Ravil Kassilgov, partner
TKS Disputes
The Mutual Agreement Procedure with a Foreign State
As a Defense Mechanism in Tax Disputes
According to the author’s observations, since the introduction of administrative justice in Kazakhstan[1], the quality of tax dispute resolution has been steadily improving. This is not only reflected in the favorable court statistics for businesses and citizens, but also in the evolving status of administrative courts. Much of this progress is driven by judges adopting new, and at times quite bold, approaches to resolving longstanding legal conflicts.
In this article, we will explore this non-standard and groundbreaking approach to assessing the value of the mutual agreement procedure with a foreign state, which represents a breakthrough in judicial practice.
- The Essence of the Mutual Agreement Procedure
A mutual agreement procedure (MAP) is a mechanism outlined in double tax treaties (DTTs) that allows taxpayers to request assistance from the competent authorities of their home state to resolve tax disputes resulting from the improper application of tax treaties by the other state. Typically detailed in Article 25 of DTTs, the MAP enables the competent authorities of both contracting states to engage in discussions and reach a mutually acceptable solution, thereby eliminating double taxation or correcting tax inconsistencies with the provisions of the treaty.
The mutual agreement procedure enables taxpayers to safeguard their rights when the actions of one state lead to taxation that is inconsistent with the provisions of international agreements.
According to official statistics from the Organization for Economic Cooperation and Development (OECD)[2], as of the beginning of 2022, 31 MAPs were in progress in Kazakhstan. Throughout the entire year, only one of these 31 procedures was completed.
It is important to note that the speed of MAPs in Kazakhstan is significantly slower compared to countries such as Hungary, Latvia, Chile, Hong Kong, Croatia, Bulgaria, Liechtenstein, and Estonia. While the total number of MAPs in Kazakhstan in 2022 was higher than in these jurisdictions, the number of completed procedures in these foreign jurisdictions far exceeded Kazakhstan’s. In 2022, only one MAP was finalized in Kazakhstan, compared to 14 in Hungary, 4 in Latvia, 6 in Chile, 4 in Hong Kong, 6 in Croatia, 5 in Bulgaria, 4 in Liechtenstein, and 5 in Estonia.
In contrast, countries such as Germany, Italy, France, Switzerland, Belgium, the Netherlands, Sweden, Denmark, and Norway handle and complete hundreds of MAPs annually, highlighting the high level of development in MAP implementation.
Kazakhstan, however, holds a record for the slowest MAP processing times. The average duration of one MAP in Kazakhstan is 67 months. Slovenia and Vietnam take second and third places, with average durations of 63 and 58 months, respectively. For comparison, the average duration in Germany is 26 months, Spain 23 months, Switzerland and the UK 20 months, and Canada and the Netherlands 19 months.
Despite the inefficiency of Kazakhstan’s state bodies in implementing MAPs, individual cases illustrate the practical value of this mechanism.
- MAP: A Case Study Example
- The Essence of the Dispute
In 2020, a branch of a Polish company operating in Kazakhstan (the Branch) faced additional corporate income tax assessments following a tax audit. The additional assessments were imposed due to the Branch’s failure to timely submit the tax residency certificates of its Polish parent company (the Company). As a result, the tax authority excluded general administrative and management expenses from the Branch’s deductions and denied the application of a reduced 10% tax rate on the Company’s net income.
The Company’s legal position in its dispute with the tax authority was based on the following points:
- Article 7(3) of the DTT between Kazakhstan and Poland[3] (the Convention) states that, in determining the profits of a permanent establishment, a deduction is allowed for expenses incurred for the purposes of the permanent establishment, including management and general administrative expenses, regardless of whether these expenses were incurred in the state where the permanent establishment is located or elsewhere;
- Article 10(6) of the Convention stipulates that a company which is a resident of one Contracting State and has a permanent establishment in the other Contracting State may be subject to tax in that other state, in addition to income tax. However, such tax must not exceed 10% of the share of the company’s profits that are taxable in the other Contracting State;
- The Convention does not impose a requirement for submitting a residence certificate by the due date of the tax declaration. Additionally, Article 24 of the Convention establishes an obligation not to impose a more burdensome taxation or any related obligation;
- According to paragraph 3 of Article 4 of the Constitution of Kazakhstan, international treaties ratified by Kazakhstan take precedence over domestic laws.
2.2 Initiation of the MAP and the Course of the Court Case
In November 2020, before filing a pre-trial complaint regarding the audit results with the Ministry of Finance of the Republic of Kazakhstan, the Company approached the Ministry of Finance, Funds, and Regional Policy of the Polish Republic (Polish Ministry of Finance) with a request to initiate a Mutual Agreement Procedure with Kazakhstan. In February 2021, the Polish Ministry of Finance officially submitted a request to the State Revenue Committee of the Republic of Kazakhstan to initiate the MAP.
Following the rejection of the complaint at the pre-trial stage, the Branch appealed to the court in August 2021. By that time, administrative courts had begun operating in Kazakhstan, which significantly influenced the course of the case.
The Branch lost the case in the first two instances. However, when the Supreme Court reviewed the case, the judicial board carefully examined the status of the Mutual Agreement Procedure. Upon discovering that the MAP had not actually been conducted, the panel overturned the lower court rulings and remanded the case to the court of first instance for reconsideration. The court’s ruling included the following key findings[4]:
“In accordance with the preamble of the Convention, the Government of the Republic of Kazakhstan and the Government of the Republic of Poland have concluded the Convention, guided by the desire to strengthen and develop economic, scientific, technical and cultural relations between the two States in order to eliminate double taxation and prevent evasion of taxes on income and capital.
According to Article 31 of the Vienna Convention on the Law of Treaties (hereinafter referred to as the Vienna Convention):
- A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of the object and purpose of the treaty.
- For the purposes of treaty interpretation, the context covers, in addition to the text, including the preamble and annexes.
Based on the foregoing, the Judicial Board considers that, based on the good faith implementation of the provisions of an international treaty, and the Convention in particular, there should be a mutual agreement procedure between the Competent Authorities of the two States, aimed at achieving the objectives of the Convention and initiated by the Ministry of Finance Republic of Poland.
However, according to articles 26 and 27 of the Vienna Convention, pacta sunt servanda – every treaty in force is binding on its parties and must be performed by them in good faith. A party cannot invoke the provisions of its domestic law as justification for its failure to perform a contract.
Thus, in the opinion of the judicial board, the filing of a claim by the Company in court does not terminate the obligation of the MoF RK or its authorized representative State Revenue Committee of the MoF RK to conduct the mutual agreement procedure.”.
Thus, the court ruled that the MAP between the two States must be completed regardless of the status of the taxpayer’s appeal against the audit.
This conclusion aligns with paragraph 1 of Article 25 of the Convention, which states that a MAP may be initiated “irrespective of the remedies provided by the domestic law” of the States.
2.3 Completion of the MAP and Litigation
Despite the Supreme Court’s direct instruction to complete the Mutual Agreement Procedure, the Kazakh authorities subsequently suspended the procedure, citing the ongoing appeal of the inspection results in court. Upon the second consideration of the case, the court returned the Branch’s claim, treating the incomplete MAP as an indication of failure to comply with the pre-trial dispute resolution process.
The Branch successfully appealed the decision to return the claim, after which the case was heard by a third court, which again dismissed the claim.
The course of the case shifted at the appeal stage. We utilized all available procedural tools to highlight the importance of completing the MAP for the proper resolution of the case. This included requests to involve the Ministry of Finance of Poland, motions to suspend the case, issuing a private ruling, and requesting and securing evidence. The Branch’s position was further bolstered by the support of the prosecutor’s office, while the court played an active role in facilitating the dispute’s resolution. Ultimately, in March 2024, thanks to the constructive stance of the Ministry of Finance, the MAP was finalized with a positive outcome: the residence certificates were accepted, and the additional charges were canceled.
The dispute was resolved through a mediation agreement that aligned with the terms agreed upon by the two states under the MAP.
- Concluding Remarks
The Mutual Agreement Procedure is a crucial tool in a taxpayer’s arsenal to protect against double taxation and unfair taxation in international transactions.
In the case discussed, the resolution of the tax dispute took over three years – a considerable amount of time. However, considering the substantial efforts made by the Judicial Panel on Administrative Cases of the Supreme Court of Kazakhstan to ensure uniformity in judicial practice concerning tax and other disputes, each case reviewed becomes important not only for the immediate parties involved but for the broader business community as well.
It is possible that future disputes with similar circumstances may not take as long to resolve. The prosecutor’s office may act more swiftly to defend investors’ rights, the courts may take a more proactive role, and the tax authority may expedite the completion of the MAP. This would save resources for all involved and improve Kazakhstan’s investment climate. These are probabilities that are not difficult to envision today; it only remains to work diligently to bring them to fruition.
[1] July 1, 2021 – the date of the enactment of the Administrative Procedural Code of the Republic of Kazakhstan and the commencement of operations of the new administrative courts
[2] https://www.compareyourcountry.org/map-statistics
[3] Convention between the Government of the Republic of Kazakhstan and the Government of the Republic of Poland for the elimination of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital (ratified by Decree of the President of the Republic of Kazakhstan dated April 21, 1995 No. 2223)
[4] Decision of the Judicial Panel on Administrative Cases of the Supreme Court of the Republic of Kazakhstan No. 6001-22-00-6ap/1073, dated January 19, 2023