By Xueliang Ji and Julien Chaisse
There are a growing number of special economic zones (SEZs) being established in China, not only in areas along the coast, but also in more inland areas of mainland China which are aiming to attract more foreign investment. Taxation is a very significant instrument in achieving this goal. In the case of developed states, like the US, taxation mainly originates from personal income taxation. Developing countries, on the contrary, (like China) are focusing more on the taxation of corporations and enterprises. The resulting increase in taxation, may lead to more disputes, making dispute resolution methods essential.
When tax related disputes arise, there are several ways to resolve them. Firstly, local remedies can be used. Taxpayers can initiate local litigation or submit their disputes to the relevant administrative tribunal. Besides local litigation, the dispute resolution methods regulated in bilateral investment treaties (BITs) can come into function here, namely mandatory arbitration. A great advantage of mandatory arbitration within BITs is that investors can determine when there has been a breach of a treaty obligation and launch a claim.
The arbitral tribunal under BITs that deals mainly with investment issues may not actually be that proficient in resolving tax related disputes. In this situation, dispute resolution methods in the bilateral tax treaties between the contracting states may be of more appropriate use. There are two or three main steps to resolve tax related disputes via this route, with differences due to the fact that many bilateral tax treaties do not incorporate a mandatory arbitration clause in the content. Firstly, the relevant competent authority to which the taxpayers have submitted their dispute should resolve the dispute unilaterally. If it cannot solve the dispute itself, the Mutual Agreement Procedure (hereinafter “MAP”) process can be initiated. After the MAP, if there are still unresolved disputes remaining, the mandatory arbitration clause can be implemented.
With regard to mandatory arbitration, the BEPS Project initiated by the OECD, especially Action 14, and the OECD model convention, are particularly relevant. Although they are only advisory, some states, especially developed ones, have incorporated this dispute resolution method into their bilateral tax treaties. Although it is clearly regulated in the model convention, it provides the flexibility for states to incorporate it. Based on the OECD model convention, if the competent authorities can resolve all the disputes during the MAP process, arbitration will not be started.
For taxpayers, they tend to recourse to the mandatory arbitration clause as the tax related disputes resolution method of choice. On one hand, taxpayers enjoy more rights under a mandatory arbitration clause. On the other hand, mandatory arbitration can make up for MAP’s shortcomings. MAP only requires the competent authorities to “endeavor”, in other words, try their best to get disputes resolved. However, a resolution is not mandatory. Foreign taxpayers are pursuing the certainty of a stable investing environment and the mandatory tax related arbitration can provide this certainty, as arbitration can make up for the shortcomings of MAP in resolving tax related disputes. This is for a number of reasons. Firstly, the arbitration is more neutral when compared with the MAP. Secondly, as contracting states are afraid of losing state sovereignty, they will be more likely to reach an agreement during the MAP process, which can improve the efficiency of MAP to some extent. Lastly, based on the OECD model convention, taxpayers can enjoy more profits after the arbitral award has been made.
Independent arbitration is mainly used and accepted as a tax disputes resolution method. The arbitral tribunal will decide the case alone and the competent authorities have limited effect on the final award. During the arbitration, the arbitrators can consider either the disputes of law or fact, or a mix of both. The award can be comprehensive as a result. As the arbitrators are more professional and less biased than those staff in the contracting competent authorities, the final award will be more reliable as a result.
As there are many free trade zones (hereinafter “FTZs”) in mainland China, some of them can be used to incorporate mandatory arbitration in tax matters. If it is implemented well, it can be regulated as a statute and be used in the whole state. If not, it can be improved and the shortcomings can be overcome as a result. There are several advantages. The mandatory arbitration in tax matters is beneficial for where the tax related disputes occurred. For one thing, it sends a positive message to foreign investors that it is committed to offering a predictable and secure investment regime. For another, it creates an incentive to develop domestic policies favorable to attracting new investment and maintaining ongoing investment including policies that are predictable, certain and transparent. As a result, the Chinese government should incorporate it into its bilateral tax treaties, because based on the certainty it brings for taxpayers, it not only better protects foreign investors, but also attracts more foreign direct investment (FDI).
Further reading
Books
- Michael Lang and Jeffery Owens, INTERNATIONAL ARBITRATION IN TAX MATTERS (IBFD, 2015).
Journals
- Julien Chaisse, Investor-State Arbitration in International Tax Dispute Resolution– A Cut above Dedicated Tax Dispute Resolution, 41 VIRGINIA TAX REVIEW 149 – 222 (2016).
- Koel RoyChoudhury, Special Economic Zones in China, 7 SIES JOURNAL OF MANAGEMENT 114-120 (2010).
- William W. Park, Arbitration and the Fisc: NAFTA’s Tax Veto, 2 CHI. J. INT’l L. 231 (2001)
- MJ McIntyre, Comments on the OECD Proposal for Secret and Mandatory Arbitration of International Tax Disputes, 7 FLA TAX REV 622 (2006).
Treaties
- OECD Model 2008.
- OECD Model 2010
- OECD Model 2014.
- OECD Model 2017.
- OECD Model Commentaries 2017