Britain's exit from the EU means that the benefits of the EU Arbitration Convention will no longer be available to tax treaty disputes between the UK the EU. The EU Arbitration Convention is considered a fix for a number of flaws that are inherent to "classic" OECD settlement mechanisms. Brexit means that tax treaty dispute resolution will suffer, in particular between the UK and Luxembourg, unless BEPS and the Multilateral Instrument are able to step in and help.
Brexit and the new business relationship
The actual "Brexit" is not foreseen to happen before 2019, as the UK and the remaining EU Member States have a two-year period to negotiate a framework for a new relationship. It is well worth considering Brexit's impacts on cross-border disputes in order to prepare for changes because, in the long run, the UK will become a third state and therefore no longer profit from the harmonising common rules of EU law. In this new context, Luxembourg's aim is to bridge the gap that Brexit will create between the EU and the UK.
Indeed, the UK's decision has put the spotlight on Luxembourg as a place where financial businesses that want to keep market access can relocate. Some moves are already underway. Rather than a replication of London, however, Luxembourg policymakers consider the services available in the Grand Duchy "complementary" to those in Britain's financial centre. There is a symbiotic relationship between the two business hubs: "We have had a co-operative approach with London for decades and that's what we want to continue tomorrow," says Luxembourg's Finance Minister Pierre Gramegna. "It's our largest partner for the financial centre of Luxembourg."
Shifting business from the UK to Luxembourg will increase cross-border tax issues between the countries, and ultimately the number of dispute resolution cases.
"Traditional" dispute resolution
Traditionally, the only parties to a tax treaty are the contracting states. Ultimately, however, if a dispute is not resolved, then the relief or burden embodied in such a decision is borne by taxpayers. Taxpayers may a priori defend their rights in domestic courts only, a mechanism which does not guarantee a uniform resolution of the dispute because courts in different countries may base their rulings on diverging facts. It could also happen that a certain treaty provision is interpreted differently by each court. The result may be double taxation or double non-taxation.
In order to address this lack of coordination, most tax treaties provide for state-to-state mutual agreement procedures (so-called "MAPs"). The tax treaties between the UK and Luxembourg are no exception, nor are the UK's treaties with most, if not all, other EU members. The treaties provide for the settlement of disputes by way of intergovernmental negotiations. Along this system, a taxpayer who will suffer tax in a way that is contrary to the treaty can appeal to the competent authority of his or her state of residence. This authority will examine whether the complaint is justified and then, if deemed appropriate, present the case to the competent authority of the other contracting state. The two competent authorities will then endeavour—but are generally not obliged—to resolve the case by way of an intergovernmental MAP.
Those procedures are part of classic diplomatic negotiations. The contracting states are bound by the final decision.
The advantages of this system mainly lie in the procedure being cheap for the taxpayer, with the main cost being administrative and professional adviser fees. The weaknesses consist in there being no guarantee for the taxpayer that an agreement will be reached and, if it is, that any change will be implemented thereafter. Even where cases go through the system successfully, MAPs can be very time consuming: it is not uncommon for a MAP to take 8-10 years to resolve.
EU tax dispute resolution
The aforementioned EU Arbitration Convention has been the EU's solution to the shortcomings of this traditional system. The Convention establishes a procedure for resolving disputes in which double taxation occurs between enterprises of different Member States as a result of one enterprise's upward adjustment of profits. This is an improvement on the traditional MAP insofar as the EU-resident taxpayer can be certain that a procedure will be started, and that the double taxation will be eliminated. The duration of the proceedings is also restricted: the competent authorities have two years to negotiate an agreement—failing which, the case will be referred to a tax arbitration commission that will deliver an opinion within six months. The competent authorities than have another six months to decide whether to accept the arbitration decision or to agree on an alternative.
With the UK stepping out of the EU Arbitration Convention, the quality of tax treaty dispute resolution may suffer, as MAPs will be resolved according to the traditional resolution method again. There is a chance that BEPS and the Multilateral Instrument will provide some help in this area. Watch this space for the second in this two-part article series, in which we'll dig deeper into new possibilities.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
