Notification in Tax Treaties

Tax treaties provide a mechanism for the signatory governments to resolve specific cases of double taxation: the competent authority process. To use it, treaties require taxpayers to notify the other government within a specified period of time when an action taken by the country where it is doing business will cause it to suffer double taxation.

Usually, the notification clock starts ticking from the time the taxpayer receives notice that a country’s actions that will cause it double taxation. For example, the U.S.-China Treaty (Article 24) requires that a case must be presented within three years from the first notification of the action resulting in taxation not in accordance with the provisions of the treaty.

Sometimes notification can be tricky. For example, a Chinese related party overwithheld on a related party interest payment to its U.S. parent company, but due to an oversight, neither side recognized the error until several years later. The overwithholding took place in 2005. The Chinese taxing authority audited the 2005 year of the Chinese entity in 2007; the audit resulted in no change to the Chinese company and a letter indicating as such was issued that year.

The audit did not address the overwithholding; nor did the Chinese company raise the issue. Did the receipt of that letter start the notification clock? In other words, to seek help from the U.S. government must the U.S. parent company make a competent authority request in the U.S. within three years of receipt of that letter?

The parties realized the error in 2008, and the Chinese entity applies to its government for a refund of the overwithholding. The Chinese government denies the request. Does the letter informing the taxpayer about the denial constitute the government action causing double taxation and start the notification clock?

To protect your opportunities for competent authority relief, file a protective claim under section 9.03 of Revenue Procedure 2006-54, covered in the next blog, as soon as possible and make your best arguments in your competent authority request.

And note. Some treaties have stricter notification rules requiring that a case be brought to the other government within a certain number of years from the end of the taxable year to which the case relates. For example, the Canadian treaty requires notification within six years, and the Mexican treaty, four and a half years.

Competent Authority: Rev. Proc. 2006-54 Basics

Companies must pay tax on the income they earn, but each dollar of revenue should be taxed by only one country. Our tax laws and our network of tax treaties help assure that companies do not suffer this double taxation. Yet when companies operate internationally, governments sometimes disagree on which gets to tax the worldwide revenues of a company. Tax treaties attempt to both prevent double taxation and also to provide a mechanism to correct double taxation if it occurs. Click here for the IRS’s tax treaty website: Tax Treaties.

That mechanism, the Mutual Agreement Article of our treaties, sets out the process by which the governments “mutually agree” to resolve a particular case of double taxation via the negotiations between the “competent authorities,” of the two governments. The IRS’s competent authority office, employing forty analysts, is located in Washington DC (with a small satellite office in California).

According to the Organization for Economic Cooperation and Development (OECD), as of 2007 the countries with the largest numbers of cases are Germany, the United States, France, Canada, Austria and the Netherlands (OECD Survey of Country Mutual Agreement Procedure Statistics, released 9/29/09).

Though surprising, the US competent authority handles mostly cases resulting from the actions of a foreign government, such as Canada or Japan. Such foreign-initiated adjustments make up over 80 percent of the U.S. competent authority’s caseload. The good news is that in approximately 90 percent of all competent authority cases, the governments eliminate double taxation entirely.

Applying for Competent Authority Assistance

Revenue Procedure 2006-54 provides all the details on filing a request for competent authority assistance. With some narrow exceptions, requesting competent authority assistance is free. Section 4.01 of the revenue procedure covers when to file a competent authority request. If you receive an adjustment for another country’s taxing authority that you believe will cause double taxation or is in any way contrary to the treaty, you may request assistance. Or, if the IRS takes an action that you believe will cause double taxation you may request competent authority assistance as soon as the amount of the proposed adjustment is communicated in writing to you.