The Development of Administrative Co­operation.

10 T HE I NTERNATIONALIZATION OF T AX A DMINISTRATION Administrative cooperation has increasingly come to play a key role in the co­ ordination of national taxes on international business. As has been stressed in previous chapters, governments have preferred to avoid the political problems of trying to agree principles for the definition and allocation of the international tax base, and they have consequently relied on the more pragmatic development of ad hoc solutions by administrative processes. When problems of international taxation became prominent again in the 1970s, both policy discussion and practical coordination between tax administrators assumed even more importance. International administrative cooperation has been more highly developed in tax matters than in other areas of business regulation, although in a partial and patchy way due to the unevenness of the treaty network. But it has not proved easy to resolve the underlying issues of principle through administrative procedures. Indeed, the problem of legitimacy has also arisen in relation to the procedures themselves, since the lack of adequate substantive criteria has made it harder for governments and officials to accept procedural fairness, while business organizations have opposed proposals for the strengthening of administrative cooperation because of their lack of confidence in the fairness of either the principles or procedures of international taxation.

1. The Development of Administrative Co­operation.

The prevention of international double taxation was from the beginning coupled with proposals for administrative cooperation to combat international evasion and avoidance. Due to concern about international capital flight the problem of evasion was specifically included in the brief of the Technical Committee set up by the League of Nations in 1922, which became the Fiscal Committee see Chapter 1 section 4a above. However, the overriding aim was to facilitate international capital movements, and the International Chamber of Commerce at its 1922 Congress condemned `all proposals attacking the freedom of exchange markets or the secrecy of banking operations ¶ although several members of the ICCs Fiscal Commission thought that the problem of evasion should not be ducked ICC 1925. The preparatory reports and Commentary to the original draft Treaty on Mutual Administrative Assistance in Matters of Taxation of 1928 stressed that the purpose was to ensure not only that incomes were taxed once and once only but also that no­ one should avoid tax. The combating of fraud would be for the general good, but it was important to avoid the appearance that the international arrangements entailed `an extension beyond national frontiers of an organised system of fiscal inquisition ¶ or an `organised plan of attack on the taxpayer ¶ League of Nations 1927, 1928. Ironically, it was precisely in such terms that, over sixty years later, the multilateral convention for administrative assistance in taxation drawn up through the OECD and the Council of Europe was denounced by business groups and representatives see below. In practice, progress on establishing arrangements for administrative cooperation was significantly slower than on agreements for the prevention of double taxation. A study in 1937 for the League by Mitchell Carroll estimated that fewer than half of the bilateral double taxation treaties had been supplemented by provisions for mutual assistance. 1 Asked by the Assembly of the League to study measures against evasion, the Fiscal Committee proposed a general multilateral convention for mutual assistance, but the replies were disappointing. Governments were reluctant to modify their domestic laws, or to require information from their nationals, for the purpose of complying with the needs of foreign administrations; 2 the committee was therefore reluctantly obliged to accept that assistance would have to be based on the existing legal powers of governments, which in view of their diversity ruled out a multilateral convention PRO file IR40­5703. The two model treaties agreed at the 1928 meeting, for administrative assistance in taxation and for judicial assistance in collection of taxes, were combined into one by the Mexico and London models on the grounds that the type of cooperation necessary was the same for assessment and collection, and that negotiators could easily restrict administrative cooperation to assessment alone, `as is not infrequently done in bilateral agreements ¶ merely by omitting the provisions on collection League of Nations 1946, p.44. Noting the distrust of mutual assistance arrangements, which had restricted their conclusion to some fifteen countries mainly neighbouring countries in continental Europe, the Fiscal Committee emphasised the safeguards which should make such 1 Ten by inclusion of assistance provisions in the treaty and fifteen by means of a separate mutual assistance convention League of Nations FFiscal99, contained in PRO file IR40­5703. 2 Report of the 8th session of the Fiscal Committee, 1938, in US Congress 1962A. See also Piatier 1938 for a study of the problems and progress made before the War. arrangements palatable. In particular, a state could only be required to take actions normally available under its own laws and practices and which could reciprocally be taken by the state requesting the assistance; a state could also refuse a request which would involve a violation of commercial secrecy, or which concerned its own nationals, or which in its opinion would compromise its security or sovereign rights; and the same provisions for confidentiality should apply to information supplied as would apply in the supplying state. 1 Also, the assistance convention was specifically tied to the treaties for prevention of double taxation by direct taxes and death duties, applying only to taxes covered by those treaties. Despite these safeguards, and despite the rapid spread of tax treaties in the postwar period, very few treaties for mutual assistance were concluded; instead, provisions for cooperation were made in the double taxation prevention treaties themselves. However, the administrative assistance provisions were reduced to a single article on Exchange of Information Article 26 of the OECD and UN models, and few treaties included a provision for assistance with collection. This tied mutual assistance even more closely to the prevention of double taxation, which not only limited the scope of assistance even between treaty partners, but also meant that states which saw no benefit in negotiating tax treaties need accept no obligations to provide assistance to combat tax avoidance or evasion. In the 1980s, the US authorities have attempted to plug this gap as part of the campaign against tax havens, by using other inducements and pressures to try to obtain specific Tax Information Exchange Agreements, especially with Caribbean countries; however, they have not found it easy to secure agreements containing satisfactory relaxations of bank and commercial secrecy laws without offering a quid pro quo such as US tax exemption for specific offshore business such as insurance see Chapter 7 section 3 above and section 2b below. While the growing network of tax treaties helped to facilitate international capital movements especially once direct restrictions on such movements began to be lifted from 1958, the emphasis shifted from concern about tax evasion to the large grey area of international avoidance. The increasingly complex structures developed by international business advisers for taking advantage of the differences in national taxation raised difficult questions of legitimacy in the allocation of the international tax base; but, as we have seen in earlier chapters, these were not tackled directly by the tax treaty principles, but to a great extent left for resolution by direct negotiation, often on a case­by­case basis. Hence, the apparently modest tax treaty provisions for administrative assistance took on a great importance, no longer primarily for blatant evasion, but to facilitate a coordinated administrative approach to avoidance. 1 Some significant changes have been made in these conditions in the modern treaties, but they remain broadly similar: see below, section 2.b. Nevertheless, the work in the inter­war period had established a vital principle, without which these issues could not have been confronted at all. This was that the tax authorities of treaty partner states could consult together directly for the purposes of application of the provisions of tax treaties. A general article providing for consultations between the `competent authorities ¶of the contracting states to facilitate the application of the treaty, and even its interpretation and adaptation to changing circumstances, was included in the model treaties, 1 originating with the 1928 draft. More specifically, since the Carroll report and the 1935 Allocation convention, it had become clear that a procedure to ensure harmony in the application of the treaty principles was necessary: in particular, transfer pricing adjustments to the accounts of a branch or subsidiary by one state might result in double taxation unless a mechanism was established to ensure a corresponding adjustment by the state taxing the related entity. The business lobbies had pressed for a right to an automatic corresponding adjustment and access to international adjudication, but this had been resisted by the state officials, who preferred such adjustments to remain a matter for their discretion and mutual negotiation. Only recently has there been a revival of the possibility of adjudication of corresponding adjustments and other conflicting treaty interpretations see section 3 below. Although the tax authorities have considered it to be easier to secure the necessary compromises and accommodations by treating the issues as technical matters for resolution by discretionary and secretive administrative processes, this has also to a significant extent undermined legitimacy. Thus, administrative cooperation through direct contacts between national administrators has been a key factor in the effective operation of international tax arrangements. The authority for these direct contacts is primarily derived from the bilateral tax treaty provisions, especially those for information exchange Article 26 of the model, corresponding adjustment Article 92 and mutual agreement Article 25; in addition, some newer treaty provisions also require administrative cooperation, notably the rules for denial of treaty benefits to ineligible non­residents to prevent treaty­shopping see Chapter 7 section 3 above. By providing for direct contact between administrators, without the need for communication through diplomatic channels, the tax treaties established a process of administrative internationalization which was, and to a considerable extent remains, unique. Similar arrangements have more recently been developed for coordination of other types of economic regulation, notably among bank supervisors e.g. the Basle Committee of Bank Supervisors, see Chapter 6 section 1c above and regulators of markets for financial services, but the administrative cooperation in those areas has so far been confined, formally at least, to information exchange. The tax treaty administrative provisions have gone further than others since they cover not only exchange of 1 Article XIX of the London model, see section 3.b below. information and policy concertation, but also explicitly provide for coordinated enforcement in individual cases, which has also led to establishing procedures for simultaneous examination of related taxpayers see section 2.c below. An especially important development was the formation in 1972 of the Group of Four, an informal organization bringing together the tax administrations of France, Germany, the UK and the US. In addition to annual meetings for policy discussions at the highest level of Commissioner or the equivalent, programmes have been developed at staff levels for joint study of specific problems, and it was from these contacts that the simultaneous examination procedures developed. Regarded as an informal arrangement, the proceedings of the Group of Four are confidential and even its existence was treated as secret for some years. 1 Although officials deny that individual cases are dealt with multilaterally within Group of Four meetings, it does seem that these meetings are used at least to select cases and agree procedures, although in principle any substantive discussions about specific taxpayers must be on a bilateral basis. Further, the discussions of particular industries which are an important part of the working level meetings are likely to entail reference both to aggregate data and individual illustrative examples. PATA, the Pacific Association of Tax Administrators, is a Pacific area version of the Group of Four Australia, Canada, Japan, the US set up in 1980, which also holds both annual meetings at Commissioner level and regular meetings of working officials, to study and exchange information on specific industries petroleum, grain, commodities, banking, exchange practical experiences, and even discuss specific cases. Comparable meetings have also been held by a European Group of Six, consisting of Belgium, France, Germany, Luxembourg, the Netherlands and Britain. Other more ad hoc groups have exchanged information about and discussed specific industries, such as oil and gas and forestry products. 2 Some more formal organizations have also facilitated administrative contacts and coordination. The importance of the activities of the Committee on Fiscal Affairs of the OECD has been stressed already: its formal work has been confined to policy questions and it is regarded as too large a group to be effective for more specific matters, although its meetings provide a useful occasion for direct personal contact and even camaraderie. Perhaps surprisingly, the European Community has not yet provided a significant forum for multilateral cooperation, despite the adoption of the Directive on mutual assistance in 1977 EC Council 1977, which envisaged consultations in a committee of competent authorities of member states plus the 1 Exceptionally, a press release was issued on 3 October 1985 by the German Ministry of Finance on the occasion of the groups meeting in Berlin, briefly describing the aims and organization of the group: Germany, Ministry of Finance 1985. See also UK House of Commons, Written Answers, vol.939 cols. 269­270 16 Nov. 1977. 2 Much of my information on these matters derives from interviews with officials involved, in Britain, the USA, France, Germany and Japan. Commission Article 9, and a pooling of experience in the field of transfer pricing and if appropriate the drawing up of rules in this field Article 10. In the first decade of existence of the Directive these possibilities for multilateralization were largely ignored: the main member states preferred to deal with each other bilaterally under their tax treaty provisions, 1 and indeed several member states Germany, Italy and the UK were considered by the Commission to be failing in their obligation to implement the Directive in domestic law. However, the extent of coordination in enforcement by EC members may increase with the accelerating pace of direct tax harmonization related to completion of the internal market. In particular, the Community has now provided a lead in establishing a procedure for arbitration of claims for corresponding adjustments EC Council 1990C, see section 3.a.iii below. Other bodies have concentrated more on the exchange of experience and training. CIAT the Inter­American Centre of Tax Administrators has been in existence since 1967, linking 26 countries in the Americas including Canada and the US, holding annual assemblies which discuss tax administration questions such as planning and control and tax simplification, as well as regular technical conferences which have covered international matters, including the exchange of information under treaties CIAT 1978, and publishing a regular newsletter and a Review. CATA the Commonwealth Association of Tax Administrators, based at the Commonwealth Secretariat in London, has held general meetings every three years since its establishment at the 1976 Commonwealth Finance Ministers meeting, interspersed with technical meetings or seminars discussing matters of common interest such as tax incentives CATA 1985: it also carried out a survey in the late 1970s of approaches adopted by Commonwealth member states in the taxation of TNCs. There are also close links between the tax administrations of France and her former colonies in Africa; French tax inspectors are seconded to some countries especially Ivory Coast and Gabon to provide technical assistance, and an annual meeting is held of senior tax administrators Tixier Gest 1985, p. 456. Another potentially important group, whose work has so far been confined to more general discussions, is the Study Group of Asian Tax Administration and Research, including Australia, Japan, Korea, New Zealand and the 5 ASEAN countries. Regional groups also include the African Association of Tax Administrators AATA and the Caribbean Organization of Tax Administrators COTA. If in some sense they provide the basis of an embryonic world tax administration, these bodies are as yet heterogeneous, informal and over­secretive about their existence and activities. Clearly, a significant role has been played by US Treasury 1 In its Note on International Cooperation to the Keith Committee on Revenue Enforcement Powers, the UK Inland Revenue stated in 1981 :`So far no use has been made by the UK Inland Revenue of the 1977 Directive, and little use has been made of it by other member countries. This is because it has been convenient to continue to make exchanges, where they are appropriate, under the double taxation DJUHHPHQWV¶ and IRS officials, who are present in most of the groups and whose greater experience and resources, as well as the greater difficulties they face, give them a leading role, although neither their opinions nor their policies command automatic acceptance. International administrative cooperation seems caught in a dilemma: its increasing importance calls for a more comprehensive legal basis clarifying the rights and responsibilities of both tax­gatherer and tax­payer, yet the disparities in national tax laws and practices and the difficulties of reaching agreement on general principles of fairness in defining and allocating the international tax base make it hard to obtain political support for such a comprehensive arrangement. Indeed, considerable opposition has built up, especially within the international business community, to the formalization of mutual assistance in multilateral arrangements. This came to a head over the German legislative proposals to implement the EC mutual assistance directive, and developed into more general opposition to the multilateral Convention on Mutual Administrative Assistance in Tax Matters, drawn up through the OECD and the Council of Europe and opened for signature in January 1988 Council of Europe 1989. Although this convention essentially establishes on a comprehensive and multilateral basis the legal provisions for information exchange and mutual assistance in assessment and collection along lines familiar since the 1928 model treaties, it was opposed by bodies such as the Business and Industry Advisory Committee BIAC of the OECD and the Taxation Commission of the ICC, and strenuously denounced in the press especially the European edition of the Wall Street Journal. The objections centred on the lack of adequate safeguards for the taxpayer and the failure to provide a right to double taxation relief, for example by a right of access to arbitration of double taxation claims, as the necessary counterpart to any strengthening of revenue powers ICC 1985; OECD­BIAC 1985. As a result, agreement on the text was held up not only by the familiar objections from Switzerland and the other banking centres, but also by the German representatives, who felt constrained by the political opposition of business groups. Once adopted, several key states Australia, Germany and the UK announced that they would not sign the Convention, while others, notably France and the US, indicated that they would only adhere to the information exchange provisions and not the provisions on assistance in collection US Congress 1990B. It is clearly not possible to overcome the problem of legitimacy of international tax arrangements merely by measures to strengthen powers of cooperation in enforcement. The unwillingness of the tax authorities to accept the application of due process standards to the administrative cooperation arrangements is understandable, as it reflects the difficulties in establishing agreement on the substantive criteria for international taxation. Yet without some measure of agreement on such criteria, as well as procedural safeguards for international administrative arrangements, the legitimacy of international taxation will remain problematic.

2. Obtaining and Exchanging Information