Australia-UK MOU on Arbitration- what difference does it make

Introduction

The UK's HMRC and the Australian Taxation Office ("ATO") have entered into a Memorandum of Understanding ("MOU") under the Multilateral Instrument ("MLI") setting out the procedure for mandatory binding arbitration of double tax treaty disputes. The MOU took effect from 21 May 2021.The MOU provides welcome clarity on the arbitration procedure for Australian-UK double tax treaty disputes, particularly in giving fixed timeframes for the process, detailing the information and level of detail required for submitting a request for arbitration, and offering the taxpayer greater involvement than with the existing mutual agreement procedure ("MAP"). However, the arbitration itself is still largely a bilateral inter-state process which offers contracting states a high degree of flexibility, and gives little control to the affected taxpayer.

Mutual agreement

Under a double taxation treaty, there are often situations where issues need to be resolved by the process of mutual agreement. For example, where an Australian incorporated company is controlled and managed from the UK, a dispute may arise concerning the tax residence of the company.

In such situations, Article 26 of the 2003 Australia-UK Double Taxation Convention (the "Double Tax Treaty") provides for the mutual agreement procedure ("MAP"), whereby the taxpayer can present their case to the Competent Authority of either contracting state to that Treaty. If the case appears to be justified and cannot be resolved unilaterally, the Competent Authority that was presented with the case has an obligation under the Treaty to work with its counterpart contracting state to agree a resolution which avoids taxing the person in a way not in accordance with the Double Tax Treaty.

The key disadvantages of the MAP for that taxpayer are that it is merely a consultative process at the discretion of the Contracting States. The states only have an obligation to "endeavour" to reach a resolution. It is an exclusive inter-state process which offers little certainties and involvement to the taxpayer. It provides for no fixed end date and lacks transparency.

Further, it is clear from the recent decision in GE Financial Investments v HMRC [2021] UKFTT 210 (TC) that states do not always reach a mutual agreement and that it can be a long drawn-out process.

In that case, GE Financial Investments ("GEFI") presented its case to the Competent Authorities in the UK and US in November 2014. The two Competent Authorities entered into MAP discussions in October 2015 on two issues: (i) whether GEFI was a resident of the US under the Double Tax Treaty, and (ii) whether GEFI carried on business in the US through a permanent establishment situated therein.

In the absence of a MOU between the US and UK, no agreement was reached between the two Competent Authorities on either issue. The case was ultimately litigated and judgment was not handed down in the First Tier Tribunal until June 2021, over six years since GEFI presented its case.

Mandatory binding arbitration

Mandatory binding arbitration under the Multilateral Instrument ("MLI") provides a structured framework for resolving double taxation treaty issues. If after two years (unless a different time period is agreed between the Competent Authorities) the two contracting states have not agreed a resolution of the case under the MAP, the taxpayer can make a request that those unresolved issues be submitted to arbitration.

Mandatory binding arbitration offers clear advantages for a taxpayer in that it provides for a final decision on the issue(s) in question and a timeframe for that final decision.

The MOU signed on 21 May establishes the mode of application of the mandatory binding arbitration process provided for in the MLI for double tax disputes under the Double Tax Treaty.

Key features of the MOU

Two types of process

The MOU affords the contracting states a great degree of flexibility. There are two arbitration processes expressly provided for in the MOU but the Competent Authorities also have a discretion to jointly determine an unspecified "different type" of arbitration process.

The default process provided for is "baseball arbitration" whereby the two Competent Authorities each submit to the Chair of the arbitration panel a proposed resolution which addresses all of the unresolved issues in the case. The arbitration panel must select one of the two, alternative, proposals. It cannot substitute its own judgement. Whilst baseball arbitration can reduce the costs and time of the dispute, the resolutions that are submitted must be limited to a "disposition of specific monetary amounts." A supporting position paper may also be submitted. The panel's autonomy is limited as there is no provision for a reasoned opinion.

Where there is an unresolved issue relating to application of a provision of the Double Tax Treaty, such as whether a taxpayer is resident or whether a permanent establishment exists (a "threshold question"), the Competent Authorities can submit alternative proposed resolutions which turn on the outcome of that threshold question.

The second process provided for offers more involvement to the taxpayer and may be better suited to disputes where assigning a specific monetary amount is an unsuitable method for resolving the case.

If the Competent Authorities mutually choose to adopt this procedure, they must each provide to their counterpart and the panel any information which is considered necessary for the panel to reach its decision. The information should include a description of the facts, the unresolved issues and the position and supporting arguments of the Competent Authority.

The taxpayer who made the request for the arbitration is permitted to present their own position in writing (directly or through their representatives) to the arbitrators, to the same extent that they can do so in the mutual agreement procedure. The Competent Authorities will submit the written information to the panel on behalf of the taxpayer. The arbitration decision in this procedure will identify the sources of law relied upon and the reasoning which led to its result. The arbitration decisions have no precedential value.

Timeframes

The MOU provides for fixed time limits for each of the stages of the arbitration. These are significant in driving the process towards a conclusion that is absent from the MAP. The time frames in the MOU are set out in the flow chart below. However, whilst clarity over the time frame is welcomed, it should be noted that a taxpayer cannot even request that an arbitration process be commenced until 2 years after the taxpayer has presented its initial case under the Mutual Agreement Procedure.

Costs

Unless otherwise jointly determined by the Competent Authorities, each Competent Authority and the taxpayer requesting the arbitration will bear the costs related to their own participation in the arbitration process, including travel costs and costs related to the preparation and presentation of its views. Therefore, if the second arbitration process is chosen, taxpayers should be prepared to pay their own costs incurred for submitting their positions. The Competent Authorises will jointly determine the compensation of the arbitrators and they will bear in equal shares all other costs related to the arbitration proceedings.

Reservation

Australia has chosen to reserve the right to exclude from arbitration any case that relates to the application of Australia's general anti-avoidance rules. The UK has not reserved the right to exclude any arbitrations.

Implementation

The MOU provides that the arbitration decision will be adopted within 60 days after the Panel's decision is communicated to the Competent Authorities. The decision will be adopted by the two Competent Authorities by reaching a mutual agreement on the case. However, that mutual agreement will only be given effect to after "all persons directly affected" by the case have confirmed in writing that (i) they accept the mutual agreement and (ii) that they have withdrawn all issues that have been resolved by the decision from any court or tribunal proceedings. The taxpayer is therefore given further involvement at this key stage.

Authors: Nicholas Gardner, Partner; Tom Cummins, Partner; Fraser Collingham, Trainee