On 24 September 2019, the General Court (the ‘Court’) upheld the European Commission's (the ‘Commission’) ruling ordering Luxembourg to recover EUR 23.1 million from Fiat Chrysler Finance Europe (‘FFT’1) and annulled the Commission's ruling ordering the Netherlands to recover EUR 25.7 million from Starbucks. The Court confirmed that:
- Even if direct taxation falls within the competence of the Member States of the European Union, the Commission could assess whether the national tax rulings were consistent with the EU state aid rules.2 This was not backdoor fiscal harmonization.
- The Commission is permitted to use the arm's length principle as a tool to assess whether the transactions that were the subject of the rulings were remunerated as though they had been negotiated at arm’s length, or whether those rulings in fact conferred a selective advantage on FFT and Starbucks.
- The Commission’s conception of the arm’s length principle can effectively be applied in all Member States independently of whether that principle has been expressly or impliedly incorporated into national law.
- In FFT, the Court upheld the Commission's assessment that the tax ruling granted a selective advantage by reducing FFT’s tax burden in comparison with the ‘normal’ rules of taxation in Luxembourg law for arrangements between independent (non-group) companies.
- In Starbucks, the Court held that the Commission had failed to demonstrate that the tax ruling conferred an economic advantage within the meaning of EU state aid rules on Starbucks.
The two judgments confirm that the Court is broadly supportive of the Commission’s methodology for determining whether a transfer pricing ruling in respect of intra-group transactions confers a selective advantage under the EU state aid rules. This is likely to provide encouragement to the Commission as it pursues further state aid taxation cases, although it will need to conduct a thorough analysis if it is to show that a particular tax ruling confers a selective advantage within the meaning of the EU state aid rules.
Multinationals should, therefore, be aware that national tax rulings and other special tax arrangements are likely to be a focus of Commission scrutiny and that further state aid enforcement action can be expected.
On 24 September 2019, the Court delivered two important judgments regarding the application of EU state aid rules to tax rulings by Member States.3 The judgments concern two separate decisions of October 2015, in which the Commission found that a tax ruling by Luxembourg regarding FFT, and a tax ruling by the Netherlands regarding Starbucks, constituted illegal state aid (the ‘contested decisions’).4 The decisions were appealed by both Member States as well as by the alleged aid beneficiaries.
The same chamber (and the same judges) of the Court upheld the FFT decision, but annulled the Starbucks decision. This is at first sight a rather remarkable outcome given that there were many similarities in the Commission’s analysis of the two tax rulings as a form of selective economic advantage. A closer analysis confirms that the Court has broadly endorsed the application of the EU state aid rules to special tax arrangements for multinationals and has upheld the Commission’s approach to transfer pricing issues. That said, the Court has sent a clear message to the Commission that it must conduct a thorough analysis of how national tax authorities have conducted their assessments to arrive at a particular tax ruling. An alleged erroneous application of a particular transfer pricing methodology or the use of one methodology as opposed to another is not enough to establish that a company has benefited from an economic advantage within the meaning of the EU state aid rules.
II. The Commission’s contested decisions
In the contested decisions, the Commission scrutinized the transfer pricing policies that had been accepted by the Luxembourg and Dutch authorities in each tax ruling.
The Commission applied what has become its traditional three-step test to determine whether the tax rulings granted a selective advantage. First, it identified a “reference system of ‘normal taxation’” in the relevant Member State. Second, it compared the tax treatment granted to the companies in question with this reference system. Third, it examined whether the Member State had established that the derogation (if any) from the reference system, identified in step two, could be justified by the basic or guiding principles of the reference system.
In the FFT case, the Commission found that the transfer pricing methodology constituted a selective advantage because it: (1) reduced the company’s capital base in a manner that was not justifiable economically; and (2) applied a remuneration to this capital that was much lower than market rates. In the Starbucks case, the Commission found that the transfer pricing methodology in the advance pricing arrangement (APA) concluded by the Dutch tax authorities with Starbucks constituted a selective advantage because the level of the royalties and other payments made by the Dutch entity to UK and Swiss entities did not reflect ‘normal’ market conditions. In the Commission’s view, these deficiencies artificially reduced the tax bases of these companies in Luxembourg and in the Netherlands, respectively, thereby conferring an economic advantage.
III. General Court judgments
The contested decisions were challenged on a number of grounds. The Member States and the companies claimed that the Commission had misused its powers by imposing a form of tax harmonization through the back door. A further key objection to the application of the EU state aid rules to tax rulings concerning transfer pricing arrangements involving multinationals has been the Commission’s application of the “arm’s length principle” and its determination of the correct methodology to calculate whether this principle had been respected in each of the decisions at issue.
The Netherlands argued before the Court, amongst other things, that it had applied the most appropriate transfer pricing methodology and that the Commission had simply prioritized one methodology over another; thus making the transfer pricing method an end in itself. The Commission had essentially argued that the methodology applied by the Dutch authorities for arriving at an arm’s length price was flawed and did not reflect economic reality. The Court ruled in the Netherlands’ (and Starbucks’) favor and held that the Commission had not managed to prove the existence of an economic advantage within the meaning of the EU state aid rules.
The Court held that the Commission had wrongly found that the mere choice of one methodology to calculate the arm’s length price as opposed to another would have conferred an advantage on the Starbucks entity in the Netherlands (SMBV5). Instead, the Commission should have demonstrated that the methodological errors identified in the Dutch approach had led to a reduction of the tax burden.
The Commission had also faulted the Dutch authorities for not analyzing a royalty paid by one Starbucks subsidiary to another, but without undertaking its own assessment of whether the royalty complied with the arm's length principle. The Court held that the mere finding by the Commission that the APA did not analyze the royalty does not suffice to demonstrate that that royalty was not actually in conformity with the arm’s length principle. It added that it was incumbent on the Commission to demonstrate that the methodological errors identified in its analysis had indeed led to a reduction of Starbucks’ tax burden.
Fiat Chrysler Finance (FFT)
By contrast, in the FFT judgment, the Court upheld the Commission's finding that the Luxembourg tax ruling minimized the carmaker's tax burden, giving rise to an advantage that favored FFT over others, in breach of EU state aid rules. The Court ruled that the Commission was entitled to apply the arm’s length principle as described in the FFT decision. Importantly, it concluded that the Commission was correct in finding that the tax ruling at issue had endorsed a methodology for determining FFT’s remuneration that did not enable an arm’s length outcome to be achieved and that resulted in a reduction of FFT's tax burden. The Court also rejected claims that forcing FFT to reimburse up to EUR 30 million contravened the principle of legal certainty.
Finally, the Court confirmed a presumption of selectivity for ad hoc aid measures. Luxembourg's tax ruling was an “ad hoc individual measure” - in other words, it was only destined to one company and by nature selective. The Commission was not required to “identify undertakings that were in circumstances legally and factually comparable”6 to the company receiving the ruling and compare their respective tax status to establish selectivity.
The Court has dismissed the argument that the application of the EU state aid rules represented an effort by the Commission to encroach into national tax policy – or backdoor harmonization. It held that “[s]ince the Commission has the power to monitor compliance with [the EU's state aid rules], it cannot be accused of having exceeded its powers when it examined the tax ruling at issue in order to determine whether it constituted state aid and, if it did, whether it was compatible with the internal market”.7
Perhaps more fundamentally, the Court seems to have endorsed the Commission’s view that its conception of the arm’s length principle can effectively be applied in all Member States independently of whether that principle has been expressly or impliedly incorporated into national law. This may have particular ramifications for Apple and Ireland and their ongoing state aid disputes, in respect of which a Court ruling is expected next year.
The Court also made short shrift of criticisms that by voiding tax deals negotiated by national tax authorities, the Commission was sowing legal uncertainty for companies operating both in Europe and in third countries.
Whether taxpayers can be so sanguine about this remains to be seen. Clearly, advance pricing agreements are and are likely to remain a fundamental component of tax compliance for many multinational enterprises and it is clearly important that a taxpayer is able to rely on any such agreement that is struck with a Member State. If the Commission is, as these decisions have held, empowered to revisit any such agreement after it has been struck by a national tax authority then this can only create uncertainty, particularly given that transfer pricing is not an exact science and can only ever approximate an arm’s length outcome.
However, the Starbucks case in particular does highlight that the Commission’s powers here are not unrestricted and that it will need to conduct a thorough analysis of the underlying transactions before challenging any particular agreement. This, at least, is a welcome development.
In the aftermath of the rulings, the Competition Commissioner, Margrethe Vestager commented that the two rulings provided “important guidance” and stated that “it will continue to be a main priority for [her] to look into aggressive tax planning measures … to assess if they result in illegal state aid”8.
The Commission is likely to draw on the Court’s interpretation of the role of the arm's length principle in its ongoing investigations concerning tax rulings issued by the Netherlands (IKEA and Nike) and by Luxembourg (Huhtamäki).9 On the other hand, the Court’s ruling in Starbucks, that the Commission failed to demonstrate that an advantage was granted, may provide some ammunition to alleged beneficiaries in these type of cases, as it has placed a high burden of proof on the Commission.
1 Formerly Fiat Finance and Trade Limited.
2 The Treaty on the Functioning of the EU includes state aid rules which are intended to ensure that Member State resources, in whatever form, are not deployed to distort competition or create an unfair advantage in the EU Internal Market. State aid is an advantage given by a Member State that may provide a company with an unfair competitive edge over its commercial rivals. EU rules generally prohibit state aid unless it can be justified under certain circumstances related to general economic development.
3 The judgments are Luxembourg v Commission and Fiat Chrysler Finance Europe v Commission, Joined Cases T-755/15 and T-759/15 (the “FFT judgment”); Netherlands v Commission and Starbucks and Starbucks Manufacturing Emea v Commission, Joined Cases T-760/15 and T-636/16 (the “Starbucks judgment”).
4 See Commission Decision (EU) 2016/2326 of 21 October 2015 on State aid SA.38375 (2014/C ex 2014/NN) which Luxembourg granted to Fiat, OJ L 351, 22.12.2016, p. 1 (the “Fiat decision”); and Commission Decision (EU) 2017/502 of 21 October 2015 on State aid SA.38374 (2014/C ex 2014/NN) implemented by the Netherlands to Starbucks, OJ L 83, 29.3.2017, p. 38 (the “Starbucks decision”).
5 Starbucks Manufacturing EMEA BV of the Netherlands, part of the Starbucks group, which inter alia, is responsible for the production of roasted coffee beans and for their provision to Starbucks shops in Europe, the Middle East and Africa.
6 FFT judgment, para. 358.
7 FFT judgment, para. 107.
8 Answers to the European Parliament questionnaire to the Commissioner designate Margrethe Vestager in preparation for her confirmation hearing on 8 October 2019.
9 Commission press releases of 18 December 2017 (IKEA), 10 January 2019 (Nike) and 7 March 2019 (Huhtamäki).