25 September 2019 Mark Daniel - Nayantara Ravichandran

State Aid and Taxation update: General Court rules on Fiat and Starbucks appeals

In brief

On 24 September 2019, the General Court (the "Court") upheld the European Commission's ("Commission") ruling ordering Luxembourg to recover EUR 23.1 million from Fiat and annulled the Commission's ruling ordering the Netherlands to recover EUR 25.7 million from Starbucks. The Commission had found in October 2015 that certain tax rulings issued by the Member States in question on the transfer pricing applicable to intra-group transactions constituted unlawful state aid.

More specifically, the Court found that:

While direct taxation falls within the competence of Member States, the Commission was entitled to consider whether the rulings were consistent with the EU state aid rules.
The Commission was permitted to use the arm's length principle as a tool to assess whether the transfer pricing rulings conferred a selective advantage on Fiat and Starbucks.
In Fiat, the Court rejected the applicants' arguments and upheld the Commission's assessment that the tax ruling granted Fiat a selective advantage by reducing its tax burden in comparison with the normal rules of taxation in Luxembourg law for arrangements between independent (non-group) companies.
In Starbucks, the Court annulled the Commission's decision on the grounds that it had failed to demonstrate that the tax ruling conferred an advantage within the meaning of state aid rules, on Starbucks.

Although the outcome for the Commission was clearly mixed, the Court is broadly supportive of the Commission's approach in its state aid investigations into tax rulings, particularly in relation to the use of the arm's length principle to assess if a transfer pricing ruling conferred a selective advantage to a group of companies. This is likely to embolden the Commission in its approach to state aid taxation cases, despite recent cases where the Court has annulled the Commission’s decisions.

The Commission is likely to rely on the Court's observations around the arm's length principle in its ongoing investigations concerning tax rulings issued by the Netherlands in favour of IKEA and Nike and by Luxembourg in favour of Huhtamäki. However, the Court’s decision in Starbucks that the Commission failed to demonstrate that an advantage was granted will provide some ammunition for taxpayers in the ongoing cases, when it comes to the standard of proof that the Commission must follow.

Affected parties have two months and ten days in which to appeal the judgments to the Court of Justice (“CJEU”). While Fiat is likely to challenge the decision, it remains to be seen whether the Commission will simply reopen its investigation into Starbucks and/or appeal the Court's decision. The Commission has recently appealed several decisions of the Court annulling its state aid decisions, including the recent judgment annulling its decision on the aid scheme nature of the Belgian excess profit rulings.

Background

The EU state aid rules regulate Member States' allocation of resources in favour of individual companies. State aid is given when a selective economic advantage is granted to a company or certain companies by a Member State, through State resources, and such advantage distorts competition. As a general rule, state aid must not be granted unless authorised by the Commission.

Tax rulings, agreements between a taxpayer and the tax authorities of a Member State with respect to the tax affairs of that taxpayer, may be caught by the state aid rules when they give rise to a reduced tax liability for certain companies as compared to the liability that would arise under the generally applicable regime. While a tax ruling doesn’t prima facie constitute a breach of the state aid rules (and the Commission recognises that Member States may provide prior administrative rulings on how specific transactions would be treated), tax rulings which apply the general rules in an inconsistent or overly lenient manner may give rise to state aid.

Since 2014, there has been increased state aid enforcement in relation to taxation. The initial cases, including Fiat and Starbucks, focussed on individual tax rulings granted by Member States in favour of specific companies, generally around transfer pricing for transactions as between group companies. Since then, the Commission has also investigated "aid schemes" i.e. where the measures in question are part of the underlying tax regime and, even without any "implementing measures" by the tax authorities, may grant selective advantages to certain companies (see for example the UK CFC case and the initial investigation into the Belgian excess profits ruling case).

Commission’s decisions in Fiat and Starbucks

Commission’s decision in Fiat

Fiat Finance and Trade ("FFT") is a Luxembourg-based company that provides treasury and finance services, such as intra-group loans, to other Fiat companies in Europe. In 2012 the Luxembourg tax authorities issued a ruling endorsing a transfer pricing method to allocate profits to FFT.

The Commission found that the taxable profits of FFT could have been determined in a similar way as for a bank, as a calculation of return on capital deployed by the company for its financing activities. The Commission took the view that the tax ruling endorsed an artificial and extremely complex methodology that was not appropriate for the calculation of taxable profits reflecting market conditions. In particular, it found that the tax authorities made a number of economically unjustifiable assumptions and downward adjustments that significantly reduced FFT’s capital base. In addition, the remuneration applied to the already reduced capital base was much lower than the market rates. As a result FFT paid taxes only on a small portion of its actual accounting capital at a very low remuneration. The Commission's assessment showed that under market conditions, the taxable profits declared by FFT in Luxembourg would have been 20 times higher.

Luxembourg justified its ruling on the basis that the transfer pricing analysis was consistent with a domestic circular on transfer pricing. However, the Commission found that the circular was overly broad and that the authorities did not appear to have been consistent in its application. In the absence of a coherent reference system the Commission found it appropriate to make an independent assessment on how the arm’s length outcome should have been calculated.

Commission’s decision in Starbucks

Starbucks obtained a tax ruling from the Netherlands in 2008 fixing the remuneration of the coffee-roasting operations of its Dutch subsidiary, Starbucks Manufacturing EMEA BV (“Starbucks Manufacturing”). Starbucks Manufacturing was the only coffee roasting company in the group in Europe, selling and distributing coffee and related products to Starbucks outlets in Europe, the Middle East and Africa. According to the Commission, through the ruling the Dutch tax authorities allowed Starbucks Manufacturing to artificially reduce its Dutch taxable profits through the payment of: (i) a “highly inflated” price for green coffee beans to a Swiss group entity, and (ii) a royalty to a UK group entity for coffee-roasting know-how, which did not “adequately reflect market value”. The Commission therefore concluded that the tax ruling endorsed artificial and complex methods to establish taxable profits that did not reflect economic reality.

General Court’s decisions

The parties' contentions

In Fiat, Luxembourg and Fiat raised various pleas arguing that the Commission erred in determining that the tax ruling was selective; that the Commission's analysis effectively led to tax harmonisation in disguise; that the Commission was wrong to find the tax ruling gave rise to an advantage and infringed Article 107 TFEU by assessing advantage on the basis of the arm's length principle; and that recovery of aid would be incompatible with legal certainty. Similar pleas were raised in Starbucks. The Republic of Ireland (which is currently appealing the Commission’s decision in relation to tax rulings in favour of Apple) intervened in both appeals, supporting the applicants’ arguments.

The two arguments below stand out as points that may have wider significance:

Arm’s length principle

One of the main points of contention in both appeals was whether the Commission was right in treating the arm’s length principle as an inherent part of Article 107 TFEU (and therefore the concept of “state aid”), and whether this principle was independent of the OECD methodology. The applicants argued that the Commission used an ‘autonomous EU law arm’s length principle’ as the appropriate frame of reference under which to judge whether the tax rulings in question granted a selective advantage.

The applicants contended that the Commission had incorrectly relied on Belgium and Forum 187 v Commission as an authority for the proposition that a version of the arm’s length principle exists in EU state aid law. Ireland, an intervener, suggested that the Commission was extrapolating a principle that the Court had not in fact established because in Forum 187 the arm’s length principle had been incorporated into national law, and the judgment referred to OECD guidelines that had also been incorporated into national law. The Commission noted that its assessment of the ‘selectivity’ of the tax measures was judged by reference to national corporate tax systems and it was only its assessment of ‘advantage’ that relied on the arm’s length principle.

The Commission reiterated that the principle was inherent to Article 107 TFEU (and could be relied on as part of the assessment of ‘advantage’ regardless of its incorporation in national law) since it is merely a general principle to ensure that companies are not treated more favourably than under the general tax regime. If Member States were not required to comply with the arm’s length principle, the operation of Article 107 TFEU would depend on whether the principle had been incorporated into national law and might vary from one Member State to another. In relation to Forum 187 the Commission said that the principles in the case were derived from Article 107(1) TFEU, not Belgian national law or the OECD guidelines.

Tax harmonisation

The applicants (and other stakeholders) were also concerned that the Commission had overreached its authority. In particular, Luxembourg submitted that the Commission was implementing a “disguised” tax harmonisation despite direct taxation falling within the exclusive competence of Member States under Article 114 TFEU. Starbucks also suggested that the Commission was imposing substantive rules of tax law under the guise of equal treatment, undermining the autonomy of Member States. The Commission acknowledged that Member States have autonomy in the area of direct taxation but noted that national tax measures must comply with the EU state aid rules. It noted that its decisions did not call into question the entire tax system but were intended to penalise the grant of a tax ruling under which a company was given preferential treatment.

General Court's findings

In both Fiat and Starbucks, the Court endorsed the Commission's application of the arm's length principle, and its reliance on Forum 187, to assess whether the tax rulings conferred a (selective) advantage on the companies. The Court makes it clear that the arm's length principle is a legitimate tool under Article 107 TFEU that allows the Commission to check that intra-group transactions are remunerated as if they had been negotiated between independent companies. As to the use of the OECD Guidelines for the assessment under the at arm’s length principle, the Court observed “that those guidelines are based on important work carried out by groups of renowned experts, that they reflect the international consensus achieved with regard to transfer pricing and that they thus have a certain practical significance in the interpretation of issues relating to transfer pricing”.

In both cases, the Court emphasised that the Commission had not exceeded its powers by engaging in tax harmonisation, despite direct taxation falling within the exclusive competence of Member States. Rather, the Court held that the Commission was merely exercising its power under the state aid rules to verify whether the tax rulings conferred an advantage on their beneficiaries as compared to 'normal' taxation, as defined by national law.

In Fiat, the Court rejected the applicants' arguments and upheld the Commission's assessment that the tax ruling conferred a selective advantage on Fiat since the methodology endorsed by the ruling resulted in the lowering of its tax liability as compared to its liability under national law absent the ruling. It also rejected the arguments that recovery of the alleged aid would be incompatible with the principle of legal certainty and contrary to the rights of the defence.

In Starbucks, the Court annulled the Commission's decision in its entirety on the grounds that the Commission had failed to demonstrate to the requisite legal standard that the tax ruling derogated from the general corporate system and conferred an economic advantage on Starbucks. It noted that it was not sufficient for the Commission to identify methodological errors by the national authority when assessing transfer pricing. In addition, it was required to show that such errors do not allow a reliable approximation of the arm's length outcome to be reached and lead to a reduction in the taxable profit, compared with the tax burden arising out of the application of the normal taxation rules.

In both cases, the Court discussed and assessed the technical transfer pricing arguments advanced by the parties in a detailed way.

Impact

The recent state aid investigations by the Commission should be seen against the backdrop of the wider initiatives at an EU and global (G20/OECD) level addressing perceived tax avoidance and harmful tax competition. As part of these initiatives, we have seen the adoption of a Directive providing for the automatic exchange of cross-border tax rulings since 2017, the Anti-Tax Avoidance Directives (ATAD) and the Directive on the mandatory disclosure of potentially aggressive tax planning arrangements by intermediaries from mid-2020 onwards (DAC6). The information made available and exchanged via these channels may in turn lead to further state aid investigations.

Looking more broadly at developments in the international tax sphere, at an OECD/G20 level, the work on developing a consensus solution to the tax challenges arising from the digitalisation of the economy (BEPS 2.0) seems to be advancing rapidly and may result in a (partial) overhaul of some fundamental taxation principles, such as the arm’s length principle.

It should also be noted that there have been certain changes to the Dutch tax regime and ruling practice based on the broader debate around the OECD base erosion and profit shifting (BEPS) and EU tax-avoidance measures. Similarly, Luxembourg has enacted a law to clarify the concept of the arm's length principle in line with the 2010 OECD Model Tax Convention. Following discussion with the Commission's competition officials, the Luxembourg tax authorities have also issued a circular to reshape the transfer pricing framework for companies carrying out intra-group financing activities and to provide guidance in terms of substance and requirements in line with the OECD Guidelines.

The Court has overruled the Commission in other recent state aid cases. The Court annulled the Commission's decision that excess profit rulings granted by Belgium were part of an illegal state aid scheme and it also found that the Commission erred in classifying a Polish retail tax as constituting state aid. Most recently, it rejected the Commission's finding that a Hungarian tax based on turnover derived from advertisements in Hungary constituted state aid. However, the Fiat decision shows that the Court is not opposed in principle to the Commission's focus on state aid and taxation.

The Court’s findings in Fiat and Starbucks have implications for several ongoing cases. While the technical merits of each case are different (as evidenced by the differing decisions reached by the Court in Fiat and Starbucks), some of the underlying issues are similar. First, the concern that the Commission is infringing Member States’ right to determine domestic tax laws and effectively pushing for tax harmonisation via state aid rules. Second, whether the Commission is correct in arguing that the at arm’s length principle is inherent in Article 107 TFEU (and the concept of state aid) and automatically part of the national reference system. In addition, there is the question whether the Commission can (or should) use the OECD methodology to clarify the arm’s length principle.

These issues are of direct relevance in the ongoing appeals in front of the Court with respect to the Commission's recovery orders against Apple (EUR 13 billion in 2016) and Amazon (EUR 250 million in 2017). The Court heard the oral arguments in Apple on 17-18 September 2019 and is likely to hear others later in the year. The Commission has ongoing in-depth investigations concerning individual tax rulings granted by the Netherlands in favour of Inter IKEA and Nike and by Luxembourg in favour of Huhtamäki. Following the Court’s decision on the Belgian excess profit rulings on 14 February 2019, the Commission announced last week that it has opened in-depth investigations to assess whether individual excess profit rulings granted by Belgium to 39 multinational companies gave those companies an unfair advantage over their competitors.

Next Steps

Affected parties have two months and ten days in which to appeal to the CJEU. Fiat is likely to challenge the decision before the CJEU.

It remains to be seen whether the Commission will decide to appeal the Starbucks decision, reopen its investigation to correct the deficiencies in its assessment, or both in parallel (perhaps the most likely outcome). The Commission has recently appealed the Court's judgment on the Belgian excess profit rulings but has in addition opened a formal state aid investigation into each of the 39 multinationals that obtained an excess profit ruling. It may have additional incentive to appeal given the pending appeals at the Court and a significant number of ongoing investigations.

The Court's decisions have immediate effect, even if they are subject to appeal. Luxembourg and the Netherlands both implemented recovery proceedings in 2016, with the aid amounts placed in escrow. The amounts are likely to remain in escrow, at least for Fiat, until the appeals to the CJEU are determined.

Conclusion

The decisions show that the Court is willing to support the Commission in its state aid investigations into tax rulings in principle. This is likely to embolden the Commission in its approach to state aid taxation cases, despite a number of cases where the Court has annulled the Commission’s state aid decisions. The Court’s observations, particularly in relation to the arm's length principle and tax harmonisation, are broadly supportive of the Commission and are indicative of the approach that it is likely to take with respect to similar issues in ongoing appeals, including those relating to Apple and Amazon.

However, the Starbucks decision and the Court's recent decisions in other state aid cases shows that the Commission is not immune from challenge. It seems likely that the Court will interrogate carefully whether the Commission has demonstrated that the tax rulings in question actually confer an advantage on the beneficiary. This is likely to provide some practical ammunition to taxpayers in ongoing cases.