transaction makes an equal and opposite adjustment. This prevents the taxpayer from being taxed twice on the difference. The problem is that sometimes tax authorities don’t agree: naturally, if the country making the adjustment thinks that the price should be changed so that they are entitled to more taxable profit, it wants the other country to accept that it is entitled to less.

Christians characterises the disputes that emerge as unique in international law: though they can be initiated by non-governmental third parties, they are ultimately disputes between two governments. By contrast, under trade and investment treaties, disputes are either directly between the individual and a foreign government, or pursued only at the discretion of the home government:

The aggrieved taxpayer acts as both instigator and a third wheel in international tax disputes, creating a triangle of interests in the pursuit of resolution.

Mutual Agreement Procedures and confidentiality

Although taxpayers have some domestic routes to challenge a situation of double taxation, we are most concerned with the treaty-based routes. The first is the Mutual Agreement Procedure (MAP), in which diplomats from two governments negotiate a solution. The volume of MAPs is huge:  Christians quotes figures showing that in 2009, OECD members received 1599 new MAP requests, bringing the total pending to 3413 at the end of the year. The problem, says Christians, is that the vast majority of these agreements is negotiated in private. Attempts to access them through Freedom of Information cases in the US have failed.

the MAP process defies empirical observation of the tax law as it is implemented in practice.

The second treaty-based route for taxpayers is to force the two governments into arbitration. This is also a confidential process, and it’s a relatively new addition to model treaties (one rejected by the UN committee). The idea, according to Christians, is to push countries to speed up the MAP process, which, as the statistics cited above show, has a large backlog.

The paper focuses on the US and OECD model treaties, but it’s important to note here that under the UN model treaty, taxpayers do not have recourse to arbitration in this way. This is because the UN committee was concerned about the costs of arbitration for developing countries, who they felt might be more likely to capitulate than participate in a costly international process.

Soft law and power politics

The conclusion in the paper presents an interesting theory. Christians’ argument is that a heavy reliance on confidential negotiated settlements prevents the development of jurisprudence in tax disputes that would effectively create ‘hard’ international tax law. Instead, governments’ experiences through the MAP process are aggregated and filtered through the development of the OECD model treaty and transfer pricing guidelines, both of which have the qualities of ‘soft’ law.

Instead of disseminating international tax experientially, such as by publishing individual case studies, countries are sharing the knowledge they gain from experience by writing this knowledge into abstract rules that can be applied to future cases.

(Interestingly, LSE’s Eduardo Baistrocchi has previously argued that the lack of good case law is one reason for the difficulty faced by both taxpayers and governments in enforcing the arm’s length principle.)

While one motivation for this dynamic may be to safeguard taxpayer confidentiality, Christians proposes two other drivers. The first is to preserve national autonomy: countries can diverge from soft law when it suits their interests.

Soft law thus spares tomorrow’s governments from being constrained by today’s compromise, and allows governments to make mistakes in practice without permanent damage, yet preserves institutional memory in the documentation of best practices.

Second, she suggests that soft law ‘obscures power politics’, allowing OECD members to draft new soft law based on the information available to them, but preventing outside observers from fully understanding the drivers and likely impacts.

Observers of the international tax regime may suspect that poor states suffer from the current allocation of international tax revenues, but inequalities cannot be easily documented as in other treaty contexts where the adjudication process is more open.

An interesting avenue for development research would be to study how often disputes involving developing countries are resolved through MAPs, and which side tends to benefit most from the resulting settlements.