Danish High Court rules on the application of EU Arbitration Convention and MAP in transfer pricing case

By Susi Baerentzen, Ph.D., Carlsberg Foundation Postdoctoral Fellow, Amsterdam

On September 9, 2021, the High Court of Eastern Denmark ruled in a remarkable transfer pricing case on the application of the EU Arbitration Convention and mutual agreement procedures. The High Court set a low threshold for the burden of proof that the taxpayer must meet to request a mutual agreement procedure (MAP).

This ruling, along with the general developments in Danish transfer pricing case law, is an indication that settling disputes by arbitration is an outcome that will become ever more important in the future of Danish tax law.

Background

Transfer pricing cases have been very much on the rise in Denmark in recent years. The Danish Tax Agency has thoroughly tested the boundaries of the legislation, and many cases have been appealed to the tax appeals agency, just like the Ministry of Taxation has pursued several fundamental cases before the courts.

Litigation seems to be inevitable in transfer pricing cases, and the question about how to settle double taxation disputes has been evident, as well, because of the cross-border nature of these disputes. Lately, the EU Arbitration Convention (90/436/EEC) has played a significant role and— perhaps— indicated how important this way can be of settling disputes by arbitration for the future.

When applying the EU Arbitration Convention, the first step is to initiate a MAP for the tax administrations of the states involved to negotiate a settlement to eliminate the double taxation arising from the income adjustment one of them made. If an agreement cannot be reached within two years, an arbitration tribunal consisting of an advisory commission must be set up to provide an opinion. Ultimately, this opinion then forms the basis for the competent authorities to eliminate the double taxation.

Today, the EU Arbitration Directive (2017/1852/EU) has replaced the arbitration convention and widened the scope of application to cover other disputes on the application and interpretation of double tax conventions than those merely relating to transfer pricing.

Historically speaking, only one Danish transfer pricing case has ever reached past the mutual agreement procedure and necessitated an arbitration tribunal in the 20 years the convention has been in force. Interestingly, this happened recently in an unpublished case involving the UK, just like the Danish High Court recently ruled in a fundamental case on the application of the EU arbitration convention and mutual agreement procedures in another published case involving Sweden. The latter of the two cases will be analyzed below.

Facts of the case – SKM2021.582.OLR

The ruling from September 9, 2021, concerns a fashion seller, which is part of a global group. This group had changed its transfer pricing model in 2007, which resulted in two audits and ultimately in double taxation: in Denmark and in Sweden. The Swedish tax administration accepted the changed transfer pricing model, meaning, that income that was no longer taxed in Denmark because of the changed model was taxed in Sweden instead.

On November 10, 2014, the Danish Tax Agency increased the taxable income for the Danish corporation H1 A/S in two audits. For the income year 2007 the increase was DKK 110.978.000 (approximately USD 16 million) and for the income years 2008-2011, it was DKK 1.868.076.970 (approximately USD 272 million). The case at hand is not related to these increases but merely to the mutual agreement procedure.

In a ruling dated January 4, 2018, the Danish Tax Agency denied the initiation of a MAP between the competent authorities in Denmark and Sweden, according to the EU Arbitration Convention. The argument for denying the procedure was that the case was not considered as presented in due time, according to the three-year time limit in Article 6(1) of the convention. The tax administration calculated the three-year deadline according to the tax assessment dated November 10, 2014, since the case had also not been duly submitted before the deadline, according to Article 7(1) of the convention with regard to the minimum requirements information stated in Article 5(a) of the Revised Code of Conduct for the convention (2009/C 322/01).

In its ruling, the Danish High Court reiterated the object and purpose of the EU Arbitration Convention: to ensure as soon as possible an effective elimination of presumed double taxation, which can ultimately be achieved by eliminating an ascertained double taxation by reference to arbitration in cases in which the competent authorities have not been able to reach a previous agreement. In terms of the three-year deadline in Article 6(1) of the convention, the Danish tax administration regards the ruling as the “first notification of the action which results or is likely to result in double taxation.”

The High Court further made reference to the OECD Model Tax Convention and noted the tax administration cannot deny a request to initiate a mutual agreement procedure according to what corresponds to Article 6(1) of the convention simply because it does not consider that the taxpayer has proven that such double taxation will occur.

Consequently, the High Court stated that the threshold for the burden of proof that the complaint is substantiated, and that the mutual agreement procedure can therefore be initiated, is low.

Finally, the High Court clarified that the reference to Article 6(1) included in Article 7(1) of the convention must be understood simply to refer to the case being timely submitted and not as a statement that the submission requires that the case has actually been submitted according to Article 7(1), as well.

Ultimately, the Danish Tax Agency’s denial of initiating a MAP procedure has been unjust.

Remarks

The recent developments in Danish tax law relating to the EU Arbitration Convention are interesting, especially when considered as a whole.

First, the fact that the Danish tax authorities have just now made use of an arbitration tribunal after 20 years is hardly surprising given the fact that this measure puts the decision in the hands of tax experts of independent states. Viewed in light of how aggressive the tax authorities have been in their claims in transfer pricing cases—especially in recent years—it seems like an unlikely solution.

Keeping both the aggressive protection of Danish taxation in transfer pricing cases and the reluctance to hand over the decision to an independent power in mind, it seems even more interesting that the Danish Tax Agency should be reluctant to initiate a mutual agreement procedure in a case that seems to very obviously result in double taxation.

Ultimately, this change in strategy will not only continue to result in a higher number of transfer pricing disputes, it’s more likely that mutual agreement procedures and arbitration will be brought into play in the future, as well.