The ECJ handed down a highly significant judgment today in the case of Fiat and Luxembourg v Commission concerning the application of the EU State aid rules to tax rulings. The case concerned a 2012 tax ruling provided to Fiat Finance and Trade (FFT), a Luxembourg company which provided treasury services and financing to Fiat Chrysler Group.
In short, the Court of Justice found that the Commission’s arguments were misconceived as they were not grounded in Luxembourg law. Whilst all countries have some objective basis for determining profit allocation, meaning their rules in the abstract can often be expressed as seeking “arm’s length” treatment, this does not override the need to consider the specifics of how that principle finds concrete expression in domestic law.
This blogpost details how we got to today’s result, through the ruling 10years ago to the judgment today.
The ruling
The 2012 tax ruling concerned the method for determining the profit allocation to FFT. The profit allocation was determined using a transfer pricing method known as the Transactional Net Margin Method (TNMM). This determined the profit of FFT to be EUR 2,542 million (with a range of +/- 10%), consisting only of the remuneration due to the company, as calculated by reference to the capital needed by FFT to bear its risks (FFT faced market risk, credit risk, counterparty risk and operational risk) and to perform its functions (FFT was involved for instance in market funding and liquidity investments; relations with financial market actors; and financial coordination and consultancy services to the group companies). However, no remuneration was due under the ruling in respect of FFT’s holdings in the non-European entities (FFC in Canada and FFNA in America).
The Commission decision
On 21 October 2015, the European Commission communicated its decision that the ruling amounted to State aid, as it improperly reduced FFT’s tax burden since 2012 by €20 – €30 million. Whilst the Commission found that the use of TNMM was appropriate (recital 247), it found that there were a number of aspects of the methodology used in the analysis which were flawed (recital 248):
- The Commission for instance found that the use of hypothetical regulatory capital as a profit level indicator was inappropriate as regards determining remuneration due to FFT (recital 249), with the consequent effect of significantly reducing the remuneration due to FFT (recital 256). Instead, FFT’s total capital ought to have been used (recital 249).
- Notwithstanding this conclusion, the Commission also found that the calculation of the hypothetical regulatory capital was too low, both in terms of calculating the regulatory capital that would be required by Basel II (minimum capital requirements on financial institutions) (recital 268) and the deductions that would be appropriate from that capital (recital 277).
- Further, the Commission concluded that the level of return applied to the capital to be remunerated was too low (recital 292).
The Commission concluded by finding that the entirety of FFT’s capital ought to have been taken into account for the purposes of calculating the appropriate remuneration due to FFT, to which a single rate should then be applied (recital 311).
GCEU
In a judgment handed down on 24 September 2019, the General Court rejected the appeal and upheld the Commission’s decision:
- The Court agreed with the Commission’s finding that the entirety of FFT’s capital ought to have been taken into account for the purposes of calculating the appropriate remuneration to which a single rate should then be applied (paragraph 279).
- The Court agreed with the Commission that the use of hypothetical regulatory capital was inappropriate (paragraph 279).
- The Court agreed with the Commission that the Luxembourg tax authority was wrong to conclude that no remuneration was due in respect of FFT’s holdings in the non-European entities (FFC in Canada and FFNA in America) (paragraph 279).
As with the other judgments of the General Court concerning State aid and tax rulings (such as Amazon, Apple and Starbucks), it was found that the reference framework should be the corporate tax system. It was also found that the Commission was entitled to use the arm’s length principle to determine whether there had been a deviation from the reference framework and could be assisted in doing so by OECD guidance.
Advocate General opinion
Arguments in the case were heard in May 2021. In a punchy opinion handed down in December 2021, Advocate General Pikamäe advised the European Court of Justice to overturn the General Court’s decision and to allow the appeal. The AG concluded that only the rules and principles of the Luxembourg legal system should be analysed in assessing the existence of an advantage under Article 107 TFEU. As a result, the Commission should not, as it had done in the case, be permitted to replace Luxembourg rules with rules extraneous to the domestic system. To this end, the “arm’s length principle” was wrongly used as the benchmark for “normal taxation” in assessing whether the Luxembourg tax ruling granted to Fiat Chrysler constituted a selective advantage. The AG concluded that the Court’s erroneous identification of the reference system vitiated the entirety of the Commission’s analysis.
European Court of Justice
Today (8 November 2022), the European Court of Justice in its judgment agreed with the assessment of AG Pikamäe and found that the decisions of the General Court and the Commission should be annulled. The Court stressed that the determination of whether State aid has arisen will depend upon a comparison between the scheme for “normal taxation” and that which applied to the taxpayer in question. To undertake such a comparison, it is the domestic tax rules which should be considered. Rather than using an abstract version of the “arm’s length principle” for this comparison, it is hence the manner in which the arm’s length principle is expressed in the domestic rules which should be considered (which was to be found in Article 164(3) of the Luxembourg Tax Code and specified in the related Circular No 164/2). The Court did not stop there. It also highlighted that resorting to non-domestic rules, as the Commission had done, was contrary to the TFEU rules on the approximation of Member State law – i.e. direct tax rules can only be harmonised in EU law where there is unanimous consent (according to articles 114(2) and 115 TFEU). The approach of the Commission and General Court failed to pay due respect to the Treaties insofar as the “autonomy of a Member State in the field of direct taxation… [is] fully ensured” (paragraph 94) except for specific EU tax rules unanimously adopted. The subsidiary line of reasoning also failed as it was predicated on the principal line of reasoning (despite the superficial references to the relevant provisions of Luxembourg law).
Ramifications
It cannot be overstated how significant this judgment is for the other State aid tax ruling cases, such as Apple, in that the court applied a more rigid interpretation to the scope of the domestic rules than the General Court and the Commission. The ECJ held that the concrete terms of the arm’s length principle are to be derived from national law (see paragraph 95). In the case of Apple, there was no “arm’s length principle” in place when the 1991 tax ruling was granted. This finding then must augur well for Ireland and Apple as the ruling will not be required to align with an autonomous arm’s length principle. Instead, it will merely be the rules in Ireland which existed at the time which sought to ensure that there was an objective basis for determining the profits on a non-resident trading company (see Dataproducts and Belville Holdings cases). A successful finding for the Commission in the Amazon case at the Court of Justice is very unlikely meanwhile given the Commission’s apparent misconception of the scope of Luxembourg law.
Although the judgment is highly critical of the Commission, the Court did however offer a fig-leaf at paragraphs 119-122. State aid can arise from the provision of a tax ruling, such as where the domestic rules are “manifestly inconsistent with the objective of non-discriminatory taxation of all resident companies…pursed by the national tax system, by systematically leading to an undervaluation of the transfer prices applicable to integrated companies or to certain of them, such as finance companies, as compared to market prices for comparable transactions carried out by non-integrated companies” (paragraph 119).
My position (set out more fully in a 2021 LQR article and a 2022 MLR piece) meanwhile has always been that there was another way to tackle these cases – an approach which focused on the key issue at the heart of the original investigations which was a suspicion of administrative impropriety.
Whether the Commission has the stomach for further litigating these issues is another matter…
taxatlincolnox 