A review of the application of EU State Aid rules is crucial for determining if a national tax incentive scheme for IPs is being implemented lawfully. The result of such a compatibility analysis is not certain. In some decisions, the Commission considered “Tax Box” regimes as not being State aid because they were not selective or specific but rather legitimate general tax policy measures. This approach is, however, at variance with the settled case law of the Court of Justice (CJ), best seen in the judgement of Spain v Commission9 concerning a tax preference for outbound exportrelated investments. In essence, under the settled case-law, a tax incentive favouring certain investments or activities, although open to all economic operators, can be considered selective on the basis that it benefits the limited number of undertakings which actually carry out the investments in question. 

The CJ’s approach has recently been questioned by the General Court (GC). The GC has made the case that a finding of selectivity under Article 107(1) TFEU requires not only that a tax regime provides an incentive but also that this favours certain undertakings or sectors. In other words, for the GC, to be considered selective within the meaning of State aid rules, a tax incentive shall be proven to be either formally or de-facto in favour of a distinct group of undertakings or beneficiaries belonging to one or more industrial sectors. This means that tax measures open to all economic operators cannot be considered selective.

Under the notorious Italy v Commission judgement 10, the CJ found that the test to be applied in deciding whether an incentive was selective or not was the notion of ‘justification by the nature or scheme of the tax system’ as opposed to the question of whether it was open or not to all economic operators. If the incentive falls within the nature or scheme of the tax system it will be classified as a legitimate general tax measure rather than a selective State Aid. 

The reason for the CJ’s approach is undoubtedly the phenomenon of tax competition for foreign direct investment (FDI). It is a fact that Member States compete with each other in order to attract FDIs and that tax competition for FDIs can be both inter-Member State or intra-Member State (where the State provides for fiscal autonomy to its regions). It is of note that tax incentives favouring FDIs are very effective tools because they provide a high-valueat a reduced cost to the exchequer. They do not count as tax expenditures. Rather they erode the tax base of other countries. If uncontrolled, such forms of incentives would start a race to the bottom, which would fragment the internal market. 

This is the reason why the Commission, supported by the CJ, has taken a strict stance on selectivity for tax incentives even if they are effectively open to all economic operators. The more these schemes are available the more they are harmful to the internal market. Against this background, the test established by the CJ marks the correct delimitation between State aid and legitimate tax policy making such incentives not selective.  

The Relevant Rules

The framework for assessing the compatibility of State aid for research and development and innovation is found in the Communication from the Commission concerning the Framework on State aid for research, development and innovation.11 At point 4.5.3.1 of the Guidelines relating to ‘Fiscal measures’, the Commission states that in order to assess the compatibility of a tax incentive with State aid rules, the aid intensity of the measure must be calculated otherwise is not transparent and the aid cannot be approved. It follows that the guidelines are only applicable to Input or Back-End Incentives, which are measurable forms of State aid.

Secondly, the Communication on the application of the rules on aid to the measures of direct taxation of companies (the Commission Notice on Fiscal Aids) should be mentioned. These guidelines are important because they allow to distinguish between aid and 'genuine' fiscal measures. The following points of the Communication are relevant:

  1. (Points 13-15) providing the distinction between aid and general tax measures;
  2. (Points 21-22) providing the distinction between application / interpretation of tax by the tax and discretionary tax treatment (e.g. individual tax rulings);
  3. (Points 23-26) making reference to the nature of the tax system.

Thirdly, some limited guidance can be found in Commission Communication SEC (2006) 1515/COM/2006/0728 final, on the use of tax incentives for research and development. Section 1.2 of the Communication provides that measures open to all companies that operate (are taxed) in a Member State are in principle general measures.

Finally, reference should be made to Commission practice. In addition to the decision on the Dutch Interest Box, reference should be made to the Commission's decision of 13 February 2008 on the Spanish tax reductions for investments in intangible assets, aid scheme N 480/2007. For the Commission the notified tax regime did not constitute aid because it was not selective and was open to all economic operators. This was an IP regime corresponding to a Front-End Incentive with Nexus providing for tax exclusion of 50% of the income related to the exploitation of intangible assets developed by the beneficiary of the scheme.

For the reasons illustrated above, one should consider however that that decision does not accurately reflect the settled case-law on the subject, and is therefore a bad precedent on which to base the compatibility of a system of IP tax regime of the type of a Patent Box.

The Selectivity Reasoning

It is settled case-law that the concept of aid is more general than that of subsidy because it includes not only positive benefits, such as subsidies, but also measures which, in various forms, mitigate the charges which are normally included in the budget of an undertaking and which accordingly, without being subsidies in the strict sense, have the same nature and the same effect. Tax cuts may constitute State aid. Art. 107(1) TFEU prohibits aid that favours certain undertakings or certain productions namely those being selective.

In this respect, Article 107(1) does not distinguish between State measures on the basis of their objectives but only their effects12. Tax reductions which may benefit only one or several categories of undertakings are accordingly State aid, irrespective of the fact that the beneficiaries constitute one or more distinct economic subsectors within a larger group of competing undertakings. The fact that a tax reduction applies without giving the authorities any measure of discretion and automatically to all undertakings according to objective criteria, is not decisive to fulfil the specificity criterion. 

Indeed, for the CJ, the only requirement for selectivity is that certain undertakings other than the beneficiaries, being in a comparable legal and factual situation from the point of view of the tax system, are excluded from the benefit. Accordingly, the fact that the undertakings making different investments than the ones giving rise to a tax reduction would be excluded from the benefit, is sufficient to show that that tax reduction fulfils the condition of specificity.

In order to establish the selective nature of a tax measure, it is not necessary for the competent national authorities to have a discretionary power in the application of a tax reduction13, although the existence of that discretion may enable the public authorities to favour certain undertakings to the detriment of others and, therefore, to establish the existence of the specificity condition under Article 107(1) TFEU. In fact, a tax reduction granted to all economic operators objectively defined as those carrying out certain investments does benefit only one category of undertakings, namely those that make the investments covered by the measure. Such a finding is sufficient to show that the tax measure complies with the requirement of specificity, which constitutes one of the defining features of State aid, namely the selective nature of the benefit in question14.

It is true that not all the differentiations in tax treatment between undertakings constitute State aid. An examination of the national tax systems and social security schemes or other rules affecting undertakings’ costs shows that the national laws regulating those interventions do not lay uniform rules but also provide for derogations from the common rules and specific regimes applicable to certain undertakings on the basis of objective conditions. It is therefore necessary to distinguish, among such differential treatments, those arising from the application of general principles deriving from the logic of the tax or regulatory system to specific situations and those favouring certain undertakings by objective terms that depart from the internal logic of the common rules but rather pursue other objectives which can also be general policy objective but are not stated as principles of the tax or regulatory system in question.

It is for this reason that only the nature and structure of the tax system of the Member State in which the national measures can provide, in principle, a proper justification for the exceptions to the otherwise generally applicable tax rules. In that case, those derogations in so far as they are consonant with the logic of the tax system in question and proportionate to attain the differentiation stemming from the inner logic of that system, do not meet the requirement of specificity15.

Possible Justification of IP Regimes

It should be noted that, in the present state of Union law, direct taxation falls within the competence of the Member States, and again according to settled case-law, Member States must exercise that competence consistently with Union law.16 On this basis Member States must avoid taking any measure capable of constituting State aid incompatible with the internal market.

However, in order to justify a tax incentive with respect to the nature or structure of the tax system, it is not enough for a Member State to state that they are intended to promote a general policy objective such as to favour research and development activities. That purpose is, undoubtedly, a general economic objective, but that may not be enough. It must also be shown that the incentive falls within the overall logic of the tax system, and applicable to all taxable undertakings subject to the same legal and factual conditions under the tax system of reference17.

Therefore, the fact that the contested measures pursue a commercial or industrial policy objective such as the promotion of IP investment is not sufficient to avoid to take the measures outside the scope of Article 107(1) TFEU. The only way to implement a IP tax regime of the type of a Patent Box in a way that is compatible with the rules on State aid is by showing that the incentive that is inherent to the internal nature of the tax system (this is the meaning incentive open to all economic operators acceptable by the CJ).

One can make an example of a IP tax regime of the type of a Patent Box that does not constitute State aid because justified by the nature and scheme of the tax system.

A tax regime reducing the tax burden does not constitute State aid, provided that it applies without distinction to all firms and all production in relation to certain production activities, objectively defined and pursuing an aim of general economic policy (for example, development of IP rights), in as far as the value of the tax reduction on the income derived from IP investments is justified by the nature of the tax system, such as, for example, the principle of tax neutrality according to which the high profitability of certain investments and the high tax yield justifies a current tax reduction in order to equalise the overall taxation borne during in a given multiannual period by less profitable investments.