On 19 September 2018, the European Commission concluded that a tax ruling granted by Luxembourg to McDonald’s Europe Franchising did not constitute illegal State aid. The Commission acknowledged that Luxembourg had correctly applied the Luxembourg-United States tax treaty. While this decision concerns an individual case, it suggests that State aid rules are not an appropriate tool to tackle hybrid mismatches relating to permanent establishments.

McDonald’s Europe Franchising, a Luxembourg resident company, had set up a branch in the United States (US) to which it allocated intellectual property rights. The related royalty income was correspondingly allocated to the branch. Luxembourg viewed the branch as a permanent establishment (PE), but the US did not. Accordingly, the activities were not taxed in the US. At the same time, the assets and income were exempt from tax in Luxembourg, as Luxembourg applied the provisions of the Luxembourg-US tax treaty to the PE’s income and assets. Effectively, this resulted in a hybrid mismatch outcome (double non-taxation of the royalty income).

The Commission now ended the formal State aid investigation that it had begun in December 2015 into this tax ruling. It concluded that Luxembourg did not treat McDonald’s more favourably than other companies in a similar legal and factual situation by confirming the hybrid mismatch outcome. The US branch met all criteria to qualify as a PE under the applicable Luxembourg tax provisions. Consequently, Luxembourg validly applied the relevant tax treaty provisions to exempt the PE’s assets and income from Luxembourg taxes, without giving a selective advantage to McDonald’s.

The Commission duly noted Luxembourg’s intention to make the recognition of a foreign PE subject to stricter conditions in the future. We refer in this respect to the pending bill of law 7318 discussed in our tax flash of 20 June 2018.

The Commission’s decision may be appealed by interested parties within two months of the publication in the Official Journal of the EU. The press release of the Commission is accessible here. The press release of Luxembourg’s finance minister welcoming the Commission’s decision is accessible here. Various State aid cases are still pending before the EU general court concerning the tax treatments of Apple, Starbucks, Fiat, Amazon and ENGIE, and the Belgian excess profit ruling scheme. Formal State aid investigations are still ongoing concerning the UK CFC financing exemption, Inter IKEA in the Netherlands and the Gibraltar tax ruling regime. The Commission continues to look into the tax practices of EU Member States and is expected to open more investigations in the coming months.