Criticism against the European Commission’s State aid decisions over tax arrangements intensified following the August 2016 decision on Apple. In that decision, the Commission found Ireland to have given Apple a benefit of approximately €13bn in illegal State aid through tax rulings. The amount that Ireland is directed to recover from Apple in unpaid tax (for the period 2003–14) has inevitably raised some eyebrows.
The decision on Apple followed earlier State aid decisions, in which the Commission deemed that a Netherlands tax ruling for Starbucks, a Luxembourg tax ruling for Fiat Finance and Trade and a Belgian excess profits scheme all constituted illegal state aid. Luxembourg’s tax rulings for Amazon, Engie and McDonald’s are currently being investigated by the Commission.
The Commission requires that the benefit resulting from tax rulings found to constitute illegal State aid is repaid as of the date it was received, to the extent such retroactivity is allowed under EU law. This aspect of the Commission’s decisions has raised concerns, not merely due to the obvious financial impact on the balance sheet of the multinationals concerned, but also as to whether the principle of legitimate expectations has suffered a setback by the Commission’s decisional practice.
The Commission argues that certain tax rulings confer an advantage, in that these rulings benefit the tax subjects concerned by allowing them to pay a lower tax than other companies in a comparable position. Critics of the Commission’s decisions, including the U.S. Treasury, have raised concerns that the Commission’s approach departed from prior case law, that retroactive recoveries defied legitimate expectations and that this novel approach was inconsistent with international norms.
State aid control over tax rulings
Multinational companies pursue the issuing of tax rulings to obtain certainty as how specific facts and circumstances, whether transaction-based or otherwise, will be treated under a particular member state’s tax regime. The Commission does note in its 2016 Notice clarifying key concepts relating to the notion of State aid that the legal certainty and predictability on the application of general tax rules, is best ensured if its tax ruling practice is transparent and the rulings are published.
The Commission views the lowering of tax liability of a particular tax payer by virtue of a tax ruling endorsing a result that does not reflect in a reliable manner what would result from a normal application of the ordinary tax system, to confer a selective advantage upon the recipient, as compared to companies in a similar factual and legal situation.
Surprise over the Commission’s State aid control over tax rulings serves only to confirm that multinational companies, their tax advisors and even tax authorities are more often than not disregarding EU jurisprudence when embarking on affirming tax arrangements through administrative rulings.
The Commission outlined its approach in its 1998 Notice on the application of the state aid rules to measures relating to direct business taxation, while the 2016 Notice confirmed the application of state aid rules to fiscal measures. What has changed is the investigation of individual tax rulings, rather than tax regimes, as well as the reliance on the OECD Transfer Pricing Guidelines for Multinationals Enterprises and Tax Administrations (the “OECD Guidelines”).
The ECJ clarified in 1974 (Case 173/73, Italy v Commission EU:C:1974:71) that the Commission's competence in the field of State aid control also covers the area of direct business taxation. It matters not whether state measures manifest as direct subsidies or tax relief to economic operators.
The Commission’s objective in its State aid control over tax rulings is to prevent the distortion of competition through the granting of tax advantages that are not available to all similarly situated taxpayers in a given member state. The Commission’s interpretative approach is clarified in the Commission’s 2016 Notice.
In 2006, the ECJ endorsed the arm’s length principle for determining whether a fiscal measure prescribing a method for an integrated group company to determine its taxable profit gives rise to a selective advantage for the purposes of Article 107(1) TFEU (Joined Cases C-182/03 and C-217/03 Belgium and Forum 187 v. Commission EU:C:2006:416). Accordingly, a fiscal measure that endorses a method for determining an integrated group company's taxable profit in a manner that does not result in a reliable approximation of a market-based outcome in line with the arm’s length principle can confer a selective advantage upon its recipient. That would be the case where such a fiscal measure results in a reduced taxable profit, and thus reduced corporate income tax liability.
It is inevitable that the Commission relies heavily on the ECJ’s 2006 judgment in Forum 187. In its 2016 Notice, the Commission confirms that where “uncertainty justifies an advance ruling”, a national tax authority may indicate how it will set arm’s length profits for intra-group transactions. However, the method for calculating arm’s length profits must give a reliable approximation of a market-based outcome. If not, the tax ruling confers a selective advantage.
The Commission views the arm’s length principle as inherent in, and even an application of, Article 107(1) TFEU. Going a step further, the Commission concludes in its 2016 Notice that it may have regard to the guidance of the OECD they capture the international consensus on transfer pricing and provide useful guidance to tax administrations and multinational enterprises on how to ensure that a transfer pricing methodology produces an outcome in line with market conditions. As such, the Commission asserts that it may even assess whether a national tax authority applies the most appropriate method of calculation.
That the Commission holds the view that the arm's length principle it applies in assessing transfer pricing rulings under the State aid rules is an application of Article 107(1) TFEU has been vehemently challenged in commentary (and judicially on appeal). The application of the arm’s length principle by the Commission prohibits unequal treatment in taxation of undertakings in a similar factual and legal situation. Consequently, if a transfer pricing arrangement complies with the guidance provided by the OECD Guidelines, including the guidance on the choice of the most appropriate method and leading to a reliable approximation of a market based outcome, a tax ruling endorsing that arrangement is unlikely to give rise to State aid.
Irrespective of the merits of the criticism of the Commission’s approach in this second wave of state aid control over tax rulings, it is clear that EU member states, while enjoying autonomy in the design of their direct taxation systems, may issue tax rulings constituting fiscal measures that infringe EU State aid rules.
While the EU courts may reverse parts of the Commission’s ratio on appeal, as things currently stand it becomes imperative for multinational companies to review any administrative tax rulings issued in their favour by a tax authority in an EU member state. In particular it should be assessed whether such rulings comply with the arm’s length principles, in accordance with the Commission’s interpretative approach.
In practical terms, multinational companies with corporate structures that present cross-border similarities to the ones under investigation by the Commission and which have obtained relevant tax rulings, should ensure that:
- Tax rulings obtained in the past decade are justified not only under the domestic laws of the country where the ruling is obtained, but also under the OECD Guidelines and the Commission’s recent decisional practice
- Transfer pricing arrangements currently in place are assessed and scrutinised, particularly as regards their arm’s length principle approach -the current commoditisation of transfer pricing studies raises additional concerns as to whether they are watertight against state aid control
- Where any risk is identified in the course of such assessments, a legal risk assessment is carried out by specialised counsel
- Where legal risks are indeed identified, corrective measures should be taken immediately, so as to minimise the risk of recovery of any benefit later found to constitute illegal State aid. The principle of legitimate expectations may be applicable under certain circumstances.