Understanding procedures are intergovernmental negotiations enshrined in international tax law, which are intended to eliminate double taxation despite the application of a double taxation agreement. This always involves specific individual cases in which taxpayers are directly affected. Understanding procedures are strictly regulated in their procedure. Certain conditions must be met. In addition, taxpayers have no influence on the negotiations. Furthermore, they bear the costs of the understanding procedure, even if no official fees are incurred. However, the results of these negotiations are unpredictable. The same applies for the duration of the mutual understanding procedure. Nevertheless, the number of mutual understanding procedures is increasing. Although the Federal Republic of Germany invests additional funds in coping with the increasing number of mutual understanding procedures, the processing time is usually very long. However, where a decision is ultimately reached, its adoption by the taxable person precludes further legal measures.

If taxpayers in several countries who have concluded double taxation agreements (DTAs) among themselves are to pay taxes on the same taxable object, this contradicts the basic idea of the agreement. Nevertheless, this circumstance may well exist in certain cases. A classic example of this is the approach of appropriate transfer prices to internationally affiliated companies.

So what to do? Fortunately, one would think that there is a solution to this. Such questions about the allocation of taxation rights can be clarified in the context of an agreement procedure. Taxable persons who are affected by double taxation, which is actually to be avoided, can submit an application to initiate an understanding procedure. This sets in motion a process in which taxpayers hope that the states involved will ultimately agree on a solution that will reverse double taxation.

We would like to explain here how exactly an agreement procedure takes place, what costs and other consequences accompany it, and how long such a procedure takes.

The primary legal basis for the understanding procedure is integrated into the respective double taxation agreement. The OECD Model Agreement (OECD-MA) regulates this in Article 25. Individual approaches can also find their way into the DBA. For example, in the DTA Germany-USA time limits differing from the OECD-MA are agreed.

In addition, parallel to the DTA, the respective national tax regulations always play a role. Before an agreement procedure is reached, the State receiving the request to initiate the procedure is first obliged to examine whether a solution can be reached at national level.

In addition, the Federal Ministry of Finance has issued a BMF letter declared as a leaflet. Further details are addressed here that apply to all international arbitration proceedings.

First of all, you have to determine whether the prerequisites for an agreement procedure are available. For example, there must be a case in which more than one state raises and enforces a tax claim on a tax object. In other words, at least two tax rulings from different countries must be legally binding, aimed at the same tax context. This must also be done in accordance with the regulations in the respective DTA and with national law. This is important because otherwise only an objection to the infringing financial authority will help. An agreement procedure would be excluded here.

However, an agreement procedure can already come into question before the entry into force of a tax assessment. Because if the ongoing investigation of taxes shows that such double taxation threatens, then this procedure is already sensible and permissible in advance. In this way, the threat of double taxation can also be avoided.

However, if the prerequisites for an understanding procedure are available, one must also pay attention to the time aspect. Because an agreement procedure must start within a certain period of time. As already mentioned, the regulations for this are contained in the DTA. To do this, you have to submit a request for an understanding procedure to the competent tax authority. Responsible is the tax authority which carries out the taxation in the country of residence of the taxable person. In Germany, this means that the Federal Central Tax Office (BZSt) takes over the case. There, a taxable person must submit his application for an understanding procedure. Where more than one taxable person is subject to double taxation, the application may be made only at Community level. For its part, the competent financial authority checks whether the formal conditions for an agreement procedure are met.

The language is also important when submitting the application. If you submit an application to the BZSt in German, you must attach a copy translated into the working language agreed between the authorities involved. After prior agreement with the authorities, you can also submit the application in the working language. As a rule, English is provided as a working language.

However, if the BZSt refuses an application, the taxable person may lodge an appeal. The first measure in this regard is the objection pursuant to § 347 (1) sentence 1 AO.

You have to specify on which legal basis you submit the application. Because at least in the EU, in addition to the classical agreement procedure based on a DTA, two other ways are possible. On the one hand, this is possible through a dispute settlement within the framework of the EU arbitration convention. On the other hand, a dispute settlement within the framework of the EU double taxation agreement dispute settlement law (EU-DBA-SBG) can also come into question. However, both alternatives are only applicable in certain cases. In the case of double taxation in connection with a third country, at most the now further described understanding procedure based on a DTA comes into consideration anyway.

The national competent authority then contacts the foreign tax authority responsible for collecting the tax in question in its state. If the application is received by the BZSt, it invites the Land tax authority in charge of taxation in Germany to comment on the case. If, on the other hand, the application has been received by a foreign authority, it transmits the information to the BZSt. In this case, the BZSt contacts the Land tax authority responsible in Germany and asks them to assist in the agreement procedure. In addition, the BZSt also checks whether the application submitted abroad meets all the necessary conditions. Only when all the preliminary steps prescribed by the national authorities justify the continuation of the procedure does the actual negotiation take place.

Now begins a mostly lengthy struggle. For this purpose, the authority receiving the request for the mutual understanding procedure shall communicate its views on the situation to the foreign partner authority in a position paper. From the point of view of the German authorities, the general principles governing intergovernmental negotiations apply. The focus is on clarifying the tax situation. For this purpose, all participating states carry out their own investigations. If these results or the conclusions based on them already lead to a different opinion, one of three possible solutions is chosen. On the one hand, an attempt is made to bring about clarification in a conversation. However, it is also possible to convene a panel of experts from the respective authorities. Or you refer the matter to an expert qualified in the matter, who will draw up an opinion or otherwise broker an agreement.

Often the respective resistance is related to the amount of tax that is at stake for one of the states. Nevertheless, the desire to reach an agreement is usually very great. As a result, most agreements result in agreement. Therefore, arbitration as regulated in the DTA is very rarely used.

During the mutual understanding procedure, the taxpayer lodging the complaint remains uninvolved insofar as he cannot directly influence the negotiations. He may, however, submit applications. Furthermore, he regularly receives information on the status and further course of the procedure. It is also obliged to participate. This also means that he also has to provide information on the case, although this is by no means done within the framework of a regular external audit. Documents to be submitted must be translated into the working language used.

When an intergovernmental agreement is finally reached, the taxpayer is informed of the solution. If this seems acceptable, the taxpayer must agree to this solution and discontinue any pending legal proceedings. It also undertakes not to use any other legal means in this context. Only through this explicit declaration of consent of the taxpayer can the implementation of the solution take place.

If, on the other hand, no agreement is reached by means of an agreement procedure, the previous taxation remains in force in principle. However, at least from the German point of view, a mitigation of the disputed taxes can be considered. For this purpose, either § 34c EStG or § 163 AO can apply. In doing so, the tax office checks whether either an offset of the taxes paid abroad with the German tax comes into question, or whether you can reduce the tax on the basis of an equity check.

Some special features are important in understanding procedures within the EU. This concerns the exclusion of alternative methods of understanding. Because if you have already initiated an agreement procedure on the basis of a DTA and then either an agreement procedure on the basis of the EU arbitration or the EU-DTA-SBA would like to bring, then this leads to an official termination of the first initiated agreement procedure.

On the other hand, it is not possible to initiate a further agreement procedure in the case of an agreement procedure already requested on the basis of the EU-DTA-SBG. This is excluded according to a BMF letter published only recently on this topic.

An understanding procedure usually takes quite a long time. This means periods of many months or years. This is due both to the often complex nature of the issues under examination and to the labour-intensive exchange between the authorities involved at home and abroad. In 2020, for example, the OECD published statistics on international understanding procedures. This shows, in particular, the duration of international agreements at transfer prices with an average of 35 months. For Germany in particular, it is even almost 80 months.

In addition, the capacity of the German tax administration to resolve disputes within the framework of such mutual understanding procedures is limited. One can also assume that the situation abroad can be similar. In any case, the German financial administration can hardly keep up with the increasing number of disputes despite an increase in the federal funds earmarked for this purpose.

On the one hand, the recent sharp increase in the number of requests for understanding procedures is due to the rapidly increasing globalization. Cross-border issues in the field of taxation are now commonplace. This is already the case for medium-sized and small companies. On the other hand, the awareness of the tax authorities at home and abroad regarding the application of international tax law is now significantly higher than it was a few years ago. Therefore, a more critical implementation of national law with regard to cross-border taxation operations is now applied.

But also the consequences of the increasing international tax competition, which leads many governments in more developed industrial nations to stricter measures to avoid tax evasion, are relevant here. Examples are the ATAD initiative or the adoption of a minimum corporate tax rate at international level. Because the respective legislation based on this can sometimes lead to conflict cases despite DTA.

In addition, professional support is cost-intensive due to the complexity of such situations. It is true that the authorities themselves bear the costs incurred by the agreement procedure on their part. But applicants also have to reckon with certain costs. The costs of possible translations of documents and applications that have to be submitted are usually still relatively manageable. After all, costs in an agreement procedure can also be incurred during the preparations. After all, often only law firms specialized in international tax law take on such matters. As a tax consultant, you must also have an understanding of double taxation abroad. And also in the course of the procedure and in the decision to adopt the agreement, one should be aware of the tax consequences.

Certainly, the average length of time that an agreement procedure may take may seem anything but appropriate. And of course, one would prefer to do without the experience of double taxation. But sometimes you come only with some effort and a lot of patience to his right. Because if a DBA exists that excludes double taxation per se, then please get your right (and money). It is questionable whether an agreement procedure is also worth the financial effort. Because even without fees should be necessary in most cases support from the professional side. Therefore, before applying for an agreement procedure, the question must be asked whether the effort and the patience may be worthwhile. Here you should seek the advice of a tax consultant.

In the complexity of a cross-border tax situation, for which an understanding procedure may come into consideration, one should therefore be expertly best advised for at least three reasons. Finally, on the one hand, the prerequisites for an agreement procedure are naturally only given in certain cases. But it will only come to an agreement procedure if you can prove these conditions well. Therefore, an accompaniment by a tax consultant skilled in international tax law is highly recommended.

In addition, a tax consultant should advise on the choice of the appropriate – and possibly most promising – communication procedure (if this is related to an EU case). After all, once you have committed yourself to a procedure, a change in the procedure is practically impossible.