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Comments on revision of competent authority revenue procedure.

July 19, 2000

On July 19, 2000, TEI President Charles W. Shewbridge, III sent the following letter to Elvin T. Hedgpeth, IRS Deputy Director, International, concerning the revision of Rev. Proc. 96-13, which deals with the procedures for requesting Competent Authority assistance under an applicable income tax treaty. The letter was drafted under the aegis of TEI's International Tax Committee, whose 1999-2000 chair is Michael P. Boyle of Microsoft Corporation. Materially contributing to the preparation of the comments were G. Richard Eigenbrode of Applied Materials, Inc., Thomas R. Howe of Unisys Corporation, Jeffrey J. Lonsdale of Lamar Hunt Family Companies, Roger H. Newman, Jr. of Microsoft Corporation, and Alan B. Richer of General Electric Company.

On behalf of Tax Executives Institute, I am pleased to respond to the Internal Revenue Service's request for comments on the proposed revision of Rev. Proc. 96-13, 1996-1 C.B. 616, which deals with the procedures for requesting Competent Authority assistance under an applicable income tax treaty. Representatives of TEI met with representatives from your office on March 16 to discuss substantive changes to the procedure. This letter confirms, supplements, and elaborates on those discussions.

The U.S. Competent Authority generally assists taxpayers with respect to matters covered in the mutual agreement procedure provisions of tax treaties. Taxpayers may request U.S. Competent Authority assistance when they consider the actions of the United States, the treaty country, or both will result in taxation contrary to the provisions of the applicable treaty. All requests for Competent Authority involvement must be submitted in accordance with Rev. Proc. 96-13. As the number and size of cross-border transactions increase and U.S. treaty partners devote more resources to double taxation issues (particularly in the transfer pricing and permanent establishment areas), the Competent Authority process has gained in importance.

TEI commends the IRS for seeking taxpayers' views on how this important facet of U.S. tax administration can become more effective. Although the negotiations are government to government, taxpayers are parties in interest to the negotiations. If the Competent Authorities are unable to reach an agreement, it is the taxpayer that will suffer. The revised procedure should be designed to reach a resolution of double taxation issues in as expeditious a manner as possible. Specific aspects of the Competent Authority process are discussed below.

Effect of IRS Reorganization

As part of the modernization of the Internal Revenue Service, the Competent Authority function has been moved to the new Large and Mid-Size Business (LMSB) Division. The U.S. Competent Authority, imbedded in the new Office of the Director, International, now reports to the LMSB Commissioner. The office will handle all Competent Authority issues, however, whether or not generated within the LMSB Division. International examiners will also be in the LMSB Division.

TEI believes it is important that the reorganization of the IRS not be perceived as diminishing either the significance or the autonomy of the Competent Authority function. The Competent Authority function has traditionally been separate from the IRS's Examination function, and its placement within the LMSB organization should not be allowed to compromise that autonomy. The Institute urges the IRS to adopt formal procedures to insulate the Competent Authority function and preserve its independence.

Interaction with Appeals

In recent years, the IRS has undertaken a variety of initiatives to encourage the early resolution of significant issues, including transfer pricing matters. See, e.g., Rev. Proc. 94-67, 1994-2 C.B. 800 (procedure for requesting accelerated issue resolution); Rev. Proc. 96-53, 1996-2 C.B. 375 (procedure for obtaining an advance pricing agreement). Among the avenues open to the taxpayer is simultaneous review of issues by Competent Authority and Appeals. Under section 8.01 of Rev. Proc. 96-13, a taxpayer may request Competent Authority and Appeals to consider an issue at the same time or at a later date. The U.S. Competent Authority also may request the involvement of Appeals if it is determined that such involvement would facilitate the negotiation of a mutual agreement in the case or otherwise would serve the interest of the IRS. The simultaneous procedure has the potential of reducing the overall time required to resolve disputes.

One consequence of these many initiatives has been increased flexibility for the taxpayer to select a dispute resolution procedure accommodating its needs and style. TEI recommends that this flexibility be retained under the new reorganization. In particular, the simultaneous Appeals/Competent Authority process should be retained.

Lapse Time

The most recent statistics for Competent Authority cases indicate that the average time period for resolution of transfer pricing disputes has been reduced in fiscal year 1998 to 779 days (from 876 days in 1997). Although TEI commends the IRS for its improvements in this area, two years is too long. Hence, we believe that more needs to be done to speed up the resolution of Competent Authority cases. For example, steps should be taken to streamline and circumscribe the involvement of field personnel, which often unnecessarily lengthens the process. Although we recognize that consultation with the field may be necessary, we suggest that the field's role in resolving the dispute should be limited to responding to questions within a specific time frame(1).

Cross-border business transactions are moving at lightning speed in today's economy and tax administration must keep pace. LMSB clearly recognizes this fact in adopting globalization as one of its strategic thrusts. A key to responding in the global economy is speed. Therefore, the Institute recommends that the U.S. Competent Authority establish a goal of resolving cases in one year or less. To encourage other countries to adopt this goal, the IRS could publish statistics on the time it takes to reach a resolution with specific countries. In addition, the United States should work with organizations such as the Organisation for Economic Cooperation and Development (OECD) to encourage countries to resolve Competent Authority issues more expeditiously. At a minimum, the IRS should consider suspending interest on deficiencies when the Competent Authority proceedings extend beyond a year.

Taxpayer Involvement in the Process

The Competent Authority process is a government-to-government program and the taxpayer is not a direct participant. Taxpayers remain, however, true parties in interest because, until the dispute is resolved, they face multiple taxation. Hence, taxpayers should be kept advised of the progress of the negotiations. Otherwise, taxpayers may well view the Competent Authority process as a black hole where cases enter the system and never leave. Reports from the Institute's members indicate that taxpayers are becoming more and more involved in the processing of the cases. The IRS should continue this trend, which will facilitate the negotiation of a settlement.

Notwithstanding the desirability for more taxpayer involvement, the only reference to taxpayer involvement in Rev. Proc. 96-13 is in section 4.09, which relates to the pre-filing conference. TEI recommends that the revised procedure specifically include sections providing for the formal involvement of taxpayers in the Competent Authority process. For example, the procedure should state that taxpayers will be permitted to review and comment on any tentative settlement before it becomes final. In addition, taxpayers could be given the opportunity at the start of formal Competent Authority proceedings to outline the facts.

Deficiency Interest and Exchange Gain or Loss

In some cases, the Competent Authority process has not provided full relief from double taxation because the Competent Authorities do not address issues involving deficiency interest or exchange gains and losses arising from the settlement. The Mutual Agreement Procedure article of U.S. tax treaties provide the Competent Authorities with the power to waive (or reduce) interest on deficiencies or to provide for the tax treatment of exchange gains or losses. Although the article may vary from treaty to treaty, the 1996 U.S. Model Income Tax Treaty provides that the Competent Authorities may agree to (i) "the same characterization of particular items of income" and (ii) "the application of the provisions of domestic law regarding penalties, fines, and interest in a manner consistent with the purposes of this Convention." In addition, prior delegation orders have granted the U.S. Competent Authority the authority to "administer all those functions derived from the operating provisions of the tax treaties and tax information exchange agreements." Del. Order No. 114 (Rev. 9), 1990-2 C.B. 326. See also Del. Order No. 97 (Rev. 31), 1992-2 C.B. 357, which granted the U.S. Competent Authority the authority to enter into and approve a written agreement "to provide for the mitigation of economic double taxation...." In most cases, therefore, the Competent Authorities may waive interest and penalties or provide for the income tax treatment of exchange gains or losses.

If the issue of interest is not addressed in the Competent Authority settlement, the taxpayer may secure only partial relief since the treatment of these items -- as well as the timing of income or loss recognition -- frequently varies among treaty partners. For example, a settlement resulting in an increase in Canadian tax liability and a corresponding reduction in U.S. tax liability may result in effective double taxation because deficiency interest is not deductible under Canadian law. In other cases, the treaty partners may calculate deficiency and refund interest as of different years. Some countries (such as Switzerland) may reflect the adjustment in the year of settlement and not provide refund interest (or charge deficiency interest) from the year to which the adjustment pertains; other countries (such as France) generally do not pay interest on tax refunds.

Taxpayers may also recognize foreign currency exchange gain or loss in connection with a Competent Authority settlement or repatriation pursuant to Rev. Proc. 99-32, 1999-34 I.R.B. 296 (adjustment to conform accounts to reflect section 482 adjustments). We recommend the Competent Authority include the treatment of interest and exchange gain and loss resulting from a settlement as subjects for negotiation between the Competent Authorities. At a minimum, if the Competent Authorities are unable to reach an agreement, this fact should be taken into account in assessing interest and penalties against the taxpayer.

Additional Years and Issues

The revised procedure should delineate how taxpayers may propose to add years and issues after the Competent Authority process has begun. The current procedure fails to address this issue in a clear and concise manner.


The 1996 U.S. Model Income Tax Treaty does not contain an arbitration provision, but such an article has been included in the U.S.-Germany and U.S.-Netherlands tax treaties (which entered into force, respectively, in 1991 and 1993). In addition, the European Union has instituted a mandatory procedure that provides for binding arbitration to solve disagreements between EU taxing authorities in respect of transfer pricing disputes that cannot be resolved through the Competent Authority process within two years. During our March 16 meeting, you asked for TEI's comments on whether an arbitration procedure should be initiated and, if so, how it should be structured.

TEI believes that any mechanism that drives the negotiating parties toward resolution should be encouraged. The Institute thus believes that the use of arbitration in the international arena could play a useful role. Arbitration would put additional pressure on treaty partners to negotiate in good faith and to present positions that are reasonable.

The Institute recommends that the United States adopt a consensual arbitration procedure where both Competent Authorities agree to binding arbitration, with taxpayer consent, if they are otherwise unable to reach agreement after two years. (Obviously, as lapse time decreases, the time frame could also be shortened.) The type of arbitration used will depend upon the facts and circumstances of the individual cases. The Competent Authorities should have discretion in choosing the type of arbitration, but should be required to consult with the taxpayer. Since arbitration of necessity involves each Competent Authority surrendering its country's sovereignty, it is especially important that the affected parties -- including the taxpayer -- all be part of the process. For example, some taxpayers may prefer to use "baseball" arbitration, i.e., the arbitrator should have no discretion to reach his or her own conclusion, but must accept one of the positions put forth by the parties. Other taxpayers may prefer permitting the arbitrators to select from a range of results. Remaining flexible will ensure that the arbitration is effective.

In TEI's view, three arbitrators should be used. (Each country should select one and the two arbitrators should select the third.) The cost of the arbitration should be borne equally by the countries involved. Taxpayers should be kept apprised of the status of the arbitration and permitted to supply any additional facts, if needed, and, in appropriate cases, react to proposals from the countries or the arbitrators. Moreover, in cases where the facts are not agreed, the arbitrators should be permitted to make their own findings of facts, perhaps by examining witnesses or meeting separately with the taxpayer. Finally, we believe that six months is a reasonable time frame in which the arbitrators should reach a decision.

Specific Countries and Issues

During the March 16 meeting, a question was raised concerning specific countries with which taxpayers have experienced problems of double taxation. You also inquired about issues other than transfer pricing that would most likely rise to the Competent Authority level in the future.

TEI members report that Japan has been a particularly difficult country to deal with, especially in respect of the use of "secret comparables" in transfer pricing disputes. In addition, Korea tends to classify all services as technical services subject to the royalty withholding provisions of the U.S.-Korea treaty. Finally, the globalization of the economy and corporate structuring along product lines and customers (rather than geography) will increase the pressure on regional and headquarter allocation issues. There is little guidance on what constitutes stewardship and this issue will become more important in the future.


Tax Executives Institute appreciates this opportunity to present our views on the proposed revision of Rev. Proc. 96-13. If you have any questions, please do not hesitate to call Michael P. Boyle, chair of TEI's International Tax Committee, at (425) 9368937, or Mary L. Fahey of the Institute's professional staff at (202) 6385601.

We recognize that some delays may be attributable to the lack of adequate resources or fully trained personnel in other countries' Competent Authority functions. We urge the IRS to encourage foreign countries to fully staff those functions.
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Title Annotation:Tax Executives Institute's comments on the IRS' proposed revision of Rev. Proc. 96-13
Publication:Tax Executive
Geographic Code:1USA
Date:Sep 1, 2000
Previous Article:Comments on optional forms of benefits for defined contribution plans.

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