The European Competition Commissioner, Margrethe Vestager, announced on 20 March 2023 that new State aid investigations into “aggressive tax planning” practices of multinationals can be expected. This follows an in-depth inquiry into tax ruling practices in European Union (“EU”) Member States for the period 2014-2018.
While the European Courts have annulled several European Commission (“Commission”) decisions that ordered companies to repay to the State advantages gained from tax rulings, they have decided that State aid law also applies to tax measures, even if direct taxation is a prerogative of Member States. However, as this article sets out, the European Courts have limited the Commission’s review.
In particular, by its judgment of 8 November 2022 in the Fiat Chrysler case (C-885/19 P), the Court of Justice of the European Union annulled a Commission decision ordering Fiat Chrysler to refund EUR 30 million of tax advantages to Luxembourg. It clarifies when a tax ruling can be considered State aid.
These are the key takeaways of this judgment:
- Although not harmonized at the EU level, direct taxation must comply with State aid rules. Therefore, the Commission may review tax rulings under State aid law and verify, for instance, that the tax system is applied consistently with the objectives pursued.
- As long as direct taxation is not harmonized at the EU level, it is up to Member States to determine the tax regime applicable to companies. Therefore, the Commission should consider that the normal tax system, against which discriminations favoring certain companies may be State aid, is determined by national law.
- When examining whether a tax measure favors certain companies over others, the Commission cannot substitute the normal national applicable law with its own standard of normality.
This judgement will likely impact pending investigations into the tax rulings issued to other companies and in ongoing proceedings. It will also set the approach the Commission may take in potential new investigations.
In short, this judgment says that if a tax ruling is issued in compliance with the national legal framework and not manifestly inconsistent with the objectives pursued by the national tax regime, it is unlikely to be State aid.
The Commission decision that Fiat Chrysler has been unduly favored by Luxembourg
In 2013, the Commission launched a series of State aid investigations into tax rulings issued by various Member States to multinational companies. Amongst the investigated rulings, there was one issued by Luxembourg to the Fiat Chrysler Group.
In that case, a group entity established in Luxembourg provided treasury services and financing to the other group companies established throughout Europe. The Luxembourg tax ruling approved an advance transfer pricing arrangement whereby profit allocation enabled the Luxembourg-based entity to determine its corporate income tax liability to Luxembourg. The applicable legal framework required transactions between group companies (“integrated companies”) to be treated as if concluded between independent companies at arm’s length (“stand-alone companies”).
By its decision of 21 October 2015 (SA.38375), the Commission considered the tax ruling to be State aid because it conferred a selective advantage favoring the Fiat Chrysler Group over other companies by lowering its tax liability in Luxembourg, compared to what would be the case if intra-group transfer prices were charged at arm’s length. The Commission did not use the method provided under national law to assess arm’s length because it considered that it departed from a reliable market-based approximation. Instead, the Commission used an independent assessment method devised by the OECD to determine whether the tax measure conferred an undue advantage on the group. The Commission therefore ordered repayment of that advantage.
The annulment of the Commission decision by the Court of Justice
Fiat Chrysler and Luxembourg challenged the Commission decision before the General Court of the EU, which confirmed the Commission’s approach in its judgment of 24 September 2019 (T-755/15 and T-759/15). Fiat Chrysler and, this time, Ireland, brought an appeal to the Court of Justice which rendered its judgement on 8 November 2022.
The Court of Justice reiterated the three-step analysis to determine if a tax measure favors certain companies above others (i.e. is “selective”):
- first, the Commission must identify the reference system, that is the normal tax system applicable in a country;
- second, the Commission must demonstrate that the tax measure constitutes a derogation from that reference system because it differentiates between operators who are in a comparable factual and legal situation;
- third, although the tax measure is a derogation from the reference system, the measure is not selective if the Member State shows that it is justified by the nature or general structure of the system.
Any mistake by the Commission in the first step may flaw its entire analysis because that step is the foundation to assess selectivity. In this respect, the Court of Justice considered that, without harmonization at the EU level, only the national provisions are relevant to determine the normal tax system of a country. It is up to the Member States to determine “whether particular transactions must be examined in the light of the arm’s length principle and, if so, whether or not transfer prices forming the basis of a taxpayer’s taxable income and its allocation among the States concerned, deviate from an arm’s length outcome”. This flows from the principle of legality of taxation.
National provisions can, however, be questioned if the Commission establishes, for instance, that the parameters laid down are manifestly inconsistent with the objectives pursued by the national tax system.
Hence, by disregarding Luxembourg’s national rules on determining arm’s length transactions, both the General Court and the Commission infringed State aid law and the Treaty rules on Member States’ fiscal autonomy.
Covington can assist you in complying with State aid rules and develop an appropriate strategy in the eventuality that the Commission would launch an investigation.