ARTICLE 25

Mutual Agreement Procedure

This Article provides the mechanism for taxpayers to bring to the attention of the Contracting States’ competent authorities issues and problems that may arise under the Convention. It also provides a mechanism for cooperation between the competent authorities of the Contracting States to resolve disputes and clarify issues that may arise under the Convention and to resolve cases of double taxation not provided for in the Convention. The Article also provides for the possibility of the use of arbitration to resolve disputes that cannot be settled by the competent authorities. The competent authorities of the two Contracting States are identified in paragraph 1(e) of Article 3 (General Definitions).

Because Article 25 makes a number of changes to the corresponding provision of the prior Convention, paragraph 2 of Article 7 of the Protocol provides that, within three years after the entry into force of the Convention, the competent authorities shall consult with respect to the

implementation of Article 25 and, taking into account experience with respect thereto, determine whether any modifications to Article 25 would be appropriate.

Paragraph 1

This paragraph, like the OECD Model, provides that where a resident of a Contracting State considers that the actions of one or both Contracting States will result in taxation that is not in accordance with the Convention he may present his case to the competent authority of his State of residence or, if his case comes under paragraph 1 of Article 24 (Non-Discrimination), to the competent authority of the State of which he is a national.

Although the typical cases brought under this paragraph will involve economic double taxation arising from transfer pricing adjustments, the scope of this paragraph is not limited to such cases. For example, if a Contracting State treats income derived by a company resident in the other Contracting State as attributable to a permanent establishment in the first-mentioned Contracting State, and the resident believes that the income is not attributable to a permanent establishment, or that no permanent establishment exists, the resident may bring a complaint under paragraph 1 to the competent authority of his State of residence.

It is not necessary for a person bringing a complaint first to have exhausted the remedies provided under the national laws of the Contracting States before presenting a case to the competent authorities. The case must be presented within three years of the first notification of the action resulting in taxation not in accordance with the Convention. (See Article 5 of the Protocol, discussed below, for time limits regarding claims for refund of taxes withheld at source) Although the U.S. Model would avoid any time limits for presenting a case for competent authority action, Italy advocated a three-year limit, which is consistent with the OECD Model. The phrase “first notification of the action resulting in taxation not in accordance with the provisions of the Convention” should be interpreted in the way most favorable to the taxpayer. See paragraph 18 of the OECD Commentaries to Article 25. With respect tog Italy’s existing practice for implementing these benefits See Article 5 of the Protocol, discussed below

Paragraph 2

This paragraph instructs the competent authorities in dealing with cases brought by taxpayers under paragraph 1. It provides that if the competent authority of the Contracting State to which the case is presented judges the case to have merit, and cannot reach a unilateral solution, it shall seek an agreement with the competent authority of the other Contracting State pursuant to which taxation not in accordance with the Convention will be avoided. Any agreement is to be implemented even if such implementation otherwise would be barred by the statute of limitations or by some other procedural limitation, such as a closing agreement. In a case where the taxpayer has entered a closing agreement (or other written settlement) with the United States prior to bringing a case to the competent authorities, the U.S. competent authority will endeavor only to obtain a correlative adjustment from Italy. See, Rev. Proc. 96-13, 1996-3 I.R.B. 31, section 7.05. Because, as specified in paragraph 2 of Article 1 (Personal Scope), the Convention cannot operate to increase a taxpayer's liability, time or other procedural limitations can be overridden only for the purpose of making refunds and not to impose additional tax.

Paragraph 3

Paragraph 3 authorizes the competent authorities to resolve difficulties or doubts that may arise as to the application or interpretation of the Convention. This paragraph follows the OECD Model treaty. The U.S. Model contains a non-exhaustive list of examples of the kinds of matters about which the competent authorities may reach agreement. This list is not in the Convention because the negotiators viewed it as unnecessary. The negotiators agreed that the list would not grant any authority that is not implicitly present as a result of the introductory sentence of paragraph 3. Thus, under this paragraph, the competent authorities may agree to settle a variety of conflicting applications of the Convention. The competent authorities may, for example, agree to the same attribution of income, deductions, credits or allowances between an enterprise in one Contracting State and its permanent establishment in the other or between related persons. These allocations are to be made in accordance with the arm's length principle underlying Article 7 (Business Profits) and Article 9 (Associated Enterprises). Agreements reached under these subparagraphs may include agreement on a methodology for determining an appropriate transfer price, common treatment of a taxpayer's cost sharing arrangement, or upon an acceptable range of results under that methodology. They may also agree to apply this methodology and range of results prospectively to future transactions and time periods pursuant to advance pricing agreements.

The competent authorities also may agree to characterize particular items of income in the same way, to characterize entities in a particular way, to apply the same source rules to particular items of income, and to adopt a common meaning of a term. The competent authorities can agree to the common application, consistent with the objective of avoiding double taxation, of procedural provisions of the internal laws of the Contracting States, including those regarding penalties, fines and interest. The competent authorities may seek agreement on a uniform set of standards for the use of exchange rates, or agree on consistent timing of gain recognition with respect to a transaction to the extent necessary to avoid double taxation. Agreements reached by the competent authorities under paragraph 3 need not conform to the internal law provisions of either Contracting State.

Paragraph 3 explicitly authorizes the competent authorities to consult for the purpose of eliminating double taxation in cases not provided for in the Convention and to resolve any difficulties or doubts arising as to the interpretation or application of the Convention. This provision is intended to permit the competent authorities to implement the treaty in particular cases in a manner that is consistent with its expressed general purposes. It permits the competent authorities to deal with cases that are within the spirit of the provisions but that are not specifically covered. An example of such a case might be double taxation arising from a transfer pricing adjustment between two permanent establishments of a third-country resident, one in the United States and one in Italy. Since no resident of a Contracting State is involved in the case, the Convention does not apply, but the competent authorities nevertheless may use the authority of the Convention to prevent the double taxation.

Paragraph 19 of Article 1 of the Protocol makes clear that the competent authorities can agree that the conditions for application of the anti-abuse provisions in paragraph 10 of Article

10 (Dividends), paragraph 9 of Article 11 (Interest), paragraph 8 of Article 12 (Royalties), or paragraph 3 of Article 22 (Other Income), have been met. As with all other matters, the competent authorities’ agreement does not have to relate to a particular case. Thus, if the competent authorities become aware of a type of transaction entered into by several taxpayers, they could reach an agreement that all such transactions are entered into with a main purpose of taking advantage of a relevant Article. In that case, treaty benefits would be denied to all taxpayers who had entered into such transactions. It is anticipated that the public would be notified of such generic agreements through the issuance of press releases. It is anticipated that the standard of judicial review regarding such an agreement would be the same as for a determination with respect to a particular taxpayer.

Paragraph 4

Paragraph 4 provides that the competent authorities may communicate with each other directly for the purpose of reaching an agreement. This makes clear that the competent authorities of the two Contracting States may communicate without going through diplomatic channels. Such communication may be in various forms, including, where appropriate, through face-to-face meetings of the competent authorities or their representatives.

Paragraph 5

Paragraph 5 contains an arbitration procedure found in several recent U.S. tax treaties, although the arbitration procedures currently are operative only under the treaty with Federal Republic of Germany. Paragraph 5 provides that where the competent authorities have been unable to resolve a disagreement regarding the application or interpretation of the Convention, the disagreement may, by mutual consent of the competent authorities and the affected taxpayers, be submitted for arbitration. Nothing in the provision requires that any case be submitted for arbitration. If a case is submitted to an arbitration board, however, the board's decision in that case will be binding on both Contracting States and the taxpayer(s) with respect to that case.

When a case is referred to an arbitration board, confidential information necessary for carrying out the arbitration procedure may be released by the States to the board. The members of the board, and any staff, however, are subject to the disclosure rules of Article 26.

The arbitration procedures will not come into effect until the Contracting States have agreed through an exchange of diplomatic notes. Pursuant to paragraph 2 of Article 7 of the Protocol, within three years after entry into force of the Convention the competent authorities will consult to determine whether it appropriate to exchange diplomatic notes implementing the arbitration procedure, taking into account the operation of Article 25 and the experience with respect to arbitration of international tax disputes .

The Memorandum of Understanding elaborates on the circumstances under which an exchange of diplomatic notes implementing the arbitration procedure will take place. It notes the understanding that the two States will exchange diplomatic notes implementing the arbitration procedure at such time as either the provision under the U.S.-Germany income tax treaty, or the

similar provision in the European Communities agreement signed on 23 July, 1990, has proven to be satisfactory to competent authorities of both the United States and Italy. The arbitration procedures themselves also will be established through an exchange of notes.

The Memorandum of Understanding also sets forth the procedures that will apply to arbitration proceedings if the arbitration provision is implemented pursuant to an exchange of notes. The competent authorities may agree to modify or supplement the arbitration procedures set forth in the Memorandum of Understanding. However, they shall continue to be bound by the general principles established therein.

Other Issues

Treaty effective dates and termination in relation to competent authority dispute resolution

A case may be raised by a taxpayer under a treaty with respect to a year for which a treaty was in force after the treaty has been terminated. In such a case the ability of the competent authorities to act is limited. They may not exchange confidential information, nor may they reach a solution that varies from that specified in its law.

A case also may be brought to a competent authority under a treaty that is in force, but with respect to a year prior to the entry into force of the treaty. The scope of the competent authorities to address such a case is not constrained by the fact that the treaty was not in force when the transactions at issue occurred, and the competent authorities have available to them the full range of remedies afforded under this Article. Even though the prior Convention was in effect during the years in which the transaction at issue occurred, the mutual agreement procedures of the Convention would apply.

Triangular competent authority solutions

International tax cases may involve more than two taxing jurisdictions (e.g., transactions among a parent corporation resident in country A and its subsidiaries resident in countries B and C). As long as there is a complete network of treaties among the three countries, it should be possible, under the full combination of bilateral authorities, for the competent authorities of the three States to work together on a three-sided solution. Although country A may not be able to give information received under Article 26 (Exchange of Information) from country B to the authorities of country C, if the competent authorities of the three countries are working together, it should not be a problem for them to arrange for the authorities of country B to give the necessary information directly to the tax authorities of country C, as well as to those of country A. Each bilateral part of the trilateral solution must, of course, not exceed the scope of the authority of the competent authorities under the relevant bilateral treaty.

Relation to Other Articles

This Article is not subject to the saving clause of paragraph 2 of Article 1 (Personal Scope) by virtue of the exceptions in paragraph 3(a) of that Article. Thus, rules, definitions,

procedures, etc. that are agreed upon by the competent authorities under this Article may be applied by the United States with respect to its citizens and residents even if they differ from the comparable Code provisions. Similarly, as indicated above, U.S. law may be overridden to provide refunds of tax to a U.S. citizen or resident under this Article. A person may seek relief under Article 25 regardless of whether he is generally entitled to benefits under Article 2 of the Protocol, regarding limitation on benefits. As in all other cases, the competent authority is vested with the discretion to decide whether the claim for relief is justified.