Large UK companies are more likely to have tax disputes overseas than in the UK, so understanding how to proceed with claims overseas is important. Though avoiding disputes is the best course of action, some are unavoidable.

UK companies will be used to tax authority HM Revenue and Customs (HMRC) playing with a ‘straight-bat’ and the tax tribunal being rigorous and fair. But outside the UK tax authorities may be under-resourced, susceptible to political influence, even corrupt; the legal framework may be ambiguous, and the rule of law compromised. Agreements with government as to tax payable may be unenforceable if they conflict with the legislation.

Avoiding disputes is clearly better than trying to resolve them once they arise. But some disputes are simply unavoidable. Many jurisdictions operate capriciously and seek retrospective taxation. Be particularly aware where you are being taxed based on an agreement or industry understanding – these are all too easy for tax authorities to overtrump – and, if they do, they have the better of the arguments if the underlying legislation is in their favour. It is worth reviewing any such positions now in order to check how watertight the agreement or understanding actually is.

Research by Thomson Reuters found that FTSE 100 companies were involved in more disputes with tax authorities overseas than with the UK's HMRC. Some of those disputes will involve a very different experience from that of dealing with HMRC.

Anyone who has had to deal with HMRC will know what to expect: a robust, methodical, forensic analysis of the issue. Any settlement will be principled and fact-based – ensuring that the right tax is charged in the right place at the right time. HMRC is also concerned to ensure consistency across taxpayers – and nothing which might smack of a ‘sweetheart’ deal. This might mean that the issue is unlikely to be resolved quickly, but HMRC will play with a ‘straight bat’.

Fiscal authorities may be under-resourced, susceptible to political pressures or even blatantly corrupt.

And if a tax dispute does have to be referred to the tax tribunal, one can expect a rigorous and fair hearing, supported by specialist counsel and familiar procedural devices, such as a form of disclosure and statements of truth.

Not all fiscal authorities behave this way. They may be under-resourced, susceptible to political pressures or even blatantly corrupt. The legislative framework may be unclear or contradictory. The courts may be unsophisticated and biased. There may be tax-authority friendly limitation periods and record-keeping, both by the tax authorities and the local subsidiary, may be poor. In extreme cases, foreign companies may be easy targets for capricious governments, desperate for money, and simply hoping to ‘extort’ a payment in exchange for dropping the demand. All the power of the state could be brought to bear to force the foreign company to comply with the demand, and the protections available under the rule of law may be limited or non-existent.

What to do if a dispute arises

Some emerging, common issues that give rise to tax disputes are the imposition of a sudden, new tax targeted at a specific sector or company, a demand for payment of tax based on a dubious interpretation of existing legislation or a breach of a longstanding agreement or understanding as to the application of a particular tax or exemption from it.

If a dispute does arise with the tax authorities, whether central or local government, there are some common issues to consider.

Obviously, local law advice should be obtained as soon as possible. However, in many jurisdictions, lawyers will not be as specialised as they are in the UK, and they may not be familiar with some of the wider strategic questions arising out of the dispute.

Carefully consider the legislative basis for the tax demand. Were all the necessary steps taken? For example, there may be framework legislation which requires local by-laws to be enacted annually before a particular tax can be levied. Were the relevant by-laws enacted in time or at all?

It is not uncommon for agreements and understandings apparently to be reached with government or other public bodies as to precise levels of taxation. Even if documented, they may be poorly drawn, ambiguous or unenforceable where they are inconsistent with the prevailing legislation.

Carefully consider the legislative basis for the tax demand. Is failure to pay a civil matter, giving rise to a debt claim, or a criminal offence? The state may be permitted to seize property or even arrest staff if the demand is not paid. There may be a risk of seizure or arrest even where this is not strictly permitted. In those circumstances, consider whether it is possible to move assets or people out of the jurisdiction until the dispute blows over. On the other hand, where the demand is blatantly politically motivated, a political solution, involving lobbying stakeholders, for example, might not be helped if the foreign company is seen to be abandoning the jurisdiction.

In some jurisdictions it may be necessary to ‘pay to play’ by paying the disputed tax first before arguing the merits of the demand. This obviously carries significant risks, as it may be practically difficult or impossible to recover any money paid in response to a tax demand, even if the demand turns out to have been invalid.

It may be important to understand whether the jurisdiction concerned operates a civil or common law regime – both being common across emerging markets and being based either on the French or English legal systems.

It may be sufficient simply to defend the claim for the tax in the local court, provided there is a reasonable chance of justice being done. But consider other possible remedies which may be available, such as judicial review. The demand may be so unreasonable that no reasonable person acting reasonably could have made it or a breach of the company’s legitimate expectations. However, where there is a legislative framework supporting the tax demand, it can be dtifficult to establish a legitimate expectation, particularly where it is based on some informal assurance, or even a written agreement, which is inconsistent with the legislation.

But otherwise, it is fair to say that the usual best practice considerations apply: make sure the facts are conveyed in the best light possible and that arguments are well marshalled.

Bilateral investment treaties: possible protection?

It may be possible to pursue a claim under a bilateral investment treaty (BIT) between the UK and the relevant foreign country. Some BITs require a company to exhaust all local remedies first or wait a prescribed period before claiming under the BIT. Others require it to make an irrevocable choice between domestic remedies and a claim under the BIT - the so-called ‘fork in the road’ principle. It is important to examine the BIT carefully to avoid making the wrong choice.

BITs protect foreign investors by ensuring, among other things, fair and equitable treatment (FET), non-discrimination between foreign and domestic investors, and protection against expropriation.

Fair and equitable treatment

If the foreign investor believes that its rights under the BIT have been infringed, it can bring an arbitration claim against the state concerned. Although many BIT arbitrations on taxation are based on some form of discrimination between nationals and foreign investors, it is not necessary to show discrimination in order to found a claim under the FET standard.

FET is an international standard, independent of the treatment by the host state of an investment by its own nationals, meaning the fact that nationals are treated just as unfairly is no defence when the host state violates the FET provision with respect to foreign investment.

In some cases, international tribunals have referred to the legitimate expectations of foreign investors with respect to the policy of the host state. Tribunals accept that investment decisions are made on certain basic expectations and assumptions. As a general principle, states remain free and sovereign to issue regulations which are not what investors might have hoped for. But there may be circumstances where it would be unreasonable for the host state not to respect the legitimate expectations of foreign investors, particularly where it comes to drastic changes in the tax policy of the host state. This is an area that remains largely unexplored.

Expropriation

In order to distinguish between simple regulation and regulatory expropriation, the tribunal will apply a quantitative test to look at the severity of the measure’s effect on the investment. An expropriation occurs if the interference is substantial and deprives the investor of all or most of the benefits of the investment permanently or for a substantial period of time. This can be a difficult test to satisfy. Even a high tax rate absorbing 50% of the property of the taxpayer may not be confiscatory. However, an increase in taxes to an extent that the investment becomes economically unsustainable has been held to be expropriation.

Costs

Unsurprisingly, bringing an arbitration claim against a foreign state can be expensive – not only will the company have to pay its own lawyers’ and experts’ costs, but it will also have to bear half of the tribunal’s, which will typically be in six figures at least. If the arbitration is unsuccessful, then the tribunal is also likely to require the company to pay at least part of the state’s costs. On the other hand if the claim is successful then the company may recover a proportion of its costs. The costs exposure can be significantly reduced by seeking funding from a litigation funder who will provide finance for the costs of the litigation in exchange for a proportion of the tax recovered or ‘saved’.

Enforcement of awards

Even if the BIT claim is successful it will be necessary to enforce the tribunal’s award against the state in question. States are in most countries entitled to immunity from enforcement, unless the assets against which the company is trying to enforce are in use for commercial purposes.

So while a BIT claim is another weapon in the armoury of a foreign investor, it is not something to be entered into lightly.

Enforcement and the ‘revenue rule’

If the foreign investor is unable successfully to challenge the tax demand domestically or by a BIT claim, it may be that the local taxpaying entity does not have the funds to meet the demand. The investor will be concerned about the risk of the foreign state seeking to enforce its tax demand abroad, whether in the UK or elsewhere.

It is a fundamental principle of English private international law that the courts will not enforce foreign revenue laws. This is an almost universal principle, and it is known in the US as the ‘revenue rule’. One explanation for the rule is that the enforcement of revenue claims is an extension of the sovereignty of the foreign state into another sovereign state.

However, the revenue rule has been eroded in recent years by international agreements and other cross-border developments in the field of mutual assistance, at least as between European Union member states.

There may also be mutual assistance provisions in double-taxation treaties between the UK and the foreign state. However, outside of Europe, and in the absence of such mutual assistance provisions, the investor should be able to avoid enforcement of the foreign tax demand if its assets are outside of the foreign jurisdiction.

This update is based on an article by Jason Collins and Richard Dickman, which appeared in Tax Journal on 10 January 2020.