The most accessible instrument for avoiding double taxation is the mutual agreement procedure. Neither Russian legislation nor international tax treaties regulate it in any detail. This article gives examples of how it is used in international practice, and recommendations for improving it in Russia.
Prospects for the mutual agreement procedure in Russia
From January 2021, the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the Multilateral Convention, MLI) will enter into force in Russia. The provisions of this instrument change the rules for applying 71 of the 84 agreements for the avoidance of double taxation (double tax treaties) in force that the Russian Federation has concluded with other countries.
The MLI introduces standards on "eliminating double taxation without creating an opportunity for tax avoidance": minimum standards, which are mandatory for all countries, and optional standards, which a state introduces at its choice. The minimum standards are aimed at preventing abuse of the provisions of double tax treaties, and at improving the mutual agreement procedure, which is to give the taxpayer a right to have questions of double taxation resolved.
The mutual agreement procedure will help taxpayers acting in good faith to defend, on an individual basis, the right to apply tax relief under a double tax treaty in two states at the same time. Its purpose is to protect the taxpayer's interests, Vasile Lupu notes.
For taxes withheld at source, the MLI will apply no earlier than 1 January 2021 to double tax treaties concluded with jurisdictions that have already ratified the Multilateral Convention. For all other taxes, it will apply according to the time it takes to agree the new terms with each particular country, but no earlier than 1 January 2021. For the MLI to apply to a particular treaty, the partner state must sign the convention and include Russia in the list of countries in respect of which it applies. Alongside the tightening of the rules on granting tax relief, however, the MLI obliges states to agree tax questions between themselves without litigation in each of them. In that situation the mutual agreement procedure comes to be in demand among businesses.
It is worth looking at when the procedure is a good instrument for establishing fair taxation.
An example
A Russian citizen owns real estate and a business in Russia and in Austria, took a direct part in the activity of these companies, which interact with each other, and received income in both countries. The Russian and Austrian tax authorities have each recognised this Russian citizen as their tax resident: he must pay tax on his worldwide income into the budget of each of these states, and report on controlled foreign companies to the authorised bodies. The provisions of the double tax treaty will not resolve this problem with any certainty. The taxpayer is in a difficult position. His income is subject to double taxation, and he now has to persuade the tax authorities of each country that he has acted in good faith, and to avoid additional cost. The simplest way to settle the situation is for the competent authorities, under the bilateral treaty, to determine the person's residence by mutual agreement for the purposes of applying the double tax treaty. The taxpayer then needs to assess the prospects of using the mutual agreement procedure.
How the mutual agreement procedure is regulated
Although double tax treaties contain provisions on the mutual agreement procedure, in practice a taxpayer still rarely has a chance to defend their interests, because domestic legislation has no procedure and no rules for it.
The BEPS Action Plan provides for improving the mutual agreement procedure so that it protects the right to have double taxation eliminated where states have already concluded a double tax treaty. To fill the gaps in domestic legislation, Action 14, "Dispute Resolution Mechanism" (Mutual Agreement Procedure – MAP), of the BEPS Action Plan was developed.
In Russia, Chapter 20.3 of the Tax Code of the Russian Federation and the Guidance on Conducting the Mutual Agreement Procedure (the Guidance) are based on the fundamental principles of MAP.
The mechanism is available to a person involved in cross-border transactions (paragraph 2 of Article 142.8 of the Tax Code), or to the competent authority of a foreign state that is a party to a double tax treaty. Either may initiate the resolution of a dispute about how income, profits and property are taxed when the provisions of a double tax treaty with a particular country are applied. Those provisions determine the procedure and the time limits for an intergovernmental mutual agreement procedure (paragraph 1 of Article 142.8 of the Tax Code). The parties must file applications for the procedure with the Russian Ministry of Finance (paragraph 3 of Article 142.8 of the Tax Code), which regulates the procedure in Russia.
Under the Guidance, published in 2019, the mutual agreement procedure allows a taxpayer, where the states have a double tax treaty, to protect their income if tax is paid twice because of an incorrect interpretation and the actions of the tax authorities of the states that are parties to the legal relationship. Russia can conduct such procedures with the 89 countries with which it has a double tax treaty. No fee is charged for conducting them, Vasile Lupu points out.
Situations are treated as disputed if:
• the actions of the tax authority of one or both of the states between which a double tax treaty has been concluded have led, or may lead, to taxation that is not in accordance with its provisions;
• any difficulties or doubts that arise in the interpretation or application of the double tax treaty need to be settled by mutual agreement;
• consultations are required between the competent authorities on questions not provided for in the double tax treaty, with a view to eliminating double taxation.
If three years have not yet passed since the actions that conflict with taxation under the double tax treaty, the taxpayer may file an application with the Russian Ministry of Finance for a mutual agreement procedure.
The following set of documents has to be prepared:
• an application for the procedure;
• a statement setting out the main particulars of the applicant (in free form);
• a copy of the state registration certificate, OGRN or OGRNIP (for legal entities and individual entrepreneurs);
• the applicant's claim, with a reference to the double tax treaty;
• the position of the person to whom the double tax treaty applies on the question of how the taxation is inconsistent with the provisions of the treaty;
• detailed information on the facts and circumstances of the case;
• particulars of the tax period specified in the application;
• copies of contracts and other documents;
• copies of the materials of the tax audit;
• detailed particulars of any pre-trial or court appeal, and of any decisions on the situation in question in Russia or abroad.
The Ministry considers the application unilaterally. No time limit is set for considering it and for deciding to open the procedure or to refuse it. Under the general recommendations of the OECD and the practice of various countries, that period may be from 30 to 90 days from the date the taxpayer's application is received.
The Russian Guidance does not regulate relations between the Russian Federation and the other state. For an agreement to be reached, under the OECD Recommendations and general practice, the time for considering an application to conclude a bilateral (multilateral) agreement is 24 months. Domestic legislation does not set that time. It remains an open question which authorised bodies will deal with each other, and whether there are sanctions for states (authorised bodies) that fail to meet the time limit.
As a result of the mutual agreement procedure, an organisation will be able to adjust the amount of profits tax and also to recover it under Article 78 of the Tax Code.
It has to be remembered, however, that Russia has declined to apply the other form of dispute resolution, arbitration. All disputes between the Russian and foreign competent authorities can therefore be resolved only within the mutual agreement procedure. It is the only instrument, but it is not yet clear how effective it is.
How the mutual agreement procedure is applied in OECD member countries
In 2017 the leaders in mutual agreement procedures were Germany (1241), the United States (983), France (882) and India (763). Only 14 procedures were initiated in Russia. In 2018 the leaders were unchanged: Germany (1198), the United States (1007), France (972) and India (841). Russia had 24 procedures, although over 2016-2018, according to the OECD, only 4 of them were closed.
The mutual agreement procedure is being improved, and it is becoming more widely used. Compared with 2016, the number of procedures initiated rose substantially: in 2018, for example, there were 59% more than two years earlier. In Russia the number of procedures rose by 71%.
OECD statistics
At the end of 2016, 8002 mutual agreement procedures were under consideration, of which 1496 had been initiated in the same year; the average time taken to consider a procedure on transfer pricing was 30 months, and on all other tax issues 17 months. At the end of 2017, 7500 procedures were under consideration, of which 2076 had been initiated in the same year; the average time taken to consider a procedure on transfer pricing was 30 months, and on all other tax issues 17 months. At the end of 2018, 6924 procedures were under consideration, of which 2385 had been initiated in the same year; the average time taken to consider a procedure on transfer pricing was 33 months, and on all other tax issues 14 months.
The duration of these procedures increased for transfer pricing issues, but decreased for general issues. It should be noted that some countries apply commitments on international arbitration, which form part of the OECD's general recommendations on mutual agreement procedures.
Examples
France. The mutual agreement procedure is divided into two phases. In the first, which is in writing, the tax authorities set out their positions. The second is negotiation at meetings of joint committees. The procedure is a semi-diplomatic process. The taxpayer is not entitled to consult the competent authorities of the states and does not take part in the negotiations. At the end of the procedure the competent authority tells the taxpayer of the decisions taken by the authorities of both states. If the taxpayer agrees with the decision, the taxpayer is invited, so as to avoid the risk of a double exemption, to refrain from any administrative or judicial remedy challenging both the substance and the form of the taxation in question. If the taxpayer rejects the proposal or does not reply to the decision, the decision lapses, and the taxpayer's position may be settled in each state on the basis of the interpretation of the legislation and of court proceedings. If the states do not reach an agreement, the procedure ends without double taxation being eliminated. In that case the taxpayer's position is settled in each country separately.
Germany. If the mutual agreement procedure does not result in an agreement within two years, the competent authorities of the contracting states are obliged to appoint an advisory commission and to obtain its opinion. They may extend this two-year period with the consent of the participants in the process.
Malta. The taxpayer must first make a formal application in writing to the authorised body. The taxpayer has the right to send the same request to the second contracting state (unlike in France). To help the case to be resolved promptly under the mutual agreement procedure, the taxpayer is advised to submit all supporting materials to both competent authorities of the participating countries in good time and simultaneously.
Recommendations for improving the mutual agreement procedure
It has to be remembered that Russia has not introduced provisions on international arbitration, and has implemented only the mutual agreement procedure, so the scope for using its provisions effectively is limited. Despite the gaps, and the differences in how the OECD rules have been adapted, the way the procedure would be applied in Russia can be modelled on the existing provisions and on international standards. Taken together, these provisions form a basis on which business can join the Russian Ministry of Finance in discussing questions of double taxation.
Further improvement of the mutual agreement procedure can be guided by how it would operate under the draft BRICS Multilateral Convention. That draft has been prepared in line with the OECD's general recommendations, and it would coherently improve the Guidance of the Russian Ministry of Finance that is already in force, through the following standards:
• in addition to the mutual agreement procedure, it is advisable to implement the provisions and the procedure for international arbitration that exist under the MLI;
• an unresolved dispute for an amount of more than 100 thousand US dollars, or an equivalent amount in the national currency of the contracting states, may be considered in the mutual agreement procedure (or in international tax arbitration, if that is implemented);
• the competent authority that has received the application is obliged, within 30 days, to notify the competent authority of the other contracting state and to send it copies of the application and the documents;
• each competent authority appoints one qualified person (an arbitrator, if arbitration is implemented) within 60 days of the date on which the application to settle the cross-border tax dispute is filed; the two appointed qualified persons (arbitrators) unanimously choose a third arbitrator within ten days of the date of their appointment;
• qualified persons (arbitrators) are chosen from among natural persons who are nationals of the contracting states, competent in international taxation, holding academic titles and degrees, independent of the competent authorities of the contracting states and of the applicant, and not otherwise interested in the outcome of the case; the three qualified persons (arbitrators) form an arbitration panel competent to consider the tax dispute;
• the collegiate international tax (arbitration) panel considers the dispute within no more than one year from the day it is formed, under the rules of procedure;
• the decision of the collegiate international tax (arbitration) panel is final and binding on the competent authorities of the contracting states and on the applicant; the panel's decision may become a precedent if the competent authorities of the contracting states mutually express that intention.
To protect the interests of all parties to international legal relations and to prevent double taxation, it is advisable in Russia to:
• specify, in the Tax Code and in the Guidance, the procedure and the time limits for carrying out what has been agreed in the mutual agreement procedure (a refund of tax withheld or paid in excess, or an additional tax assessment);
• add to the Guidance specific time limits for the Russian Ministry of Finance to reply to a taxpayer's application, and the consequences if the application is left without attention;
• clarify the powers and the actions of the tax authorities of each country within the procedure; so that the procedure is conducted transparently and an optimal result can be reached, it should be specified how the Russian Ministry of Finance acts if Russia initiates the procedure and, conversely, if Russia is the respondent state;
• build an open, unified database of decisions in mutual agreement procedures, which would make practice consistent and make it possible to predict decisions on questions that arise and, as a result, would automatically fill the gaps in the regulation of this mechanism. Such a database could publish both anonymised decisions (if the taxpayer wishes to keep the matter confidential) and specific decisions (depending on the consent of the participants in the procedure). A public catalogue of such cases would be informative, and would allow taxpayers to understand the logic and the operating principle of the procedure, to plan their activity, and to avoid difficult exchanges with the tax authorities of different countries.
Greater transparency in mutual agreement procedures and in fiscal control, including through a genuine expert assessment of each case, will produce an effective instrument for protecting the interests of taxpayers and of the budget. These factors will support good relations and dialogue between business and the state.
"Preparing and defining a long-term strategy for protecting one's interests, for submitting documents and for dealing with both states are also of great importance. The unique circumstances of each particular case, and the specifics of the legislation of the country involved, have to be kept in mind. Given those particular features, it is advisable, taking the international rules and the case law of both countries into account, to prepare a detailed set of documents that can form the basis of a tax dispute if the outcome is unsatisfactory for the taxpayer," Vasile Lupu, head of the international tax practice at Consul Group.
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