The Implications of the Arbitration Convention : A step back for the European Community or a step forward for elimination of transfer pricing related double taxation?

Sammanfattning: It was assumed in the mid 1990s that 60% of all global trade took place within a group of enterprises. With increased globalisation leading to an increase in mergers and acquisitions this figure is most likely higher. Thus intra-company and intra-group transactions form a major part of business. These transactions, due to the association between the enterprises, may not always reflect the conditions that a market with independent actors would dictate. There are various reasons for this, which include not only tax considerations but also difficulties in establishing conditions that reflect those that inde-pendent companies would apply, in other words conditions in accordance with the arm’s length principle. In cases where these conditions are not in accordance with what the state considers as an arm’s length price, the profits of the enterprise located in that state may be adjusted for taxation purposes under transfer pricing provisions. The complexity of transfer pricing rules and the various methods for establishing an arm’s length price result in different interpretations and increased uncertainty for multinational enterprises that often face different rules for determining a correct transfer price. Therefore, enterprises may often face transfer pricing adjustments of their profits due to the complexity and differences in transfer pricing legislation. Transfer pricing adjustments potentially lead to unresolved double taxation, in fact business reports have indicated that 42% of the transfer pricing adjustments lead to double taxation. Therefore it is imperative to have legal mechanisms that resolve potential double taxation. The Convention on the Elimination of Double Taxation in Connection with the Adjustment of Profits of Associated Enterprises (Arbitration Convention) was adopted to give the multinational enterprises, facing double taxation due to adjustments of their profits, a remedy that obliged the states to resolve the double taxation. This was the first, and is still the only, EC-wide mechanism that technically guarantees that transfer pricing double taxation is resolved and thus holds a great improvement over other existing mechanisms to resolve double taxation. The Arbitration Convention was originally a proposed EC Directive but was transformed into a intergovernmental convention. This has resulted in that the European Court of Justice (ECJ) has no jurisdiction to interpret the Arbitration Convention or its application. Furthermore there is no supranational or international organ that could take action against states that interpret or apply the Conven-tion in an unintended manner. The chosen legal form has also resulted in different interpretations as to what status the Arbitration Convention has compared to bilateral tax conventions, and thus whether it precedes them. This could prove troublesome when future bilateral treaties are concluded or where there already exist tax treaties that have different solutions to transfer pricing related double taxation. The risk of the Convention being interpreted differently is greatly increased by the various undefined terms and lack of precise provisions in the Convention. Therefore, the Convention has been subject to an inconsistent application and interpretation from the date it came into effect in 1995. The Convention was only given a five year life span, after which it was destined to be renewed if the contracting states so expressed, involving the same ratification process as at the initial acceptation of the Convention. However, as this was inefficient, a Prolongation Protocol was signed to amend the Convention with an automatic extension of its life. As it took till 2004 for this Protocol to be ratified and finally enter into force on 1 November 2004 it created one of the main interpretation and application differences in the life of the Convention. The function of the Convention’s procedures and thus its efficiency in resolving double taxation is impeded by the numerous interpretation differences and lack of precise pro-visions in the Convention. The fact that there is no way to guarantee that the provisions of the Convention are precisely followed, partly since there are uncertainties regarding the precise interpretation but also partly since there is no organ that could enforce a uniform application of the Convention, further impedes the efficiency of the Convention, which is clearly seen in practice. Another question of interpretation and application raised is that, although the Convention was originally intended as a means for resolving transfer pricing related double taxation, there have been arguments that the Convention could apply to double taxation due to provisions concerning thin capitalisation as well. These provisions bring about similar conditions as those the Convention requires for its applicability and, although a different area of law, the connections in the conditions are many and undeniable.