Nuts, Bolts, and Nuances of the Competent Authority Process: Relief is provided in most cases, but pitfalls and new issues are multiplying.

AuthorDunahoo, Carol

The competent authority procedure is a dispute resolution mechanism available to taxpayers facing cross-border disputes under an applicable tax treaty. The taxpayer may invoke this procedure to require the tax administrations competent authority function to "endeavor" to resolve the dispute by "mutual agreement" with its counterpart in the treaty partner jurisdiction. Despite the seemingly weak commitment to "endeavor" to agree, the Final Report on BEPS Action 14 confirmed that treaty partners are legally obligated to endeavor in good faith to reach agreement. And, although it may seem surprising for a process that relies on good faith conduct, most cases result in an agreement, typically with one or both of the competent authorities compromising its administrations initial position. For example, the U.S. competent authority office within the Internal Revenue Service's Large Business and International Division historically has reported relief achieved for eighty-five to ninety-five percent of the total amounts at issue in the cases it closes.

Initial Considerations

Companies increasingly opt to invoke the competent authority procedure as international tax disputes proliferate around the world, with the number of cases more than doubling in the last ten reported years. It may not always be the best mechanism in a particular case, but it generally merits serious consideration by taxpayers where a treaty applies.

The taxpayer should, in any case, evaluate all available procedural options at the outset, both to identify the best option and to avoid surprises. While domestic law procedures, such as administrative appeals and litigation, are normally also available in most countries, in some cases these may prove less effective for avoiding double taxation because of their potential inability to ensure full relief without the agreement of the other contracting state. In addition, the use of one process may preclude the use of others. For example, some countries take the position that competent authority consideration may be precluded or delayed if the case is first litigated. Furthermore, where a case has been litigated under domestic law with a final judgment, some countries, including the United States, take the position that the competent authority is precluded from agreeing to a different result.

Potential pitfall: U.S. taxpayers have two additional strong incentives to consider the competent authority process where available. First, Treas. Reg. [section]901-2(e)(5) identifies competent authority consideration as one of the "remedies" the taxpayer must generally "exhaust" where "effective and practical" to avoid a potential IRS challenge to its foreign tax credit claim. Second, current IRS competent authority procedures prevent taxpayers from pursuing IRS Appeals relief first and competent authority second; competent authority consideration must be pursued either first or simultaneously with IRS Appeals.

To make an informed choice between the competent authority process and other alternatives such as appeals and litigation, taxpayers need to know how the process works, both in principle and in current practice between the jurisdictions concerned. The remainder of this article focuses on key considerations relating to these aspects.

Scope and Effect of Competent Authority Process

The competent authorities can typically address any issue regarding the interpretation or application of a relevant treaty, including, for example:

* "juridical" double taxation of a single taxpayer;

* "economic" double taxation of related taxpayers;

* PE definition and profit attribution issues;

* revenue characterization and other withholding tax issues;

* capital gains provisions;

* applicability of BEPS "principal purpose test" provisions;

* determination of corporate residence;

* requests for discretionary benefits under U.S. limitation on benefits treaty provisions; and

* under most treaties, even cases of double taxation not otherwise covered by the treaty.

The competent authority procedure can also be used to conclude generally applicable bilateral agreements regarding the interpretation or application of the treaty, such as definitions of terms not defined by the treaty, either at the request of taxpayers or at the initiative of the competent authorities.

Potential pitfall: Some competent authorities take the position, contrary to the Organisation for...

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