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A Constructive U.S. Counter to EU State Aid Cases A Constructive U.S. Counter to EU State Aid Cases

Itai Grinberg Georgetown University Law Center, itai.grinberg@law.georgetown.edu

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Tax Notes Int'l 167 (2016)

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A Constructive U.S. Counter to EU State Aid Casesby Itai Grinberg

U .S. Treasury officials and members of Congressfrom both parties have expressed concern that the

European Commission’s current state aid investigationsare disproportionately targeting U.S.-based multina-tional enterprises.1 At the same time, a Treasury offi-cial recently suggested in congressional testimony thatthere are limits to what Treasury can do beyondstrongly expressing its concerns to the commission. In

that testimony, Treasury’s representative hinted at twospecific pressure points: whether the state aid investiga-tions could undermine U.S. tax treaties with EU mem-ber states; and whether any assessments paid by theforeign subsidiaries of U.S. MNEs as a result of stateaid investigations would be creditable for U.S. incometax purposes.

Thus far, no one has raised a third pressure point:the potential application of section 891 of the U.S. taxcode, which specifically addresses discriminatory taxa-tion of U.S. MNEs. If the Obama administration wereto find that the EU state aid cases imposed discrimina-tory taxes on corporations of the United States, U.S.income tax rates on citizens and corporations of cer-tain European countries could double. Although theUnited States has never applied section 891, this maybe a case where its consideration is appropriate.

Why wouldn’t Treasury study the issues raised bythe EU state aid investigations under section 891? Theanswer might be that section 891 feels like a provisionfrom a bygone era, primarily because the issues it ad-dresses simply have not arisen in decades.

But section 891 seems to have been enacted pre-cisely to address concerns like those raised by the EUstate aid investigations. Moreover, studying the ques-tions that arise under section 891 represents a less dras-tic and more pragmatic U.S. response than threateningto terminate our tax treaties. It also opens the possibil-ity of imposing a consequence that is meaningful toforeign sovereigns, unlike the prospect that the UnitedStates would deny foreign tax credits to U.S. MNEs.Finally, as a legal matter, the questions that arise undersection 891 regarding the EU state aid investigationsmay chronologically precede the questions that ariseunder section 901. Thus, focusing on the questions thatsection 891 poses could be a means to encourage Euro-pean institutions to conclude the EU state aid cases ina sensible manner.

1See e.g., Testimony of Robert Stack, deputy assistant Treas-ury secretary (international tax affairs), Senate Finance Commit-tee (Dec. 1, 2015), available at http://www.finance.senate.gov/imo/media/doc/01dec2015Stack.pdf (‘‘We are concerned thatthe EU Commission appears to be disproportionately targetingU.S. companies.’’); Press Release, House Ways and Means TaxPolicy Subcommittee Chairman Charles W. Boustany Jr., R-La.,Chairman Boustany Opening Statement: Examining the OECDBase Erosion and Profit Shifting (BEPS) Project (Dec. 1, 2015),available at http://waysandmeans.house.gov/chairman-boustany-opening-statement-examining-the-oecd-base-erosion-and-profit-shifting-beps-project; and Remarks of Senate Finance CommitteeRanking Member Ron Wyden, D-Ore., at Finance Hearing onOECD BEPS Reports (Dec. 1, 2015), available at http://www.finance.senate.gov/hearings/international-tax-oecd-beps-and-eu-state-aid.

Itai Grinberg is an associ-ate professor of law atGeorgetown UniversityLaw Center in Washington.

The author proposes thatthe U.S. Treasury considerapplying a little-knownU.S. tax law to counter theEuropean Commission’spending state aid investi-gations.

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Background

EU State Aid

Article 107(1) of the Treaty on the Functioning ofthe European Union (TFEU) provides that state aidthat affects trade between EU member states andthreatens to distort competition by favoring certain un-dertakings is incompatible with the EU single market.2EU state aid rules require that incompatible state aidbe recovered in order to ameliorate the distortion ofcompetition created by the aid.

The state aid rules were originally designed to pre-vent EU member states from subsidizing domestic en-terprises. Under the state aid rules, the commission candemand assessments that claw back state aid, includingwhat it views as underpaid taxes, going back 10 yearswith interest. In a series of decisions reaching backdecades, the commission has found specific cases ofstate aid that violate EU rules and required the offend-ing member state to recover that aid from the affectedcompany.

State aid decisions focusing on indirect subsidiesprovided through tax benefits are not new as a generalmatter. The commission has been bringing tax-relatedstate aid cases since at least the mid-1980s. Tax-relatedstate aid decisions reached by the commission havealmost always been upheld by the Court of Justice ofthe European Union.

Until the recent assault on U.S.-based MNEs, how-ever, state aid cases in the tax area generally involvedstatutory rules that selectively favored domesticallyheadquartered companies in a given EU member state.In contrast, in the new cases the commission is claim-ing that sovereigns provided illegal state aid to foreign-headquartered companies merely by providing themlegal certainty through tax rulings that do not evenseem to be ‘‘selective’’ — in that similar rulings werebroadly available from the tax administrations of thosesame EU governments. In addition, the new state aidcases largely relate to transfer pricing matters, whichpresent notoriously difficult fact-specific determina-tions. For these reasons, the current EU state aid taxinvestigations are novel and unprecedented.

Moreover, the remedy state aid law imposes againstmember states that provide illegal state aid is deeplyinappropriate when applied to a foreign firm instead ofthe domestic ‘‘national champion’’ firms for whichstate aid law was originally intended. In these cases,when the commission finds that a member state hasprovided illegal state aid, the remedy is to require thatmember state to collect a revenue windfall from aforeign-headquartered MNE. That does make for great

politics: When the commission reprimands a memberstate for violating EU law, that member state wins.3

President Obama and others have suggested that, atleast in the technology sector, the European Commis-sion’s regulatory agenda in the past few years has oftenamounted to a protectionist attack on U.S. companies,driven by frustration at European companies’ inabilityto compete in that area.4 The new state aid investiga-tions could be seen as part of that broader trend.5Starting in 2013, the commission’s tax-related state aidinvestigations have focused like a laser on rulings is-sued to U.S. MNEs. In fact, all but one of thecompany-specific investigations and almost all of theamounts in controversy involve U.S. MNEs. This en-forcement reality contrasts with the fact that tax rulingsof the type that the commission has recently decided toexamine were also routinely procured by European-headquartered multinationals.

Section 891Section 891 provides:

Whenever the President finds that, under the lawsof any foreign country, citizens or corporations ofthe United States are being subjected to discrimi-natory or extraterritorial taxes, the President shallso proclaim and the rates of tax imposed by sec-tions 1, 3, 11, 801, 831, 852, 871, and 881 shall,for the taxable year during which such proclama-tion is made and for each taxable year thereafter,be doubled in the case of each citizen and corpo-ration of such foreign country.6

In the course of congressional debate over section891, Sen. David I. Walsh, D-Mass., presented a floorstatement that provides some insight into the statute’spurpose. He suggested that if an administration wereto ‘‘cause inquiry to be made’’ into whether a foreigntax was discriminatory, ‘‘it would seem natural that thePresident, through his executive offices, might obtainan agreement . . . to remove such features. If this weredone there would be no occasion for the President toissue [a proclamation under Section 891], and the sec-tion would have accomplished its result in an amicablemanner.’’7

2Consolidated Version of the TFEU, article 107(1), May 9,2008, 2008 O.J. (C 115) 91-92.

3Michael J. Graetz, ‘‘Behind the European Raid on McDon-ald’s,’’ The Wall Street Journal, Dec. 3, 2015.

4See, e.g., Murad Ahmed, Duncan Robinson, and RichardWaters, ‘‘Obama Attacks Europe over Technology Protection-ism,’’ Financial Times, Feb. 16, 2015.

5Indeed, international relations scholars often point out thatstate aid is one of the most politicized of the EU’s regulatorypolicy levers. See, e.g., Michelle Cini, ‘‘The Soft Law Approach:Commission Rule-Making in the EU’s State Aid Regime,’’ 8 J.Eur. Pub. Pol’y 192 (2001).

6Sec. 103, Revenue Act of 1934 (1934) (current version at 26IRC section 891 (2015)).

778 Cong. Rec. 9318, at 9319 (1934) (statement of Sen. DavidI. Walsh).

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In the context of the EU state aid investigations tar-geting foreign subsidiaries of U.S.-headquarteredMNEs, the language of section 891 raises two prelimi-nary issues of statutory interpretation: the meaning of‘‘corporations of the United States’’ and the meaningof ‘‘being subjected to discriminatory taxes.’’

Walsh’s floor statement helps clarify the intent ofCongress as to those issues. He explained that the lan-guage ‘‘corporations of the United States’’ was in-tended to refer to ‘‘American concerns.’’ The discrimi-nation section 891 was intended to combat does notseem to be limited to tax burdens formally imposed onthe domestic subsidiaries of a U.S. MNE. Rather, inlight of the legislative history, the statutory term ‘‘cor-porations of the United States’’ may be best under-stood to encompass any subsidiary within the world-wide affiliated group of a U.S. MNE. Thus, forpurposes of section 891, European subsidiaries ofAmazon, Apple, McDonald’s, and Starbucks are alllikely to be ‘‘corporations of the United States.’’

Walsh also explained that being subjected to dis-criminatory taxes under the laws of a foreign countryreferred to those taxes that are framed, imposed, andenforced ‘‘so as to result in a special tax burden uponAmerican concerns, greater than those imposed on theenterprises of [the foreign country] or of the most-favored nation.’’ The issue that section 891 focuses onis not, in the senator’s telling, solely about whether thelegal rule imposing a tax on an American concern isfacially neutral. Rather, whether a tax is discriminatoryseems intended to focus on the impact of the foreignrule as applied.

Open QuestionsA wide variety of questions about how section 891

might interact with the state aid cases — as well as theapplication of section 891 more generally — have re-ceived almost no attention. It might, therefore, be fruit-ful for Treasury to make an open-ended request forpublic comments. For instance, there are importantquestions to be addressed about the relationship be-tween section 891 and U.S. tax treaties, the circum-stances under which a tax measure should be viewedas being discriminatory, and the meaning of the term‘‘foreign country’’ for purposes of section 891.

Section 891 and U.S. Tax Treaties

One might contend that section 891 contravenesU.S. tax treaties and therefore has no effect. U.S. taxtreaties generally override domestic law by reducingU.S. taxes on foreign persons in exchange for reciprocalreductions in foreign taxes on U.S. persons. They alsouniformly include nondiscrimination articles. UnderU.S. law, treaties and statutes have coequal status.When a revenue statute and a tax treaty provision con-flict, generally the later-in-time rule is controlling.Thus, one view might be that by doubling the rate oftax on a foreign country’s citizens and corporations,section 891 contravenes our treaties. In that case, since

all the relevant treaties were concluded after the enact-ment of section 891, those treaties would prevail andprevent application of section 891, so long as a treatywith the particular EU member state remains in force.

On the other hand, a fundamental judicial tenet isthat treaties and statutes are to be reconciled whereverpossible. One question, therefore, is whether the appli-cation of EU state aid rules in a discriminatory man-ner, followed by retroactive revenue reclamation, wouldbe permissible under the United States’ tax treatieswith the relevant EU member states. For EU law pur-poses, the TFEU generally trumps bilateral income taxtreaties, and so the fact that state aid findings may vio-late the tax treaties of EU member states may not bedispositive.

But for U.S. law purposes, the TFEU does not haveand cannot be granted this quasi-constitutional status.To the extent that the outcomes of discriminatory stateaid cases violate the United States’ tax treaties withEU member states, application of section 891 may notbe inconsistent with our tax treaties. Rather, the betterreading may be that section 891 remains an operativeprovision, at least in part, to the extent that discrimina-tory or extraterritorial taxation by a foreign countryviolates the terms of a tax treaty of the United States.8

When a Tax Is DiscriminatoryUnder section 891, whether corporations of the

United States are subjected to discriminatory taxes un-der the laws of a foreign country appears to refer tothe manner in which the taxes are imposed and en-forced, rather than merely whether the underlying for-eign rules being applied to corporations of the UnitedStates are themselves facially neutral. That conclusion,however, leaves open a very wide set of questionsabout the standard for determining whether corpora-tions of the United States are being subjected to dis-criminatory taxes.

The Meaning of ‘Foreign Country’Another open question turns on the meaning of the

term ‘‘foreign country’’ for purposes of section 891.The meaning is important because if the administra-tion were to conclude that U.S. corporations were be-ing subjected to discriminatory taxes under the laws ofthe EU (as opposed to the laws of a member state), aquestion would arise whether the EU is a ‘‘foreigncountry’’ for purposes of section 891.

Our understanding of the meaning of the term ‘‘for-eign country’’ for international tax purposes dependsto a significant degree on a 1932 Supreme Court case,

8Alternatively, section 891 might be viewed as a statutory ve-hicle for responding to tax treaty violations with a partial treatysuspension. For a discussion of partial tax treaty suspensions, seeRichard L. Doernberg, ‘‘Selective Suspension or Termination ofIncome Tax Treaty Provisions,’’ Tax Notes Int’l, Nov. 1990, p.1130.

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Burnet v. Chicago Portrait Co.9 In that case, the Courtheld that subnational taxes imposed by the Australianstate of New South Wales were imposed by a foreigncountry for purposes of the foreign tax credit becausethe purpose of the FTC was to alleviate double taxa-tion and the Court recognized that double taxation canoccur whether a foreign tax burden is imposed by anational government or a regional one. In reaching thatconclusion, the Court made clear that ‘‘foreign coun-try’’ is ambiguous. As the Court noted, ‘‘the term ‘for-eign country’ is not a technical or artificial one, andthe sense in which it is used in a statute must be deter-mined by reference to the purpose of the particularlegislation.’’10

When crafting section 891 in 1934, Congress wouldhave been aware of the 1932 decision in Chicago Portrait— which at the time was the Court’s most recent inter-national tax decision. Depending on the purpose of thestatute at issue, Chicago Portrait made clear that ‘‘for-eign country’’ could mean either ‘‘foreign territory’’ or‘‘foreign government’’ and, when referring to a foreigngovernment, ‘‘it may describe a foreign state in the in-ternational sense,’’ but it might also mean ‘‘a foreigngovernment which has authority over a particular areaor subject-matter.’’11 Of course, the European Unionhas a territory and is arguably a foreign governmentwith authority over particular subject matter, includingcompetition policy, as the commission’s actions in im-posing state aid assessments clearly establish.

Sequence of Analysis

As Treasury considers the tax treaty issues, FTCissues, and section 891 issues that arise when dealingwith the state aid investigations, one practical questionis: Which of these issues has to be dealt with first? Taxtreaty termination is a pure policy decision with norequired time frame for decision. Foreign tax creditabil-ity is determined under the compulsory payment rules,which require that a taxpayer exhaust all effective andpractical remedies, including available judicial appeals,before claiming the credit.12

In contrast, EU law provides that once the commis-sion decides that a member state provided a taxpayerwith illegal state aid, that state must act without delay

to recover that aid from the taxpayer.13 As a result, al-though FTCs quite likely would not be available at thetime the commission reached a decision (since appealswould be in process), that decision may mark the pointat which a corporation of the United States is sub-jected to tax for purposes of section 891. Thus, thesection 891 issues may arise well before either the taxtreaty termination or section 901 issues are ripe.

Political Economy ConsiderationsThe history of state aid law suggests that credible

sources of economic and political pressure have signifi-cantly affected the development of EU state aid investi-gations over time. Hinting that tax treaties might needto be terminated is not, however, particularly credibleas a source of pressure on the European Commission.The collateral damage caused by tax treaty terminationwould be very substantial and probably disproportion-ate to the harm caused by the current state aid investi-gations for all parties concerned. Nor can the U.S.bring credible pressure to bear on the commission bythreatening that EU state aid assessments will not becreditable to U.S. MNEs. Indeed, the U.S. has alreadyindicated to the commission that EU state aid assess-ments may be creditable foreign taxes for U.S. tax pur-poses, in order to explain that the United States has adirect stake in these proceedings, because if the FTCapplies, U.S. taxpayers will foot the entire bill for anystate aid assessments.

In contrast, section 891 constitutes a plausiblesource of leverage in connection with the state aidcases. Although the United States should be reluctantto invoke section 891, that step is substantially lessdrastic than terminating all EU member state tax trea-ties. Moreover, given the lack of guidance on preciselyhow section 891 applies, Treasury might be able to ap-propriately limit the impact of any finding under sec-tion 891.

ConclusionThis article started with a simple question: Why

shouldn’t Treasury consider the issues raised by EUstate aid investigations under section 891? True, taxrates have never doubled under section 891, and manytax lawyers have never heard of section 891. In an im-portant sense, however, Congress intended these re-sults: Section 891 was designed to create a deterrentthat would discourage foreign governments from dis-criminating against U.S. citizens and businesses. Thus,when the rule of law works as it should abroad, sec-tion 891 simply does not come up. Maybe it is time forTreasury to study section 891, if only to remind ourfriends in the European Commission that it is the lawof the United States. ◆

9Burnet v. Chicago Portrait, 285 U.S. 1 (1932).10Chicago Portrait, 285 U.S. at 6, citing Wayman v. Southard, 10

Wheat. 1, 29; Marriott v. Brune, 9 How. 619, 635, 636; AmericanTobacco Co. v. Werckmeister, 207 U.S. 284, 293; United States v.Louisville & N. R. Co., 236 U.S. 318, 333; Inter-Island Steam Nav. Co.v. Ward, 242 U.S. 1, 4; and Porto Rico Ry., Light & Power Co. v. Mor,253 U.S. 345, 348.

11Chicago Portrait, 285 U.S. at 5.12Treas. reg. section 1.901-2(e)(5) (2015). 13OJ L 83/1 (Mar. 27, 1999), as amended, article 14.

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