Competent

Authority

Procedures

To whom do U.S.
taxpayers turn
when interpreting
international tax treaty issues? The U.S.
competent authority,
of course.

By Ray A. Knight and Lee G. Knight

In Brief

Two New Revenue Procedures

The IRS has issued two new revenue procedures that replace three others. These procedures must be followed in requesting U.S. competent authority assistance when taxpayers believe actions of the U.S. or other treaty country result in taxation contrary to the provisions of a treaty.

Rev. Proc. 96-13 provides general guidance for requesting the assistance of the U.S. competent authority and has changed the scope of competent authority assistance and the procedures for requesting such assistance.

Revenue Procedure 96-14 contains procedures for requesting competent authority assistance when a tax case is pending in a U.S. court or has been designated for litigation.

The competent authorities have been given the authority to interpret the implementation of the treaties to achieve the effect of eliminating double taxation. But taxpayers should be careful not to rely solely on what the competent authorities may conclude.

International tax issues are resolved according to tax treaties administered by competent authorities of the countries that are parties to the treaties. The U.S. competent authority is the IRS Assistant Commissioner (International), who is responsible for assisting taxpayers with respect to matters covered in the mutual agreement articles included in U.S. tax treaties.

Most U.S. tax treaties permit taxpayers to request competent authority assistance when they believe that actions of the U.S. or the other treaty country result, or will result, in taxation contrary to the provisions of the treaty. For example, most tax treaties allow taxpayers to request assistance to relieve economic double taxation arising from an allocation of income between related U.S. and foreign countries under IRC section 482, or an equivalent provision under the laws of a treaty country.

Requests for U.S. competent authority assistance must comply with the procedures specified in the treaty under which relief is sought, as well as numerous requirements detailed in Revenue Procedures 96-13 and 96-14, released in early 1996 to replace three 1991 revenue procedures. The new revenue procedures not only expand the procedures for seeking competent authority relief, but also expedite the competent authority relief procedure. Revenue Procedure 96-13, issued to replace Revenue Procedures 91-23 and 91-26, provides general guidance for requesting the assistance of the U.S. competent authority. Revenue Procedure 96-14, issued to replace Revenue Procedure 91-24, amends the circumstances under which relief provided under Revenue Procedure 65-17 must be coordinated with the competent authority. Revenue Procedure 65-17 sets forth procedures to obtain an adjustment when a taxpayer's taxable income is increased by an allocation between related U.S. and foreign corporations under IRC section 482.

Interpreting Tax Treaties

The IRC provides that, in determining the relationship between a treaty provision and any U.S. law affecting revenue, neither the treaty provision nor the law is entitled to preferential status by reason of it being a treaty provision or a law. With respect to interpreting treaties, the clear import of the language controls "unless application of the words of the treaty according to their obvious meaning effects a result inconsistent with the intent or expectation of its signatories." Thus, the apparent intent of the parties is the guideline in interpreting a treaty. The words of the treaty are interpreted according to their ordinary meaning. The good faith in which tax treaties are entered into requires that their obligations be liberally construed to effect the desired relief of the quality and reciprocity between the nationals of the contracting parties. When a treaty reasonably can be construed in more than one way, the more liberal interpretation is preferred--that is, a treaty should be construed liberally. The practice of treaty signatories counts as evidence of the treaty's proper interpretation because their conduct generally indicates their understanding of the agreement. The meaning attributed to a treaty provision by government agencies charged with their negotiation and enforcement is entitled to great weight.

Courts traditionally have been reluctant to impinge on the judgment of "competent authorities" charged by the treaty states with the responsibility of interpretation and implementation. The Supreme Court has stated "our role is limited to giving effect to the intent of the treaty parties. When the parties to a treaty both agree as to the meaning of a treaty provision, and that interpretation follows from the clear treaty language, we must, absent strong contrary evidence, defer to that interpretation."

The interpretation of a treaty is not equivalent to the interpretation of a code provision. However, where there is sufficient commonality involved, the interpretation of the treaty must be considered in determining the meaning of a related code provision. If a taxpayer takes a position that a treaty of the U.S. overrides or modifies an internal revenue law of the U.S., that person must disclose such position on the tax return for that year or be subject to a penalty.

Revenue Procedure 96-13

Revenue Procedure 96-13 provides guidance similar to that found in the replaced revenue procedures but clarifies some of their provisions and contains several new provisions. The additions and changes affect both the scope of competent authority assistance and the procedures for requesting such assistance.

Clarification of Residency Applicability. Competent authority assistance is most commonly sought to relieve double taxation in transfer pricing disputes. The new procedure, however, clarifies that competent authority assistance also may be available to taxpayers seeking to establish their residency status in the U.S. Taxpayers who believe they are erroneously treated as non-U.S. residents by treaty countries or taxpayers treated as dual residents, despite the objective tiebreaker provisions contained in the applicable treaties, may now qualify for competent authority assistance. The assistance, however, generally is limited to situations where resolution of the residency issue is needed to avoid double taxation or to determine the applicability of a benefit under the treaty. Further, a request for assistance regarding residency is acceptable only if it is established that the issue requires consultation with the foreign competent authority to ensure consistent treatment by the U.S. and the applicable treaty country.

Limitation on Benefits. Many treaties contain a limitation-on-benefits article that details the requirements that must be met to qualify as a resident eligible for benefits under the treaty. The U.S. competent authority cannot issue determinations regarding a taxpayer's status under these requirements. However, the new procedure clarifies that the competent authority may issue a determination if the treaty gives the competent authority discretion to determine the availability of treaty benefits when the prescribed requirements are not met [for example, Article 26 (7) of the U.S.-Netherlands income tax treaty].

Time for Filing. In a U.S. initiated adjustment, Revenue Procedure 96-13 allows the taxpayer to submit a written request for competent authority assistance as soon as practicable after the IRS communicates in writing the amount of the proposed adjustment to the taxpayer. The old procedures did not require the taxpayer to wait for the IRS to formally propose its adjustment in writing. For a foreign initiated adjustment, the new procedure allows request assistance as soon as the taxpayer can establish the probability of double taxation.

Prefiling Conference. The taxpayer may, at any time, request a prefiling conference with the U.S. competent authority to discuss the mutual agreement process for matters covered under a treaty, including discussion of the proper time for filing, the practical aspects of obtaining relief, and actions necessary to facilitate the proceedings. Similarly, after a matter is resolved by the competent authorities, a taxpayer may request a conference with the U.S. competent authority to discuss the resolution.

Small Case Procedures. The old procedures permitted the taxpayer to file an abbreviated request form for competent authority assistance if its proposed adjustment and proposed assessment fell below certain levels. Revenue Procedure 96-13 continues this practice, but doubles the threshold for proposed adjustments and eliminates the threshold for proposed assessments. Under the new guidelines, the abbreviated request form may be filed if the proposed adjustment is not greater than the following amounts:

Type of Taxpayer Proposed Adjustment

Individual $100,000

Corporation 200,000

Other 200,000

Coordination with Appeals. Under the old procedures, the IRS encouraged taxpayers to seek remediation with appeals before requesting competent authority assistance. The U.S. competent authority, however, found it difficult to negotiate appeals settlements with its foreign counterparts because of the compromises routinely made in the appeals process. Appeals settlements often are not fully supported by the facts, and transfer pricing methodologies unacceptable to the foreign treaty partner may be used in negotiating settlements.

Revenue Procedure 96-13 gives taxpayers the option of seeking appeals review before requesting competent authority assistance, but it does not encourage this practice. Taxpayers may choose instead to (1) bypass appeals and request competent authority assistance immediately or (2) select a new simultaneous appeals procedure, under which the taxpayer or the U.S. competent authority requests that the issues be considered at the same time by both appeals and the U.S. competent authority.

The taxpayer may request the simultaneous appeals procedure at any time before the U.S. competent authority submits its position paper to the foreign competent authority. The role of appeals in this process is to assist the competent authority in developing the position that will be presented to the foreign authority. Established appeals procedures apply to this process. The U.S. competent authority, however, has jurisdiction over the issues throughout the process. Any agreements reached with the taxpayer are tentative and nonbinding on the competent authority.

If a taxpayer follows the simultaneous appeals procedure and the competent authorities fail to reach agreement, appeals is still an option for the taxpayer. Thus, regardless of the option selected, taxpayers apparently will have the benefit--in the order they choose--of both the appeals process and the competent authority process. However, Revenue Procedure 96-13 indicates that taxpayers electing the simultaneous appeals procedure are not entitled to a fresh consideration of the issue by appeals if they apply for competent authority assistance after receiving substantial appeals consideration.

Coordination with Litigation. Like its predecessor, Revenue Procedure 96-13 requires the U.S. competent authority to obtain the consent of the IRS Chief Counsel before accepting a request for assistance in a case pending in court or designated for litigation. If a court makes a final determination as to tax liability or the taxpayer enters into a binding settlement with the IRS before requesting competent authority assistance, the U.S. competent authority may obtain a correlative adjustment with the treaty country, but may not take any actions that would otherwise amend the settlement.

Accelerated Competent Authority Procedure. Revenue Procedure 96-13 introduces a new procedure that allows a taxpayer who engages the competent authority on one issue to request resolution of the same issue for subsequent periods. Before accepting such a request, the competent authority must obtain the consent of the appropriate district director, as well as the chief counsel if the case is pending in court. The request may be made at the time of filing the initial request for competent authority assistance or any time thereafter, but it must be made before the competent authorities have reached an agreement on the issue(s) involved in the original request.

Protective Measures. Both the old and new revenue procedures warn that taxpayers may need to take appropriate protective measures with both the U.S. and applicable foreign tax authorities to ensure that any agreement reached by the competent authorities is not barred by administrative, legal, or procedural barriers. Protective measures include, but are not limited to--

* filing amended returns or protective claims for refund or credit,

* staying the expiration of any period of limitation on the making of a refund or other tax adjustment,

* avoiding the lapse or termination of the taxpayer's right to appeal any tax determination,

* complying with all applicable procedures for invoking competent authority consideration, including applicable treaty provisions dealing with time limits within which to invoke such remedy, or

* contesting an adjustment or seeking an appropriate correlative adjustment with respect to the U.S. or treaty country tax.

The new procedure instructs taxpayers to time their protective measures to allow sufficient time for appropriate procedures to be completed and effective before barriers arise. It also permits taxpayers to consult with the U.S. competent authority on the timing of and need for protective measures in their particular cases.

Taxpayers must be particularly cautious in taking steps to prevent the expiration of a foreign statute of limitations. If a treaty partner declines to enter into competent authority negotiations or a competent authority agreement cannot be implemented because the foreign statute of limitations has expired, the taxpayer's failure to take protective measures may cause the U.S. competent authority to conclude that the taxpayer failed to exhaust "all effective and practical remedies." Any amount paid to foreign tax authorities that would not have been due if the treaty country had made a correlative adjustment may not constitute a creditable foreign tax. Acts or omissions by the taxpayer precluding effective competent authority assistance, including failure to take protective measures or seek competent authority assistance, may constitute failure to exhaust all effective and practical remedies. However, the fact the taxpayer has sought competent authority assistance but obtained no relief will not demonstrate that the taxpayer has exhausted all effective and practical remedies to reduce the liability for foreign tax. Any determination within the IRS of whether a taxpayer has exhausted the competent authority remedy must be made in
consultation with the U.S. competent
authority.

Waivers No Substitute. Some U.S. treaties contain provisions intended to waive or remove procedural barriers to the credit or refund of tax even though (1) the otherwise applicable statute of limitations has expired, (2) prior closing agreements have been entered into, or (3) other actions have been taken or omitted that ordinarily would foreclose relief in the form of a credit or refund of tax. Revenue Procedure 96-13 warns taxpayers not to rely on these provisions because of differences among treaty partners in interpreting these waiver provisions.

Revenue Procedure 96-14

Revenue Procedure 96-14 sets forth procedures for requesting competent authority assistance when a tax case is pending in a U.S. court or has been designated for litigation. The new procedure provides that relief under Revenue Procedure 65-17 can be requested from the appropriate district director, rather than the U.S. competent authority, if competent authority is not otherwise being requested. Revenue Procedure 65-17 sets forth procedures to obtain an adjustment when a taxpayer's taxable income is increased because of an allocation of income between related U.S. and foreign corporations under IRC section 482. In cases where relief is requested from the district director, the district director must coordinate with the competent authority before concluding the closing agreement. *

References used in this article are available upon request and in the download section of The CPA Journal's home page (www.cpajournal.com).