Corporate Tax Arrangements under EU State Aid Law : To what extent do Member States' corporate tax arrangements constitute a State aid measure within the meaning of Article 107(1) TFEU?

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International and European Law

EU Competition Law and Regulation

Master Thesis

Corporate Tax Arrangements under EU

State Aid Law

Preliminary problem statement: To what extent do Member States’

corporate tax arrangements constitute a State aid measure within the

meaning of Article 107(1) TFEU?

Student: Erwin Hendrix

Thesis supervisor: Mr. Cees Dekker 29 July 2016

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Abstract

Since 1957, when the common market has been created, Member States have agreed to renounce a part of their sovereignty in favour of EU institutions and policy makers, which have implemented a set of rules that enterprises and governments have to respect, as defined in the Treaty on the Functioning of the European Union.

Nevertheless, direct taxation is still an area that falls within the powers of the Member States, which means that they are free to devise a tax system that is best suited to their economic needs. However, they must exercise this power in conformity with EU law, which is not an easy task to achieve, as in recent years it has been shown that national tax measures have been excessively implemented by the Member States. This is confirmed by the numerous State aid investigations the European Commission has opened on the corporate tax affairs of multinational companies like Amazon, Fiat and Starbucks, in which the Commission found that the preferential tax regimes – in the form of Advance Pricing Arrangements – provided to those companies by national authorities, constitute State aid.

For this reason, the purpose of the thesis is to analyse to what extent Member States’ corporate tax arrangements constitute a State aid measure within the meaning of Article 107(1) TFEU. More exactly, the thesis focuses on the description and analysis, from an objective point of view, of transfer pricing related to corporate income taxation of multinational enterprises and the conditions that apply to transfer pricing in order to be qualified as State aid.

For a measure to be qualified as State aid, four criteria that are laid down in Article 107 TFEU need to be cumulatively fulfilled. In the absence of explicit State aid regulations for fiscal measures, it is normal that the general State aid rules and the same criteria apply to those measures. The most contentious issue is the selectivity criterion, which in tax matters is called “the selective advantage” and which constitutes the general requirement to determine if a tax measure can be considered as State aid or not.

Therefore, through the lines of this thesis, it will be shown that the boundary between legal and unlawful State aid is crossed when a selective advantage is granted to a multinational company. This results in a misapplication of the arm’s length principle and a distortion of the competition, which are imputable to the State. In such a situation, EU State aid rules are the perfect tools in the fight against illegal State aid measures and harmful tax competition.

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Introduction

“Fair tax competition is essential for the integrity of the Single Market, for the fiscal sustainability of our Member States, and for a level playing field between our businesses. Our social and economic model relies on it, so we

must do all we can to defend it.”

Algirdas Semeta1

Since the Treaty of Rome in 1957, the creation of a common market was the higher goal of the European Economic Community (EEC). Simultaneously, undistorted or fair competition, the principle underlying the State aid discipline, was set out in order to ensure that, economically, this common market would encourage enterprises to become more efficient and innovative and ultimately would increase the welfare of individual consumers facing a broader range of choices and having greater purchasing power.

Therefore, a set of rules that enterprises and governments have to respect, was defined by the Treaty establishing the European Community (EC Treaty, now Treaty on the Functioning of the European Union – TFEU), in particular, the prohibition of State aid which distorts competition to an extent contrary to the common interest of the internal market.2

In the context of competition law of the European Union (EU), where the State aid policy protects the internal market from distortions, the Member States still dispose, economically and legally, of a very powerful policy making tool, namely, direct taxation. It is evident that until today, differences in national tax systems still exist and have an influence on economic decisions by enterprises. Many Member States aspire to attract multinational companies by creating tax systems that are different from those of other Member States. This plays an

1

European Commissioner for Taxation and Customs Union, Audit and Anti-Fraud for the period 2010-2014. 2_{http://ec.europa.eu/economy_finance/structural_reforms/product/competition/index_en.htm}_.

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6 important role when companies decide where they should locate their production and their investment.

At the same time, with the creation of the internal market, where no borders exist, it is obvious that the apparition of multinational enterprises and the decisions taken by the latter have a special influence on European competition policy when these multinational enterprises apply their aggressive tax planning approaches in order to alleviate their tax burdens.3

It is not difficult to understand that if such tax planning systems exist, they are due to the fact that the Member States, which have the natural desire to see their economy grow, try to attract foreign enterprises through the implementation of beneficial tax provisions.4

Activities of this kind are not only problematic because they distort the competition and affect the trade between Member States, but they may also constitute prohibited State aid if they are special or selective in the sense that they apply only to certain undertakings.

Research problem, methodology, structure and boundaries of the

thesis

In this context, the thesis focuses on the description and analysis of transfer pricing related to the corporate income taxation of multinational enterprises and the influence of EU State aid policy on transfer pricing.

Different corporate tax arrangements will be described and analysed, and it will be shown that, under certain conditions, those arrangements may constitute State aid measures within the meaning of Article 107(1) TFEU.

This thesis contains five chapters, which will be elaborated from an objective point of view pursuing a descriptive approach.

In chapter one, I will introduce the reader to the fundamentals of State aid control in tax matters, giving some clarifications on a few basic concepts such as tax sovereignty, State aid and direct taxation, which should be understood before getting to the heart of the thesis itself.

Chapter two examines the notion of State aid for tax purposes. In particular, this analysis provides an overview of the conditions under which fiscal measures may be constitutive of State aid and what the consequences are if this form of State aid is found to be unlawful. I will

3

BEPS Frequently Asked Questions, OECD, p. 1, http://www.oecd.org/ctp/BEPS-FAQsEnglish.pdf.

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7 make a critical assessment as to the forms that fiscal State aid can take and the importance of terms like “selectivity” and “advantage” in the large notion of State aid.Under EU law an aid is selective, if it favours some undertakings or the production of certain goods over others. In tax matters, this criterion is a decisive condition for the review of State aid.

Chapter three then continues with an analysis of different tax rulings in the context of fiscal State aid law. A tax ruling is a statement provided by the competent tax authorities to a taxpayer, before a specific transaction takes place, regarding the future tax treatment of that transaction, thus providing the taxpayer concerned with legal certainty.5 The problem consists in the fact that those fiscal mechanisms may distort or threaten to distort competition between Member States and may, consequently, constitute State aid which is incompatible with the internal market.

Other important terms like “tax evasion” and “tax avoidance” and the difference between those two are also highlighted in this chapter. The distinction is very important as it is well-known that tax avoidance, contrary to tax evasion, is legal in the EU and constitutes a “legal minimization of tax liability via fiscal techniques”6

, such as shifting income from a high taxed person to a low taxed person or charging low prices for sales to low-tax affiliates but paying high prices for purchases from them.7

Chapter four can be considered as the final step of the thesis which shows how State aid rules are to be applied in the field of taxation and what may be their relevance in seeking to ensure a fair competition between Member States.

As an example given to understand a new definition, the purpose of this chapter is to place in context the investigations currently opened by the European Commission in relation to tax rulings on transfer pricing and to explore the manner in which proceedings of this kind may serve to correct abuses in European taxation practice.8

In the same chapter, I will give some final recommendations for future developments like a stricter reporting and transparency requirement the Commission should impose on all the Member States by reforming the Code of Conduct for Direct Business Taxation or by

5

Carlo Romano, ‘Advance tax rulings and principles of law, Towards a European Tax rulings system’, Doctoral Series, Vol. 4, p. 119.

6

http://www.businessdictionary.com/definition/tax-avoidance.html.

7

Jane G. Gravelle, ‘Tax Havens: International Tax Avoidance and Evasion’, Congressional Research Service. 8_{Richard Lyal, ‘Transfer Pricing rules and State aid, Fordham International law journal’, Vol. 38, 2015.}

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8 suggesting a new framework under which individual tax rulings could be subject to ex ante review from the Commission.

This seems necessary with a view to bringing legal certainty9 to an area of State aid control, which is problematic because of the overlap between national exclusive competence in direct taxation and the Commission’s prerogatives in applying State aid rules.

Chapter five contains the general conclusion of the thesis.

9

Legal certainty is a principle in national and international law, which requires making decisions according to legal rules.

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Chapter 1. Fundamentals of State aid control in tax matters

1. National tax sovereignty and fiscal federalism

In the contemporary EU law, where EU institutions and policy makers have adopted and developed supranational rules, direct taxation continues to be considered as an area that falls within the powers of the Member States. Even if the Member States of the EU are free to devise a tax system that is best suited to their economic needs, they must exercise this power in conformity with EU law.10

In recent years, the possibility of State aid presence in national direct tax measures has increased the attention of the EU.11

The sovereignty of Member States in direct tax matters is an evident advantage due to the fact that taxation provides budget revenues12, but also a difficult task to achieve insofar as, excessively implemented, national tax measures may have derivative effects by causing a distortion of competition between undertakings, and thus affect trade between Member States, which is contrary to Article 107 TFEU.13

It is in this context that the European Commission, even if it has not much room for manoeuvre in the field of direct taxation, has implemented a set of rules and packages in order to ensure a certain level of harmonization of direct tax rules between Member States as an adequate reaction to their possible distortive effects.

2. The notion of State aid within the meaning of Article 107(1) TFEU

The EU’s State aid policy is an important part of the EU’s competition regime and has been central to the Single European market objective.14

The general rules governing State aid are set out, mainly, in Articles 107-109 TFEU. The main aim of these rules is to maintain a level playing field for all companies by ensuring that

10

European Commission, Taxation and customs union, EU Tax policy strategy. Online access at:

http://ec.europa.eu/taxation_customs/taxation/gen_info/tax_policy/index_en.htm.

11_{Peter J. Wattel, ‘Some Fringe Areas of EU State Aid Law in Direct Tax Matters’, in EU Income Tax Law:} Issues for the Years Ahead, Dennis Weber, EC and International Tax Law Series, Vol. 9, pp. 139-150.

12_{Taxation is used to provide budget revenues emanating from national taxes, local taxes and social} contributions.

13_{Article 107 of the Treaty on the Functioning of the European Union – TFEU, Official Journal 115, 9 May} 2008, pp. 91- 92.

14_{Augusto Fantozzi, ‘The applicability of State aid rules to tax competition measures: a process of “de facto”} harmonisation in the tax field?’, European Association of tax law professors, online access at:

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10 a company will not receive an undue advantage over its competitors through State support.15 For that purpose, Article 107(1) TFEU imposes a general ban, subject to certain exceptions, on “any aid granted by a Member State or through State resources in any form

whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods, in so far as it affects trade between Member States”.16

The definition of State aid has given rise to a vast body of case law and legal literature. There are several criteria that need to be fulfilled for Article 107 TFEU to be applied, although until today, the European Court of Justice (“ECJ”) has not yet provided a consistent and comprehensive interpretation of those conditions.17 In general terms, there must be an intervention in the sense of a benefit, which must be granted by the State or through State resources, and this intervention must confer an advantage on the recipient, distort or threaten to distort competition and be capable of affecting trade between Member States.18 A broader description and analysis of those criteria will be looked at from different angles in chapter two of this thesis.

3. How did State aid infiltrate in national direct taxation matters?

Although the EU is not empowered to intervene in the area of direct taxation, in this sovereign area of the Member States, in the 1990s, the European Commission decided to apply State aid law systematically to tax measures with the idea to prevent the distortion of competition between Member States and to ensure that national tax systems are compatible with the aims of the TFEU.19

Due to the fact that State aid rules come from the need to maintain a level playing field for all undertakings active on the internal market, the Commission is concerned in particular with those State aid measures, which provide selective advantages to some companies, causing a distortion of competition between Member States.

15_{Global Competition Review, ‘State Aid’, 7 July 2015.}

16_{Article 107 of the Treaty on the Functioning of the European Union – TFEU, Official Journal 115, 9 May} 2008 pp. 91-92.

17_{Kelyn Bacon, European Union Law of State aid, Second edition, Oxford University Press, 2013, p. 20.} 18_{Conor Quigley, European State aid law and policy, Third edition, 2015, p. 4.}

19

Claire Micheau, Tax selectivity in European law of State aid: legal assessment and alternative approaches, European Law Review, 2015.

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Chapter 2. The interplay between State aid review and direct

taxation

1. Distortions of competition falling within the scope of State aid review 1.1. When is the question of State aid relevant to taxation?

EU State aid measures are relevant for undertakings with economic activities in the EU Member States. State subsidies and other aid to a particular undertaking or category of undertakings can distort competition and therefore constitute State aid. This was set out in 1998, by the European Commission in the “Notice on the application of the State aid rules to

measures relating to direct business taxation”20. A short description of this notice will be given in the second part of this chapter.

One should note that cross-border disparities and insufficient coordination between the tax systems of the different Member States are the essential reasons of tax distortions and that tax neutrality21 in the EU cannot be achieved without substantive harmonization of tax measures between the Member States and a rigorous State aid control. A step change in this direction occurred in 2014, when the European Commission, after investigating the tax ruling practices of various Member States including Ireland, Luxembourg and the Netherlands, issued its

Draft Commission Notice on the notion of State aid22, in which it laid down that “tax rulings

that apply more discretionary tax treatment to particular businesses compared with other taxpayers in a similar factual and legal situation would be regarded as State aid”.23

The aim of this Notice was to implement stronger conditions in order to distinguish national tax measures aimed at achieving tax neutrality of those that are fiscally predatory24 and unjustified under the EU State aid rules, and to repair any distortion that has been caused to the normal functioning of the internal market.25

20

C-384/03, Commission notice on the application of the State aid rules to measures relating to direct business taxation, Official Journal of the European Communities, 10 December 1998.

21_{A situation in which a tax does not prevent funds to be used in the most productive way. Spread Betting Trade} Centre. Online access at: http://www.thespreadbetcentre.com/glossary/taxation/tax_neutrality.

22_{Draft Commission Notice on the notion of State aid pursuant to Article 107(1) TFEU, Brussels 2014.} 23

Idem, paragraph 176.

24_{A situation in which a Member State intentionally implements a national tax measure with the purpose of} making some companies or persons less tax liable (e.g. an advance pricing arrangement).

25

Pierpaolo Rossi-Maccanico, ʻFiscal Aid Review and Cross-Border Tax Distortions’, 2012, Vol. 40, Intertax, Issue 2, pp. 92-100.

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12 1.2. When a measure is considered State aid: the four step analysis

The notion of State aid is governed by substantive criteria that are laid down in Article 107 TFEU.

The case law of the ECJ and the Commission’s practice that have sought to adapt these criteria to the particularities of direct taxation, have applied these criteria to tax measures.26 Even if the same conditions have to be fulfilled for a tax measure to be considered State aid, there are some important particularities which correspond only to tax measures and which I will analyse in a broader way in chapter three.

1.2.1. Transfer of State resources

Despite the wording of Article 107 TFEU and the quite broad interpretation the ECJ has given to the distinction between aid granted “by a Member State”27

and aid granted “through State resources”28

, I merely note that the notion of “State resources” does not only include aid granted directly by a central government, but also measures issued by regional and local authorities and even infra-State or private entities designated by the State. State resources must thus be considered in the wide sense, as including “any public resources that should

necessarily involve a cost for the Member State budget”.29

In tax matters, an advantage can be granted by the intervention of a State or through State resources not only in the case of an actual transfer of State resources, but also in the case of a loss of tax revenue by a Member State.30 For this reason, it is without importance whether this is a direct monetary transfer or an indirect transfer of government funds.31

1.2.2. Economic advantage

The second criterion for State aid is the “advantage” conferred by the measure. From the ECJ case law and the State aid practice of the European Commission follows that an advantage is granted to an undertaking within the meaning of Article 107(1) TFEU if that undertaking receives an economic benefit which it would not have obtained under normal market

26

Erika Szyszczak, ‘Research handbook on European State aid law’, Edward Elgar Publishing Edition, 2011, p. 207.

27_{An aid is granted by the State when it is generated with the own budget of the State.} 28_{Any aid granted by public or private bodies that are partly or entirely financed by the State.}

29_{Erika Szyszczak, ‘Research handbook on European State aid law’, Edward Elgar Publishing Edition, 2011,} p. 207.

30_{Commission Decision of 21 January 2016 on aid measure SA.25338 implemented by the Netherlands,} Corporate tax exemption for public undertakings, paragraph 62.

31

Justus Haucap and Ulrich Schwalbe, ‘Economic Principles of State Aid Control’, Dusseldorf Institute for Competition Economics, Discussion Paper N. 17, April 2011.

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13 conditions, namely without the State measure. As the TFEU does not contain a definition of “undertaking”, according to the case law of the ECJ this term includes every entity in any legal form, which offers goods and services on the market, regardless of the legal status and the way of financing of this entity.32

Even if the entity that receives the aid is a public company, a non-profit oriented company or even a charity, State aid rules will apply as long as this entity is in competition with companies that are intended to make profits.33 Therefore, private companies are not the only ones that are subject to State aid rules. Public authorities and bodies governed by public law fall also under the EU State aid rules, as long as they offergoods and services on the market.34 In tax matters, an advantage is generally conferred via financial support of Member States to certain undertakings. In that respect, there is a very large number of tax measures that Member States can introduce, including advantageous tax schemes, tax credits, reduced tax rates or advantageous transfer pricing rules. In most cases a tax advantage takes the form of negative State aid, which means that the State does not transfer a direct subsidy, but allows for lower tax burdens.35 Therefore, in order to establish whether an advantage exists, it is necessary to determine a general tax norm. Only by comparison with such a reference framework, it is possible to establish if certain undertakings receive a more favourable treatment by the measure that applies to them, than other undertakings that are in a comparable legal situation.36 This issue is closely related to the selectivity criterion, which in tax matters is called “the selective advantage” and which constitutes the general requirement to determine if a tax measure can be considered as State aid or not.

1.2.3. Selectivity

Aid is selective if it applies to a particular type of activity or sector, or to specific companies with the same characteristics. This selectivity criterion is met if a measure favours certain undertakings or the production of certain goods. Selectivity is what differentiates State aid from the so-called “general measures”, namely measures which apply without distinction to

32_{Case C-41/90, Höfner and Elser v. Macroton, 1991, ECR I-1979, paragraph 21; Case C-35/95, Commission v.} Italy, 1998, ECR I-3851, paragraph 36.

33_{Fact Sheet 4.3, State aid, Intereg Alpine space.} 34

Case C-280/00, Altmark case, 24 July 2003, paragraph 71; Case C-336/00, Huber case, 19 September 2002, paragraphs 61-64.

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14 all enterprises, in all economic sectors, in a Member State.37 Under this criterion, it thus must be determined whether the granting of a tax advantage is an exception to the general rule. Two types of selectivity exist: geographical selectivity and material selectivity. The first type means that a measure is selective if undertakings in a specific part of the territory of a Member State are treated differently than in the rest of this territory, and the second type concerns all other forms of uneven treatment of undertakings by the intervention of a Member State.38 As regards tax matters, material selectivity is at the centre of State aid law.39 In its Draft Notice, the Commission distinguishes between de jure and de facto selectivity. A measure is de jure selective when it applies to certain undertakings or sectors40(for instance, those that are active in certain sectors or having a certain size). A measure is de facto selective when the legal criteria for its application are not selective in themselves, but the structure of the measure is such that it favours certain undertakings or sectors.41 In the Gibraltar case42, concerning the Gibraltar corporate tax regime, the ECJ found that the reference framework to establish the existence of a tax advantage and accordingly the introduction of a Payroll Tax and a Business Property Occupation Tax were founded on criteria that were of a general nature but were materially selective, because they would inherently favour offshore companies that had no physical presence in Gibraltar and which, as a consequence, would not be subject to corporation tax.43

The selectivity criterion will be broadly analysed in chapter three of this thesis, more exactly in the context of fiscal State aid law.

1.2.4. Effect on competition and trade

Finally, a measure is liable to affect trade between the Member States if the beneficiary carries on an economic activity involving trade between Member States. This criterion is usually examined together with the “distortion of competition” criterion because they are considered as “inextricably linked”.44

37_{Fact Sheet 4.3, State aid, Intereg Alpine space.} 38

39 Idem. 40_Idem. 41

Anne-Marie Van den Bossche, Jacques Derenne, Paul Nihoul and Christophe Verdure, ‘Sourcebook on EU Competition Law’, Larcier Thematic Code, Vol. 1, 2015, p. 37.

42_{Joined Cases C-106/09 P and C-107/09 P of 15 November 2011, Commission and Spain v. Government of} Gibraltar and UK, 2011, ECR I-11113.

43_{State aid & Corporate Taxation: The State of Play, EY Seminar, Amsterdam, 8 June 2015.} 44

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15 State aid is almost always presumed to have a potential effect on competition when the State grants a financial advantage to an undertaking in a liberalised sector where there is, or could be, competition.45 It is thus sufficient to demonstrate that the beneficiary is situated on a market where companies from other Member States are also active.

With the European Commission’s “de Minimis Regulation”46, according to which any aid not exceeding a ceiling of EUR 200,000 over any period of three years does not distort competition and trade between Member States47, and is thus not subject to the general ban on State aid, this criterion is not difficult to meet.

In tax matters, this criterion neither raises particular issues. Both effect on trade and distortion of competition will generally be present where the advantages are usually in the form of schemes and benefit large categories of undertakings.48

1.3. What if the aid is found to be unlawful State aid?

Only the European Commission, which is supervised by the ECJ, can determine whether State aid is compatible with the internal market and more exactly, with the State aid policy. If the aid is found to be illegal, “the principle of full recovery, which may be deducted from the

context of Article 107 TFEU, imposes to re-establish the previous existing situation in order to remedy the distortion of competition caused by this aid”.49 The aim of the recovery is thus not to penalize, but to restore the situation that existed on the market before the aid was granted, and thus to ensure a fair competition between undertakings. It is in the competence of the European Commission to require the Member State concerned to recover the total amount that corresponds to the value of the financial advantage obtained by the beneficiary plus interests on this amount since the moment the beneficiary has received this advantage.50

If the Member State does not recover the aid that was found to be unlawful, the European Commission can take infraction proceedings against the Member State before the ECJ. The

45

Draft Commission Notice on the notion of State aid pursuant to Article 107(1) TFEU, paragraph 188, Brussels, 2014; Joined Cases T-298/07, T-312/97 etc. Alzetta, 2000, ECR II-2325, paragraphs 141-147.

46_{Commission Regulation (EU) No 1407/2013 of 18 December 2013 on the application of Articles 107 and 108} of the Treaty on the Functioning of the European Union to de minimis aid.

47_{State aid & Corporate Taxation: The State of Play, EY Seminar, Amsterdam, 8 June 2015.} 48

Michael Sánchez Rydelski, ʻThe EC State aid Regime: Distortive Effects of State aid on Competition Tradeʼ, Cameron May Edition, 2006, p. 85.

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16 national courts of the Member State cannot implement constitutionals or procedural rules that stand in the way of recovery.

In tax matters, aid recovery can raise interesting issues. The undertaking is obliged to return the difference between the tax that was in fact charged to them and the tax that should normally have been paid without the advantage. Calculating the exact amount of the aid granted to the recipient can be difficult in practice. However, I will not go into details concerning this matter, because of its irrelevance for the purpose of this thesis.

2. State aid control of fiscal measures in the system of Competition Policy

EU State aid control is an essential element of competition policy and a necessary “safeguard” for effective competition and free trade.51 Even if for decades the Member States have acknowledged that for a healthy tax competition within the internal market, fundamental changes in the structure of taxation had to be made, especially the elimination of tax obstacles to cross-border activities, they were not totally prepared to give their full attention to the elimination of such obstacles as long as they wanted to protect their national tax revenues.52

However, a political consensus among Member States to take action in order to tackle harmful tax competition led to agreement on the outline of a tax package in December 1997. This package includes the widely known “Code of Conduct for Direct Business Taxation”53

, by which Member States have agreed to terminate tax measures identified as harmful. Later, in 1998, the European Commission has published the “Notice on the application of the State aid

rules to measures relating to direct business taxation”54, which was a necessary tool in order to clarify the boundaries between, on the one hand, “legitimate” direct business tax measures and, on the other hand, fiscal aids. Following the guidelines of this Notice, the European Commission launched a review of some of the measures identified as harmful and suspected to constitute State aid that was incompatible with the common market. These measures have been outlawed and abolished or amended. It can be argued thus that the creation of a tax

51

European Commission Directorate-General for Competition, Vademecum Community law on State aid, 30 September 2008.

52_{Augusto Fantozzi, ‘The applicability of State aid rules to tax competition measures: a process of “de facto”} harmonisation in the tax field?’, European Association of tax law professors, online access at:

http://www.eatlp.org/uploads/Members/Fantozzi.pdf.

53

Code of Conduct for direct business taxation, adopted by the European Council and the representatives of the governments of the Member States after the ECOFIN Council meeting on 1 December 1997, Official Journal of the European Communities 98/C 2/01, 6 January 1998.

54

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17 package has shown its results and has increased the European Commission’s confidence to tackle direct tax measures which infringed the State aid rules, whereas until then it had been hesitant to do so.55 I will shortly describe and analyse these two instruments, as I consider that, even if they have been subject to some changes in recent years, they are still fundamental tools in order to determine which harmful tax measures may be regarded as State aid.

2.1. The “Code of Conduct for Direct Business Taxation”

The Code of Conduct for Direct Business Taxation (Code of Conduct) embodies a “soft law” process strategy from all Member States to address harmful business tax measures within the EU.

The Code of Conduct and the State aid provisions are distinct both in their formal nature and in their scope, as regards the measures they can be applied to.56 However, even if they are two different instruments, the fact that the Code of Conduct has been adopted in order to tackle harmful tax measures beyond Article 107 TFEU, which sets out the conditions for the existence of State aid, shows that those two instruments are complementary tools.57

Even if the European Commission has adopted a large number of decisions under the Code of Conduct in which it found that tax measures classed as harmful also constituted State aid, in 2000 Commissioner Monti pointed out that “it is disappointing that almost four years after

the implementation of the tax package, considerable uncertainty still surrounds it, in spite of the determination shown by most Members States and by the Commission”.58

In 2004, after the publication of the Commission Report on the application of theNotice59, the European Commission has pronounced itself on a case that has been the “new keystone in the State aid control of harmful tax measures”60, the Gibraltar case.61 In this case the importance of the Code of Conduct has again been shown. The Code of Conduct sets out the criteria against which any potentially harmful measures are to be tested. When analysing the Gibraltar

55_{Fiona Wishlade, When Policy Worlds Collide: Tax Competition, State Aid, and Regional Economic} Development in the EU, Journal of European Integration, Vol. 34, No. 6, pp. 585-602, September 2012.

56_{Edoardo Traversa and Alessandra Flamini, ‘Fighting Harmful Tax Competition through EU State Aid Law:} Will the Hardening of Soft Law Suffice?’, European State Aid Law review, Vol. 3, 2015.

57_Idem.

58_{European Commission Press Release of 23 February 2000: “Statement by Commissioner Monti concerning} the control of fiscal State aids”, online access at: http://europa.eu/rapid/press-release_IP-00-182_en.htm.

59_{C(2004) 434, Report on the implementation of the Commission notice on the application of the State aid rules} to measures relating to direct business taxation, Commission of the European Communities, 2 February 2004. 60_{Edoardo Traversa and Alessandra Flamini, ‘Fighting Harmful Tax Competition through EU State Aid Law:} Will the Hardening of Soft Law Suffice?’, European State Aid Law review, Vol. 3, 2015.

61

Joined Cases C-106/09 P and C-107/09 P of 15 November 2011, Commission and Spain v. Government of Gibraltar and UK, 2011, ECR I-11113.

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18 “Patent Box”62

under these criteria, the European Commission has found that the UK government offered a significantly lower level of tax as compared to the general UK corporate income tax level and the Patent Box was therefore considered as a harmful tax measure.

However, with the recent investigations of the European Commission concerning particular taxation arrangements offered to companies like Starbucks and Apple, it can be concluded that the Code of Conduct was not the perfect instrument in the fight against harmful tax competition. This is related to the fact that the Code of Conduct is a not binding instrument and was created because of political reasons, whereas the Commission – which has a considerable power to reassess those fiscal aids possibly in breach of the fair tax competition by formal investigations – can achieve better results. Consequently, on 8 March 2016, the Council has stated in the “Council conclusions on the Code of Conduct for Direct Business Taxation”63 that “work on the future of the Code of Conduct and its reinforcement should

focus on making better use of the existing mandate of the Code; on examining the possibilities and modalities to extend the mandate and to update the existent criteria.”64

2.2. The European Commission Notice on the application of the State aid rules to measures relating to direct business taxation

The European Commission Notice of 1998, on the application of the State aid rules to measures relating to direct business taxation65, points out and explains, through the practice of the European Commission and the case law of the ECJ, the criteria which define State aid and the distinction between general and selective measures, which is important in the determination of the existence of State aid.

According to this Notice, any derogation from a national standard basis would constitute State aid. That rigid approach was partially rejected by the ECJ in a series of cases dealing with taxation as well as material selectivity.

62_{The “Patent Box” is a tax incentive that reduces the effective UK corporation tax rate to 10 % (as compared to} 21 %) on income attributable to patents, subject to certain conditions.The Patent Box legislation was introduced by the UK Government to encourage innovation by providing an incentive for companies to “locate their high-value jobs associated with the development, manufacture and exploitation of patents in the UK and maintain the UK’s position as a world leader in patented technologies”.

63_{Press release 108/16, Council conclusions on the Code of Conduct for Direct Business Taxation, 8 March} 2016.

64_{Idem, paragraph 4.} 65

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19 To this end, in 2009, the European Commission adopted a Notice on the enforcement of State aid law by national courts, in order to inform national courts and interested parties about the remedies available in proceedings brought before national courts.

As the European Commission is constantly preoccupied with updating and simplifying the rules so that unproblematic aid measures can be implemented without its prior scrutiny, in 2012, it has set out a reform programme in the “Communication on State aid modernisation”.66

This has effect from 1 July 2016 and its aim is to transfer a large proportion of all State aid supervision and enforcement back to the Member States through a revised general block exemption. The idea is that such a transfer will enable the European Commission to concentrate its enforcement efforts upon the most important and distortive types of aid.

More recently, on 19 May 2016, the Commission has released the last part of its State Aid Modernisation initiative, by publishing the Notice on the notion of State aid.67 The aim of this Notice is to guide and help Member States and companies to identify when public support measures can be granted without needing approval under EU State aid rules.68 The Notice clarifies the definition of State aid and provides general guidance on when public investment falls under the scope of EU State aid control via the case law of the EU courts.69

2.3. The legitimacy of the State aid rules’ applicability on tax competition measures As Commissioner Margrethe Vestager said in one of her Statements in 2014, “State aid rules may be employed legitimately only to remedy distortions of competition as a result of a Member State’s granting, in derogation of its general taxation policy and practice, of a particular advantage to certain taxpayers.”70

Tax rulings may constitute State aid, when the discretion of the tax authorities exceeds the simple management of tax revenue by reference to objective criteria.

66_{Commission Communication on State aid modernization (SAM), 8 May 2012, online access at:}

http://ec.europa.eu/competition/state_aid/modernisation/index_en.html.

67_{Commission Notice on the notion of State aid as referred to in Article 107(1) of the Treaty on the Functioning} of the European Union, (2016/C 262/01), Brussels, 19 May 2016.

68

European Commission Press release, ‘State aid: Commission clarifies scope of EU State aid rules to facilitate public investment’, Brussels, 19 May 2016.

69_Idem. 70

European Commission, ‘State aid SA.38373 – Alleged aid to Apple’, Official Journal of the European Union, 17 October 2014.

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20 State aid in the form of tax measures and exemptions differs from classical subsidies-based aid. In the absence of explicit State aid regulations for fiscal measures, it is normal that the general State aid rules and principles apply.

Some commentators have argued that the application of State aid rules to tax measures may be counterproductive, as it may encourage Member States to replace preferential regimes with generally applicable low tax regimes, which will create a more serious distortion of competition than the original one.71 As Michael Kees states, “preferential tax regimes can usefully limit tax competition. Their prohibition can give rise to tax competition that is less drastic, but more widespread and therefore more prejudicial. If the Member States would be obliged to grant the same treatment to all tax bases, the inducement to compete for the more mobile tax bases would lead to such an increase in the tendency to compete for the less mobile tax bases that the final result could be even worse for all parties involved.”72

It should be noted, however, that when a measure does not apply in the same way to all economic operators, it cannot be considered to be a general measure.

A tax measure, like all other measures affecting the allocation of State resources, is subject to the constraints imposed by the application of Article 107 TFEU73 and has thus to be analysed under the State aid rules.

71

Francesco de Cecco, ‘State aid and the European economic constitution’, Hart Publishing Ltd Edition, 2013, p. 23.

72_{Michael Kees, ‘Preferential regimes can make tax competition less harmful’, National Tax Journal Vol. LIV,} No. 4.

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21

Chapter 3. A general view on corporate tax rulings in the context

of fiscal State aid law

1. Tax avoidance versus tax evasion

Tax is a significant cost factor for companies and minimizing the corporate tax burden using the degree of diligence, care and skill that prudent people would use, is a normally accepted principle in corporate tax management.74Nevertheless, in recent years, the letter and purpose of tax laws have been largely manipulated by multinational companies and national authorities of the Member States through different tax arrangements.75 This situation has raised doubts on the way in which corporate tax is managed by the Member States.

1.1. The difference between tax evasion and tax avoidance

Tax evasion usually differs from tax avoidance. Evasion of tax is an intentional act that involves a direct violation of tax law in order to escape payment of taxes76, while tax avoidance is a legitimate way to minimize taxes or to obtain a tax advantage that the government never intended. It frequently takes the form of artificial tax transactions.

Tax evasion and tax avoidance are also differently defined in each jurisdiction. Where the same transaction could be classified as legal in one jurisdiction, it could be simultaneously regarded as illegal in another jurisdiction.77

The concept of tax avoidance relates strictly to the activity of tax shelter, which includes artificial transactions or arrangements that are pursued in order to reduce or defer taxation.78 Many Member States have set up tax regimes designed to encourage multinationals to shift profits to their jurisdiction and those regimes may involve State aid within the meaning of EU rules if they are used to provide selective advantages to a specific company or group of companies.

74_{Carlo Garbarino, ‘Aggressive Tax Strategies and Corporate Tax Governance: an Institutional Approach’,} European Company and Financial Law Review, Vol. 8, Issue 3, 2011, pp. 277-304.

75_{Judith Freedman, ‘Beyond boundaries; Developing approaches to tax avoidance and tax risk management’,} 2008.

76_{Carlo Garbarino, ‘Aggressive Tax Strategies and Corporate Tax Governance: an Institutional Approach’,} European Company and Financial Law Review, Vol. 8, Issue 3, 2011, pp. 277-304.

77 Idem. 78_Idem.

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22 1.2. Combatting corporate tax avoidance: how have the concerns under EU State aid

rules been addressed in the Tax Transparency Package?

The creation of a Single Market that is more efficient in economic terms has made the fight against corporate tax evasion and corporate tax avoidance a political priority for the European Commission. This priority was established early in 2014, when the European Commission opened a few State aid investigations on the corporate tax affairs of well-known multinational companies like Amazon, Apple, Fiat Finance and Trade, and Starbucks, and found that the preferential tax regimes accorded to those companies by national authorities, constitute State aid.

As a reaction, in October 2015, the EU Member States unanimously agreed on an automatic exchange of information on cross-border tax rulings. In order to re-establish the link between taxation and real economic activity and to tackle corporate tax avoidance, the European Commission has identified tax transparency as a priority.79

In March 2015, the European Commission launched a Tax Transparency Package80 including a number of initiatives to advance the tax transparency agenda in the EU, such as assessing possible new transparency requirements for multinationals, reviewing the Code of Conduct on business taxation, etc.

The automatic exchange of information will facilitate the work of the European Commission when investigating whether State aid rules have been breached.

2. Fiscal State aid

2.1. What is fiscal State aid?

Fiscal State aid is a topic having received considerable attention in the past year. State aid granted in the form of tax benefits constitutes fiscal State aid or tax aid.

If fiscal State aid exists, it is because Member States share the same preoccupation: to have a strong economy with good job opportunities for the future that may bring higher tax revenues. As the power to tax is still in their hands, Member States have different possibilities to further their economic aims by various tax measures.

79_{European Commission Press Release, ‘Combatting corporate tax avoidance: Commission presents Tax} Transparency’, 18 March 2015.

80

Communication from the Commission to the European Parliament and the Council on tax transparency to fight tax evasion and avoidance, COM(2015), Brussels, 18 March 2015.

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23 While the fundamental freedoms do not distinguish between general and specific tax measures which have discriminating or restrictive effects, this distinction is crucial in the field of State aid law under Article 107 TFEU. It is thus primordial to identify “selective” tax measures as opposed to general measures, which do not constitute State aid or which do not apply to only “certain” undertakings or goods but to the entire economy.81

The core principle is that there cannot be discrimination among taxpayers in a comparable legal and factual situation, unless the differentiation is justified by the nature or the general logic of the system. For this reason, if a tax measure provides an advantage that is selective and if this selectivity is not justified, the tax measure can be qualified as State aid under the EU State aid rules.

2.2. Forms of fiscal State aid

Fiscal State aid may take various forms. A State may implement selective measures or “aid schemes” that favour particular economic sectors or categories of companies, or particular regions. These measures may consist in the introduction, increase, decrease or abolition of specific taxes, like taxes on selected goods or services or with respect to certain undertakings. The same effect may be achieved by providing a selective advantage for certain activities in the context of a general tax, like income tax or wealth tax. Finally, other discretionary rulings in favour of individual undertakings that mostly refer to tax rulings, also exist.

All those measures can constitute fiscal State aid, without necessarily been qualified as unlawful State aid. However, there is no doubt and recently was demonstrated through the well-known investigations of the European Commission, that a specific tax measure, like tax rulings or tax schemes, can infringe the rules on the four fundamental freedoms as defined in the TFEU82 and at the same time infringe the State aid rules.

As regards tax schemes, if a beneficial tax measure is not generally available to all types of businesses, it is likely to constitute State aid, no matter how broad the favoured sector or group of favoured undertakings is.83 These schemes, which have been abundantly commented in the general press, take advantage of gaps and unconformity caused by the absence of coordination between the domestic tax systems of the Member States and result in very

81

Wolfgang Schön, ‘Taxation and State aid law in the European Union’, Common Market Law Review, 1999, Vol. 36, pp. 911-936.

82

Commission Decision of 8 July 2009 on the Groepsrentebox scheme no. C4/2007 (ex N 465/2006), Brussels, C(2009), 4511 final, paragraph 75.

83

Jonathan Hare, Stephen Morse, Peter Halford, ‘20 questions on State aid and tax’, Tax Journal, 25 February 2016.

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24 significant losses in tax revenues for the States concerned. Sometimes, the States themselves consciously design specific tax regimes in order to favour some companies or group of companies. By doing so, they promote actively “harmful tax practices” which the Organisation for Economic Co-operation and Development (OECD) has called “Base erosion and profit shifting”, and this situation may hinder the capacity of the Member States to take appropriate actions, particularly in the form of anti-avoidance measures.

Tax rulings will be broadly analysed in this chapter as they have given rise to considerable debate in the recent years, due to the various forms they can take and their incompatibility with State aid rules.

3. Tax rulings as State aid

Tax uncertainty arises from the difficulty in applying ambiguous tax laws and anticipating the consequences of a future tax. Before making an investment decision, investors must anticipate the prospective tax burden, as it can be a significant cost factor. Consequently, in order to tackle this tax uncertainty, investors use the tax authorities’ advise and avoid the risk of an unfavourable interpretation of a tax issue.

In the past years, the European Commission has been investigating under EU State aid rules certain tax practices in several Member States following media reports alleging that some companies have received significant tax reductions by way of “tax rulings” issued by national tax authorities.

A tax ruling or, more precisely, an advance tax ruling is “any advice, information or statement

provided by the tax authorities to a specific taxpayer or group of tax payers concerning their tax situation in respect to a specific future transaction”.84

Tax rulings are proposed by tax authorities to a specific company or group of companies in order to clarify how their corporate tax will be calculated, and this is legal.85

However, tax rulings may involve State aid within the meaning of EU rules if they are used to provide selective advantages to a specific company or group of companies. The European Commission has acknowledged that “every decision by the administration that departs from

the general tax rules and benefits individual undertakings, leads in principle to the

84

Carlo Romano, ‘Advance tax rulings and principles of law, Towards a European tax rulings system?’, Vol. 4, Doctoral series, IBFD Publications BV, 2002, p. 485.

85

European Commission press release, ‘State aid: Commission investigates transfer pricing arrangements on corporate taxation of Apple (Ireland), Starbucks (Netherlands) and Fiat Finance and Trade (Luxembourg)’, Brussels, 11 June 2014.

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presumption of State aid and must be analysed in detail.” Tax rulings are used in particular to

confirm transfer pricing arrangements.86 3.1. Tax rulings on transfer pricing

3.1.1. The role of tax rulings on transfer pricing in the avoidance of taxes

Transfer pricing is of increasing importance to companies, as in a globalized economy their operations are extended to different countries with diverse taxation regimes. Transfer pricing refers to the prices charged for commercial transactions between different subsidiaries of the same group of companies which are located in different countries. As the European Commission has acknowledged in the cases of Amazon, Apple and Starbucks, tax rulings on transfer pricing are not problematic and they are not necessarily illegal or abusive. What is illegal or abusive is transfer mispricing, also known as transfer pricing manipulation or aggressive transfer pricing. From fiscal State aid perspective, aggressive transfer pricing, which is not compliant with the principle of arm’s length pricing, which I will describe in the next subtitle, can amount to fiscal State aid within the meaning of Article 107 TFEU, if it provides a selective economic advantage to a specific company or group of companies. Such a “selective deviation from the arm’s length principle amounting to an advantage can lead to

an indirect distortion of competition between undertakings”87, which is incompatible with the internal market.

3.1.2. The Arm’s length Pricing Principle and the OECD’s Transfer Pricing Guidelines on Profit shifting

In response to the threat to taxation revenues posed by transfer pricing practices, the Member States have signed a variety of bilateral and multilateral agreements that adopt variants of the arm’s length pricing principle.88

According to the OECD’s Transfer Pricing Guidelines for

Multinational Enterprises and Tax Administrations89, “a transfer price should be the same as

if the two companies involved were two unrelated parties negotiating in a normal market, and not part of the same corporate structure”90.

Many companies strive to use the arm’s length principle faithfully, but many others strive to move in exactly the opposite direction, trying to distort artificially the price at which the trade

86_Idem.

87_{Harmful Tax Competition: An Emerging Global Issue, OECD, Paris, 1998, pp. 31-32, Report on Harmful Tax} Competition.

88_{Prem Sikka and Hugh Willmott, ‘The dark side of transfer pricing: its role in tax avoidance and wealth} retentiveness’, Critical Perspectives on Accounting, Volume 21, Issue 4, April 2010, pp. 342-356.

89

Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, OECD, Paris, 2010. 90_{Idem, paragraph 4.123.}

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26 is recorded and to minimise the overall tax bill. As transfer pricing rules are of key importance in computing the actual market value of a cross-border transaction between affiliated undertakings,91 they are of special attention in the context of State aid law.92 As Claire Micheau argues, “the core element is the method used to calculate the advantage”.93

The OECD guidelines are not binding, but they represent the most appropriate way of estimating an arm’s length price or level of profit and they have also been taken as a basis for the European Commission’s analysis in previous State aid cases.94 The European Commission has found that in all of those cases tax rulings in the form of advance pricing arrangements have been concluded between the national tax authorities and a group of companies, like Amazon, Starbucks, etc. and it found that those arrangements constitute State aid within the context of Article 107 TFEU.

3.1.3. Advance Pricing Arrangements

In response to the uncertainty and risk to which companies are exposed by transfer pricing, in almost all Member States, there are different ways of avoiding disputes with tax authorities through “Advance Pricing Arrangements” (APAs).95 An APA is a contract, usually for multiple years, between a taxpayer and a tax authority specifying the pricing method the taxpayer will apply to its related-company transactions. The function of the APAs, which are practices invented in the USA, is to guide and clarify the undertakings on the transfer pricing method adopted, mitigating the possibility of disputes and facilitating the financial reporting of potential tax liabilities. The basic principle is the arm’s length principle, that is used in order to identify the level of profits that would be achieved under market conditions.96 Advance pricing arrangements which “are not directed at determining an arm’s length price or those whose systematic result is a price which could not truly be regarded as an approximation of a market price, may constitute State aid in so far as they have the effect of

91_{Claire Micheau, State Aid, Subsidy and Tax Incentives under EU law and WTO law, Kluwer Law} International, Alphen aan den Rijn, 2014, p. 197.

92_Idem. 93_Idem. 94

Richard Lyal, ‘Transfer pricing rules and State aid’, Fordham International Law Journal, Vol. 38, 2015, pp. 1017-1034.

95_{Prem Sikka and Hugh Willmott, ‘The dark side of transfer pricing: its role in tax avoidance and wealth} retentiveness’, Critical Perspectives on Accounting, Volume 21, Issue 4, April 2010, pp. 342-356.

96_{Richard Lyal, ‘Transfer pricing rules and State aid’, Fordham International Law Journal, Vol. 38, 2015,} pp. 1017-1034.

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27 diminishing the amount of tax payable by companies which are part of multi-national groups”.97

3.2. Selective advantage granted by tax rulings

In order to determine whether a specific tax measure contains a selective advantage, a fiscal State aid test has been developed in the European case law, comprising three steps.98 The first step consists in the determination of a general or normal tax regulation that is applicable in the Member State: “the reference system”. The second step entails determining whether the tax measure under scrutiny forms a deviation from that reference system. When the measure does form a deviation from the reference system, during the third step of the analysis will be determined whether that measure is justified by the nature and general scheme of the reference system.

3.2.1. The benchmark or general system of reference

The determination of the reference tax system or framework against which the tax measure is assessed, is a key issue and therefore it is necessary to strike a balance between a too broad framework and a too narrow one. If a broad framework, like a general corporate tax system, is defined, any tax measure which does not correspond to this framework, could be deemed to be selective and therefore to constitute State aid. For this reason, the ECJ has developed an approach based on the objective pursued by the measure. The measure will be interpreted in

the light of the objective pursued by the general system of reference and will be considered

State aid if a preferential treatment is attributed to certain categories of undertakings deviating from a rule previously applicable to all operators.

According to the European Commission, this preferential treatment should derive from the core principles of the tax system in the Member State concerned.99 In the Starbucks case, the reference system is formed by the general Dutch system of corporation tax, which is targeted at the tax on profits of all taxpaying companies in the Netherlands, irrespective of whether it concerns a group of companies or an independent company.

97

Idem. 98

Judgments of the ECJ in Portugal v. Commission, C-88/03, EU:C:2006:511, paragraph 56; Joined cases C-78/08 to C-80/08, Ministero dell’Economia e delle Finanze and Agenzia delle Entrate v. Paint Graphos etc., 8 September 2011, EU:C:2011:550, paragraph 49.

99_{Michael Sánchez Rydelski, ʻThe EC State aid Regime: Distortive Effects of State aid on Competition Tradeʼ,} Cameron May Edition, 2006, p. 82.

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3.2.2. Whether the measure constitutes a derogation or exception from the reference system

Once the general system has been established, it must be ascertained whether the measure forms a deviation from that system whereby companies that are in a comparable situation, actually and legally, are handled unequally. This is determined on the basis of the arm’s length principle, which I have described above. If the measure does not constitute a derogation from the general system of reference, it is not selective.100 For example, in the Starbucks investigation, the methodological choices in the transfer pricing report provided by the tax adviser for Starbucks, were found not to lead to a reliable approach to a market result and thereby not to fulfil the arm’s length principle. The Commission has noted that the tax measure provided to Starbucks is an unjustified reduction of its tax liability. Starbucks would otherwise be subject to a higher level of tax under the reference system and that reduction constitutes the derogation from the system of reference.101

3.2.3. Whether the measure is justified by the nature or general logic of the reference system

An advantage granted to certain undertakings by a tax measure that derogates from the general system of reference, may still be found to not be selective and to not constitute State aid therefore, if it is justified by the nature or general logic of that system.102 Examples of situations where this justification can be accepted are provided in the European Commission Notice103, such as non-taxation in the absence of profits, more favourable fiscal treatment of non-profit making organisations, simplified systems that apply to sectors such as agriculture, etc. For example, a non-profit undertaking, such as an association, is not taxed because no profit is made. By the nature of the tax system it is justified that the national authority has established derogatory rules for non-profit making entities.104

Only a limited number of justifications by the nature or the logic of the reference system is accepted by the ECJ, including the need to fight tax evasion, the need to optimise the recovery of fiscal aid or the need to avoid double taxation.105 In joined cases Paint Graphos and

100