State aid rules and the arm's length principle

The CJEU has set aside the decision of the General Court of the European Union in Fiat Chrysler Finance Europe v European Commission (Case C-885/19). The CJEU has held that the Commission had misapplied the rules identifying the necessary reference tax system in deciding that Luxembourg had applied illegal state aid in granting tax rulings in favour of Fiat and accordingly has set aside the Commission’s decision.

The decision represents an important check on the Commission’s application of State aid rules in tax cases, emphasising that Member States are, in principle, entitled to introduce their own tax rules (including particular application of the arm’s length principle) and that it is only against those rules (and not broader international tax rules) that the selective nature of any particular tax ruling must be judged.

Background

The decision is the latest in the line of State aid cases concerning tax rulings issued by Member States to multinational companies. These cases have established a number of general principles that apply where the Commission seeks to argue that a Member State has illegally granted State aid to a company through favourable tax rulings. In particular, the decision show that:

• Member States must refrain from adopting tax measures liable to constitute State aid
• For these purposes, State aid requires the intervention by the State to confer a “selective advantage” on the beneficiary
• The finding of a “selective advantage” requires a determination as to whether, under the particular legal regime, the national measure favours certain undertakings over others which are in a comparable factual and legal position and which accordingly suffer different treatment which can be described as discriminatory
• In order to classify a national measure as “selective”, the Commission must first identify the “reference system” (ie the normal tax system applicable) and must then demonstrate that the measure derogates from that normal system.

This particular case concerns tax rulings in the form of advance pricing agreements (APAs) provided by Luxembourg to Fiat Chrysler Finance Europe (FCFE) dating back to 2012. The rulings granted by Luxembourg related to the intra-group financing activities of FCFE and confirmed that the transfer pricing analysis put forward on behalf of FCFE had been accepted.

In 2014, the EU Commission decided to initiate formal investigation proceedings in respect of this tax ruling, which eventually led to the adoption by the Commission of a decision declaring that the ruling constituted illegal State aid for the purposes of Article 107(1) of the TFEU. In particular, the Commission contended that the tax ruling conferred a selective advantage on FCFE, in so far as it had resulted in a lowering of its tax liability in Luxembourg by deviating from the tax which it would have been liable to pay under the ordinary corporate income tax system. In reaching this decision, the Commission considered that the reference framework was the general Luxembourg corporate income tax system and that the objective of that system was to tax the profits of all companies resident in Luxembourg.

Fiat appealed and the General Court of the EU upheld the Commission decision. Fiat further appealed that decision, supported by Luxembourg and Ireland, to the CJEU.

Decision of the CJEU

The CJEU has held that the original decision of the Commission that the APAs were illegal State aid must be annulled. The Court held that the Commission (and the General Court) had been wrong to treat the broad general system of the Luxembourg corporate tax system as the “reference system” for determining if there had been a “selective advantage” granted in this case.

FCFE had argued that the Commission had been wrong to identify the general Luxembourg corporate tax system as the reference system without including the specific provisions dealing with the taxation of group companies within Article 164(3) of the Luxembourg Tax Code. The Commission had argued that the general Luxembourg tax system for taxing companies, in essence, incorporated the OECD arm’s length principle as a way of ensuring the taxation of the profits of all resident companies. On this basis, it did not matter that the tax ruling might have been in accordance with Article 164(3) of the Tax Code.

The CJEU has agreed with FCFE on that point. In dismissing the relevance of Article 164(3), the Commission “applied an arm’s length principle different to that defined by Luxembourg law”. The decision failed to take into account how that principle had been actually incorporated into Luxembourg law with regard to group companies. Moreover, whilst the Luxembourg tax system might, in general terms, apply an approach corresponding to the arm’s length system, the specific detailed rules for the application of that principle are defined by national law and must be taken into account in determining the correct reference framework. In the absence of harmonisation of EU law, the specific methods and criteria for determining an arm’s length outcome falls within the discretion of the Member States.

“Moreover, even assuming that there is a certain consensus in the field of international taxation that transactions between economically linked companies, in particular intra-group transactions, must be assessed for tax purposes as if they had been concluded between economically independent companies, and that, therefore, many national tax authorities are guided by the OECD Guidelines in the preparation and control of transfer prices… it is only the national provisions that are relevant for the purposes of analysing whether particular transactions must be examined in the light of the arm’s length principle and, if so, whether or not transfer prices, which form the basis of a taxpayer’s taxable income and its allocation among the States concerned, deviate from an arm’s length outcome. Parameters and rules external to the national tax system at issue cannot therefore be taken into account in the examination of the existence of a selective tax advantage within the meaning of Article 107(1) TFEU and for the purposes of establishing the tax burden that should normally be borne by an undertaking, unless that national tax system makes explicit reference to them.”

Luxembourg had chosen to implement specific rules in Article 164(3) for the calculation of transfer prices in the context of group financing arrangements, but the Commission’s analysis of the reference system did not take into account those legislative choices, aimed at clarifying the scope of the arm’s length principle and its implementation. In so doing, the Commission had misapplied the rules in Article 107(1) in failing to correctly identify the reference decision and its decision should be set aside.

Comment

The decision is an important one emphasising that Member States, in principle, are able to dictate their own tax rules (within the framework of EU law) and that includes applying and interpreting the arm’s length principle according to national rules. The Commission cannot not simply refer to the OECD transfer pricing guidelines as a guiding baseline and argue that Member States have failed to apply them to the advantage of certain taxpayers. It is necessary for the Commission to show that a Member State has treated a taxpayer advantageously compared to the reference tax system and it would only be where that basic reference system can be shown to have incorporated the arm’s length principle that departure from it would potentially give rise to State aid. In this case, the Commission had failed to take into account specific rules adopted in Luxembourg as a means of applying transfer pricing rules to group financing companies and those rules formed part of that basic reference system of taxation. Luxembourg was perfectly entitled to introduce such rules and the application of them to the taxpayer in this case did not amount to State aid.