Rev. Proc. 91-23: competent authority.
On March 18, 1991, the Internal Revenue Service issued Rev. Proc. 9123, 1991-1 C.B. 534, setting forth the procedures concerning requests for assistance of the U.S. Competent Authority in resolving instances of taxation in contravention of an income, estate, or gift tax treaty to which the United States is a party.(1) We understand that the IRS is undertaking to revise Rev. Proc. 91-23 to address issues such as the use of foreign statutes of limitations and the effect of an Appeals settlement on the resolution of a Competent Authority dispute. Tax Executives Institute is pleased to submit the following comments in conjunction with the IRS's Competent Authority initiative.
Rev. Proc. 91-23 was generally a welcome development for taxpayers because it reaffirmed the government's commitment to implementing treaty protections against double taxation. In addition, the revenue procedure broke new ground with respect to Advance Pricing Agreements (APAs), which were themselves introduced in 1991. As more and more corporations enter into cross-border transactions and as U.S. treaty partners devote more attention to double taxation issues (particularly in the transfer pricing and permanent establishment areas), the Competent Authority process has become increasingly important.
One of the most persistent problems plaguing the Competent Authority process is the length of time it takes to conclude a settlement. TEI applauds the IRS for its recent improvements in this area, and we encourage the government to continue its efforts to expedite the process. We believe that the key elements to longterm improvement of the process are taxpayer involvement, accessibility, and taxpayer knowledge of the steps necessary to preserve access to Competent Authority. Through the adoption of the following recommendations, TEI believes that the efficiency and effectiveness of the process in eliminating double taxation can be increased.
First, taxpayers should be authorized to request Competent Authority assistance before pursuing a case with Appeals in order to mitigate problems associated with "hazards of litigation" settlements in Appeals and with foreign statutes of limitations.
Second, taxpayers should be encouraged to become more involved in the process. For example, taxpayers should be permitted to reply directly to inquiries from treaty partners regarding the nature and operation of their business.
Third, the revised revenue procedure should specifically address issues of deficiency interest or exchange gain or loss resulting from the settlement and provide that such issues (consistent with the underlying treaty) should be addressed in the Competent Authority negotiation.
Fourth, in light of the increasingly multijurisdictional nature of tax issues, the IRS should adopt procedures to coordinate Competent Authority cases among multiple treaty partners and should work with our treaty partners to develop such procedures. In addition, the IRS should share with taxpayers its vast knowledge of foreign procedures and statutes of limitation.
Finally, certain areas merit discussion between the U.S. Competent Authority and our treaty partners outside the context of a specific case. We urge the U.S. Competent Authority to work toward reaching understandings with our major treaty partners regarding the threshold for creating a permanent establishment (particularly in the service industry) and the acceptability of taxpayer-initiated "compensating adjustments" pursuant to the temporary regulations under section 482 of the Internal Revenue Code.
II. Expediting the Competent Authority Process
A. Coordination with Appeals Procedures. Section 5.04 of Rev. Proc. 91-23 provides that taxpayers "must generally pursue their right of administrative review with Appeals before requesting Competent Authority assistance." Certain narrow exceptions are permitted, for example, where the disagreement is limited to the amount of the adjustment or the method used by the IRS to compute the amount of the proposed adjustment. 1991-1 C.B. at 537. According to press reports, the IRS is considering modification of this provision because foreign competent authorities sometimes balk at Appeals settlements on the ground they are based on the hazards of litigation rather than resolution of the legal or factual issues involved in the Competent Authority dispute. In addition, the IRS has issued Announcement 93144, 1993-39 I.R.B. 12 (Dec. 6, 1993), which contemplates the issuance of a revenue procedure permitting taxpayers to go directly from examination to Competent Authority.(2)
The major impediment to taxpayers seeking Competent Authority assistance is the time-consuming nature of the process. Long delays may cause the amount of interest to exceed the tax eventually found to be owing. Foreign law may not provide for extensions of the statute of limitations a prerequisite to seeking U.S. Competent Authority assistance. In addition, even where a taxpayer acts diligently to extend a foreign statute of limitations, it is not always possible to toll the statute long enough for the competent authorities to come to agreement. Requiring taxpayers to seek review of an issue at Appeals in some cases may serve only to exacerbate the timeliness issue. Moreover, an Appeals settlement based on resolution of issues other than those involving transfer pricing may cause the Appeals process to be perceived as a negotiation rather than a legal determination, thereby prompting some treaty partners to resist resolution of the case.
We recommend that taxpayers not generally be required to exhaust their remedies with Appeals before requesting Competent Authority assistance. Rather, taxpayers that are willing to accept an adjustment agreed to by the competent authorities should not be required to go through the Appeals process. Such an approach would eliminate barriers taxpayers now face with foreign competent authorities by shortening the time required to complete the process and thereby reducing the difficulties with extending foreign statutes of limitations and the administrative costs of both the taxpayer and the government. The key to this process, however, is flexibility; taxpayers should not be required to by-pass Appeals.
We also recommend that a taxpayer choosing to forgo Appeals should not be required to waive its rights to a subsequent review by Appeals in the event the competent authorities fail to reach an agreement (or with respect to issues not considered by the Competent Authority). In such a case, settlement of a case at Appeals on a basis similar to that of the U.S. Competent Authority's negotiating position may be appropriate.
B. Taxpayer Involvement in the Process. Section 11.02(c) of Rev. Proc. 91-23 provides that, as a condition to receiving Competent Authority assistance, a taxpayer must concede that it is not entitled to participate in the negotiations between competent authorities. While the Competent Authority process is, in the final analysis, a government-to-government negotiation, we believe that focused taxpayer involvement would both expedite the process and facilitate the negotiation of a settlement acceptable to the taxpayer and the competent authorities. Thus, we recommend that the taxpayer be permitted to respond directly to requests by the foreign competent authority for information regarding the nature and operation of the taxpayer's business. Targeted, direct communication by the taxpayer is likely to be more effective in avoiding misunderstanding or misinterpretation of data, though obviously the U.S. Competent Authority should be kept fully apprised of any such communication. In addition, we recommend that the taxpayer be permitted to review and comment on any tentative settlement before it becomes final. Such a review is essential to ensuring that the settlement reached by the Competent Authority does not trigger even more contentious disputes in future years.(3)
C. Agreements for Subsequent Years. Issues that may give rise to double taxation (and therefore potentially become the subject of Competent Authority negotiations) frequently relate to recurring matters. For example, in cases involving issuance of debt from a foreign subsidiary to a domestic parent, where the foreign tax authority imputes interest income at a rate that exceeds the market rate as determined under section 482, a Competent Authority settlement may not resolve the double taxation problem in respect of subsequent years (in which the debt remains outstanding). The taxpayer is therefore forced to either require repayment of the debt or to wait for foreign adjustments for each subsequent year and then seek Competent Authority relief.
TEI believes that the competent authorities should be permitted to "roll over" settlements to subsequent years. As in the APA process, the competent authorities could agree to application of a methodology for a prescribed number of years, assuming no changes in critical assumptions. To encourage taxpayers to bring such cases to the attention of the U.S. Competent Authority, the revised revenue procedure should expressly state that the U.S. Competent Authority will, in appropriate cases, attempt to negotiate a settlement that applies to years subsequent to the years in issue. (This would be akin to the nascent accelerated issue resolution program.)
III. Access to Competent Authority
A. Pre-Filing Procedure. Because of the mystique surrounding the competent authority negotiations, taxpayers may find the process daunting.(4) In addition, the documentation requirements set forth in the Competent Authority procedure may make some (particularly smaller) taxpayers hesitant to seek assistance. For example, section 4 of Rev. Proc. 91-23 sets forth a list of documents and statements that must be submitted as part of a request for Competent Authority assistance, including a requirement for taxpayer consent to disclosure of information to the foreign Competent Authority.
TEI believes that taxpayers could be encouraged to request Competent Authority assistance, and would do so earlier in the process, if they were afforded the opportunity to discuss their cases on an informal basis before making a formal request. We appreciate that, as a matter of practice, the Competent Authority has been flexible in consulting informally with taxpayers before a formal request for assistance is made. We urge that the IRS make that informal opportunity known to all taxpayers by providing in the revised revenue procedure that a pre-filing conference is available upon request of the taxpayer.(5)
B. Foreign Statutes of Limitation. Section 7 of Rev. Proc. 91-23 requires that a taxpayer take protective measures to stay a statute of limitations in a foreign jurisdiction in regard to any matter in which Competent Authority assistance may be requested. A taxpayer must take such steps notwithstanding any waiver or extension of limitations periods under the relevant treaty.
In some foreign jurisdictions, there is simply no formal mechanism for extending the limitations period. For example, in Switzerland, voluntary extensions by taxpayers are not permitted. In other countries, there may be informal means available for extending the statute, but taxpayers may be unaware of their existence.(6)
We recognize that taxpayers must take reasonable actions to ensure that an adjustment ultimately agreed upon by the competent authorities will not be barred. We also agree that the taxpayer is often in the best position to position to know, early on, that a proposed adjustment is probable and that Competent Authority assistance will be requested. Nevertheless, we believe that the U.S. Competent Authority should assist taxpayers by sharing its knowledge of applicable rules and procedures of major treaty partners.
Not all taxpayers with foreign operations have access to sophisticated tax advice in the jurisdictions in which they operate. By the time a U. S. adjustment has been proposed, or even appears likely, it may be too late for a taxpayer to take protective measures in the foreign jurisdiction; the statute may have already expired. Moreover, in light of the divergence between actual practices and treaty provisions in some countries, taxpayers face myriad traps for the unwary in attempting to preserve the possibility of a Competent Authority settlement.
While the U.S. Competent Authority cannot possibly keep taxpayers apprised of the constantly changing laws and practices of all jurisdictions, we believe it would be helpful to taxpayers, and ultimately to the Competent Authority process, if the IRS issued periodic guidance on procedures for extending periods of limitations in major treaty countries. Such guidance could also explain foreign treaty partners' interpretations of waiver provisions. In addition, such guidance could provide some information regarding the level of administrative appeal a taxpayer may pursue in a particular foreign jurisdiction without forfeiting access to Competent Authority assistance in that country.
IV. Elimination of Double Taxation
A. Deficiency Interest and Exchange Gains and Losses. 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 competent authorities clearly have the power to waive (or reduce) interest on deficiencies or to provide for the tax treatment of exchange gains or losses, based on the Mutual Agreement Procedure article of the applicable tax treaty. Although the article may vary from treaty to treaty, Article 25 of the 1977 OECD Model Treaty and the proposed 1981 U.S. Model Treaty each 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, the Assistant Commissioner (International) has 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 grants the Assistant Commissioner (International) 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.
The treatment of these items, as well as the timing of income or loss recognition, frequently varies among treaty partners. If the issue is not addressed in the Competent Authority settlement, the taxpayer may achieve only partial relief. 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 the Canadian Income Tax Act. In other cases, the treaty partners may calculate deficiency and refund interest as of different years. Some countries (such as Switzerland) reflect the adjustment in the year of settlement, and do not provide refund interest (nor charge deficiency interest) from the year to which the adjustment pertains; other countries (including France) generally do not pay interest on tax refunds. Similarly, taxpayers may recognize foreign currency exchange gain or loss in connection with a Competent Authority procedure settlement or repatriation pursuant to Rev. Proc. 65-17.(7) We recommend the Competent Authority procedure include the treatment of interest and exchange gain and loss resulting from a settlement as subjects for negotiation between the competent authorities.
With respect to the transfer pricing penalty under section 6662(e) of the Code, we recommend that the revised revenue procedure confirm that the penalty will be eliminated (or reduced) automatically where a Competent Authority settlement reduces a U.S. adjustment. In addition, we recommend that, where a penalty has been proposed in connection with a proposed adjustment and the treaty partner strongly objects to the penalty, the Competent Authority consider elimination of the penalty.
B. Preservation of Foreign Tax Credits. Section 9 of Rev. Proc. 91-23 provides that the failure to request the assistance of the Competent Authority will generally constitute a failure to exhaust all administrative remedies regarding a foreign adjustment, thereby triggering denial of foreign tax credits. See also Treas. Reg. [section] 1.901-2(e)(5)(i) (providing that, in order for a foreign tax to be creditable, a taxpayer must exhaust all "effective and practical" remedies, including the invocation of competent authority, to reduce foreign tax liabilities). The revenue procedure does not provide a de minimis rule.
In light of the significant time and resources required to achieve a Competent Authority settlement, taxpayers should not be required to choose between an expensive, time-consuming, and potentially futile request for Competent Authority assistance or forgoing foreign tax credits where the amount involved is insubstantial (e.g., where the foreign tax attributable to the adjustment is less than five percent of the taxpayer's U.S. tax liability for the year (before use of any foreign tax credits) or a specified amount). A de minimis exception would serve the government's interest in conserving resources to deal with (and possibly expedite) cases involving larger amounts without sacrificing significant U.S. tax revenues through the granting of foreign tax credits. Moreover, such an exception would not encourage foreign governments to tax subsidiaries of U.S. companies more aggressively, since only insubstantial amounts would be eligible for the exception. Finally, we note that adoption of a de minimis exception would be consistent with Treas. Reg. [section] 1.901-2(e)(5)(i), which provides that a remedy is effective and practical only if the cost thereof is reasonable in light of the amount at issue and the likelihood of success.
V. Conditions for Invoking Rev. Proc. 65-17
Section 8 of Rev. Proc. 91-23 introduced the requirement that a taxpayer request Competent Authority assistance as a condition for receiving relief pursuant to Rev. Proc. 6517, which provides a procedure for adjusting accounts and for transferring amounts as a result of a section 482 adjustment. Previously, taxpayers could forgo Competent Authority assistance and apply directly to the district or Appeals office for relief under Rev. Proc. 65-17. Rev. Proc. 9123 essentially requires all taxpayers facing a section 482 adjustment to apply to the Competent Authority for application of Rev. Proc. 65-17.
We submit that this requirement could unnecessarily delay the resolution of cases that could otherwise be resolved at the district or Appeals leveL It imposes a burden on the taxpayer to gather and submit the required data, as well as a burden on governmental resources that could more effectively be devoted to resolving unagreed cases. Once an adjustment has been agreed to by the taxpayer and the government, the use of Rev. Proc. 65-17 to repatriate earnings that have been subject to U.S. tax results in no detriment to the U.S. government.
In the interest of expediting the settlement of cases, we recommend that the authority to enter agreements for use of Rev. Proc. 65-17 be returned to the district and Appeals levels. In addition, where Rev. Proc. 65-17 is applied following a Competent Authority settlement, we encourage the Competent Authority to urge the treaty partner to refund any withholding tax paid on a prior dividend that is recharacterized pursuant to the revenue procedure.
VI. General Recommendations
A. Compensating Adjustments. Temp. Reg. [section] 1.482-iT(e)(2), which was issued on January 13, 1993, provides a "compensating adjustment" mechanism that permits taxpayers to make adjustments after the transaction is completed to reach an arm's-length price. TEI believes the compensating adjustment mechanism may provide a valuable "safety net" for taxpayers in attempting to comply with the arm's-length standard (and to avoid penalties in the event of an adjustment). As was recognized by the drafters of the 1993 temporary regulations, a corporate tax department is not always able to be involved in the setting of transfer prices because of, for example, the pace of change in the taxpayer's industry or the autonomy of sales functions in a particular company. The compensating adjustment mechanism provides a potentially useful avenue for such taxpayers to comply with the requirements of section 482.
The mechanism will be practicable, however, only if treaty partners recognize the method. Taxpayers are wary that some treaty partners will not recognize the effect of a compensating adjustment. Indeed, we understand that in certain countries (such as Italy), it is illegal to file a tax return reflecting intercompany prices that deviate from the company's financial books. Moreover, we are concerned that, because the adjustment would be initiated by the taxpayer, rather than the government, a taxpayer whose compensating adjustment is not recognized by a foreign jurisdiction may be precluded from obtaining competent authority assistance in that jurisdiction.
We urge the U.S. Competent Authority to discuss the compensating adjustment concept with our major treaty partners. In particular, the U.S. Competent Authority should attempt to reach an understanding with our major treaty partners regarding recognition of the compensating adjustment mechanism. At a minimum, we recommend that the U.S. Competent Authority approach treaty partners to determine whether their competent authorities would address taxpayer-initiated compensating adjustments.
B. Permanent Establishment. Increasingly, U.S.-based multinational corporations face assertions by treaty partners that their operations in the foreign jurisdiction rise to the level of a "permanent establishment." The threshold for creation of a permanent establishment has typically not been defined by a "bright-line" test under treaty language or interpretative documents. The need for certainty is increasing, however, as more and more corporations expand their operations across borders. The issue is particularly unsettled in respect of services.
We urge the U.S. Competent Authority to attempt, in the course of negotiating particular cases with our treaty partners, to reach some understanding regarding uniform principles to be applied in determining whether a permanent establishment exists. Absent clearer language in existing treaties, the Competent Authority could be instrumental in reducing the significant uncertainties taxpayers face.
C. Multijurisdictional Procedures. Multinational corporations generally operate through complex networks of intercompany arrangements in multiple jurisdictions. Because of the bilateral nature of the U.S. tax treaty network, Competent Authority negotiations may not proceed on a multilateral basis. To ensure that the U.S. Competent Authority continues to help in eliminating double taxation, it is critical that the Competent Authority explore possibilities for managing and concluding cases that involve more than one treaty partner.
We urge that the Competent Authority work with treaty partners, as multijurisdictional cases arise, to reach coordinated bilateral agreements. In addition, we recommend that the U.S. Competent Authority encourage taxpayers to request its assistance in such cases. In the interest of expediting the progress of the separate negotiations, one possibility would be to provide greater latitude to taxpayers (and their foreign affiliates) involved in multijurisdictional matters to assist the respective governments in coordinating information gathering.
Tax Executives Institute appreciates this opportunity to present our views on Rev. Proc. 91-23, 1991-1 C.B. 534, setting forth the Competent Authority procedures. If you have any questions, please do not hesitate to call Lisa Norton, chair of TEI's International Tax Committee, at (201) 5733200 or Mary L. Fahey of the Institute's professional staff at (202) 638-5601.
1 The revenue procedure superseded Rev. Proc. 82-29, 1982-1 C.B. 481, and Rev. Proc. 77-16, 1977-1 C.B. 573, as amplified by Rev. Proc. 79-32, 1979-1 C.B. 599.
2 Announcement 93-144 provides that taxpayers can request the involvement of Appeals in the competent authority process, in accordance with the procedure set forth in Rev. Proc. 91-23. Rev. Proc. 91-23, however, does not currently contain such a procedure and, indeed, specifically requires taxpayers to exhaust their administrative remedies with Appeals before proceeding to Competent Authority. (The announcement presumably anticipates the revision of the revenue procedure.) In addition, we recognize that if taxpayers are permitted to forgo Appeals and go directly to Competent Authority, it will be necessary to address the extent and nature of Appeals involvement in the development of the case. TEI is in the process of reviewing Announcement 93-144 and will submit comments on the proposal soon.
3 Announcement 93-144 provides that Appeals personnel may become involved in the case after the Competent Authority process begins. If the Competent Authority negotiators seek assistance' from Appeals, taxpayers should not be excluded from the case development. We urge the IRS to proceed cautiously to ensure that in expediting consideration of the issues by Competent Authority, taxpayers are not eliminated from the process.
4 TEI recognizes, however, that the United States is apparently the only country to provide taxpayers with formal guidelines on the Competent Authority process and to encourage, as a matter of official policy, its residents to seek Competent Authority assistance. In the absence of written procedures in other countries, guidance from the U.S. Competent Authority is even more important.
5 The IRS may also wish to consider raising the ceiling (say, to $100,000 for both individuals and corporations) for the small case procedure set forth in Section 10 of Rev. Proc. 91-23 from the current limits of $10,000 in proposed tax adjustments for individuals and $25,000 for corporations. Although TEI members' companies would generally not be eligible for such a procedure, raising the ceiling would open up the process for smaller taxpayers.
6 In the Netherlands, for example, a taxpayer can usually achieve an extension of the limitations period (ordinarily five years for larger corporations) by filing an appeal upon receipt of automatic assessment (even though the assessment may conform to the taxpayer's return), and simultaneously requesting that consideration of the case be delayed.
7 Rev. Proc. 65-17, 1965-1 C.B. 833, as amplified, amended, and clarified by Rev. Proc. 65-31, 1965-2 C.B. 1024; Amendment I, 1966-2 C.B. 1211; Amendment II, 1974-1 C.B. 411; Rev. Proc. 70-23, 1970-2 C.B. 505; Rev. Proc. 71-35, 1971-2 C.B. 573; Rev. Proc. 72-48, 1972-2 C.B. 829; and Rev. Proc. 7253, 1972 2 C.B. 833. Rev. Proc. 65-17 generally provides a procedure for adjusting accounts and transferring amounts as the result of allocations of income or deductions made under section 482 of the Code. The taxpayer may request permission to receive payment from the related entity from, or to, which the allocation of income or deductions was made, in an amount equal to a part or all of the amount allocated, without further U.S. income tax consequences.
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|Author:||Weiland, Ralph J.|
|Date:||Jan 1, 1994|
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