Do you have business activities in an EU Member State? Are you a well-established market actor? Is your brand successful and well-known? Risk management requires reviewing whether your group is at risk of having benefited from unlawful State aid. State aid rules apply to all corporate taxpayers throughout the EU. These three questions help you to self-assess your situation.
1. Does your structure allow certain income to remain untaxed?
The European Commission’s fiscal State aid investigations are part of the movement focused on multinationals paying their “fair share” of tax. In the absence of fiscal harmonisation, State aid is used as a political pressure tool. One of the elements the Commission looks at is stateless income: Income that remains untaxed due to hybrid mismatches (see the McDonald’s case) or the incoherent application of domestic rules (see the Belgian Excess Profit Ruling case). Inconsistencies in transfer pricing analysis may similarly result in stateless income. This may be the case if the risks, assets and functions are described inconsistently in the transfer pricing documentation in various jurisdictions.
Recommended action: review if your group uses hybrid financial instruments or hybrid entities in transactions with European group entities.
2. Has the tax treatment of your operations in an EU Member State been confirmed in a tax ruling?
In all recent and current investigations in fiscal State aid, the Commission has been looking at tax rulings. The Commission obtained these rulings either through public sources (Luxleaks) or in answer to requests for information addressed to all Member States. The Commission has no access to the database of rulings automatically exchanged under the EU rules on mutual assistance in tax matters.
The Commission consistently underlines that most tax rulings should not raise State aid concerns. The Commission does not question national ruling systems in general, but focuses on what in its view are “outliers”.
Recommended action: If entities in your group obtained advance tax rulings in an EU Member State, review if the facts were implemented as described and if the legal analysis was sufficiently developed.
3. Are your profits allocated in line with economic reality?
The first investigations into individual fiscal State aid, which started in June and October 2014, concerned transfer pricing (see the Starbucks, Fiat and Amazon cases). The Commission assessed also in the Apple case whether the profit allocation reflects economic reality. Payments to entities achieving a nil or very low effective tax rate, e.g., Swiss entities benefiting from preferential regimes, may raise particular attention.
The Commission’s claim, in these cases, that the arm’s length principle can be directly derived from the EU treaties’ definition of State aid is not yet tested before the European courts. In the Commission’s view, the OECD transfer pricing guidelines are merely useful guidance, especially considering seemingly inconsistent national practices on transfer pricing rulings. The European courts will have to provide clarity and take a final stance, as all Commission’s decisions to order recovery of unlawful aid are under appeal.
Recommended action: review the pricing of intragroup transactions (and supporting documentation), with a focus on interest and royalties, and the alignment between profit allocation and significant people functions.
Going further in managing your State aid risk
Proactively assessing a potential State aid exposure will also help you anticipating and answering potential State aid questions by auditors. The risk of being subject to an investigation and ultimately of having to repay State aid may affect your financial statements. Reviewing your existing structure(s) will furthermore give you an edge in adapting your business to the changes introduced by other changes to EU tax rules against base erosion and profit shifting. These measures will have an impact beyond the EU’s borders.