Competently negotiating the U.S. competent authority process

Tax Executive, The, May-June, 2007 by Kerwin Chung, Richard McAlonan

Introduction

The competent authority process has received extensive consideration recently as corporate tax departments have begun reviewing their transfer pricing in light of the Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). In measuring the potential benefit of transfer pricing tax positions under FIN 48, the availability and likelihood of obtaining relief from double taxation must be considered. Competent authority is the short-hand name for the process established under the mutual agreement procedure (MAP) articles of U.S. tax treaties that enables taxpayers to obtain double taxation relief when one treaty country makes a transfer pricing adjustment. The need to evaluate whether transfer pricing is arm's length, which is often based on professional judgment, combined with the need to determine whether double tax relief is available through the competent authority process (with which few corporate tax departments have direct experience) can make the FIN 48 process daunting for transfer pricing positions. This article is intended to educate corporate tax professionals on the competent authority process and provide practical advice on negotiating the process.

What Is Competent Authority and How Is It Organized?

The U.S. Competent Authority assists taxpayers regarding matters covered in the mutual agreement procedure articles of the income tax treaties to which the United States is a party. (1) U.S. income tax treaties designate the Secretary of the Treasury as the U.S. Competent Authority. This responsibility has been delegated to the Deputy Commissioner (International), Large and Mid-Size Business Division, who serves as the U.S. Competent Authority in administering the operating provisions of tax treaties, including reaching mutual agreements in specific cases and interpreting and applying tax treaties. (2) The IRS Office of Tax Treaty serves as the staff for the U.S. Competent Authority on tax treaty matters by administering the MAP process. (3) The staff of approximately 30 analysts and managers is divided into three branches that are responsible for the following geographic areas:

(1) Americas;

(2) Europe and Middle East; and

(3) Asia/Pacific.

Within the branches, it is common for individual analysts to focus most of their efforts on cases with a particular country. For example, the branch responsible for Europe and the Middle East has an analyst who coordinates the U.K. cases, and the branch responsible for Asia/Pacific has an analyst who coordinates the India cases. This specialization is extremely valuable, and these analysts can provide helpful information to taxpayers undergoing a foreign examination. The branch assignments are not rigid, and analysts assigned to one branch (geography) sometimes work cases involving treaty partners in other geographies to balance workloads among the branches.

Why Do You Need Competent Authority?

A. Reasons for Requesting Competent Authority Assistance. U.S. tax treaties permit taxpayers to request competent authority assistance when they consider that the actions of the United States, the treaty country, or both, result or will result in taxation that is contrary to the provisions of the treaty. The most common reason for requesting competent authority assistance is to relieve economic double taxation arising from a transfer pricing adjustment under section 482 of the Internal Revenue Code or an equivalent provision under the laws of a treaty country. Competent authority assistance may also be requested with respect to other issues as provided in the tax treaties, including residency and withholding tax issues and discretionary determinations whether a taxpayer is entitled to the benefits of a treaty under the limitation on benefits articles.

B. Double Taxation Caused by Transfer Pricing Adjustments.

The most common reason why taxpayers request competent authority assistance is to relieve economic double taxation resulting from a transfer pricing adjustment by the IRS or a foreign tax authority. Absent the relief provided by the competent authority process, a transfer pricing adjustment in one jurisdiction would result in the amount of the adjustment being taxed twice, which in turn could result in a spike in the company's global effective tax rate. This negative effect and the benefit of competent authority relief can be understood through the following examples:

Example 1--Base Case

Tax Return Position    Income     Tax Rate   Tax

Parent                   50         40%       20
Subsidiary               50         30%       15
Totals                   100                  35

In this example, the multinational group has 100 of total income attributable to intercompany transactions between Parent and Subsidiary. Under the group's transfer pricing analysis, the 100 of income is allocated equally between the Parent and Subsidiary. The group's global effective tax rate is calculated to be 35 percent (35 tax / 100 income = 35 percent).