Application of the Double Tax Treaties to Tax Disputes
Zhanar Kasymbekova, Senior Attorney, Bracewell & Giuliani L.L.P.
An essential criterion of assessing the investment climate of any country is indeed sufficient guarantees of protection of the investor's interests – both from the perspective of national legislation, and recognition and enforcement of international treaties in such country. Foreign investors (this is true for foreign entities in Kazakhstan and Kazakh entities abroad) must be confident that in certain cases they can expect additional protection through proper application of the provisions of international treaties to them. Given that Kazakhstan sees a steady trend towards an increase in tax disputes falling under the Double Tax Treaties, to which Kazakhstan is a party (the "double tax treaties"), this article addresses certain aspects of their application to tax disputes.
Application of International Treaties to Settlement of Tax Disputes
Double Tax Treaties apply to any parties, resident in one or both Contracting States, and have as their purpose to avoid double taxation by applying the limits, within which a certain object may by taxed by each of the two states. It should be noted that no exception in this respect is represented by non-resident subsoil users operating under the subsoil contracts with the Republic of Kazakhstan. As is generally known, such contracts provide for special tax treatment, which must apply throughout the entire contract term and may only be changed in certain circumstances. However, operation of any special tax treatment with respect to such subsoil user should not prevent from application of the double tax treaties thereto, as the latter have priority. Therefore, proper application of a double tax treaty is the key to proper taxation.
Kazakhstan's practice is governed by the Instruction Concerning Procedure for Application of the Conventions (Treaties)for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital between the Republic of Kazakhstan and foreign states, which has been developed in order to clarify only general principles of application of double tax treaties. It very clearly provides that in each specific case the reliance, in the first place, should be upon provisions of an applicable double tax treaty. Nevertheless, in handling the disputes falling under a particular double tax treaty the tax authorities and courts frequently confine to application of said Instruction and special provisions of Chapter 31 of the Kazakhstan’s Code On Taxes and Other Compulsory Contributions (the "Tax Code") related to international treaties. Or, which is quite common as well, they interpret provisions of the double tax treaties from the perspective of the national law. Such misapplications essentially contravene purposes of the double tax treaties per se and the principle of helping the contracting states to preserve the balance of interests between taxpayers and the State.
Based on the foregoing, I believe it would be appropriate to consider, first of all, direct application of the treaty, which is of great practical importance for proper taxation.
Pursuant to the Kazakhstan’s Constitution (paragraph 3, Article 4), the international treaties ratified by Kazakhstan have priority over its laws and apply directly, unless an international treaty implies that the application thereof requires enactment of a domestic law. For tax purposes, the Tax Code (paragraph 5, Article 2) provides that, if an international treaty ratified by the Kazakhstan sets forth any other rules than those contained in the Tax Code, the rules of such treaty shall apply.
In most cases, the double tax treaties, to which the Republic of Kazakhstan is a party, have been ratified in their entirety and do not contain any requirements for the parties to follow any additional procedures as to application thereof. In the absence of such requirements and procedures, tax treaties may be applied directly to any tax relations. This rule is material for settlement of the tax disputes of such category, because it defines the limits applying thereto the domestic legislation of a contracting state, in our case Kazakhstan. In particular, provisions of Chapter 31 of the Tax Code, which set forth special terms for the international treaties, and provisions of the Instruction may govern a tax and tax relations to the extent that it complies with the double tax treaty.
This rule is also ensuing from the other provisions of Kazakhstan's legislation. Article 25 of the Edict of the Kazakhstan’s President On the Procedure for Execution, Performance and Denunciation of International Treaties of the Republic of Kazakhstan dated 12 December 1995 states that interpretation of international treaties shall be subject to the Kazakhstan’s Constitution and provisions of the international law. In turn, provisions of the international law, in particular, Vienna Convention on the Law of Treaties (ratified by the Republic of Kazakhstan as of 31 March 1993) also contain the rules, whereby such interpretation of international treaties is permitted.
Practical significance of all said provisions is of utmost importance to this end, because any interpretation of international treaties (in our case, the double tax treaties) subject to the national legislation (other than the Constitution) is not permitted.
Chapter 6 Special Provisions of some treaties (that is based on the OECD Model Tax Convention on Income and Capital) envisages that the competent authorities of the contracting states shall seek to achieve mutual agreement in settlement of any difficulties or doubts arising in the interpretation or application of a treaty. The US Double Tax Treaty, in particular, provides that the competent authorities of the contracting states may agree to the same allocation of income, deductions, credits or allowances of a resident of one contracting state to its permanent establishment located in the other contracting state.
In view of all the above-mentioned clauses and provisions, the conclusion can be made that until the competent authorities reach a mutual agreement as to the application of any provisions of the double tax treaty, such treaty directly applies and governs any tax relations. Furthermore, any unilateral interpretation of such provisions of the treaty by a competent authority or a court of any one of the contracting states is not permitted.
Accordingly, the double tax treaty has direct effect on and is to be directly applied to the tax relations, and governs the same. Any provisions of the double tax treaty may be applied, clarified or interpreted, provided only that is has the direct effect. In the event of any issues or disputes, whether on substance of tax liabilities, or with respect to the procedure for application of a double tax treaty, which covers such liabilities, this rule may be crucial for a non-resident taxpayer in order to properly determine the taxable object.
Alternative Methods of Dispute Resolution within the Double Tax Treaties
Since we will further elaborate on additional methods and possibilities of the tax dispute resolution within the double tax treaties, we should briefly discuss how a taxpayer can defend his interests from improper taxation in accordance with the order and procedures set forth by the Kazakhstan’s legislation or, in other words, by means of protection provided in Kazakhstan.
Section 18 of the Tax Code contains general provisions of how a taxpayer may challenge the results of any tax audit regardless of residency. According to the existing procedure, an act is to be drawn up based on the results of a respective tax audit, which, in case of any tax offences, serves as a basis to issue a notice of assessment of taxes and other mandatory payments to the budget, including penalty thereon. If a taxpayer disagrees with the audit results and the notice, then he has the right to challenge it within 15 business days of receipt thereof in the higher tax authority or within a 3-month period in the court (paragraphs 1 and 2, Article 552; Article 566 and Chapter 27 of the Civil Procedural Code of the Republic of Kazakhstan).
As a rule, a taxpayer seeks judicial protection if his appeal, after its consideration by a higher tax authority, has not been sustained in full or in part. Therefore, such taxpayer will always consider appealing to court as a measure of last resort because, from the perspective of law, a final decision must be rendered in relation to the dispute in court proceedings after it has been considered in courts of all instances (in certain exceptional cases, it is possible that the decision will be revised, for example, based on newly discovered facts). However, it is clear that even after all of the above procedures have been completed, taxpayers are not always satisfied with the outcomes. For such cases, double tax conventions, which are based on the Model Tax Treaty, have special provisions whereby the taxpayer may take his case outside the national jurisdiction of a contracting state. One of such provision is the Mutual Agreement Procedure (Article 25), whereby it is guaranteed to the taxpayer that, where the taxpayer considers that the actions of one or both of the contracting states may result in taxation not in accordance with the provisions of the double tax treaty, the taxpayer may, irrespective of the means of protection provided by the domestic law of those states, present his case to the competent authority of the contracting state of which he is a resident. Accordingly, if the non-resident taxpayer has previously used the remedies stipulated by the laws of the Kazakhstan and is not ultimately satisfied with the outcomes because he believes that the tax treatment, which has been applied to him, is not in conformity with a certain tax convention, the taxpayer may, pursuant to the Mutual Agreement Procedure, present his dispute for resolution to the competent authorities of the two contracting states.
The mutual agreement procedure (the "MAP") per se does not fall under the domestic laws of the two contracting states. It is intended to resolve existing disputes within the tax treaty pursuant to its objectives such as avoidance of double taxation and providing a non-resident taxpayer with a proper and fair tax treatment. Subject to these objectives, competent authorities of the two contracting states may consider only those disputes which fall under the events as provided for by paragraph 1 of Article 25 of the tax treaty, i.e. in the event of taxation imposed not in accordance of the provisions of the tax treaty, and only to the extent that such disputes are subject to the double tax treaty. This is a mandatory requirement for a dispute to be resolved within the MAP. Normally, tax disputes are of a mixed nature when both domestic laws and the tax treaty are violated. In this case, such dispute may be resolved by a competent authority to the extent that it directly relates to the tax treaty. It is important that the appellant takes into account the limits of such resolution because it is exactly the wrong application or non-application of the tax treaty that results in wrong application of the provisions of domestic laws. In this circumstances, the taxpayer needs to prove that such direct relation exists which should be properly reflected in his objection. When speaking about agreement procedures as stand-alone procedures which do not depend on the domestic laws and treatments established in the contracting states, it should also be noted that completion of such procedures does not depend on the status of the tax dispute in any of those states. The taxpayer's filing an objection to have his dispute resolved within the MAP does not restrict any of his rights and options to seek protection of his interests applying remedies provided by national laws.
Although the tax treaties do not contain any procedures for submitting an appeal to competent authorities, they do provide for certain requirements to be followed with by the taxpayer in order to have the dispute considered within the MAP. These requirements, first of all, apply to where and when the taxpayer may file his objection. Pursuant to paragraph 1, Article 25, the taxpayer shall file such objection to the competent authority of the state of which he is a resident; and the period for filing the application is determined by a specific tax treaty and may be from three to five years of the date when the taxpayer received a tax notice or when actions resulting in wrong taxation were taken against him. In this regard, it should also be noted that it is not only the fact that taxes have been imposed or a request to pay such taxes (notice of imposed taxes) has been received but just a threat in the form of actions undertaken by tax authorities that constitute grounds for appeal. If the latter is the case, the period for filing the application must commence on the date when the taxpayer became aware of such actions.
Pursuant to paragraph 2, Article 25 of the tax treaty, if the competent authority finds the objection to be justified and if the competent authority is not itself able to arrive at a satisfactory solution, it will endeavour to resolve the case by mutual agreement with the competent authority of the other contracting state, with a view to avoid the taxation which is not in accordance with the double tax treaty. Therefore, the competent authority, which has received the taxpayer's objection, must determine if the objection represents a valid case under the double tax treaty. Only if the tax authority determines that the existing dispute has in full or in part resulted from a breach of the provisions of the double tax treaty or from the measures which do not conform to the treaty, it shall be obligated to take measures provided for by paragraph 2, Article 25 of the double tax treaty, i.e. to initiate the mutual agreement procedure.
Any agreement reached under the MAP shall be implemented notwithstanding any time limits or other procedural limitations in the domestic law of the contracting states (paragraph 2, Article 25). This rule is effectively one of the rules which determine and guarantee that the decision, which is made under the MAP, must be enforced notwithstanding the outcomes of the dispute resolution in accordance with the provisions of the national law of the contracting state and notwithstanding the time limits for enforcement of such decision in such contracting state.
In Kazakhstan, the established practice is that the decision, which is made within the MAP under the double tax treaty, is subject to mandatory enforcement. The enforcement procedure depends on who has made the final decision on the tax dispute pursuant to the domestic legislation of Kazakhstan. If there is a court decision in relation to the dispute, then, as we see it, such decision may be enforced through review by the same court based on new evidence. However, if the dispute has been resolved only by a tax authority, then the Ministry of Finance, being the competent authority, shall be obligated to cancel the previously issued notice or to issue a new notice such notice to be in accordance with the decision made by the competent authority. Although this procedure is described in view of the applicable legislation of Kazakhstan, it should be noted that it would be reasonable if the Kazakh laws were accordingly amended to include provisions which would allow enforcement of such decisions in the same manner as the decisions of foreign courts are enforced.
Despite the obvious advantages of the MAP described above, it should be noted that, unfortunately, in practice it can be a lengthy procedure and the reason for this is that the competent authorities do not always consider it necessary to initiate the MAP because they see it as their right rather than their obligation. This is equally so in relation to the competent authorities of the other contracting state which are not always willing to promptly respond and support the initiation of the MAP. In Kazakhstan, such practice is often used by the Ministry of Finance which, in our view, places serious constraints on the role and importance of the Ministry as a competent authority when resolving disputes within the MAP. It appears that this is exactly the reason why the actions of the two competent authorities are, as a rule, time consuming and may place a burden for the taxpayer submitting his objection. At the same time, if the competent authority, to which the taxpayer has submitted his objection, accepts that the objection is valid, then, as we understand it, such appellant has the right to demand initiation of the MAP by such competent authority since Article 25 of the double tax treaty obligates such competent authority to do so. The same approach should be applied to the other competent authority, to which the request to initiate the MAP has been addressed since the double tax treaty provides that such other competent authority should endeavour to complete this procedure as soon as reasonable practicable.
In conclusion, it should be noted that, while the mutual agreement procedure can be quite burdensome both time-wise and from the perspective of restitution of his interests, it sometimes can be the only alternative for the non-resident taxpayer to ultimately protect his interests.
Zhanar Kasymbekova is a Senior Attorney with the branch of Bracewell & Giuliani L.L.P. in Kazakhstan and has been leading the trial department of the firm since 2000. She concentrates on representing clients in issues relating to tax and civil (business) law. She has experience of litigation in courts of Kazakhstan representing major Kazakhstani and foreign investors in issues relating to double taxation, taxation of subsoil users, tax assessments and tax disputes.
* The English text of the article was provided by the author.
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