Where should the line be drawn between the prohibition on State aid and Member States’ fiscal autonomy? According to the Commission and the General Court, the Luxembourg tax ruling given to Fiat fell on the wrong side of this line and constituted unlawful State aid. But the CJEU disagreed. Its judgment in the Fiat and Ireland cases puts an end to the Commission’s assertion of an overarching EU arm’s length principle and reasserts Member States’ fiscal autonomy.
The CJEU held that the Commission and the General Court had got the State aid assessment wrong by applying an arm’s length principle that was different from the rules actually applicable in Luxembourg. The issue, as argued by Ireland, was whether the domestic transfer pricing rules were correctly applied – if they were correctly applied, the Luxembourg tax rulings could not be State aid.
Tax rulings are common practice and effectively provide companies with clarity as to the calculation of their tax liabilities. Tax rulings hit the headlines in 2014 when several hundred tax rulings issued by the Luxembourg tax authority were leaked to the press. Since 2014, the Commission has concluded several in-depth investigations into whether tax rulings constitute State aid and challenges to its decisions have been brought before the General Court. The decision on the tax rulings issued by Ireland to Apple has the most significant amount of tax at stake (EUR 14.3bn collected from Apple is now sitting in an escrow account) so it is no surprise that Ireland submitted its own appeal in the Fiat case to set out arguments that are equally relevant in the Apple case. The Commission lost in Apple before the General Court but is appealing to the CJEU.
The Fiat case relates to an advance pricing agreement (APA) granted by the Luxembourg tax authorities in 2012 in favour of an undertaking in the Fiat group (FFT) that provided treasury and financing services to group companies established in Europe. The APA, based on Luxembourg law and administrative practice, was intended to bring about a reasonable approximation of the market price. The Commission concluded that the APA constituted unlawful State aid, broadly, on the basis that it allegedly allowed intra-group transactions to be priced other than at arm’s length prices and the General Court confirmed the Commission’s decision.
The CJEU has now set aside the General Court’s judgment and annulled the Commission’s decision. This is a huge victory for Fiat, Luxembourg and Ireland, and other taxpayers caught up in similar State aid cases involving tax rulings, such as Apple.
What is the correct reference system?
Without getting too technical, there are a number of conditions to be fulfilled for a measure to constitute unlawful State aid. The condition at the centre of the Fiat case is that the measure must confer a selective advantage on the beneficiary. It is crucial for assessing the existence of an advantage and whether it is selective that the reference system is correctly identified. The Commission is required to carry out a comparison with the tax system normally applicable in the Member State. Where the Commission went wrong (and where the General Court erred in law by endorsing this) is that when defining the “normal” taxation of an intra-group company, the arm’s length rule actually applicable under Luxembourg national law was disregarded and instead a hypothetical tax system applying a different arm’s length principle was used as the comparator.
The CJEU noted that any fixing of the methods and criteria for determining an arm’s length outcome falls within the discretion of the Member States and that there are significant differences in the detailed application of transfer pricing methods between the Member States. There is no autonomous arm’s length principle to be applied independently of the national law.
Interestingly, the CJEU emphasises at the end of the judgment that tax rulings can still be found to be State aid in certain circumstances. But in the decision at issue, the Commission did not carry out the correct examination to show this because its analytical framework did not include all the relevant norms implementing the arm’s length principle under Luxembourg law.
Complexity of transfer pricing
Cases like this beg the question whether it is a good use of the Commission’s time and resources to challenge individual tax rulings. Transfer pricing cases are fact dependent and evidence intensive. Transfer pricing of group financial transactions, in particular, is complex, as can be seen by the time spent by the OECD’s working party on the chapter on financial transactions for the Transfer Pricing Guidelines before their eventual publication in 2020.
Harmonisation of corporate taxes across the EU
State aid has been used repeatedly by the Commission as a tool for tackling tax competition but as this case shows it is not the right tool for the job. The EU is not a fiscal union and, as we have seen, attempts by the Commission to fully harmonise corporate taxes across the EU have so far been unsuccessful. The latest attempt is “BEFIT”, a single corporate rulebook with a common tax basis and formulary apportionment for allocation of profits which, if implemented, would enable greater fiscal uniformity. This should mean that the State aid rules would not need to be used as a method of tax harmonisation. As the BEFIT proposal is intended to piggy-back off the international tax reform rules under Pillar Two, the proposal will not be published until 2023 but the Commission is currently consulting on the framework.