But there are now signs of change.

Under the standard ‘mutual agreement procedure’ (MAP) found in most current tax treaties, taxpayer claims that they are being taxed not in accordance with the treaty require that the two competent authorities ‘endeavour’ to resolve the dispute through bilateral negotiation. The major weaknesses of the MAP are that it better serves the competent authorities than taxpayers, does not require resolution of the dispute, and is cumbersome and wasteful. Indeed, it was pressure from the international business community that was largely the impetus for the OECD’s work in this regard.

The growing acceptance of arbitration in tax treaties is at odds with a long-held and deeply-engrained resistance to ceding fiscal sovereignty, especially over tax policy matters. The OECD’s early view on mandatory arbitration in tax was that it ‘would represent an unacceptable surrender of fiscal sovereignty.’ Perhaps for this reason, the model tax treaty arbitration provision differs from other commercial arbitration in that there is greater control given to the competent authorities (at the expense of the affected taxpayer). The competent authorities appoint the arbitrators, determine the questions to be resolved, and have significant control over the arbitral procedure. In short, to the extent possible, even the arbitration provision itself addresses sensitive concerns regarding fiscal sovereignty.

The provision and its early adoption in tax treaties, particularly between states with close relationships (for example, Australia and New Zealand, US and Canada), can be explained by the widely-held view that the provision’s real effect will be upon the competent authorities’ negotiations pursuant to the MAP in which the arbitration is embedded. States are so averse to submitting to arbitration (especially in the rare case involving tax policy rather than transfer pricing) that they will earnestly endeavour to resolve international tax disputes through negotiation.

If the provision’s primary effect is to improve MAP outcomes without actual resort to arbitration (as appears likely to be the case), it could indeed facilitate the resolution of a specialised but important class of international tax disputes. (The overwhelming majority of cases submitted for resolution under MAPs involve transfer pricing disputes.) Perhaps more importantly, however, the mechanism might also suggest an alternative way forward in the seemingly stalled discussions about a ‘top-down’ Asia Pacific community. The emerging dispute resolution paradigm for tax treaty arbitrations points to an interesting hybrid model for the many sovereign states that make up this particular regional community.

Japan has begun to embrace international tax arbitration in its recent treaties. With little fanfare, in August 2010 Japan signed its first double tax treaty to include mandatory arbitration with the Netherlands. The Hong Kong–Japan tax treaty, signed in November 2010, also includes the provision. Japan has recently been negotiating amendments to its tax treaty with the United States, and it is believed that mandatory arbitration under the MAP is being discussed. Such actions can be interpreted as Japan signalling to its trading partners (and their tax-resident multinational enterprises) that it is committed to resolving international tax disputes, even at the cost of putting jealously-guarded tax sovereignty on the line. Willingness to cede fiscal sovereignty would seem necessary for the creation of a robust regional arrangement.

Australia also recognises the importance of a modern treaty network to its aspirations of becoming a regional hub for multinational companies, and does not want to discourage Asian economies from competing for its resources. To date, Australia’s only tax treaty to include an arbitration provision is the Australia–New Zealand treaty signed in 2009. It is too early to tell how Australia will approach tax treaty dispute resolution going forward with Asian and other trading partners. Australia’s ambivalence towards tying its own hands when resolving trade and especially investment disputes may suggest a broader, more sceptical attitude towards arbitration of international disputes where firms are concerned.

As the web of bilateral tax treaties between the states of the Asia Pacific inevitably grows, the inclusion of the ‘hammer’ of mandatory arbitration would refocus the emphasis on bilateral negotiation between the two competent taxing authorities in resolving international tax disputes pursuant to the MAP. The growing number of transfer pricing (and other) disputes arising under MAPs — evident also from the latest Annual Report of Japan’s National Tax Agency (2010, p40) — and the growing acceptance of the model arbitration provision in tax treaties mean there will be more occasions for disputes to arise. They will increasingly highlight the importance of sovereignty concerns underlying international tax arbitration.

Dispute resolution in this area can be an indicator and determinant of the cohesion of any meaningful Asia Pacific community. Such a community will be forced to take account of the glorious variety of (sometimes neurotic) attitudes toward sovereignty exhibited by the regional powers. Tax treaty arbitration provides one interesting avenue for doing so.

Micah Burch is Senior Lecturer at Sydney Law School. This article was originally published here and draws on the research project, ‘Fostering a Common Culture in Cross-Border Dispute Resolution: Australia, Japan and the Asia-Pacific’, funded by the Australia-Japan Foundation which is part of the Department of Foreign Affairs and Trade.