BACKGROUND

  • On 21 October 2015, the EU Commission announced that rulings granted by the Luxembourg tax authority to Fiat and by the Netherlands tax authority to Starbucks were illegal state aid. The relevant member states have been ordered to recover the unlawful benefit from the companies, estimated as around €20m to €30m each.
  • In broad terms, state aid is a benefit granted by a public body that applies selectively to businesses in one sector and gives them a competitive advantage over other businesses and so harms competition within the EU.
  • In principle, tax rulings can qualify as state aid if they amount to a benefit that is granted by a state, is selective, and distorts competition.
  • If the Commission determines that unlawful state aid has been granted, the relevant member state is required to claw back the benefit, in principle without limit of time.

FACTS

Fiat Financing and Trade (FFT)

  • Fiat had a financing company in Luxembourg that acted as a group treasury company, with a business broadly comparable to that of a bank.  The company was the centralised treasury resource for the group as a whole, dealing with cash pooling, external bank relationships, forex, risk management, etc.  The ruling concerned the transfer pricing methodology to be used by FFT to determine its taxable profits.
  • The Commission has determined that the ruling was based on an “artificial and extremely complex methodology” including “economically unjustifiable assumptions and down-ward adjustments”: it produced a taxable profit that the Commission estimated was only a twentieth of what might be expected on an arm’s length basis.

Starbucks Manufacturing EMEA BV

  • Starbucks had a coffee roasting company in the Netherlands. It was granted a tax ruling in 2008 on the Dutch tax treatment of two intra-group transactions: it bought unroasted (green) coffee beans from a sister company in Switzerland, and it paid royalties to a sister entity in the UK for the licensing of know-how relating to the roasting of the beans (the UK entity was a limited partnership and neither it nor its member were taxed in the UK or the Netherlands on its income).
  • The Commission has determined that the price paid to its affiliate in Switzerland was significantly higher than an arm’s length price, and could not be justified by the alleged quality of the beans, and that the royalty paid to the UK was also significantly larger than could be justified.

DECISIONS

  • In each case, the EU Commission determined that the company had been granted a selective tax advantage  by the relevant member state, arising from the state agreeing to an “artificial” transfer pricing method that did not properly reflect the economic reality, which enabled the company to pay less tax.

WHAT DOES THIS MEAN FOR OTHER TAXPAYERS?

  • In the first instance, do not panic. It is likely that Fiat and Starbucks (and the other companies being investigated for potential state aid, including Apple and Amazon) will appeal and there are reasons to believe at least some of the appeals might be successful. For example, it might be said that the treatment is not selective because it was based on the general law and administrative practice of the tax authority in the relevant member state and that in principle a similar ruling was available to any taxpayer upon request.
  • Secondly, even if Fiat and Starbucks lose their appeals, it is unlikely that the EU Commission will investigate the tax rulings granted to hundreds or thousands of other businesses to determine if there is state aid. It is more likely that the Commission might investigate a few more exemplary cases, where the facts are particularly bad, to encourage compliance by others. It is also possible that member states will be asked to review historic rulings, although there is little political appetite for that.
  • Going forward, the tax ruling behaviour in many EU member states has already changed markedly. In parallel, following the suggestion of the OECD in its BEPS reports, the EU has already implemented a directive that will require more transparency in relation to tax rulings, including automatic exchange of cross-border tax rulings between tax authorities, which should mean that there is much less chance of a tax ruling granted today being found to be state aid in a few years’ time.
  • That said, taxpayers who are currently relying on historic tax rulings similar to those in Fiat and Starbucks should review their position to determine if they might be vulnerable to attack.

IMPACT ON PRIVATE FUND LUXCOS

  • The ruling against Fiat begs the question whether rulings obtained by a large number of private funds in relation to their Luxcos will be impacted.  We think not.
  • The Fiat ruling was very different from those typically obtained by Luxembourg asset holding companies used by private investment funds.
  • First, it is important to understand the difference between tax rulings (ATAs) and transfer pricing rulings (APAs). The Fiat and Starbucks cases both involve APAs (transfer pricing only) and so should not impact ATAs obtained by Luxcos which usually just confirm the generally applied law in Luxembourg (for example, the treatment of hybrid instruments as debt, the ability to claim a deduction for return on such instruments, and the non-applicability of withholding tax to such returns). These ATA rulings are generally seen as confirmatory of the law, not departing from it. Such rulings do not seem amenable to challenge on state aid grounds.
  • APAs in Luxembourg no longer determine the margin to be retained by a fund Luxco on back-to-back financing  and OECD principles now need to be applied to determine the appropriate margin. It is possible to obtain an ATA from the Luxembourg tax authorities confirming the appropriate margin for a Luxco on its finance activities, but, obtaining an APA in this context is less typical than obtaining an ATA, with Luxcos often just relying on a transfer pricing report to justify the (typically low) margin.
  • However, in any case, the functions of the Luxco in the  Fiat case differ greatly from those of a typical fund Luxco. A fund Luxco is essentially just a finance conduit and does not bear material credit risk. Unlike in the Fiat case, its functions are not comparable to those of a bank. As such, the limited margin being retained within such structures should be justifiable on OECD principles and the generally accepted low margin in relation to such activities (whether or not supported by an ATA) should not be impacted by the Fiat ruling.