European Court clarifies EU Commission's powers to police member states' taxation policies under state aid rules
In major state aid news, the General Court, the first instance tribunal of the European Court of Justice issued two judgments on 24th September 2019 which dealt with the power and competence of the European Commission to rule on member state's tax policies. It clarified the circumstances in which transfer pricing arrangements agreed between multi-nationals and the host member state could amount to unlawful state aid in breach of Article 107 of the Treaty for the Functioning of the European Union (TFEU). The consequence of these rulings is that the Commission is likely to increase its state aid enforcement actions against aggressive tax avoidance schemes in the EU.
Two Commission decisions of October 2015 were under review. The first related to certain transfer pricing arrangements agreed between a Dutch subsidiary of Starbucks and the Netherlands, the other related to similar transfer pricing arrangements of Fiat, the Italian motor car manufacturer approved by the Luxembourg Government.
The General Court struck down the Commission's decision against Starbucks and the Netherlands but upheld the Commission's case against Fiat and Luxembourg.
In this article we review the Starbuck and Fiat cases and ask how the different judgments can be reconciled and where this leaves the Commission's jurisdiction and power to enforce the state aid rules against member states.
In October 2015 the European Commission decided that Luxembourg and the Netherlands had granted selective tax advantages to Fiat Finance and Trade and Starbucks, respectively and these were unlawful under EU state aid rules.
Following in-depth investigations, which were launched in June 2014, the Commission concluded that Luxembourg had granted selective tax advantages to Fiat's financing company and the Netherlands to Starbucks' coffee roasting company. In each case, a tax ruling issued by the respective national tax authority artificially lowered the tax paid by the company. These tax rulings are perfectly legal under the tax law of the respective member state. They were issued in the form of comfort letters issued by tax authorities to give a company clarity on how its corporate tax will be calculated or on the use of special tax provisions.
However, the Commission found that the two tax rulings under investigation endorsed artificial and complex methods to establish taxable profits for the companies. In short the Commission's case was that they were contrived and did not reflect economic reality. In both cases the companies concerned set prices for goods and services sold between companies within the Fiat and Starbucks groups (so-called "transfer prices") that do not correspond to market conditions. As a result, most of the profits of Starbucks' coffee roasting company were shifted abroad, where they escaped taxation, and in the case of Fiat their financing company was able to pay taxes on what the Commission found were underestimated profits.
This is type of behaviour that the Commission held was unlawful under EU state aid rules. The method by which the transfer prices were calculated were extremely complex but the Commission found that however complex they were tax rulings cannot use methodologies, to establish transfer prices which have no economic justification and which unduly shift profits to reduce the taxes paid by the company. That would give the company an unfair competitive advantage over other companies (typically SMEs) that are taxed on their actual profits because they pay market prices for the goods and services they use. Therefore, the Commission ordered Luxembourg and the Netherlands to recover the unpaid tax from Fiat and Starbucks, respectively, in order to remove the unfair competitive advantage they have enjoyed and to restore equal treatment with other companies in similar situations. The amounts to be recovered were between €20 - €30 million for each company.
The European Competition Commissioner, Margrethe Vestager, stated at the time of the imposition of the decisions: "Tax rulings that artificially reduce a company's tax burden are not in line with EU state aid rules. They are illegal. I hope that, with today's decisions, this message will be heard by Member State governments and companies alike. All companies, big or small, multinational or not, should pay their fair share of tax".
General Court Rulings
On 24 September 2019, the General Court struck down the 2015 Commission decision described above which found that certain transfer pricing arrangements used by a Dutch subsidiary of Starbucks and accepted by Dutch tax authorities for calculating the corporate taxation constituted unlawful state aid as it gave the company a competitive advantage. The General Court concluded that that the Commission had not demonstrated the existence of an economic advantage under Article 107 of the TFEU. The General Court stated that the Commission was required to justify its choice of methodology for assessing the presence of an unfair economic advantage.
The General Court ruled that the Commission was entitled to analyse the tax ruling at issue under the arm's length principle. The concept of advantage must be assessed compared to 'normal' taxation, and whether intra-group pricing was not conducted in market conditions. The arm's length rule allows the Commission to assess whether intra-group transactions are valued at the same level as they would have been between independent companies, in determining whether a selective advantage has been given to a corporate group.
In relation to advantage, the General Court found that the Commission is required to justify its choice of methodology and it relied too heavily on non-compliance with its chosen methodology. Non-compliance in itself does not automatically lead to the conclusion that there has been an unlawful reduction in tax burden. In this regard the Commission failed to determine under the arm's length principle that Starbuck's transfer pricing scheme produced a taxable profit that was too low. Therefore whilst the Commission was perfectly entitled to use the arm's length principle the General Court concluded that the Commission's decision should be struck down due to evidential failings.
Contrast the Starbuck's case with the General Court's judgment in the appeals brought by Luxembourg and Fiat against the Commission decision of October 2015. The essence of the Commission's case was that transfer pricing arrangements accepted by Luxembourg tax authorities when calculating the corporate taxation of Fiat Finance and Trade (FFT) constituted unlawful state aid. The General Court found that the transfer pricing methodology approved by the tax ruling minimised FFT's remuneration and on that basis their liability for tax was calculated.
The Court reiterated the Commission's entitlement to use the arm's length principle to calculate whether that been an unfair tax advantage given to Fiat. But the Court ruled that the corollary of a breach of that principle in the circumstances of this case was that the tax ruling at issue conferred an unfair advantage on FFT which resulted in a lowering of FFT's tax liability as compared to the tax that it would have had to pay under Luxembourg tax law applying the arm's length principle. Therefore the General Court upheld the Commission's 2015 decision against Fiat and Luxembourg.
Reacting to the delivery of these two judgements Competition Commissioner Vestager stated that: "All companies, big and small, should pay their fair share of tax. If Member States give certain multinational companies tax advantages not available to their rivals, this harms fair competition in the EU. It deprives the public purse and EU taxpayers of much needed funds to fight climate change, to build infrastructure, to invest in innovation".
The Commission has become increasingly active in looking at
aggressive tax planning measures introduced by companies and
approved by member state governments and whether those schemes
amount to unlawful state aid. It is currently pursuing more cases
against national member states.
Although the Commission cannot claim total success in its approach with the General Court's judgments they will undoubtedly embolden them in tackling taxation under the state aid rules.
The Starbucks case was lost on the grounds of evidential failings rather than any fundamental misdirection as to the law or the methodologies for assessing unlawful state aid. The Commission will take great comfort from that.
The judgments confirm that, while member states have exclusive competence in determining their laws concerning direct taxation, they must do so in respect of EU law, including State aid rules. In addition the General Court has also the confirmed the Commission's approach to assess whether a measure is selective and if transactions between group companies give rise to an advantage under EU State aid rules can be based on the so-called "arm's length principle". The Commission is likely to increase its enforcement activities against aggressive tax planning as a result of these rulings.
Robert Bell is partner at Bryan Cave Leighton Paisner LLP
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