According to the EU Arbitration Convention, transactions between affiliated companies should be in conformity with transfer pricing rules and thus should be at arm’s length. The tax authorities of Member States can adjust the profit made on a transaction when it is not at arm’s length. Affiliated companies should be dealing as if they are wholly independent from each other.
Double taxation can occur when the tax authorities of a Member State adjust the profits on an intercompany transaction upwards and the tax authorities of the other Member State doesn’t allow a corresponding downward correction of the profits (= tax deduction) of the affiliated company. The at arm’s length principle is violated because the Member States apply different transfer prices resulting in double taxation.
The EU Arbitration Convention offers a solution to eliminate double taxation. Based on the EU Arbitration Convention one of the companies can request a mutual agreement procedure with the tax authorities of the Member States. Both Member States need to come up with a mutual agreement within two years or else an Advisory Commission will be established. The Advisory Commission will deliver its opinion within six months. After this the Member States can come to a mutual agreement which is different from the opinion, but they have to do this within six months. If they don’t mutual agree within six months, the opinion of the Advisory Commission is binding.
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