“Futile and unrewarding”: the wilderness years of the international tax regime

Almost all histories of the international tax regime begin with the League of Nations: from the model conventions issued by its Fiscal Committee in 1928, to the Mexico and London draft model conventions.  The latter was agreed by a group of primarily European countries in 1946 at Somerset House, just across the road from where I am now. The League never reconciled the differences between the two conventions, and so the modern history of the regime is usually dated from 1963, when the OECD’s Fiscal Committee first agreed an OECD model bilateral tax convention. For the last 50 years, the OECD model has been the foundational text of the international tax regime, even forming the template for its United Nations equivalent.

While I knew that the United Nations initially tried and failed to pick up the League’s work, the interregnum between 1946 and 1963 is often raced over quite quickly in tax history stories: Sol Picciotto devotes five pages to it in his magisterial International Business Taxation [pdf]. So I decided to sit down in the British National Archives to see what I could find out about this intervening period. The transition from the League to the OECD is important because it is often stated that the OECD picked up and ran with the London Draft, which suited the interests of its members. The Mexico draft, largely agreed among developing countries, fell to one side, according to this account, paving the way for an international tax regime that has a bias in favour of capital exporting states. While I will shed a bit of (sceptical) light on this in what follows, I am mainly going to tell the story through some of the more colourful excerpts from the archives. Today we will look at the UN Fiscal Commission, and I’ll follow this up next week with the OEEC (later OECD) Fiscal Committee to which the baton passed.

Part 1: The “Imperialist” powers’ efforts fail at the United Nations

The sense one gets from both the official reports of UN Fiscal Committee meetings between 1947 and 1951, and the British participants’ own readouts, is that political divisions between groups of states were less problematic than the lack of a clear and compelling mandate to achieve anything in particular. In the committee’s first session, it was the participant from the United States who drafted the proposals for further work that made their way into the final draft, even though he also initiated a protracted (and familiar) discussion about being realistic given limited secretariat resources. Indeed, at the second session, “the secretariat work had been unevenly done and was on the whole badly presented”, said the British participant, WW Morton, who regarded the secretariat’s approach as “over-academic”. (There is a theme of hostility towards things being ‘academic’ in these Inland Revenue files, which I am not taking personally).

By this point, cold war divisions had already emerged, although the sense from the British accounts is that they were not insurmountable, since the Soviet group was content on occasions to make its statements and then abstain from votes, or else be outvoted. Still, here is a flavour of the kind of thing, taken from Morton’s readout. He describes the member from the USSR stating that international work on double taxation put “pressure on the under-developed countries to the advantage of highly developed countries” since it primarily reduced the taxation of their investors.

Extract from British participant's report of the UN Fiscal Committee's second session

Of the second session, Morton observed that “the session was not very productive” but was keen to support anything that might allow the UK to conclude more tax treaties with developing countries. Everyone could agree to support information gathering and dissemination, and the translation of the secretariat’s compendium of international tax agreements into Spanish was something the British supported enthusiastically, keen as they were to obtain tax treaties with Latin American countries (more on that here).

Extract from British participant's report of the UN Fiscal Committee's second session


It is in the Commission’s third session that we can first see a divide between developed and developing countries. The International Civil Aviation Organisation (ICAO) had brought a proposal for reciprocal exemption of airlines, by which companies operating flights would be exempt from taxation in the countries to which they fly, paying it only in the country where they were based. India, Pakistan, Venezuela and Cuba raised objections, pointing out that if only one country signing the treaty had an airline, “reciprocal exemption is quite unfair.” The ICAO proposal was, however, consistent with the treaty policy of the UK, and other countries with their own airlines. The ICAO proposal fell after a vote in which the developing countries were joined by the Soviet group, but Morton attributed this to a “procedural tangle” and poor chairing, rather than an insurmountable division. “As will be observed, the work of the Session was only modestly productive. Nevertheless, it is probably worth holding.”

When the Commission’s work reached the ECOSOC, however, it appears that sentiment had changed. Morosov, the Russian participant (also its representative on the Commission itself) expressed his familiar objection that the Commission’s work on double taxation “was in reality intended to promote economic conditions favourable to the activities of British and American monopolies,” concluding that the Commission “was engaged in futile operations, and that it was therefore useless to keep it in existence.” According to his Polish counterpart, “the majority of the Commission had, by certain of the recommendations adopted by that body, tried to exploit the authority of the Economic and Social Council to relieve investors from the highly-industrialised capitalist countries of the taxation which those less highly developed countries were entitled to enforce.”

Extract from ECOSOC discussions of the report of the third session of the UN fiscal commission


Morton, the British representative on the Commission, had previously reported an informal conversation with Morosov from which he concluded that this language was more of a formality, and that Russian objections were far from fatal to the Commission. It was thus the British who really plunged the knife in to the Commission, responding that the UK was “in agreement with the Soviet Union and Polish delegations as to the desirability of winding up the Commission’s activities, although for other reasons than those advanced by them.” The UK wanted to see preparatory work for ECOSOC discussions carried out by “small groups of experts with the assistance of the Secretariat,” rather than by a permanent functional commission serviced by a dedicated secretariat. This would appear to have been the death knell for the UN Fiscal Commission, which was wound up in 1954.

So in this quick look through the archives, we’ve seen that the demise of the UN Fiscal Committee was not only a product of inter-country rivalry (though that produced some entertaining diplomatic fireworks). Perhaps more significantly, it was a matter of failure to gather institutional momentum, in part due to the lack of effective secretariat support, and lukewarm support from across the board. The UK and US were never strongly in favour of a permanent international committee examining taxation issues. As we will see in part 2 next week, this was not merely scepticism of the UN: the British also opposed the creation of a “gathering of international chatterers” at the OEEC, which eventually became the OECD Committee on Fiscal Affairs…


Developing Countries’ Role in International Tax Cooperation

Developing Countries' Role in International Tax CooperationOver the past year I’ve worked with the secretariat of the Intergovernmental Group of 24* on a paper that discusses how developing countries could engage with a range of international tax cooperation issues. The paper can be downloaded here: Developing countries’ role in international tax cooperation [pdf].

The G-24 plays a caucusing role for its members in the IMF and World Bank, and so tax cooperation is becoming increasingly important for it as those organisations’ profile in tax work increases. There were some interesting presentations at the G-24’s last technical group meeting in February, and its most recent ministerial communique [pdf] includes the following statement, a mix of welcoming current initiatives and noting areas where they are insufficient for emerging markets and developing countries (‘EMDCs’):

We welcome ongoing initiatives on international tax cooperation such as the Automatic Exchange of Information (AEoI) initiative and the Base Erosion and Profit Shifting (BEPS), and call for a framework that ensures effective participation of EMDCs. We support the development of a digital global platform with least compliance cost for implementation of AEoI. We appreciate the work of the UN Tax Committee and encourage multilateral support to upgrade the Committee to an intergovernmental body to enhance the voice of EMDCs on international tax policy matters. We also call for more attention to developing fair tax rules to guide the taxation of multinational corporations and for international cooperation to prevent harmful international tax competition, negative spillovers from shifts in tax policies in major countries, and illicit financial flows.

One of the interesting elements of this project was the diverse positions and interests within an equally diverse group of ‘EMDCs’. Below, for example, is a table showing participation in international tax organisations and institutions. This was such a moving target that we had to set a ‘freeze date’ of 25th May 2017.

G-24 participation in international tax initiatives, May 2017

I hope the report provides a good overview of the state of play and issues involved on that date. Below is the text of the recommendations section, which gives a flavour of the document.

The G-24 has highlighted the importance of effective international tax cooperation to support developing countries’ efforts to mobilise domestic resources, so that they can achieve their development goals.  It could build on this recognition by setting out to develop a pro-active agenda for international tax rule reform that meets the needs of developing countries, and identify different international forums through which to achieve it. G-24 members could work together within existing forums such as the UN tax committee and OECD to put their issues of concern on the agenda. The UN tax committee’s potential has yet to be fully realised by developing countries, and there may also be new opportunities created by enhanced participation in OECD initiatives. G-24 members could strengthen their engagement by enhancing national political oversight of UN and OECD tax work, as well as advocating a stronger, upgraded UN tax committee when the opportunity next arises.

On tax avoidance and evasion, G-24 members could consolidate their participation in multilateral conventions on information exchange and mutual assistance, and could share their knowledge and experiences in this area to build each other’s capacity to benefit from their participation, as well as to identify reforms to international tax standards that might reduce the administrative hurdles to benefit.  Where necessary, this could lead to alternative, but compatible, standards in areas such as transfer pricing and tax treaties that give a greater share of the tax base to developing countries.

As some G-24 countries are capital-exporters to other developing countries, they could take up the IMF and OECD’s recommendation to perform ‘spillover analyses’ of the main aspects of their tax systems that have the potential to adversely affect other developing countries’ tax revenues, whether by encouraging tax competition or increasing incentives for tax avoidance. Also with regard to tax avoidance, G-24 members could share experiences across regional economic groupings such as ASEAN and MERCOSUR to advocate codes of conduct on tax competition, as well as working through ECOSOC for the adoption of the UN tax committee’s proposed code of conduct on exchange of tax information.

Above all, the G-24 provides a political platform for forging common views on international development issues among developing countries, in which tax coordination is a main concern.  It is able to work with the OECD within its inclusive framework, and a number of G-24 members are now participating in many of its initiatives. It can also support the efforts of the UN and other forums in which developing countries can more actively engage so that they can benefit more effectively from international tax rule reforms and cooperation.  A sustainable approach to international tax cooperation in the long term requires international institutions that reflect the increasingly diverse needs of countries with an interest in international tax standards.

*Just as there are 19 countries in the G-20, and 134 countries in the G-77, there are now 26-and-a-half countries in the G-24. The ‘half’ is China, which has the status of ‘special invitee’.

Some follow-up on parliamentary scrutiny of the UK-Senegal treaty

As my last post anticipated, the ratification of the UK-Senegal tax treaty was debated in parliament last week. It was great that a debate on the impact of a tax treaty between the UK and a developing country happened at all. Some important issues came up:

  • What is the role of the Department for International Development in the UK’s treaty policy with respect to developing countries? None, on the basis of the reply from the minister, David Gauke.
  • Why is there no cost-benefit or development impact analysis of the UK’s treaties with developing countries? Mr Gauke said that it would not be possible to do this in a meaningful way, although as this post by Francis Weyzig points out, Ireland and the Netherlands have both now published analyses that do consider the effects of their treaties on developing countries.
  • Does the UK government bear any moral responsibility for the outcome of a negotiation with another sovereign state? That is certainly an interesting point for further consideration.

This was a good start in comparison to last year’s discussion of the UK-Zambia treaty, but these topics were still only skated over. The format of these ‘debates’ is always the same: the opposition shadow minister asks some questions, the minister responds from his briefing notes, and then the committee votes ‘yes’. It is near impossible to have a real discussion about substantive matters, such as the UK’s red line on a withholding tax clause for technical service fees (discussed below). This is partly because of the mountain of treaty detail within which substantive issues are hidden, but also because all parliament can do is vote ‘yes’ or ‘no’ after the treaty has been signed.

There are two things the UK could do about this, which other countries have done. First, it could commission a comparative review, along the lines of those that have now been conducted for Ireland and the Netherlands, which highlights the main distinctive features of its treaties with developing countries so that non specialist MPs can engage with them meaningfully. Second, it could publish its treaty negotiating position, as Germany and the US have both done, with an opportunity for public and parliamentary debate on this position in general terms.

Now, some technical discussion. The night before the debate, I bumped into one of the British negotiators, who said he was “not very impressed” with my post on the treaty. The next day, the Labour opposition asked some questions based on input from ActionAid, which followed the same lines as my comments. The minister responded with much the same criticism I’d heard the previous night, so I’m going here to set the record straight on the technical points, insofar as I can from my non-technical background.

Technical service fees

I stated last week that “this treaty does not include a clause permitting Senegal to tax fees for technical services paid to the UK,” but this was imprecise wording. As Mr Gauke pointed out, the treaty does permit such fees to be taxed in Senegal, but with a major restriction. They can only be taxed in Senegal if the British recipient of the fees has a physical presence in Senegal for 183 days in a year. Even then, the fees can only be taxed as net profits, not gross fees as the standalone clause would have allowed for. The whole debate at the UN on this clause begins from the view that a physical presence is increasingly irrelevant in the 21st century economy, and that it is very difficult for developing countries to get an accurate view of a service provider’s net profits.

As the minister continued, “Senegal’s approach to the taxation of services differs from that of the UK,” and this is one area where the UK approach prevailed. This appears to be a red line for the UK now, but it’s worth noting that (on a quick count) Great Britain has nine treaties with sub-Saharan countries that do permit them to tax technical services without a physical presence. Senegal is arguably therefore disadvantaged relative to quite a few of its regional neighbours.

Supervisory activities

As I noted last week, the UK-Senegal treaty doesn’t follow the UN model treaty [pdf] wording on supervisory activities in connection with a building site, which states (my emphasis):

The term “permanent establishment” also encompasses: (a) A building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only if such site, project or activities last more than six months

I said in my post that this means “supervisory activities associated with a building site in Senegal conducted by a British firm will not be taxable in Senegal,” but as Mr Gauke clarified, the treaty “does allow that” in practice. This is because the commentary to the OECD model tax treaty has been amended to incorporate it. It states in paragraph 5.17:

On-site planning and supervision of the erection of a building are covered by paragraph 3. States wishing to modify the text of the paragraph to provide expressly for that result are free to do so in their bilateral conventions.

The International Bureau of Fiscal Documentation (IBFD), in a commentary on the differences between the UN and OECD models, seems to concur that there is no longer any substantive difference between the two on this point:

According to the UN Model, supervisory activities are covered by this provision, irrespective of whether they are performed by the main contractor or subcontractor. The OECD Model does not include these activities in the text of the construction clause. According to the OECD Commentary, supervisory activities were, until 2003, explicitly subsumed under the construction clause provided the work was performed by the main contractor itself. Supervisory activities performed by a subcontractor were not, however, considered to be covered by this provision. This difference between the OECD and UN Models disappeared due to the changes to the OECD Commentary in 2003. The supervisory activities of a subcontractor were then also considered to be covered by the provision.

But the difference does seem to be important to many countries. They prefer to take the UN option of explicitly providing for the taxation of supervisory activities, rather than leaving it to a clarification in the commentary on page 101 of the 496-page model treaty. Turning to the reservations and observations published alongside the OECD model, twenty countries, including six OECD members, have made an official note along the lines that they reserve the right to have the supervisory activities wording included in their treaties. They are: Australia, Korea, Slovenia, Slovak Republic, Mexico, Portugal, Albania, the Democratic Republic of the Congo, Hong Kong, Serbia, Argentina, Malaysia, the People’s Republic of China, Singapore, South Africa, Thailand, Vietnam, India, and Indonesia. There is also the following anomalous note:

Bulgaria does not adhere to the interpretation, given in paragraph 17 of the Commentary on Article 5, and is of the opinion that supervision of a building site or a construction project, where carried on by another person, are not covered by paragraph 3 of the Article, if not expressly provided for.

Royalties for TV and radio broadcasts

I also pointed out that the treaty was unusual in not including a reference to TV and radio broadcasts in its definition of royalties. The UN model states (my emphasis):

The term “royalties” as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, or films or tapes used for radio or television broadcasting,

Again, I said that this meant such payments could not be taxed by Senegal. The minister responded that, “the OECD commentary on the provision makes clear that cinematographic films include material for TV broadcast.” It does indeed state at paragraph 12.10 that:

Rents in respect of cinematograph films are also treated as royalties, whether such films are exhibited in cinemas or on the television.

But this is a little more restrictive than the UN wording, as there is no mention of radio. Of course, this may be splitting hairs, especially as only Argentina and Vietnam have observations in the OECD model on this point. But this time the IBFD discussion seems to support the view that there is a substantive difference here:

As the OECD Model does not include, in the definition of the term “royalties”, payments made as a consideration for the use of, or the right to use, films or tapes used for radio or television broadcasting, the UN Model deviates in this respect from the OECD Model.

Questions the opposition should ask about the new UK-Senegal tax treaty

Back in February, the UK and Senegal signed a bilateral tax treaty. The treaty is up for ratification this week, so I thought it time to take a look. Ratification happens through the delegated legislation committee, and entails very little debate. The last time a treaty between the UK and a developing country was ratified, I thought it was a shame that there had not been more discussion, which is why I’m writing in advance this time. I’ve also commented in the past, as did ActionAid and Mike Lewis, on the Danish treaty with Ghana.

So what questions might an interested Shadow Financial Secretary ask during this ratification debate? Here are three suggestions.

First, they might ask about a few of the provisions within the treaty that disadvantage Senegal and that seem to go against modern negotiating trends. The table below shows some provisions within the UK-Senegal treaty that follow the OECD model (which favours the developed country) rather than the UN model (which is supposed to reflect a good balance in a negotiation between a developed and a developing country). The first of the three percentage columns shows that these are all provisions that have been included in the majority of treaties signed by developing countries in recent years; the second shows that they are included in the majority of Senegal’s treaties; the third shows how often the UK has conceded them to developing countries.

Selected provisions from the UK-Senegal tax treaty in context

Data source: ActionAid tax treaties dataset, forthcoming

The treaty is particularly unusual in that supervisory activities associated with a building site in Senegal conducted by a British firm will not be taxable in Senegal, nor will royalties paid to the UK for radio and TV programmes broadcast in Senegal. Both of these provisions are included in around 90% of tax treaties signed by developing countries, but are omitted from this one. It would certainly be interesting to ask why.

Second, it is notable that this treaty does not include a clause permitting Senegal to tax fees for technical services paid to the UK. This is something that Senegal’s chief negotiator has for years advocated strongly for, including in this submission to the UN tax committee [pdf]. The UK has many older treaties with developing countries that include this provision, but more recently it seems to have changed position, opposing them. In this negotiation, it looks like Senegal made a concession on this point. This is a contentious issue at the UN tax committee, but the committee – which has members from the UK and Senegal – looks to be heading towards including it within its model treaty. It would therefore be very interesting for politicians to debate the UK’s position.

Third, the ratification debate on this treaty could be an opening for a broader discussion of what the UK aims to achieve through its tax treaties with developing countries. To set this in context, in the chart below, every point represents a tax treaty signed by a developing country, with the vertical axis showing how source-based it is (that is, how much its content permits the developing country to tax investors from the treaty partner). The higher the point, the more the balance of the treaty tends towards the developing country’s favour. There’s a leisurely upward trend.

Source/residence balance in tax treaties: UK and Senegal highlighted

Data source: index based on the forthcoming ActionAid tax treaties dataset

The UK’s agreements with developing countries are in red, while Senegal’s are in blue. The UK-Senegal treaty is purple. While it looks to be about average for both countries, it is certainly one of the more restrictive (“residence-based”) treaties signed by developing countries in recent years. This seems to be typical of treaties signed recently by the UK, but a worse deal for Senegal than it has obtained for a few years. The implication that the UK is one of the toughest tax negotiators with developing countries is surely worth political interrogation, at a time when its Department for International Development is urging developing countries to improve tax collection.

The tax treaty arbitrators cometh

Next month sees the results of the OECD’s Base Erosion and Profit-Shifting project, as well as a discussion at the UN tax committee on alternative dispute resolution in tax treaties. India has apparently vetoed the inclusion of mandatory binding arbitration by default in the OECD model tax treaty, and it remains an optional provision within the UN model too. This post will show that arbitration provisions in treaties with developing countries are nonetheless on the march, and it will discuss some of the issues that this raises. It is taken from some comments I submitted alongside Todd Tucker on a draft paper for the UN committee’s discussion.

I’ve just returned from a field visit to, among other countries, Vietnam. With around 60 tax treaties in force, it’s been one of the most enthusiastic concluders of tax treaties over the last two and a half decades. It’s also quite clear that the General Department of Taxation regrets some of the things that the country gave away in its early negotiations. It is endeavouring to apply some provisions of these treaties in unconventional ways, and coming under pressure from foreign businesses who say that by doing so it is breaking with international norms. I sat in on a large meeting between the Vice Minister of Finance and Vietnam Business Forum (VBF) members, at which these concerns were raised. According to a typical statement from the VBF [pdf], Vietnam’s interpretations have “made the application of DTA[s] of foreign enterprises impossible, effectively it obliterate[s] the legitimate benefit of enterprises.”

As a consequence, Korean investors have recently begun to invoke the mutual agreement procedure (MAP) in the Korea-Vietnam tax treaty. Vietnam’s first ever MAP negotiation was taking place while I was there. MAPs, remember, do not require the two countries to reach an agreement, just to try their best. The resulting backlog of disputes among OECD countries is the reason why the OECD now seems to favour mandatory binding arbitration. Vietnam does not want to see mandatory binding arbitration clauses in its tax treaties, having already had its fingers burnt with investor-state arbitration. I am informed that such a clause was proposed by the US and rejected by Vietnam when the two countries negotiated their new tax treaty.

Vietnam said no, but others have not. One outcome of the Netherlands’ programme of renegotiations with developing countries, which is supposed to be about adding anti-abuse clauses, has been the insertion of binding arbitration clauses in several treaties with African countries. Here are all the arbitration clauses in African tax treaties to date (based on searching the IBFD tax treaties database for the term ‘arbitration’). They key column to look at is “how triggered”. Whereas the Canadian and Italian arbitration clauses require both countries’ consent before the case enters arbitration, all the others, following the OECD and UN model provisions, are binding on the developing country and can be triggered by either the other country or the taxpayer. The rest of the typology indicates that, as per usual, OECD-type provisions are more common than UN-type ones, even though the latter are supposed to be better for the developing country.

Arbitration clauses in African tax treaties

If we search for the term ‘arbitration’ in the IBFD tax treaties database, there are 219 results (caveat: not all of these references might be to ‘an arbitration clause’ as such, and some foreign-language treaties may have been missed). As the table below shows, arbitration clauses are of particular importance to jurisdictions whose treaty networks are used as part of tax planning strategies. By far the most arbitration clauses are in the treaty networks of the Netherlands and Switzerland, although the presence of Liechtenstein and Luxembourg in the top 10 list may also be indicative. At least two of the Swiss clauses, in its treaties with Peru and Argentina, are actually Most-Favoured Nation clauses triggered if the Latin American countries agree to binding arbitration with a third country. This suggests that, for Switzerland at least, arbitration clauses are important for its competitive position.

List of countries by number of tax treaties with some kind of arbitration clause

Here are a few issues that are presented by the spread of arbitration provisions that are binding on developing countries:

  1. There is barely any MAP experience in many developing countries. Interviews with revenue authority staff across numerous developing countries indicate that, outside perhaps the BRICS, many countries have yet to enter into a single MAP. Vietnam is a typical example. So the case for arbitration based on the huge backlog in OECD and G-20 countries is simply not there in many other countries, and may never be. Furthermore, that developing countries do not have the same experience of MAP negotiations as developed countries is a further reason why they should wait before agreeing to mandatory binding arbitration. If arbitration is designed primarily to increase pressure for a resolution in MAP, then the pressure on a developing country to capitulate at this stage will surely be increased by its inexperience in arbitration as well as MAP.
  2. The current UN model provision does not provide for the possibility of optional arbitration. If arbitration helps solves a structural problem in tax treaties, it is good for developing countries to consider it. But one way for them to take it slow is to sign up for clauses that create the option of arbitration without forcing them into it, such as those in the Italian and Canadian treaties with African countries. With such a provision, developing countries could build up some experience before deciding whether mandatory and binding arbitration is right for them. Unfortunately, this is not the current path taken by the UN committee, and so there’s little chance of developing countries obtaining it in negotiations.
  3. Arbitration enhances the negative impact of negotiation oversights. We know that, as in the case of Vietnam’s early treaties, the present impact was often not anticipated at the time the agreements were signed. While this situation has improved in some developing countries, in others, treaties are still being concluded now without adequate awareness among all parties of how they will bind future governments. There are various reasons for this, including: lack of technical expertise at the time of negotiation; politically driven negotiations in which the content of these treaties is barely considered; changing tax systems and economic conditions, especially the growth of e-commerce and services; new tax planning mechanisms; the relative autonomy of a small set of negotiators; weak or non-existent parliamentary ratification processes. Binding arbitration will further enhance this ‘golden straightjacket’ impact of tax treaties, reducing room to manoeuvre in cases where latter day tax treaties frustrate present day policy goals. This would especially be the case if a multilateral instrument were used retrospectively to add arbitration provisions to existing tax treaties.

A final thought. There are lots of reasons why eliminating all forms of double taxation faced by cross-border investors is a sensible thing to try to do. It is what tax treaties are supposed to be for. But sometimes governments, especially in developing countries, might deliberately choose to prioritise the maximisation of their tax base even when that leads to some double taxation. This is, arguably, what China, India and Brazil have done by adopting their own approaches to transfer pricing. Perhaps it is good if tax treaties leave sufficient space for this, so long as countries take seriously the repercussions of making use of that space.

Is tax treaty arbitration really a bad thing for developing countries?

I’m at the United Nations tax committee annual session this week, where I’ve learnt that I have to be careful what I write here, after a couple of posts from this blog were included in an input document [pdf]. Erk!

I’ve been taking the opportunity to discuss with delegates the recent article [£] by the chief of the UN committee’s secretariat, Michael Lennard, on the inclusion of arbitration in tax treaties with developing countries. Lennard begins from the concern that I’ve raised here too, which is that the BEPS Action Plan implies the use of a multilateral treaty to introduce mandatory arbitration clauses into existing tax treaties.

There are a number of potential problems with arbitration from a developing country perspective, which Lennard outlines, drawing on the experience of investment treaty arbitration. Briefly:

  • the cost of a full blown arbitration could be prohibitive for developing countries, forcing them to capitulate on some occasions, or alternatively stacking the process in favour of more wealthy countries who can afford the most skilled and experienced legal representatives.
  • Because transfer pricing expertise is limited in developing countries, it’s likely that most arbitrators themselves will come from developed countries, in which case their neutrality – or at least their sensitivity to the realities of developing country tax administration – might be questioned.
  • There is a range of concerns about the lack of transparency in arbitration outcomes, which is a problem for scrutiny (I’ve shared before a paper by Alison Christians on this topic), but could also mean that countries and lawyers only have their own experience to learn from, further biasing the arbitration process against developing countries to whom arbitration would be new.

Lennard also talks about a range of ways that arbitration might work better for developing countries. I’m just going to focus on one aspect of this, which is the ‘simplified procedure’ that is used in the UN model’s optional clause. (It’s also known as ‘baseball arbitration’, because it’s used in pay negotiations in the US baseball league).

Under the simplified procedure, the arbitrator doesn’t have to produce her own solution that tries to synthesise the concerns of the two sides. Instead she just chooses between one side’s position or the other.

Delegates I spoke to here said that the analogy with investment arbitration doesn’t hold when the simplified procedure is applied:

  • The costs are much lower, because there’s no need for lengthy meetings, the process demands much less time from the arbitrator, and – so one committee member said to me – you don’t need a lawyer to prepare written submissions.
  • The arbitration tends to move countries’ positions closer together, because it’s an all or nothing outcome, and a more conservative position might be more likely to succeed.
  • The democratic scrutiny point notwithstanding, transparency isn’t such a concern because the arbitrator is only permitted to choose one side, not to explain her reasoning – so there is very little to learn from past experience.

These discussions have certainly changed my thinking a bit, but I’m not sure that it is as clear-cut as those who favour arbitration suggest. In a judgement-based process, as opposed to a purely rules-based one, the quality of submissions is sure to affect the outcome. And it’s inevitable that an imbalance between countries in resources, expertise and experience will translate into an imbalanced outcome. Isn’t it?