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May 29, 2020 Practice Point

The OECD’s International Compliance Assurance Programme

By Kun-Chol Kim, S.J.D. Candidate, University of Florida Levin College of Law, Gainesville, FL

I. Introduction

Cooperative compliance, a model that emerged in 2008,1 aims to improve taxpayer service and tax compliance by requiring transparency in exchange for certainty.2 The model requires taxpayers to demonstrate how they handle transactions and tax risks; in return, it requires tax administrations to provide early certainty as to how it will treat those tax risks.3 The United States also introduced a Compliance Assurance Process (CAP) in 2005, beginning as a pilot and made permanent in 2011.4 The CAP allows the IRS and taxpayers to work together prior to the tax return and provides an “acceptable” level of assurance.5

According to the OECD, the cooperative compliance model is built on seven pillars: transparency, disclosure, commercial awareness, impartiality, proportionality, openness, and responsiveness.6 These pillars require tax administrations to be impartial and to understand the commercial drivers, and to impose disclosure and transparency obligations on taxpayers. Without this mutual understanding and cooperation between taxpayer and tax administration, any cooperative compliance model could not succeed.

The OECD Forum on Tax Administrations (FTA)7 introduced a new cooperative compliance model, the international compliance assurance programme (ICAP) pilot in January 2018 to provide increased tax certainty to multinational enterprises (MNEs) through multilateral cooperative risk assessment and assurance processes by requiring MNEs to engage in a fully transparent manner.8

The ICAP is a voluntary program in which eight FTA member tax administrations participated in the first phase (ICAP 1.0).9 The second phase (ICAP 2.0) began on March 28, 2019 with 17 FTA participants.10 This phase is open to other countries and MNEs to join.11 

Transfer pricing and permanent establishment risks12 were the two main international tax risks covered by ICAP 1.0, but ICAP 2.0 covers a wider range of risks, including hybrid mismatch arrangements and withholding taxes.13 The OECD states that ICAP can cover a broad spectrum of international and cross-border risks most effectively when it is targeted to the risks that are a concern to all involved tax administrations.14

Although still in a pilot stage, it seems clear that the two main objectives of ICAP are (i) providing effective tax assurance by facilitating cooperation between tax authorities and MNEs and (ii) reducing the mutual agreement procedures (MAP) inventory by providing such tax assurance. The question is whether ICAP can satisfy these objectives.

II. Overview of ICAP

  A. ICAP’s Six Drivers and its Anticipated Benefits

In Handbook 1.0, the OECD identified the four anticipated benefits15 and the six drivers behind the development of the ICAP risk assessment process. The ICAP drivers are intended to (i) create an environment where tax administrations can work together to use effectively information contained in an MNE group’s CbC report (CbCR)16 and master file for better and more standardized information for transfer pricing risk assessment; (ii) supplement and support the MAP to prevent unnecessary disputes and limit MAP inventory growth; (iii) bring initiatives and standards together as identified in best practices–areas of cooperative compliance, joint audits, and risk management–and explore new approaches for MNE compliance frameworks for multilateral tax risk assessment and assurance; (iv) advance international collaboration; (v) provide a pathway to improved tax certainty for low-or medium-risk MNE groups; and (vi) capitalize on the multilateral context to provide improved assurance for tax administrations.17 These can be summarized into two main objectives: to provide effective tax assurance by facilitating cooperation between tax authorities and MNEs, and to reduce the MAP inventory.

  B. The ICAP Risk Assessment Process

In March 2019, the OECD released the second phase ICAP Handbook (Handbook 2.0) which updated the risk assessment process based on the first phase pilot.18 Previously, the ICAP 1.0 risk assessment process required an MNE and tax administrations to hold a “pre-risk assessment workshop” to discuss the contents of the document before the risk assessment.19 After the pre-assessment workshop and kick-off meetings, the tax administrations performed a Level 1 risk assessment for 8 weeks, and in this phase, the participating tax administrations conducted a joint workshop to review relevant information such as the CbCR, tax filing history, tax returns, financial statements, ownership and group structure, rulings, and publicly available information.20 If the tax administrations determined that the risk was low or there was no risk, an assurance letter was issued. If tax administrations were unable to conclude that the risk was low or there was no risk, additional assessments were conducted through the Level 2 risk assessment, which generally required more information and clarification of certain tax information.21 The entire process including the Level 2 assessment took less than 40 weeks.22

ICAP 2.0 offers a revised four-stage process.23 During Stage I (pre-entry), an MNE is required to provide any documentation “beyond basic information” to the ultimate parent entity’s (UPE’s) tax administration. The documentation must include high-level information of jurisdictions where most of the UPE’s global revenue is raised, where key activities are undertaken, and any covered risks it proposes to be included in its ICAP risk assessment in addition to transfer pricing risk.24 During Stage II (scoping), tax administrations review a summary of all of the MNE’s relevant transactions, and the MNE is required to provide a scoping documentation package.25

Once Stage II is completed, each of the relevant tax administrations works from the same documentation package as they discuss their findings on risk assessment and issue resolution (Stage III).26 When the assessment is complete, the MNE receives a completion letter providing the outcome (Stage IV).27 The ICAP 2.0 risk assessment process also takes less than 40 weeks.28

  C. Eligibility

Neither Handbook 1.0 nor 2.0 specifically identifies requirements for participation in the program. Because ICAP uses the CbCR for risk assessment, however, it seems only those MNEs that are subject to CbC reporting are eligible to participate, and (as noted) the BEPS Action Item 13 requires only MNEs with revenues of €750 million or more to file a CbCR.29

III. Analysis of the Two Main ICAP Objectives

  A. ICAP as a Tax Assurance Method

As noted above, the first key objective of ICAP is to provide tax assurance by facilitating cooperation between tax authorities and MNEs. Considering the voluntary nature of ICAP and the resources that MNEs need to use, the question is whether ICAP provides sufficient tax assurance to attract MNEs.

    i. APA-Type Assurance with Lower-Level Legal Certainty

ICAP is a pre-audit “multilateral cooperative risk assessment and assurance process,” which is designed to provide MNEs with “increased tax certainty” with respect to certain of their activities and transactions.30 Both ICAP and advance pricing agreements (APAs) provide similar tax assurance, except that an APA applies only to transfer pricing while ICAP covers a wide range of risks that include transfer pricing.

An APA is a pre-dispute administrative approach that aims to prevent transfer pricing disputes arising from applying the arm’s length principle to transactions.31 The APA process attempts to facilitate principled, practical and cooperative negotiations to (i) resolve transfer pricing issues prospectively, (ii) use the resources of the taxpayer and the tax administration more efficiently, and (iii) provide a measure of predictability for the taxpayer.32 Therefore, the key similarity between ICAP and APA is that both provide assurance and certainty at a pre-dispute and pre-audit stage.

The OECD explains that an APA is intended to “supplement” rather than replace the traditional judicial and treaty mechanisms for transfer pricing dispute resolution.33 Also, while an APA is an “agreement,” it remains questionable whether courts would treat it as a “binding contract.” In the 2013 Eaton Corp. case, petitioner contended that contract law must be applied to interpret agreements between the Commissioner and taxpayers because respondent represented that APAs are “binding contracts.”34 The court held that the legal effect of the APA at issue was governed by applicable revenue procedures:35 because those revenue procedures grant respondent the discretion to cancel the APAs at issue in certain circumstances, general contract law principles do not apply to APAs.36 Although the case was reconsidered in 2017 and the court then concluded that the IRS had abused its discretion in cancelling the APAs,37 it remains unclear from the taxpayer’s perspective how APAs are viewed. Although an APA provides certainty, there remains the possibility that an APA could be cancelled at the tax administration’s discretion if the tax administration finds that a taxpayer’s activity does not comply with the procedures. Nonetheless, because the revenue procedure requirements are reasonable and not overly complex,38 an APA still remains an attractive tool from the taxpayer’s perspective.

On the other hand, while an APA could provide a satisfactory level of taxpayer assurance, the level of assurance ICAP provides is much lower. The OECD states in Handbook 1.0 that ICAP does not “provide an MNE group with legal certainty as may be achieved, for example, through an advance pricing agreement, but gives assurance where tax administrations participating in the programme consider a risk to be low.”39

Figure 1

Figure 1

Figure 1: Level of Certainty40

The Handbook 1.0 chart shows that ICAP only provides a “comfort” level of certainty, much lower than the certainty that an APA provides. The APA provides certainty with respect to specific transactions, but the scope of ICAP is broader and could also extend to transactions with jurisdictions that do not participate in the program.41 Even if ICAP itself may not provide satisfactory assurance to an MNE, it may be used to supplement other tools, such as a domestic tax audit, an APA, and MAP, to improve tax certainty both unilaterally and multilaterally.42 Thus, ICAP could improve consistency between tax administrations in the interpretation and treatment of transactions.43 This also enables tax administrations to conduct a more effective and faster audit or evaluation of a case.44

    ii. ICAP as Tax Assurance from a Corporate Perspective

In sum, ICAP is a pre-audit, APA-type tax assurance program that provides a “comfort” level of assurance. This level of assurance is lower than an APA or other similar tool provides, but it covers a wider range of risks than those tools and could be useful to supplement other tools such as APA and MAP. Considering the voluntary nature of ICAP, the program is likely to struggle to achieve its objectives without the participation of MNEs. For this reason, it is important to assess ICAP from a corporate perspective. Two main considerations apply: (i) the level of certainty it provides and (ii) time and cost weighed against its effectiveness.

Because ICAP requires multiple meetings and negotiations with tax administrations and preparation of multiple documents, an MNE will have to use its resources to support the process. In spite of the assurance it provides, it remains questionable whether a company would be willing to use its resources without gaining legal certainty. It could be argued that the ICAP cost could be lower than dealing with multiple audits, but this is a difficult argument when the extent of assurance provided is uncertain. If the assurance were rejected by all relevant tax administrations, the MNE could still be subjected to multiple audit costs. Moreover, it remains highly uncertain how much assistance ICAP will provide as a complement to other tools.

In conclusion, it seems that the ICAP needs to offer more than it currently offers to succeed. Perhaps the OECD could consider ways to provide an increased level of certainty comparable to that provided by APAs for specified transactions and a lower level of certainty for unspecified transactions.

  B. ICAP as a Pre-Dispute Resolution Mechanism

The second key objective of ICAP is to effectively reduce unnecessary MAP inventory. Due to criticisms of MAP effectiveness, the OECD attempted to improve MAP through multiple updates and BEPS Action Item 14.

    i. Overview of the MAP

MAP is the most common bilateral solution available for a cross-border tax dispute,45 currently adopted in most bilateral tax treaties (BTT).46 MAP is a negotiation process for a settlement between two countries rather than a judicial proceeding: although the designated representatives (i.e. competent authority) of the contracting states are obligated to “negotiate”, they are not obligated to “achieve results.” Thus, if the competent authorities fail to reach an agreement within the allotted time frame, the case is likely to remain unresolved. Some BTTs contain an arbitration clause, either in a mandatory or optional form, to allow unresolved MAP cases to be submitted to arbitration. While that guarantees a resolution, only 178 (as of 2017) out of over 3,000 BTTs contain such a clause.47 Only about ten cases were submitted to arbitration in the entire MAP history in the U.S.

In October 2018, the OECD released statistics on the 2017 MAP indicating that 2,076 cases were filed on or after 1 January 2017. The number of all cases filed increased by almost 39% between 2016 and 2017, from 1,496 to 2,076.48 2,745 cases are reported as complete, with 84% of the MAP cases resolved.49 That means that about 16% of the MAP cases likely remain unresolved.

Several amendments, also through BEPS Action Item 14,50 have also been made to the MAP provision in model tax conventions, but the core MAP issues remain. To address base erosion and profit shifting or double non-taxation, the OECD and G20 countries selected a “15-point Action Plan” in 2013, with final reports published in October 2015.51 Action Item 14 is a unique item focused on resolving double taxation by improving MAP. Item 14 aims to “to develop solutions to address obstacles that prevent countries from [re]solving treaty-related disputes under MAP, including the absence of arbitration provisions in most treaties and the fact that access to MAP and arbitration may be denied in certain cases.”52

Action 14 is comprised of two parts: (i) minimum standard, best practices and monitoring processes and (ii) a commitment to mandatory and binding MAP arbitration. Although it is mandatory for member countries to implement the minimum standard and be regularly monitored, with reporting to the G20 Committee on Fiscal Affairs, the adoption of best practices remains optional.53

The minimum standard is comprised of three specific standards that require member countries to:

  1. Ensure that treaty obligations related to MAP are fully implemented in good faith and that MAP cases are resolved in a timely manner;
  2. Ensure the implementation of administrative processes that promote the prevention and timely resolution of treaty-related disputes; and
  3. Ensure that taxpayers can access MAP when eligible.54 

Each specific standard provides several guaranteed measures. The first standard (item (1), above) guarantees seven measures to taxpayers: (i) inclusion of modified Article 25(1) through Article 25(3) and access to transfer pricing cases; (ii) access for cases involving a domestic or treaty anti-abuse rule; (iii) resolution of MAP cases within an average timeframe of 24 months; (iv) mandatory membership in the FTA MAP Forum; (v) timely and complete MAP statistics following the new prescribed reporting framework; (vi) peer-review of compliance with the minimum standards; and (vii) transparency in respect of positions on MAP arbitration.55

The second standard also guarantees seven measures: (i) publication of clear rules, guidelines and procedures on MAPs and ensure publication, availability; (ii) publication of country MAP profiles; (iii) certainty of the MAP function that is not dependent on the audit function or state tax policy; (iv) remuneration not based on collections; (v) certainty on adequate resource; (vi) clarification on domestic audit settlements that do not preclude access to a MAP; and (vii) roll-back of APAs in appropriate cases where there are APA programs.56

Finally, the third standard guarantees three measures: (i) access to both competent authorities in a MAP either through an amendment of Article 25(1) or through a bilateral notification or consultation process where one competent authority feels a case is not justified for MAP; (ii) identification of the documents required for a MAP request in the MAP guidance; and (iii) inclusion in the treaty of the possibility of a MAP irrespective of domestic time limits.57

Although Action Item 14 contains detailed and lengthy obligations, the core MAP issues remained unresolved as the mandatory three-point minimum standards ensure nothing more than what the Model Treaty provided by using vague language such as “in good faith” and “average timeframe.”58

Figure 2

Figure 2

Figure 2: The OECD MAP Statistics 2017, United States59

In terms of cases filed for the MAP, the statistics (set out in Figure 2) show that 795 MAP cases were filed in the United States before January 1, 2016, of which 574 cases or 72% were transfer pricing cases.60 Similarly, of the 182 U.S. MAP cases started from January 1, 2016, 135 cases or 74% are transfer pricing cases.61

    ii. ICAP to Reduce MAP Inventory

The high percentage of MAP transfer-pricing cases suggests that MNEs would rather utilize an APA to prevent transfer pricing disputes. ICAP would only be needed for the remaining 30% of MAP cases. Accordingly, the question is whether ICAP has a real potential to effectively reduce the number of non-transfer pricing MAP cases.

ICAP cannot be successful without MNEs’ active participation because it is voluntary. Because it only provides a “comfort” level of assurance, it is unclear how much protection it provides. The Handbook indicates that ICAP can serve as a supplement to other tools such as MAP, APA, and domestic tax audit, but without clarification about the protection ICAP can provide, it would not be an attractive tool for MNEs. Moreover, because ICAP provides a lower level of assurance than APA and other similar tools, there is a real possibility that a tax administration would withdraw that assurance. If that occurs, a MAP dispute will inevitably be filed.

In sum, the current ICAP form does not appear to effectively reduce MAP inventory.

IV. Conclusion

Cross-border tax dispute resolution has always been a major problem for the international tax regime as there is no single multilateral mechanism that guarantees a final and binding decision. The MAP, which is the most common bilateral solution available, remains unsatisfactory despite numerous updates, including BEPS Action Item 14.

Pre-dispute resolution tools such as ICAP and APA could be a valuable tool for corporations since pre-agreed tax consequences allows planning business actions more effectively based on anticipated tax liabilities and minimizes costly and time-consuming potential tax disputes. Nonetheless, pre-dispute resolution tools have their own limits, as shown by this analysis of ICAP. Although ICAP has potential as a multilateral pre-audit tax assurance tool, its success requires clarification about the “comfort” level of assurance provided to MNEs and the degree of protection assured. It is unlikely that MNEs will utilize a years-long process without foreseeing a substantial result in certainty. Because more than 70% of the MAP cases involve transfer pricing for which APAs currently provide greater certainty, ICAP will not be likely to reduce MAP inventory. It is unlikely that MNEs will choose a tool that provides a lower level of assurance than an APA. Moving forward, the “level of assurance” should be the key word for ICAP 3.0. 

Annex 1: Risk Assessment Process

I. Risk Assessment Process Under ICAP 1.0

A. Level 1 Assessment

A. Level 1 Assessment

B. Level 2 Assessment

B. Level 2 Assessment

II. Risk Assessment Process Under ICAP 2.0

II. Risk Assessment Process Under ICAP 2.0

  1. OECD, Study Into the Role of Tax Intermediaries (2008), at 9.
  2. OECD, Co-operative Compliance: A Framework: From Enhanced Relationship to Co-operative Compliance, OECD Publishing (2013), at 3.
  3. Alicja Majdanska & Yuchen Wu, Using Impact Evaluation to Examine Domestic and International Cooperative Compliance Programs, Tax Notes International (Mar 11, 2019), at 1045.
  4. IRS, Compliance Assurance Process.
  5. Id.
  6. See supra n. 2, at 19.
  7. The FTA was created in 2002 for commissioners from 53 OECD and non-OECD countries, including members of the G20. In May 2002, tax officials convened in London as the FTA’s Compliance Sub-group to consider what actions could be taken to exchange experiences in the area of compliance risk management and to agree on a strategy for documenting guidance on this important topic. See OECD, Compliance Risk Management: Managing and Improving Tax Compliance, Centre for Tax Policy and Administration (2004), at 5.
  8. OECD, International Compliance Assurance Programme Pilot Handbook (Paris, 2018), at 7.
  9. OECD, International Compliance Assurance Programme (ICAP).
  10. The participants are Australia, Austria, Belgium, Canada, Denmark, Finland, Germany, Ireland, Italy, Japan, Luxembourg, Netherlands, Norway, Poland, Spain, United Kingdom, and the United States.
  11. See Leading global tax administrations agree [to] collective actions on tax certainty, co-operation and digital transformation (Mar 28, 2019).
  12. Id. at 11.
  13. OECD, International Compliance Assurance Programme Pilot Handbook 2.0 (2019, Paris), at 18.
  14. See supra n. 6.
  15. The OECD expects these benefits: (i) provide fully informed and targeted use of country-by-country (CbC) information by enabling MNEs to explain their CbC reports and provide additional clarity to aid understanding of their cross-border activities to help tax administration to reach earlier decisions; (ii) enable tax administrations to jointly review the information supplied by an MNE; (iii) enable tax administrations to work multilaterally to have a comprehensive picture of an MNE’s cross-border activities to be assured either that the tax position is satisfactory or that any tax risk has been identified; and (iv) provide an opportunity to prevent disputes from reaching the MAP. See supra n. 8, at 7.
  16. As MNEs’ aggressive tax planning has raised questions regarding the transparency in financial reporting for the past several years, the OECD and the European Commission proposed the CbCR which requires MNEs with revenues exceeding €750 million to disclose information necessary for transfer pricing assessment, including tax jurisdiction, revenue from related parties and third parties, corporate income tax paid, current year corporate income tax accrued, stated capital, tangible fixed assets excluding cash and cash equivalents, and number of employees. See Leading global tax administrations agree [to] collective actions on tax certainty, co-operation and digital transformation (Mar 28,2019).
  17. See supra n. 8, at 8-9.
  18. Leading global tax administrations agree [to] collective actions on tax certainty, co-operation and digital transformation (Mar 28, 2019).
  19. Supra n. 8, at 13.
  20. Id. at 14. See also Annex 1.
  21. Id.
  22. See Annex 1.
  23. The four-state process consists of Stage I: Pre-entry; Stage II: Scoping; Stage III: Risk assessment and issue resolution; and Stage IV: Outcomes. Annex 1-II.
  24. Supra n. 13, at 21-22.
  25. Id. at 24.
  26. Id. at 27.
  27. Id. at 29.
  28. Annex 1-II.
  29. OECD, Transfer Pricing Documentation and Country-by-Country Reporting, Action 13 - 2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project (OECD Publishing, Paris 2015), at 10.
  30. Supra n. 8.
  31. Supra n. 13.
  32. OECD, OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017 (OECD Publishing, Paris 2017), at 474.
  33. Id.
  34. Eaton Corporation v. Commissioner, 140 T.C. 410 (2013).
  35. See Rev. Proc. 2004-40, 2004-29 I.R.B. 50, 2004-2 C.B. 50, 2004 WL 1472553.
  36. Supra n. 34.
  37. Eaton Corp. & Subs. v. Commissioner, T.C. Memo. 2017-147.
  38. The IRS has grounds for canceling an APA if it finds: (i) taxpayer’s misrepresentation, (ii) mistake with respect to a material fact, (iii) failure to state a material fact, (iv) failure to file a timely annual report, (v) lack of good faith compliance with the APA terms and conditions, or (vi) failure to file an annual report that is timely, complete, and accurate. Otherwise, an APA cannot be canceled. Rev. Proc. 2015-41.
  39. Supra n. 8.
  40. Supra n. 13, at 8.
  41. Id.
  42. Id. at 9.
  43. Id.
  44. Id.
  45. The MAP was first introduced by the OECD in 1963 in its Model Tax Convention on Income and on Capital (OECD Model).
  46. Supra n. 1 at 13. See also OECD, Draft double taxation convention on income and capital: [report of the O.E.C.D. Fiscal Committee] (OECD 1963) Art. 25.
  47. H.M. Pit, Arbitration under the OECD Multilateral Instrument: Reservations, Options and Choices, 71 Bull. Int. Tax’n 10 (2017), IBFD, at 445. See International - Arbitration under the OECD Multilateral Instrument: Reservations, Options and Choices.
  48. OECD, OECD Mutual Agreement Procedure Statistics for 2017.
  49. Id.
  50. See infra n. 51.
  51. Multilateral Instrument, Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, Information Brochure, at 4. See OECD official webpage.
  52. OECD/G20 Base Erosion and Profit Shifting Project, Making Dispute Resolution Mechanisms More Effective, Action 14: 2015 Final Report, at 11.
  53. Supra n. 51 at 28.
  54. Id. at 9.
  55. Id. at 13-17.
  56. Id. at 17-21.
  57. Id. at 28-37.
  58. See S.P. Govind & L. Turcan, Cross-Border Tax Dispute Resolution in the 21st century: A Comparative Study of Existing Bilateral and Multilateral Remedies, Derivatives & Financial Instruments IBFD (2017), at 3.
  59. OECD, OECD Mutual Agreement Procedure Statistics for 2017.
  60. Id.
  61. Id.