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EU commission rules that favourable tax deals may constitute illegal state aid

Multinational companies across the EU and beyond (and their advisors) will have, with much trepidation, paid close attention to the landmark ruling of the EU… Read more

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Multinational companies across the EU and beyond (and their advisors) will have, with much trepidation, paid close attention to the landmark ruling of the EU commission on 21 October. Margrethe Vestager, the EU competition commissioner, declared that preferential tax deals offered by Luxembourg to Fiat and by the Netherlands to Starbucks constituted unlawful state aid under EU rules.

Ms Vestager found that “comfort letters”, issued to the companies confirming approval of their tax planning in each of the relevant jurisdictions, had been used to guarantee favourable treatment. Starbucks and Fiat were each ordered by the commission to pay up to €30 million in unpaid taxes to the relevant national authorities. The outcomes of similar investigations into tax deals given to Amazon and Apple, by Luxembourg and Ireland respectively, are still pending, though the latter could result in Apple being ordered to make a significantly higher payment in respect of unpaid tax (the Financial Times reported, on 21 October, that this could run into billions of Euros).

At the heart of the ruling are so called “transfer pricing” arrangements, used by each of the companies involved, which set the price of goods and services sold by entities to other members of their corporate group. Such arrangements have become increasingly subject to attack in recent years, with critics arguing that they allow large multinational groups to artificially shift profits to low tax jurisdictions. The commission accuses a Dutch Starbucks’ subsidiary of paying inflated prices to a Swiss sister company for coffee beans, and also to another UK group company for coffee roasting know-how, thus substantially reducing the tax charge in the Netherlands.

The commission also alleges that a Fiat subsidiary provided loans to other group companies on terms which were not arm’s length in order to shift income into Luxembourg from other higher tax paying jurisdictions. The commission found that these structures “did not reflect economic reality” and should not have been approved by the relevant member states.

Whilst the companies and jurisdictions involved are likely to appeal against the commission’s ruling (Starbucks has already confirmed that it will), it is significant for various reasons. Firstly, it represents the EU commission extending its authority into an area (taxation) which is traditionally viewed as a matter for sovereign national governments. More worryingly, the recent rulings will call into question the reliability of other comfort letter type arrangements given by EU governments to companies in their jurisdiction, and of generally accepted tax planning practices (the arrangement used by Starbucks in the Netherlands, for example, has been widely used for some time).

However, most importantly, the commission’s decision is viewed by many as part of the early stages of a re-thinking of international tax rules in a concerted effort to clamp down on corporate tax avoidance. In recent months and years the issue has received increasing public and political attention. The European Council has recently approved a draft directive aimed at improving tax transparency across the EU.

In addition, the OECD has also just released its “Base Erosion and Profit Sharing” (BEPS) proposals, which the G20 governments are set to approve later this month. The proposals seek to ensure greater transparency, compelling companies to disclose where they generate their revenue, hold their assets and engage their employees. National governments will also receive more information on comfort letters given to companies in other jurisdictions. Many (including the UK government) have welcomed the proposals, which seek to reform an international tax system widely viewed as outdated and ill-suited to the digital age (where intangible assets such as intellectual property and goodwill, may be shifted between jurisdictions with little effort – see the Economist, 10 October 2015).

Whatever the eventual outcome of the commission’s ruling, it’s needless to say that it will be followed by significant further developments in a rapidly changing international tax environment. Watch this space.

For more information, please contact Adam Kuan, corporate associate