“Tax Day”, the tax administration framework and the 21st century

On the 23rd of March, dubbed by HM Treasury as “tax day”, a number of consultation documents were released. The idea is to “enhance the stability and effectiveness of the UK tax system by outlining a future pathway for its tax administration and tax policy development”.

One of the documents concerns the tax administration framework and asks consultees a range of questions (from how to assist taxpayers in entering or leaving the tax system to how the system for payments and repayments should be updated) about how the system can be updated for a 21st century tax system. That goal itself is admirable. The legal machinery for tax administration was developed in a very different world, where paper and human tax officials were the norm.

Today’s world is completely different – ditigised records and automated decision-making are increasingly becoming the norm.

It would seem appropriate then to interrogate the assumptions that underpin the current legal machinery and ask whether they are still fit for purpose.

The questions asked in the call for evidence are generally geared around making the experience better for taxpayers and also more efficient for HMRC. These are not unimportant aims. But they are not really concerned with law.

To my mind the legal issues that emerge centre around liability and procedural safeguards. Consider self-assessment for instance. When everything is stripped back, the important legal fact of self-assessment is that it places liability for paying the correct taxes on the taxpayer and not on HMRC. In a world where it was difficult to verify the veracity of taxpayer’s returns, that makes sense. But given the amount of information held by HMRC today which is transmitted digitally (and automatically) by third parties, there is a question to be asked as to whether this is still appropriate. Particularly in the case of the self-employed who work through digital platforms which can transmit all relevant information to HMRC. Pre-populated tax returns are already in practice occurring (when I submitted my tax return this year, almost all of the relevant information was already inserted in my tax account) and given that this practice will likely continue and grow, it makes sense to reconsider where liability should rest.

What about the enquiry process? Once HMRC has opened an enquiry, it does not close by default. It can remain open until either HMRC decides to close it or it is forced to do so by the Tribunal (on request from the taxpayer concerned). Again, this arrangement makes more sense in a world in which it is difficult to access relevant information about taxpayers. But does it still hold firm today?

Or what about the enquiry window(s)? There are time limits governing when an enquiry must be opened: 1 year (for any reason), 4 years (where a tax loss is discovered), 6 years (where there’s been carelessness), 12 years (where there has been offshore non-compliance by an individual or partner) or 20 years (where there has been fraud). The definition of “discovery” for the purposes of the 4 year window is generously wide. Again, this makes sense in a paper world in which a human being would have to physically look at something. And it might well take 4 years for an overstretched tax official to put their mind properly to a paper return. But is that still necessary today, when online systems can pick up irregularities automatically and flag these to an inspector? There is nothing stopping HMRC from opening an enquiry every time an issue is flagged up on its system after all.

These issues and many others would seem appropriate for consideration in the 21st century. The shame is that it is not clear how these issues can get an airing in the consultation. Though perhaps like the stretched approach to “discovery”, the call for evidence questions can be generously interpreted to accommodate such a conversation.

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Taking computation seriously

We all love a debate about corporation tax – or at least about corporate tax policy.

But debates and arguments about theory, concepts and policy can be aided by a practical understanding of the mechanics of computation. Two examples should operate to help elaborate on this point: Business Rates and the Diverted Profits Tax.

First things first, corporate “profits” are an artificial construct. Unlike real receipts or payments, one cannot “see” taxable corporate profits – they are a computation; a result of the deduction of allowable expenditure (note: not all expenses incurred in deriving a profit are deductible – many items of capital expenditure will not qualify for full expensing) from receipts derived from sources which are taxable (note: not all sources are taxable, such as gambling winnings in the UK); where the receipts and payments may themselves be artificial (consider attribution on the basis of market value; or cost-splitting arrangements which must be conducted at arm’s length). The relationship with accounting meanwhile cannot be ignored in that, depending on the jurisdiction, deference may be given ultimately to an accountant’s computation of the figure for profits (as in the UK). But accounting standards similarly are not free of value judgments!

Understanding that profits are a computation concerning the relationship between receipts and payments (real and hypothetical, and influenced by political choices about what to recognise) unmasks the fact that there are other possible ways of taxing corporations. Some propose that in the case of a multinational enterprise which is formed of a group of companies, profits could be diviied up between States on the basis of a formula. Others more radically suggest taxing corporations on a cash-flow basis – tax the sales minus certain deductions for certain expenses.

Aside from the potential for reform however, the computational nature of profits highlights that corporations may already be taxed on bases which are not “corporate profits” and, most intriguingly, these taxes may reduce the taxable corporate profits.

Such taxes should cause some pause for thought given their implications for the allocation of corporate profits – they sneak under the radar and can be significant in terms of quantum.

Business Rates in England provide a good example. These are charged on businesses which carry on activity in non-residential property. Others may query pedantically whether Business Rates are a tax – given that they are not labelled a tax and the benefit to operate in a locale is granted in return – but it is levied by central government, it is payable in cash, it is compulsory and the rates are out of all proportion to the benefit granted. Moreover, HMRC includes it in its breakdown of the contribution of different taxes to the Exchequer.

Business Rates for the year 2019/20 raised £29bil. For comparison, Corporation Tax raised £50bil. This comparison reveals that, relative to corporation tax policy, too little intellectual energy has been spent on business rates. More importantly however, the two figures are not unrelated. This is because the payment of Business Rates reduces corporate profits (it is an allowable expense) so the figure for Corporation Tax would be higher if Business Rates were not charged. Given the impact on corporate profits, Business Rates will necessarily reduce the quantum of dividends that could be paid to companies resident in other jurisdictions. In this way, Business Rates impact the source/residence distinction that operates at the international level.

The Diverted Profits Tax in the UK operates in a similar way – for those caught by it, the “tax” is deductible against corporate profits. However, this is only useful for those companies that pay corporation tax in the UK (i.e. resident companies or those with a permanent establishment). Thus, the tax in the way in which it operates discriminates between domestic and foreign companies, and that is before one even needs to consider, as Mason and Parada do, the manner in which the thresholds for being caught by DSTs operates, the types of activities caught and the intention behind DSTs (which combine to render DSTs discriminatory).

Consider in turn also how Business Rates are calculated. They rely upon a valuation of the property – and that valuation is undertaken by the Valuation Office Agency (VOA), an agency within HMRC. So what if the VOA undervalues a property? In that case, a taxpayer gets an advantage over competitors. Presumably this is something that ought to have concerned the European Commission (whilst the UK was a Member of the European Union) by virtue of this advantage amounting to State aid. Presumably too it should be a concern under the new “subsidy” regime in the Trade and Cooperation Agreement between the UK and the EU.

The lessons that can be taken away from examining computation in respect of these examples? First, Corporation Tax and Business Rates do not operate independently and thus the headline figure for Corporation Tax receipts would be higher in the absence of Business Rates. Secondly, Business Rates, though a tax in England, does impact other countries. Thirdly, “unseen” taxes like Business Rates can be a means of providing subsidies to taxpayers and this ought to be watched by relevant oversight bodies. Fourth, the manner in which the UK DST operates serves to further the argument that it is discriminatory.

Thus, if we care about corporation tax, we should care also about computation.

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“The Power to Get it Wrong” now published in April Issue of Law Quarterly Review

My 15,000word article on the State aid tax ruling cases (forthcoming for a long time now) has finally been published in the April Issue of the Law Quarterly Review and is available on Westlaw.

In the article, I argue that the central issue in the cases is whether the tax authorities of Belgium, Gibraltar, Ireland, Luxembourg and the Netherlands misapplied the relevant tax laws. In turn, I suggest that this is the wrong starting point and instead the focus should be on, essentially, the propriety of the tax authorities actions. Whether a selective advantage has arisen then first depends upon whether the tax authority has acted in a way which would be considered unlawful as a matter of domestic administrative law. This shifts the focus away from figuring out correct transfer pricing or other complex tax calculations to matters that we are ultimately concerned with, such as whether the tax authority has deliberately colluded with a multinational in order to give it a tax break, or has had the wool pulled over its eyes, or has failed to follow its own processes to ensure parity of treatment between taxpayers and so on. Only once unlawfulness has been demonstrated do we then have to consider also whether there has been a misapplication of the law.

I make it clear in the article that this does not mean that the Commission should lose the tax ruling cases. Indeed, I apply this new approach to the Apple case and find reasons for thinking that the Revenue Commissioners breach Irish administrative law.

Instead the advantages of my approach lie in respecting the role that tax authorities play and providing a clear framework by which the Commission can then allocate its resources to investigating past tax rulings (rather than having it assume accidentally the role of a supranational tax authority). My approach also would allow the Commission to investigate not just those cases where a tax authority has positively provided favourable assurances to taxpayers but also where it has failed, without good reason, to properly investigate or challenge the tax returns of multinationals.

If you wish to receive a copy (but do not have access to the Law Quarterly Review on Westlaw), please email me at stephen.daly@kcl.ac.uk

A longer blog on the article has been published on the UK State aid Law Association’s blog.

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The Rule of (Soft Law): Forthcoming article in King’s Law Journal

King’s Law Journal will be publishing a special issue on the COVID-19 Pandemic in 2021. I have contributed a short piece to the issue entitled ‘The Rule of (Soft) Law’, the abstract for which reads as follows:

“The COVID-19 pandemic has forced governments around the world to become innovative in how they carry out their functions. In particular, they need to respond speedily to developments as the scientific evidence evolves. Rules for regulating conduct accordingly need to constantly evolve. The ‘golden met-wand’ of law, to adopt Lord Coke’s phrase in the Case of Prohibitions, is not particularly well-tuned to assist in such regulation other than at a level of generality.

It is unsurprising accordingly that governments have had to ‘supplement’ legal provisions with soft law. There is nothing novel about this – public authorities have long been in the business of helping people to understand the law – but it does raise important questions about the nature of domestic soft law, what role it should play and whether the UK government’s use of it during the period of the pandemic has been appropriate.”

I have posted a version of the article to SSRN. Any and all comments will be greatly appreciated.

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Understanding tax as a civic right and responsibility: some musings

Spurred on by reading a stimulating and engaging paper by Jeremy Bearer-Friend (in which the author considers means by which non-cash payments could discharge tax liability), I have begun to muse on the idea of tax being a civic right and responsibility, like voting. Now the parameters for exercising the “right” to pay tax may not be as broad as the right to vote (though cf. compulsory voting), in that one cannot choose whether they must pay tax (if it is due). There is nevertheless some scope for choice: even before considering whether individuals should choose a less or more favourable interpretation of ambiguous statutory language, there are a range of express options available to taxpayers in the tax code which they may legitimately choose (e.g. capital allowances; loss-relief etc). The responsibility to pay tax, when viewed as a civic right, is one which is principally collective in nature – like the responsibility to vote. It is an instance where “we all must play our part” for the benefit of the community in which we find ourselves.

When viewed in this light, the civic right to pay tax is justified on the basis of the benefit principle – the idea being that tax must be paid as a result of the benefit that one has drawn from being a member of the community. That is lesson number 1.

Lesson number 2 is that the right can find its origin in something inherent – such as nationality or citizenship – or it can be acquired – through some relevant link such as economic nexus or time spent.

When these two lessons are applied to cross-border activities, it helps us to understand that it is no defence to double taxation to suggest that one should be taxed in only one place – at the margins there will be instances where one has the right to vote in more than one place, just like the right to pay tax. That does not of course detract from the fact that double taxation can be condemned for other reasons – such as that it is discriminatory, or it may result in disproportionate taxation when totalled up, or that it can disincentivise investment. But is cannot be condemned on the basis of the benefit principle.

These lessons help to articulate also why tax avoidance, and even more so tax evasion, are deemed to be undesirable activities in principle as they undermine the responsibilities that are owed to the collective. Few would be surprised by this revelation, but we can have more fun with the lessons than that. A parallel can be drawn between those who seek to manipulate the way in which people vote through targeted, misleading ads and the advisors who mislead unsophisticated taxpayers into engaging in tax schemes. For the same reasons and with the same force that we criticise organisations like Cambridge Analytica, we can condemn these advisors.

These lessons can be applied more generally in terms of understanding the relationship between the taxpayer and the State at a national level – illuminating issues such as privacy over one’s tax affairs – and it seems to me to be an avenue worth exploring in more detail with reference to more substantive case studies. It is certainly worth more musing when I have the time.

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Detailed analysis of the GCEU’s Apple decision

On 7 September, a lengthy case note considering the GCEU’s long awaited decision in the Apple case from Professor Ruth Mason of the University of Virginia and myself was published in both Tax Notes Federal and Tax Notes International. It may seem strange that the same article has been published in two different journals of the same publisher, but Tax Analysts (the publisher) deemed the article to be relevant to its different readerships hence putting it before its readers interested in federal tax matters and international tax matters.

In the article, which follows seven excellent articles from Ruth Mason about state aid published in Tax Notes (all available on Ruth Mason’s SSRN), we dissect the Apple judgment. Thereafter we consider its implications for state aid analysis and use of the arm’s-length standard. We also consider the drawbacks of using state aid to prevent corporate tax abuse as well as the broader implications of the case. This article is now freely available on SSRN here.

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Apple podcast and forthcoming article in Tax Notes International

A few weeks ago, I gave an interview to Tax Notes about the Apple state aid case. The podcast is available here and the transcript is available here. Professor Ruth Mason from the University of Virginia also features.

In the interview, we both give our two cents on what went wrong for the European Commission and the implications of the decision. We also recently co-authored a lengthy case note on the Apple decision which will soon be published in Tax Notes International and in which we go into much more granular detail on the case.

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Case note on Apple: an unexpected outcome

The General Court yesterday handed down its long awaited decision in the Apple case, concerning tax rulings given by the Irish Revenue Commissioners to two Apple companies in 1991 and 2007. The outcome is a surprise – not just because the Court found against the Commission but also of the comprehensive manner in which it did. After summarising the case, I will make three points that stem from the judgment.

The two Apple companies ASI and AOE, by virtue of the combination of Irish law and US at the time, were treated as neither resident in Ireland nor the US. As such, the only taxes due in Ireland would be those that could be attributed to the branches of these companies (Taxes Consolidation Act 1997, s. 25). The rulings provided formulae for determining what these amounts would be in any given year. In a nutshell, the Commission’s argument was that Ireland granted State aid to Apple because the rulings were not in line with the applicable tax rules in terms of how much taxable profit could be said to have arisen in Ireland. Far more profit ought to have been attributed and taxed. In a similarly sized nutshell, the Court rejected the Commission’s formulation of this argument on the basis that it has misconceived and misapplied the Irish tax rules and the OECD transfer pricing guidance.

There were two strands to the Commission’s central argument. The first was that the profits from Apple’s intellectual property – for which ASI and AOE held licences – should be taxable in Ireland. Critically, however, the General Court found that the Irish tax rules attributed profit from intellectual property to a branch of a non-resident company where the branch actually controls the intellectual property (S. Murphy (Inspector of Taxes) v. Dataproducts (Dub.) Ltd. [1988] I. R. 10). The Commission on the other hand had assumed it did not need to demonstrate control on the part of the branches because the head offices of the companies had no physical presence or employees. By failing to demonstrate whether the branches controlled the intellectual property, the Commission had failed to demonstrate that the Irish branches were not sufficiently taxed (see paras 184-186 in particular).

By way of similar reasoning, the Court found that the Commission did not prove that the Irish tax treatment was out of step with the OECD guidance because it erroneously assumed the profit from the intellectual property was attributable to the branches without an assessment of the functions carried out by those branches (see para 242 in particular).  Indeed, the judgment makes clear just how limited Apple’s operations are in Ireland – for instance only one person was responsible for quality control in ASI in Ireland (para 268), no branch staff were responsible for R&D facilities management (para 272) and no staff were assigned to marketing (para 274) – and thus these operations play only a limited role in generating value for the Apple group.

The second strand of the Commission’s argument was that, even if the profits from the intellectual property were not taxable in Ireland, the branches of ASI and AOE were insufficiently taxed given the value that these companies generated for the Apple Group. In a similar manner to the Starbucks judgment, the Court found that although there were some errors on the part of the Irish Revenue Commissioners in granting the rulings, the Commission had failed to prove a causal link between the errors and the provision of an advantage (see para 480). An alternative line of reasoning (that the Irish Revenue Commissioners inconsistently applied the law on attributing profit) fell short on that same basis (paras 489-504).

Though a lengthy judgment and hence one that will still take time to digest, there are some preliminary comments which spring to mind.

First, much has been made of the 13bn EUR headline figure that was at stake in the case. But the problem with that figure is that it assumed that all of Apple’s profits were taxable in Ireland. The Commission did not challenge the Irish rules on residency themselves and so had the Herculean task of somehow arguing that by misapplying the rules of profit attribution, the Irish Revenue Commissioners had undervalued the huge role that these small branches in Ireland played in Apple’s activities. A different route would have been possible if the Commission had instead argued that the Irish tax rules on residency gave rise to State aid because they were geared specifically to ensure that companies like Apple could be treated as non-resident in Ireland and the US. The articulation of that argument would rely upon digging down into the weeds of the exceptions to the exceptions in the old Irish rules on corporate residency. The time has passed for that argument, but it at least would have been more consistent with the figure of 13bn because it would have based on the notion that the profits of ASI and AOE were taxable in Ireland and not just the profits of their branches.

Second, buried in the judgment, the General Court made expressly clear that there was no EU arm’s length principle by which the transactions and arrangements in the case could be judged. Instead: ”the Commission cannot, however, contend that there is a freestanding obligation to apply the arm’s length principle arising from Article 107 TFEU obliging Member States to apply that principle horizontally and in all areas of their national tax law” (para 221). As I have argued elsewhere a different finding would have had profound constitutional implications.

Thirdly, the General Court was pretty kind to the Irish Revenue Commissioners in the judgment. Commenting on the process that led to the rulings being granted, the Court noted that the methodology was “regrettable” (para 348), “the explanations….were brief” (para 432), the Commissioners were “[un]able to [explain] the indicators and figures used” (para 433), the process was “incomplete and occasionally inconsistent” (para 479) and the rulings were “insufficiently documented” (para 500). In my forthcoming article in the Law Quarterly Review – “The Power to Get it Wrong” – I argue that State aid law should focus not on whether the tax rules have been correctly applied, but instead whether the tax authorities have followed good processes and acted reasonably when engaging with taxpayers. Essentially the question should not be whether the tax authority made a mistake, but rather whether it acted lawfully in public law terms. What the General Court has implicitly acknowledged, and what is revealed from a thorough reading of the Commission’s decisions in relation to Apple, is that there are serious questions to be answered by the Irish Revenue Commissioners as to the lawfulness of the 1991 and 2007 rulings (for instance, the length of time for which they ran, whether they were based upon sufficient information, and whether they were driven by employment consideration). But the Commission simply did not deal in any detail with the effects of these purported improprieties.

Prior to reading the judgment I would have thought there was an incredibly high likelihood that the case would be appealed. After reading it, I am less sure (though it is still a pretty good call that it will).

If you would like a copy of either “The power to get it wrong” or “The constitutional implications of an EU arm’s length principle” then please just email me (Stephen.daly@kcl.ac.uk)

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Guidance and the Rule of Law during the COVID-19 pandemic

The COVID-19 pandemic has forced governments around the world to become innovative in how they carry out their functions. In particular, they need to respond speedily to developments as the scientific evidence becomes more robust. Rules for regulating conduct accordingly need to constantly evolve. The “golden met-wand” of law, to adopt Lord Coke’s phrase in the Case of Prohibitions, is not particularly well tuned to assist in such regulation other than at a level of generality. For instance, the law can dictate that leaving one’s house is prohibited in the absence of a “reasonable excuse”, but it cannot elaborate on reasonableness at a level of specificity that people desire and need. What is “reasonable” will depend on the circumstances, and such circumstances are individuated even in ordinary times and inevitably change in times of emergency as our understanding of the crisis evolves. A law which talks of reasonableness other than at a level of generality would rapidly become obsolete.

It is unsurprising accordingly that governments have had to “supplement” legal provisions with forms of soft law, such as guidance. There is nothing novel about this use of guidance. It is not “discretionary” other than in the sense that public authorities have discretion about whether or not to issue guidance and what form it should take and so on. Public authorities such as the police do not get to dictate the legal consequences that follow from the rules (though undoubtedly vague laws do give them practical power). To be vested with legal discretion is to be entitled to determine the legal consequences – and so a legal rule itself only contains discretion for instance if it prescribes that “an official is entitled to determine what is reasonable in the circumstances”. And indeed, it is desirable that guidance should be used in such a fashion – to complement but not displace law – as it acts as a guide for individuals in order so that they can understand the legal consequences of their actions. Understood in this way, guidance and other forms of advice provided by public authorities are not a threat to the rule of law, but rather positively advance it as I argue in Tax Authority Advice and the Public.

But there are limits to this proposition – for the rule of law to be advanced, the guidance should be clear (clarity), it should align with the underlying law (correctness) and it should be accessible to individuals (accessibility). To ensure that it follows these indicia, there should be a form of scrutiny (scrutiny) and ultimately people ought to be able to rely upon the guidance (reliability).

The use of guidance during the COVID-19 pandemic does not alter this framework, but it does throw issues around compliance with the framework into sharp relief. It has not gone unnoticed that public authorities have been constantly updating their guidance during the coronavirus. Questions as a result have been raised about the correctness of the guidance where it appears not to align with the underlying law; about its clarity and accessibility; and about its reliability where it turns out that the guidance is in fact incorrect. The strongest legal protection that individuals have where they have relied upon past iterations of guidance is that provided by the doctrine of legitimate expectations – and that is not an entirely comfortable place to be. Should a public authority believe that there is a mistake in its guidance, then it may be lawful to resile from it without falling foul of the doctrine (see Chapter 6 available here). As Greg Weeks has suggested in Soft Law and Public Authorities: Remedies and Reform at page 118, poorly drafted guidance places the risk on those who seek to rely on it. With law offering little protection, people must rely on the benevolence of the public authority. At several points in my book (e.g. at pages 157, 188, 192, 195 and 200) I argue that HMRC and public authorities generally should be comfortable with the idea of making mistakes and not feeling the need to go back and fix them. They should feel more liberated to offer assurances and not use obfuscating or qualifying language. Providing people with greater certainty as to the consequences of their actions is desirable from the perspective of the rule of law and treating people with dignity.

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Ultra vires the ECB and the implications for EU State aid law

State aid lawyers should take note of today’s decision from the Bundesverfassungsgericht, the German Federal Constitutional Court (BVerfG, Judgment of the Second Senate of 05 May 2020 – 2 BvR 859/15 -, paras. (1-237)). There the Court found that the ECB had acted beyond its competences in instituting the Public Sector Purchase Programme (a programme for the purchase of government bonds) as it failed to act in accordance with the principle of proportionality. What is striking about the case is that the German Court’s decision is at odds with a decision from the Court of Justice in which it was found that the ECB had not acted beyond its competences. In turn, the Bundesverfassungsgericht found that the Court of Justice’s decision also exceeded its competences.

The case is an example of a clash of legal jurisdictions. EU law is supreme as a matter of EU law. And the Court of Justice is the ultimate arbiter of EU law in the EU. But it does not follow that the Court of Justice’s interpretation of EU law reigns supreme over its interpretation by domestic courts in all circumstances as a matter of domestic law. It has been sporadically highlighted for instance by domestic courts that EU law cannot override fundamental constitutional principles or rights and must be interpreted in light of them in domestic law. But whilst noting this in theory, the courts have generally managed to avoid finding an actual clash (see for instance, Solange II, HS2, and the Bundesverfassungsgericht’s comments on Åkerberg). In the Bundesverfassungsgerichts decision today though a domestic court has (again) unequivocally found that their interpretation of EU law differs from that of the Court of Justice (see also the Czech Constitutional Court’s response to Landtova and the Danish Supreme Court’s response to Daniski Industri). The Bundersverfassungsgericht decided that the CJEU’s interpretation of EU law was beyond the bounds of an acceptable interpretation.

I mention this in the context of State aid as the episode mirrors my argument in an article published earlier this year in European Taxation entitled “The constitutional implications of an EU arm’s length principle”. In it, I argue that there should be no autonomous EU arm’s length principle found to exist in Article 107 TFEU, as discrete from any that has been incorporated in domestic law, as such an interpretation of EU law would run roughshod over the fundamental constitutional principle that taxes are levied by domestic legislatures. As with the Bundesverfassungsgericht’s decision today, it is not an acceptable interpretation of EU law. If you wish to receive a copy of this article, please email me (stephen.daly@kcl.ac.uk)

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