Master’s thesis by

Zoi Vangeli

“The Starbucks case: Is the Commission in the right track?"

Submitted in partial fulfillment of the requirements for the

LL.M. International Business Taxation

Supervisor

Dr. Ricardo Garcia Antón

Tilburg, 12/08/2019

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CHAPTER 1 – INTRODUCTION/MOTIVATION OF THE STUDY .................................... 3

Introduction / Significance of the Study: ................................................................... 3

Research Question: .................................................................................................... 4

Benchmark/Methodology: ......................................................................................... 4

Delimitation: .............................................................................................................. 4

CHAPTER 2 – THE STARBUCKS CASE ......................................................................... 6

1.1 Analysis of the facts of Starbucks case & Arguments of the Commission when

ascertaining State - Aid infringement ........................................................................ 6

1.2 Commission’s Arguments .................................................................................... 8

CHAPTER 3 – RECONSTRUCTING THE LEGAL CONCEPTS DERIVED FROM THE

STARBUCKS DECISION ......................................................................................... 12

3.1 EU State Aid Policy evolution ........................................................................... 12

3.1.1 State Aid Law and competence of Member states in direct taxation .............. 14

3.1.2 The European legal framework of State Aid .................................................. 15

3.1.3 Fiscal state aid’s scope .................................................................................... 16

3.1.4 Notions of the provision in particular ............................................................. 17

3.1.4.1 The “State resources” criterion: ................................................................... 17

3.1.4.2 The “distortion of competition” between the Member States criterion: ...... 17

3.1.4.3 The “advantage” criterion: ........................................................................... 18

3.1.4.4. The “selectivity” criterion: .......................................................................... 18

3.1.4.4.1 Selectivity’s three - step analysis: ............................................................. 19

3.1.4.4.2 The Importance of the (wide or narrow) definition of the Reference

System ...................................................................................................................... 19

3.1.4.4.3 Legal sources of the reference system ...................................................... 21

3.1.4.5 The relation between the advantage and selectivity criterion ...................... 21

3.1.5 Landmark Case Law ....................................................................................... 22

3.2 The Arm’s Length Principle & OECD’s Transfer Pricing Guidelines ............. 30

3.2.1 Legal Nature, implementation and effectiveness ............................................ 30

3.2.2 The Arm’s Length Principle in European Law ............................................... 31

3.3 Tax Rulings ....................................................................................................... 37

3.3.1 Definitions, Legal Nature and Typology .................................................... 37

3.3.2 Advance Pricing Agreements in the EU ......................................................... 38

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3.3.3 Advance Pricing Agreements within the framework of EU’s State Aid

Legislation ............................................................................................................... 39

3.3.3.1 The Selectivity criterion in APA’s – Case law ............................................ 42

CHAPTER 4 - CHALLENGING THE COMMISSION’S ARGUMENTS BASED ON

CHAPTER 3 ........................................................................................................... 45

4.1 Integration of the advantage and selective criterion. ......................................... 45

4.2 Which reference system - which benchmark group? ......................................... 45

4.3 Which Dutch tax provisions? ............................................................................. 48

4.4 Are MNE’s and standalone companies comparable? ........................................ 48

CONCLUSIONS ............................................................................................................. 50

BIBLIOGRAPHY ..................................................................................................... 52

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CHAPTER 1 – INTRODUCTION/MOTIVATION OF THE STUDY

Introduction / Significance of the Study: The European Commission started formal State aid investigations for Apple, Starbucks,

Amazon, Fiat and McDonald’s multinationals regarding the tax rulings granted to them

by the respective tax authorities of Ireland, the Netherlands and Luxembourg. The EC’s

decisions, of the 21st of October 2015, were negative with recovery; namely that both

Luxembourg and the Netherlands’ tax rulings had granted selective tax advantages to

the companies. Similarly, on the 30th of August 2016, announced that Ireland favored

fiscally Apple by 13 billion euros.1 Moreover, Commissioner Vestager in a live press

conference on 30 August 2016 revealed that the EU Commission has currently under

scrutiny the issue of more than 1.000 tax rulings.

Οn the other hand, the United States have raised many objections towards these

investigations that are mainly focusing American companies. The United States indeed

have every reason to worry as they apply the credit system and every company that will

be obliged by the Commission to recover unpaid taxes, the same amount will have to

be credited against their US Corporate tax exposure.2 Given that the latter can also lead

to a significant reduction in cross-border activity, we understand that what is at stake is

extremely important for the global economy and the European Union’s growth most

particularly.

In this Master’s Thesis after having examined the facts of Starbuck’s Case and the

reasoning developed by the Commission in its State Aid decision, I will define my legal

framework and, based on this, I intend to critically question Commission’s arguments

when ascertains State Aid infringement regarding the Advance Pricing Agreement

issued by the Netherlands to Starbuck’s. Within this context will be illustrated that the

selectivity criterion has been erroneously interpreted in this case; moreover, the

selectivity is integrated with the separate advantage criterion and that the Commission

seems to “invent” an EU Arm’s Length Principle to support her reasoning.

1 Cachia F, Analyzing the European Commission’s Final Decisions on Apple, Starbucks, Amazon and

Fiat Finance & Trade‟ (2017) 1 EC Tax Review p. 23 2 Forester Emily, ‘Is the State Aid Regime a Suitable Instrument to Be Used in the Fight Against

Harmful Tax Competition?’ EC TAX REVIEW 2018/1, p. 32

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My final conclusion will be that the Commission should not use State Aid regulation in

order to tackle harmful tax competition within the European Union in place of the

instrument of legal harmonization which has not yet been achieved at EU level; such a

State Aid use is invasive towards the fiscal sovereignty of the Member States.

Research Question: Is the Commission right in its approach to State Aid based on

Starbucks case?

Benchmark/Methodology: The aim of this paper is to test the arguments of the

Commission in Starbuck’s case from a political and legal perspective. Within this

intent, an analytical approach towards Article 107(1), the Arm’s Length principle and

the Advanced Pricing Agreements is presented following the criteria consistently

adopted in ECJ case law, as well as in recent scholarship on the topic.

Delimitation: The issue of the recovery process of State aid with regard to tax rulings will not be

addressed in this paper.

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Outline:

1. Introduction/motivation

2. Research question. Is the Commission right in its approach to State Aid based

on Starbucks case?

3. Starbucks Case

4. Theoretical framework

5. Application of the theoretical framework to the arguments provided by the

parties in Starbucks case.

6. Conclusion

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CHAPTER 2 – THE STARBUCKS CASE

1.1 Analysis of the facts of Starbucks case 3 & Arguments of the Commission

when ascertaining State - Aid infringement

Starbucks is a MNE with two companies residing in the Netherlands, Starbucks Coffee

EMEA B.V. (Starbucks Coffee BV) and Starbucks Manufacturing EMEA B.V.

(SMBV). Starbucks Manufacturing BV buys green coffee beans from the Swiss

subsidiary company, “Starbucks Coffee Trading SARL” based on a green coffee

purchase agreement between them, while the Swiss subsidiary buys the green coffee

beans on the market. After the purchase of the green coffee beans from Starbucks

Manufacturing BV, the latter roasts these beans and mainly sells roasted coffee to

affiliated and non-affiliated parties. The roasting of the beans is conducted in

accordance with a certain knowhow4, which is owned by Alki LP, another subsidiary

of Starbucks, situated in the UK. This knowhow owned by Alki LP, in the UK, is

licenced to Starbucks Manufacturing BV through a roasting agreement, which in turn

pays a royalty to the UK subsidiary. We have therefore two main transactions: 1)

3 Chart from the Commission’s decision of 21 October 2015, C (2015) 7143 final 4 The knowhow is what procedures Starbucks should follow for the roasting of the beans.

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SMBV buying green coffee beans (raw material) and 2) the royalty payments by SMBV

to the UK subsidiary.

With respect to Starbucks Coffee BV this was the Group’s Head Office in the Europe

Middle East and Africa region with Alki LP being its shareholder. Starbucks Coffee

BV licensed Trademarks and Know-how from Alki LP paying to it a royalty, and at the

same time receiving licence payments for the I.P from developers of Starbucks shops

calculated as a percentage of their turnover, with all developers paying the same

percentage.

According to the Commission’s decision, the Dutch tax administration granted state aid

to Starbucks through an advanced price agreement (the SMBV APA) on how to apply

the transfer pricing rules between the Starbucks Manufacturing BV and the Dutch tax

administration, concluded on 28 April 2008 and for 10 years duration, (from 1 October

2007 to 31 December 2017).

The Dutch tax authorities accepted, as consistent with the ALP, the remuneration for

SMBV’s functions (including risk and assets) to be a mark-up of 9%-12% of the

relevant cost base. The latter consisted of all personnel costs of both manufacturing and

supply chain operations, the cost of production equipment (i.e. depreciation) and plant

overheads excluded however the costs of the cups, paper napkins, etc., the costs of

green coffee beans (cost of raw materials), the logistics and distribution cost for third

party services, the remuneration for the so-called “consignment manufacturing

contracts” and the royalty remuneration to Alki LP.

With regard to the royalty remuneration to Alki LP the Dutch tax authorities approved

that it can be calculated by deducting the previously mentioned 9%-12 % operating

costs mark-up from the realized operating profit (before royalty costs). Additionally,

the royalty remuneration would be deductible from the taxable corporate base and no

withholding tax would be levied.

The functional analysis of the Starbucks TP report to the Dutch Tax Authorities put the

emphasis of SMBV s operations to its roasting facilities in Amsterdam. From the almost

40-60 people employed by SMBV about half of them were working by its supply chain

and logistics operations.

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According to Starbucks, SMBV opted for the Transactional Net Margin Method for an

arm’s length principle based transfer pricing because it is less affected by transactional

and functional differences. Applying a mark up to the costs relevant for SMBV,

considered its operating costs because it adds value, was the best way for its operations

that included the offer of some/specific manufacturing and supply chain services (that

compared to the aforementioned operations of Starbuck Netherlands BV, whose royalty

receiving model from Starbucks shop developers at a constant percentage for all was

considered by Starbucks as appropriate ground for the application of the Comparable

Uncontrolled Price Method (CUP). The raw material cost is excluded as not part of the

business risks that it undertakes and adds value through its operations and as well as

the royalty which was paid to Alki LP.

The commission as part of its investigation on the issue proceeded to specify European

companies that could be considered peer companies to SMBV that is conducting the

same operations and undertaking the same risks with companies trading coffee being

selected. A comparable net profit margin calculation for the peer companies by dividing

their operating profit with their operating costs showed that form 2001-2005 the median

unadjusted cost markup margin was 7.8%. Starbucks was of the opinion that the

comparable chosen included companies with additional functions and full

manufacturing operations compared to those of SMBV and it was natural for these firms

to also include the cost of the raw materials as operating costs. By adjusting the cost

markup margins of these comparables to exclude the cost of raw materials, as Starbucks

considered proper for SMBV, the peer universe cost markup media margin for the

period under investigation would rise from 7.8% on total costs to 9.9% of adjusted

operating costs allowing some room to this markup margin to be within 9-12% of

operating costs was judged by Starbucks and the Dutch Tax authorities as a proper AL

margin for SMBV.

1.2 Commission’s Arguments According to the Commission the remuneration approved by the SMBV APA was not

in arm’s length considering the functions performed by SMBV. To be more precise the

commission expressed the following concerns:

‘Whether the Dutch tax administration correctly accepted SMBV’s classification as a

low-risk toll manufacturer when it concluded the SMBV APA’;

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More particularly, the Commission when examining the financial accounts of SMBV,

discovered an inventory risk undertaken by SMBV that challenges the transfer pricing

report’s consideration that SMBV does not bear any risk (since it just roasts coffee) and

thus should be considered a toll manufacturer.5

‘Whether the Dutch tax administration was right to accept adjustments made by

Starbucks’ tax advisor when it concluded the SMBV APA;’

In other words, the Commission did not accept the justification for two adjustments that

were targeting a common issue of achieving comparability for SMBV's transfer pricing

methodology. Namely, the first adjustment, which the tax advisor supported, had to do

with the reduction of SMBV’s cost base when estimating the taxable base, according

to the Commission: "consists in reducing the cost base retained to calculate SMBV’s

taxable base to operating expense’. And the second, it involved the deduction of a

multiple of Cost of Goods Sold from peer companies’ profit to come up with a

comparable estimate figure. This latter, which reduced taxable income in the

Netherlands, was claimed by the Netherlands to be an adjustment for working capital,

but there appeared to be no clear justification regarding its nature and why it was

implemented the way it was.6

Regarding the remuneration received by SMBV when selling its products to the shops

(without however bearing the risks for the losses which belonged to Alki): The

Commission questioned the fact that Starbucks didn’t take into account comparable

actors-competitors in the market who do more or less what Starbucks does. On the

contrary, SMBV considering its simple and low risk function set the margin that should

gain every year lower to the comparables on the market at the level of around 9-12 %

of its operating expenses. The Commission however doubted that it was an ALP

remuneration and it gave also the example of the US manufacturing company Starbucks

Manufacturing Corporation (SMC), for which the average level of remuneration for the

roasting function was at around 500 % on its operating expenses over the past four

accounting periods according to its financial accounts7.

5 COMMISSION DECISION of 21.10.2015 ON STATE AID SA.38374 (2014/C ex 2014/NN)

implemented by the Netherlands to Starbucks, para. 158 6 See above last para of the facts section 7 COMMISSION DECISION of 21.10.2015 ON STATE AID SA.38374 (2014/C ex 2014/NN)

implemented by the Netherlands to Starbucks, para. 140, Table 9

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With regard to the remuneration paid by SMBV to SCTC for the purchase of green

coffee beans : SCTC’s main functions was the purchase and sale of high quality green

coffee beans and related to this function activities. From 2006 up to 2010 the average

mark up on the costs was 3%. However, from 2011 up to including 2014 there was an

increase in the mark-up, which Starbucks applied to determine the price, the new mark-

up was 18%. The Commission focused the attention on the increase of the price mark-

up. Starbucks argued that the function executed by the subsidiary gained in expertise

and became more complex due to the C.A.F.E. Practices Program. The Commission

indeed noticed that financial accounts show an increase of the risk, but this was cash

capital, no value or function regarding the risk was increased, in comparison to the

past“Although the total assets have indeed grown significantly since 2010, this is

mainly due to increased cash holding. Operating assets net of cash have increased by

less than a third over the four years from 2010 to 2014.”8

According to the Commission, this was a way to lower the Netherland’s tax base and

shift profits to the Swiss subsidiary and when the Netherlands accepted these transfer

pricing arrangement this fact constituted state aid.

‘Whether the Dutch tax administration was right to accept SMBV’s interpretation as

regards the calculation of royalties in its profit and loss accounts, insofar as the level

of those royalties is not linked to the value of the IP in question.’9

The Commission did not considered the royalty paid to Alki LP consistent with the

arm’s length principle, because the amount for the royalty did not correspond to the

value of the Intellectual Property, but rather the royalty corresponded to the residual

profit10 in the P&L account (even though was an operating expense in the financial

accounts) and the reason is the TNMM used for the transfer pricing: “the Commission

considers that a comparison to comparable uncontrolled transactions, in particular the

roasting IP licensing arrangements in several roasting and manufacturing and

distribution agreements Starbucks concluded with third parties, demonstrates that the

arm’s length value of the royalty paid by SMBV to Alki LP for the roasting IP should

be zero. Consequently, the SMBV APA, by accepting a methodology for determining

8 COMMISSION DECISION of 21.10.2015 ON STATE AID SA.38374 (2014/C ex 2014/NN)

implemented by the Netherlands to Starbucks, para. 118-119 9 COMMISSION DECISION of 21.10.2015 ON STATE AID SA.38374 (2014/C ex 2014/NN)

implemented by the Netherlands to Starbucks, para. 156,157 10 Excess profit beyond the 9-12% mark- up

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the level of the royalty according to which all profits generated by SMBV in excess of

[9-12] % of operating expense is transferred to Alki LP, confers a selective advantage

on SMBV for the purposes of Article 107(1) of the Treaty”. 11

The tax advisor of Starbucks argued that between the Starbucks Manufacturing BV and

Alki LP a roasting agreement is concluded on the basis of which all the risk of the

Starbucks Manufacturing BV is transferred to Alki LP. Starbucks Manufacturing BV’s

only activity executed is roasting coffee beans, a routine activity, on the basis of the

knowhow of Alki LP. The SMBV finds itself the mere executor with minimal risk,

therefore the royalty price also included a remuneration for Alki’s function as principal

company. The Commission in turn questioned the fact that Alki LP does not have any

employees. Consequently, there is no one who can bare this risk. Starbucks argued that,

when they need so, they hire employees from the affiliate in the US with which they

had entered to a cost sharing agreement. Then the Commission questioned why the

SMBV does not hire the employees itself.

11 COMMISSION DECISION of 21.10.2015 ON STATE AID SA.38374 (2014/C ex 2014/NN)

implemented by the Netherlands to Starbucks, para. 360

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CHAPTER 3 – RECONSTRUCTING THE LEGAL CONCEPTS DERIVED FROM

THE STARBUCKS DECISION

3.1 EU State Aid Policy evolution Article 107 of the TFEU (Treaty on the Functioning of the European Union) made

explicitly clear the target regarding state aid: “Save as otherwise provided in the

Treaties, any aid granted by a Member State or through State resources in any form

whatsoever which distorts or threatens to distort competition by favouring certain

undertakings or the production of certain goods shall, in so far as it affects trade

between Member States, be incompatible with the internal market”.

According to the Commission’s guidelines set in “State aid action plan - Less and better

targeted state aid: a roadmap for state aid reform 2005–2009”, paragraph 7, competition

policy relies on the notion that a market-based economy provides the best guarantee for

supporting rising living conditions in the EU, with well-functioning markets being

necessary to provide consumers with products at low prices. The need to control state

aid arises from the requirement to “maintain a level playing field for all undertakings

active in the Single European Market” irrespective of their Member State of

establishment. State aid measures become a source of worry when they contribute to

distortions of competition, i.e. when they extend “unwarranted selective advantages” to

particular firms, therefore preventing proper functioning of market dynamics from

deciding relative success/failure and imposing market structure, or when they favor

concentration of market power to the receivers of state aid at the expense of non-

receivers who are forced to reduce their presence and even exit a market, or even when

such measures constitute a barrier of entry to a market favoring incumbents. State aid

furthermore it is added, does not come from free: it must be finance from budgets, that

is tax payers, directly or with the form of state funding resources being depleted from

other potential uses. 12

Therefore, the rationale for state aid laws is that competition must exclusively be

governed by market forces. If a national government grants a financial help to a

company or a sector of business activities, this advantage will disrupt the level playing

field by compromising the efficiency of the market. The concept of state aid, including

12 A. Martin Jimenez, Level playing field versus member states' direct tax policies: the State aid

(r)evolution, P. Pistone (ed) European Tax Integration (IBFD, 2018), chapter 8

13

fiscal state aid, is aimed at implementing and obtaining of this concept of competition,

where the market shall be exclusively governed by market forces. As a result of this,

the EU, that is substantially based on market values.

While, the State Aid Action Plan sets a guiding structure for the state aid regulation

perfectly compatible with the spirit of article 107 of the TFEU, we must note that their

starting position, as previously mentioned (that of defending proper functioning internal

markets and competition) has also further taken a clearer later shift to added concerns

of fiscal discipline. Such a shift is evident in the State Aid Modernization

Communication (SAM) in 2012:13 as stated in Article 14: “By putting an emphasis on

the quality and the efficiency of public support, State aid control can also help Member

States to strengthen budgetary discipline and improve the quality of public finances –

resulting in a better use of taxpayers' money. It is particularly important in order to

achieve smart fiscal consolidation, reconciling the role of targeted public spending in

generating growth with the need to bring budgets under control”. 14

This course in State aid through the past years, where additional focus appears to have

been put towards being also utilized as an instrument for imposing fiscal disciple might

not be something negative per se, it could even be argued to be beneficial by some. Yet,

it is highly uncertain how much this view on State aid is in line with article 107(1) of

the TFEU and its focus on internal market issues. Furthermore, when State aid is further

utilized as a tool of imposing particular policies with respect to corporate taxation in

the EU that could be claimed that are far from the scope of article 107(1) of the TFEU,

then it could be argued that the situation becomes more problematic15. This could mean

in effect a potential serious intervention, in name and arguably based on article 107(1)

of the TFEU and its clauses, in the taxation policy of Member States a function that

has been fully under their power and responsibility by all means, that could have the

effect of minimizing or putting indirectly in question this State power of imposing their

13 A. Martin Jimenez, Level playing field versus member states' direct tax policies: the State aid

(r)evolution, P. Pistone (ed) European Tax Integration (IBFD, 2018), chapter 8 14 https://eur-lex.europa.eu/legal-

content/EN/TXT/PDF/?uri=CELEX%3A52012DC0209&from=EN&fbclid=IwAR30I9Jy9dpewIJAAX

g-UL9xVAkvwBeg8op64WNkV68SMer-LRy6Ht-FLjY 15 According to the 2016 Commission’s Notice, par. 156: “Member States are free to decide on the

economic policy which they consider most appropriate and, in particular, to spread the tax burden as they

see fit across the various factors of production. Nonetheless, Member States must exercise this

competence in accordance with Union law.”

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direct tax policy; if taken even a step further from the oversight of fiscal discipline

goal, this could imply control of the Member State’s tax policy by the European

Commission, which could imply exercising effective control of Member States

corporate tax policies, as the Commission would potentially be the one deciding on the

implementation of respective policies, while potentially being the one to provide the

definition of what constitutes “harmful tax competition”. 16

3.1.1 State Aid Law and competence of Member states in direct taxation17 One material issue to examine is the relation between state aid law and the competence

of Member States in direct taxation. The competence in direct taxation is a shared

competence with preemption. This means that in principle member states have

sovereignty in matters of direct taxation, namely each state has its own corporate

income tax. There is only to a little extent harmonization such as the merger directive

and the parent subsidiary directive and “only where EU legislation leaves room for

discretion of the Member States to unilaterally grant specific exemptions can State aid

arise”18.

Member States, until today, haven’t chosen to give up their sovereignty in direct

taxation because the latter has a direct impact on each state’s policies. It is through

direct taxation that Member States develop their redistributive policies. Thus, it is

important to keep their sovereignty in this field.

State aid rules do have an impact on direct taxation of Member States (as the latter can

be deemed incompatible19 20) and depending on how broad the concept of state aid has

been interpreted, respectively the sovereignty of MS is proportionally reduced. Τhe

case-law of the European Courts and the practice of the Committee are moving towards

a broad notion of selectivity, with all that it implies for the sovereignty of the Member

States

16 A. Martin Jimenez, Level playing field versus member states' direct tax policies: the State aid

(r)evolution, P. Pistone (ed) European Tax Integration (IBFD, 2018), chapter 8 17 See MICHAU p. 476 18 Lang et al, Introduction to European Tax Law on Direct Taxation (Fourth Edition), Linde: 2016, p.

104 19 Cases: Belgium and Forum 187 ASBL v. Commission and Ladbroke Racing Ltd v. Commission 20 Edouard Fort, EU State Aid and Tax: An Evolutionary Approach, European Taxation September 2017,

IBFD, p. 375

15

Against this direction Advocate Maduro expressed his fear that all economic policies

will be assessed under the light of state aid regulation. Academics also worry about the

broad scope evolved which contradicts member state’s fiscal autonomy in the direct

taxation field.21

3.1.2 The European legal framework of State Aid The general provisions regarding state aid prohibition are in Articles 107 and 108

TFEU. The notion of state aid is addressed in the TFEU Article 107 (1): "Save as

otherwise provided in the Treaties, any aid granted by a Member State or through State

resources in any form whatsoever which distorts or threatens to distort competition by

favouring certain undertakings or the production of certain goods shall, in so far as it

affects trade between Member States, be incompatible with the internal market."

Article 107 (1) states when state aid is incompatible with the internal market. The

following are the four cumulative criteria which qualifies as state aid:

i. There must be an advantage, ii. This advantage must be selective (given to certain

undertakings or certain goods), iii. Must distort and threaten to distort competition

between Member States, iv. Transferred from state resources

State aid is an advantage (financial) which is granted by the state or through state

resources to a specific company or sector of activities (in favor of specific goods or

services) and this advantage distort or threaten to distort the competition within the

internal market. There must, hence, be an advantage (advantage criterion) which is

derived from state resources to certain companies (selectivity criterion) and it must

distort or threaten to distort competition.

In addition to the State aid general prohibition, the Council of Economics and Finance

Ministers adopted the Code of Conduct for business taxation, a soft law (thus not legally

binding) but with political force instrument on 1 December 1997.22 The Member States

pledged to roll back existing tax measures that constitute harmful tax competition

("rollback") and refrain from introducing any such measures in the future ("standstill").

The Code also provides also for the diagnostic criteria for such potentially harmful

21Forester Emily, Is the State Aid Regime a Suitable Instrument to Be Used in the Fight Against Harmful

Tax Competition? EC TAX REVIEW 2018/1 22 https://ec.europa.eu/taxation_customs/business/company-tax/harmful-tax-competition_en

16

measures. On 9 March 1998, the EU's Finance Ministers established the Code of

Conduct Group (Business Taxation) to assess the tax measures that may fall within the

scope of the Code of Conduct for Business Taxation while in November’s 1999 report

66 tax measures with harmful elements were identified by the Group. In addition, the

latter has been monitoring the compliance with the rollback and standstill agreements

made and reports regularly to the Council of Finance Ministers. In paragraph J of the

Code the European Commission committed itself to publish guidelines on the

application of the State Aid rules to measures related to direct business taxation. The

Commission notice (98/C 384/03) was published on 11 November 1998 and replaced

by its final notice on the notion of State aid (2016/C 262/01) of the 19th July 2016.

3.1.3 Fiscal state aid’s scope CJEU’s interpretation of the concept of fiscal state aid is broad and is not limited to

subsidies. It includes tax incentives such as credits exemptions and other tax

advantages. Everything, which decreases the tax burden lowering the taxable base is

included in the scope of State Aid law: “the definition of aid includes not only positive

benefits, such as direct subsidies, but also State measures which, in various forms,

mitigate the charges which are normally included in the budget of an undertaking and

which thus, without being subsidies in the strict sense of the word, are similar in

character and have the same effect”23 . This means that the exercise of the fiscal

competence by member states might, in certain cases, violate the TFEU.

For instance, indicatively relevant are ECJ’s decisions in case “DM Transport”(C-

256/97)24 and case “Germany v Commission” (C-156/98)25 with regard to special

depreciations and tax deferrals. Reduced taxation in “Ecotrade SRL” case (C-200/97)26.

No taxation at all or exemptions for certain taxes, in “Italy v Commission Case” (C-

23CASE “ADRIA-WIEN PIPELINE AXD WIETERSDORFER & PEGGAUER ZEMENTWERKE”

http://curia.europa.eu/juris/showPdf.jsf?text=&docid=46829&pageIndex=0&doclang=EN&mode=lst&

dir=&occ=first&part=1&cid=6150983 24http://curia.europa.eu/juris/showPdf.jsf?text=&docid=44280&pageIndex=0&doclang=EN&mode=lst

&dir=&occ=first&part=1&cid=6127569 25http://curia.europa.eu/juris/showPdf.jsf?text=&docid=45644&pageIndex=0&doclang=EN&mode=lst

&dir=&occ=first&part=1&cid=6127569 26http://curia.europa.eu/juris/showPdf.jsf;jsessionid=FE9563D55AD6487DA4BB8799DA35040B?text

=&docid=43754&pageIndex=0&doclang=EN&mode=req&dir=&occ=first&part=1&cid=6127569

17

66/02)27, whereas for tax credits the join cases Diputación Foral de Guipúzcoa and

others v Commission28 (T-269/99, T-271/99 and T272/99).29

3.1.4 Notions of the provision in particular

3.1.4.1 The “State resources” criterion30: The aid given must derive from the public budget, whether it be the general or local’s

government. And since any tax relief has a direct impact on the budget, it goes without

saying that tax advantages granted always satisfy the “state resources” criterion. It is

also important to note that the aid may come from acts of the legislative and executive

power as well as administrative fiscal authorities.

Moreover, the benchmark for examining this criterion is the beneficiary taxpayer and

not the taxpayer's state, for example, if the budget of the state ultimately benefits from

the aid granted, it is irrelevant for state aid law. So it was also decided by the

Commission in the case of Belgium on the aid schemes for coordination centers

established in Belgium (OJL 282, 30 Oct. 2003).31

3.1.4.2 The “distortion of competition” between the Member States criterion32: The two elements of this criterion, namely, 1.Τhe distortion of competition and 2.

Affecting trade between Member States are fully connected. In fact, for the fulfillment

of this criterion, the distortion of competition affecting trade between Member States is

sufficient to be potential. This broad scope of the criterion leads to its acceptance

without much consideration whenever the rest criteria are met. Yet, according to the

Notice on Business Taxation, OJC of 1998, pp.3-9, para.15, the reference system for

the examination of this criterion is the national tax system of the Member State which

granted the beneficial tax treatment.

27 http://curia.europa.eu/juris/showPdf.jsf?text=&docid=57101&pageIndex=0&doclang=EN&mode=lst

&dir=&occ=first&part=1&cid=6127569 28 http://curia.europa.eu/juris/showPdf.jsf?text=&docid=47802&pageIndex=0&doclang=EN&mode=lst

&dir=&occ=first&part=1&cid=6127569 29 H. Lopez Lopez, Selectivity (State Aid quarterly, 2010), p. 808, note 5 30 Lang et al, Introduction to European Tax Law on Direct Taxation (Fourth Edition), Linde: 2016, p.

107 31 Edouard Fort, EU State Aid and Tax: An Evolutionary Approach, European Taxation September 2017,

IBFD, p. 375 32 Lang et al, Introduction to European Tax Law on Direct Taxation (Fourth Edition), Linde: 2016, p.

108-109

18

3.1.4.3 The “advantage” criterion: As analyzed above the advantage for State aid Law does not include only positive

benefits, such us subsidies but also any kind of monetary advantage, granted by the

state or belonging to the state’s budget but not collected. The form of the advantage is

not relevant in determining whether or not it grants an economic advantage. What is

examined for state aid purposes is the effect of the measure, not the cause or the

objective of the state intervention ‘….Accordingly, Article 92 does not distinguish

between the measures of State intervention concerned by reference to their causes or

aims but defines them in relation to their effects’33. The benefit puts the beneficiary in

a more advantageous position over the others in the market, making it more competitive

than it would be without the state’s intervention.

In order to assess whether a fiscal advantage is granted we must compare it with the

standard tax system and as Member States still withhold their fiscal sovereignty in

direct taxation the tax system cannot be anything other than that of the respective

Member State’s tax system.

3.1.4.4. The “selectivity” criterion: Τhe criterion of selectivity is the key criterion which presents the greatest difficulty in

its assessment compared to the other criteria of Article 107 TFEU. As abovementioned,

a measure is considered as “selective” if it is granted to only certain undertakings or the

production of certain goods, departing so from the common system. Therefore, general

measures (applicable in a nondiscriminatory way) do not fall under the scope of article

107 TFEU.34

Yet, distinguishing the general tax measures from the selective ones is not an easy task

to perform. Therefore, it is crucial to analyze the facts of each case separately and

beyond the wording of the tax provision in question. This “de facto selectivity” test

allows to assess efficiently whether a measure - despite its characterization as general -

favors de facto certain undertakings or not. That was for instance, the case in the

decision for SEAS, a Danish electricity company and the selective tax measure favoring

in practice only the latter.35

33ITALY v COMMISSION (C- 173/73), p.13 34Micheau, State Aid, subsidy and tax incentives, (Kluwer, 2014), p. 220 35Micheau, State Aid, subsidy and tax incentives, (Kluwer, 2014), p. 226

19

Moreover, an in concreto analysis needs to be carried out in order to be assessed

whether the tax measure is indeed available to all, thus non-selective. Because, as soon

as the tax measure can favor every undertaking it doesn’t matter if some of them can

be, by result, in more favorable condition than the others.36

Ιt is important at this point to quote the view of the Commission as it was stated in its

Notice, point 13 under the title “ Distinction between State aid and general measures”,

with regard to tax measures with a mere technical character as well as tax measures

with general economic policy aims:

“….Provided that they apply without distinction to all firms and to the production of

all goods, the following measures do not constitute State aid: —tax measures of a purely

technical nature (for example, setting the rate of taxation, depreciation rules and rules

on loss carry-overs; provisions to prevent double taxation or tax avoidance),

—measures pursuing general economic policy objectives through a reduction of the

tax burden related to certain production costs (research and development (R@D), the

environment, training, employment).37

3.1.4.4.1 Selectivity’s three - step analysis: According to the commission and European Court’s practice the selectivity criterion is

assessed following a three step test as below:

1) First we need to individuate the reference system

2) Second, we must examine whether the tax measure granted derogates from the

reference system

3) Third, the state should justify the derogations on the basis of the general and natural

scheme of its tax system.

3.1.4.4.2 The Importance of the (wide or narrow) definition of the Reference

System The individuation of the reference system is the most important step in the examination

process since the second and third steps are essentially dependent on how the reference

system will be interpreted. More particularly, the reference system consisting of a set

of norms is our benchmark to assess whether we have a derogation from it. In addition,

36Micheau, State Aid, subsidy and tax incentives, (Kluwer, 2014), p. 226 37 Commission notice on the application of the State aid rules to measures relating to direct business

taxation (98/C 384/03), point 13

20

the scope of the reference system is decisive in order to discover the companies

included in the reference system and assess whether some of them are treated more

favorably than the others. And last, regarding the justification of the derogation, again

the underlying purpose of the reference system is examined.

The corporate tax system looks like a “Russian nesting doll” which includes general

rules (applicable to all taxpayers), exceptions to these general rules and exceptions to

the exceptions which apply solely to certain taxpayers with specific criteria and “If the

reference system is defined at a 'high' level within this hierarchy of tax rules, the

outcome will be dramatically different than if the reference system is defined more

narrowly at a 'lower' level within the tax system.”

For instance, as we will see below in Paint - Graphos Case for Italian cooperatives the

reference system was defined as the whole corporate tax system. All companies,

included the Italian cooperatives, fell within the scope of the whole corporate tax

system of Italy. Within this framework, the exemptions granted to the Italian

cooperatives constituted an unequal treatment compared to the treatment of the other

companies.

On the contrary in case law settled i.e regarding measures which lowered the taxable

income (and didn’t exempt it as above) the reference system was made up of this

specific rule and in order to individuate the latter “the 'Russian nesting doll' has to be

unpacked until the lowest level of generality has been identified”. This narrow

definition of the reference system was applied to the Finish “P Oy” case for exceptions

granted to the company to carry forward off settable losses despite a transfer of control.

As a result, the reference system was considered to be the specific rule that off settable

losses cannot be carried forward after a transfer of control. Further, the 'benchmark

group' was limited to companies with off-settable losses which had transferred the

control of the shares. The question to be answered in this case was whether the Finish

exception granted a more favorable treatment in the relevant company compared to

other companies with carry forward losses and transferred control of shares.38

38 Verschuur, S., Stroungi, M., State aid and tax rulings - the Commission's approach to virtual payments:

equal treatment of multinationals? European State aid law quarterly. - Berlin. - Vol. 16 (2017), no. 4; p.

598-606, 2017, p.600-601

21

As already abovementioned, the Commission’s practice and EU court’s decisions

usually define the reference system broadly, enlarging thus the scope of the selectivity

assessment. This practice becomes apparent in Commission’s references to a "tax

system", a "common system" in its since 1998 Notice, in its decisions when referring

to deviations from ‘normal taxation’, and in its since 2016 Notice par. 134 where

explicitly adopts a broad approach: “in the case of taxes, the reference system is based

on such elements as the tax base, the taxable persons, the taxable event and the tax

rates. For example, a reference system could be identified with regard to the corporate

income tax system, the VAT system, or the general system of taxation of insurance”.

Yet, the Court conducts a case-by-case examination in order to apply each time the

correct benchmark.39

3.1.4.4.3 Legal sources of the reference system The reference system must consist of all the legally binding rules of a Member State

since illegal state aid constitutes a deviation from a rule of such nature, a coercive tax.

Legally binding rules in most Member States are the laws legislated by the Parliament:

that is first, the domestic corporate income tax system, and second, applicable and in

force tax treaty-based provisions. Furthermore, non-binding rules cannot be part of the

reference system for yet another important reason; it would constitute a serious

violation of the principles of legality, foreseeability of taxation and equality before the

law.40

3.1.4.5 The relation between the advantage and selectivity criterion I find it also imperative to clarify here that according to serious criticisms raised by

scholars the two criteria, advantage and selectivity, are distinct and thus should be

examined separately, despite the recent identification of the two criteria by the

Commission and part of case law 41 . Because we may encounter cases where an

advantage has been granted (relieving the recipients of charges that are normally borne

39 Monsenego, J. (Jérôme), Selectivity in State aid law and the methods for the allocation of the corporate

tax base, Alphen aan den Rijn: Kluwer Law International, 2018, Series title: Eucotax series on European

taxation; volume 60, p. 45,46,47 40 Monsenego, J. (Jérôme), Selectivity in State aid law and the methods for the allocation of the corporate

tax base, Alphen aan den Rijn: Kluwer Law International, 2018, Series title: Eucotax series on European

taxation; volume 60, p. 52, 53 41 Richelle, I., Schön, W., Traversa, E. (Edoardo), State aid law and business taxation, Berlin: Springer,

2016, Series title: MPI Studies in Tax Law and Public Finance; 6, p .8; also Micheau, State Aid, subsidy

and tax incentives, (Kluwer, 2014), p.266; Gunn, A. Luts, J. Tax rulings, APAs and state aid: legal issues,

EC tax review. - Alphen aan den Rijn. - Vol. 24 (2015), no. 2; p. 119-125, 2015,p.121

22

from their budgets”42) but the criterion of selectivity, which requires the advantage

granted solely available to a specific group of undertakings, is not met as this advantage

is available in all undertakings in a similar factual and legal position, thus constituting

“general measures” and not state aid.43 Additionally, the need for separate examination

is also reinforced by the fact that selectivity can be justified on the basis of the general

and natural scheme of the tax system while for the advantage there is no justification

test.44

What is more, the U.S’s White Paper for the European Commission’s recent state aid

investigations of transfer pricing rulings is referred to 65 cases where the Commission

had assessed separately the advantage and the selectivity criterion. Moreover,

paradoxically, the US’ document articulates that the same findings are applied to the

Belgian Coordination Centres and ECJ’s Belgium and Forum 187 ABSL upon which

the Commission bases its recently adopted identification of the two criteria.45

3.1.5 Landmark Case Law At this point I will analyze landmark case law regarding the concepts of State Aid. Τhe

decisions on the criterion of selectivity, most particularly, demonstrate the difficulty of

the venture as, from their examination, we will find out that the content of the notion

constantly changes, with the lack of clarity as self-evidence consequence. Especially

where APA’s are under scrutiny by the European Commission the volatility of the

concept is more obvious as we will see later in the relevant chapter.

i. The Selectivity criterion in Adria-Wien Pipeline Case

In 1996 in Austria an energy tax on the delivery and consumption of electricity and

natural gas was introduced. At the same time, the Austrian parliament passed the

Energy Tax Refund Act. This law allowed business enterprises whose central business

activity was the production of tangible goods for a refund of the energy taxes exceeding

42 Commission Notice on the application of the State aid rules to measures relating to direct business

taxation (98/C 384/03), OJ C 384 (10 Dec. 1998). 43 Gunn, A. Luts, J. Tax rulings, APAs and state aid: legal issues, EC tax review. - Alphen aan den Rijn.

- Vol. 24 (2015), no. 2; p. 119-125, 2015, p.122; Schön W., Tax Legislation and the Notion of Fiscal

Aid- A review of Five Years of European Jurisprudence, Max Planck Institute for Tax Law and Public

Finance-Working Paper 2015-14, p.11 44 Micheau, State Aid, subsidy and tax incentives, (Kluwer, 2014), p. 268 45 https://www.treasury.gov/resource-center/tax-policy/treaties/Documents/White-Paper-State-Aid.pdf,

p. 7,8

23

a certain ceiling. This ceiling would be calculated in relation to the turnover structure

of the business. The ceilings were justified with reference to the competition situation

in the production sector.

According to CJEU’s decision in Adria - Wien Pipeline Case, a measure is selective

“in comparison with other undertakings which are in a comparable legal and factual

situation “in the light of the objective pursued by the measure in question”.

ii. The Selectivity criterion in the Paint Graphos Case

In Paint Graphos Case under scrutiny were the tax benefits granted to cooperative

societies. The CJEU, in this fiscal State aid case, confirmed the three-step selectivity

test. Further, in the context of this three-step selectivity analysis, the CJEU ruled that

tax measures are selective if they “are liable to favor certain undertakings or the

production of certain goods by comparison with other undertakings which are in a

comparable factual and legal situation, in the light of the objective pursued by the

corporation tax regime, namely the taxation of company profits.” Therefore, tax

advantages to cooperative societies might be justified in the light of the nature of the

corporate tax system as cooperative societies are required to distribute their income to

the members. We observe, thus, a broader scope of State Aid assessment from Adria

Wien Pipeline case to Paint Graphos as selectivity is examined in the light of the

objective pursued by the tax system.

iii. The Selectivity criterion in the Gibraltar case46

In the Gibraltar case the local government wanted to abolish the corporation tax and

introduce a payroll tax, a business property occupation tax and a company registration

fee. For the Commission47, the proposed taxation system was materially selective for

various reasons. Nevertheless, the ECJ, further extending the notion of the selectivity

criterion, decided that the proposed taxation system was selective because it favored

offshore companies with no physical presence in Gibraltar as they would escape

liability for the business property occupation tax and the payroll tax as well. Thus, for

46According to Lang (n 57) 806“On the 'policy oriented' use of competition law” in Gibraltar case a very

'wide' selectivity notion was endorsed which resulted in Article’s 107(i) use to tackle harmful tax

competition between MS, shifting its original aim. 47 Commission Decision 2005/261/EC of 30/03/2004 on the aid scheme which the United Kingdom is

planning to implement as regards the Government of Gibraltar Corporation Tax Reform, OJ 2005 L 85/1,

recital 143.

24

the first time the general tax system itself was selective (not just a measure deviating

from the reference tax system as we saw above in the Paint Graphos case) and expressly

designed in a way which favored a specified category of undertakings over others,

although they are in a legally and factually comparable situation, in light of the

objectives pursued by the system.48

iv. The Selectivity criterion in the World Duty Free Group case

A Spanish measure provided that undertakings taxable in Spain which acquired

shareholdings of at least 5% in a foreign company for at least one year were able to

deduct the amortized goodwill (from that shareholding) from their taxable corporate

income tax.

The Commission considered this measure to be selective but the General Court had a

different opinion; it decided that a mere derogation from the reference system is not

enough for the selectivity criterion to be fulfilled. Instead, the Commission also had to

identify the sole category of undertakings benefitting from the tax advantage. Because

according to the General Court, selectivity cannot be established when the tax

advantage is potentially available to every undertaking.

However, the CJEU clearly rejected General Court’s definition of the abovementioned

selectivity notion. Following the three step test firstly the reference system is identified

and examined: as in Paint Graphos case, the CJEU ruled that for tax benefits, the

reference system generally is the corporate tax system49. Secondly, the tax measure in

order to be regarded as selective must derogate from the reference system. The CJEU

also confirmed that the tax measure constitutes a derogation from the reference system

48 J J Piernas Lopez, 'The Concept of State Aid under EU Law. From internal market to competition and

beyond' (Oxford, OUP 2015),138 49 Nevertheless, even after World Duty Free, some doubts exist regarding a potential more restrictive

interpretation of the reference system by the Court: the CJEU stated: In that regard, the General Court

stated, in paragraph 50 of the judgment under appeal Autogrill España v Commission and in paragraph

54 of the judgment under appeal Banco Santander and Santusa v Commission, that the Commission, in

order to establish that the measure at issue was selective, had primarily relied, in the contested decisions,

on the ground that that measure constitutes a derogation from a reference system, in that the effect of

that measure was the application to undertakings taxable in Spain, acquiring shareholdings in

companies established outside Spain, of a tax treatment that differed from that applied to undertakings

taxable in Spain making such acquisitions in companies established in Spain, although those two

categories of undertakings were in comparable situations in the light of the objective pursued by that

reference system, namely the general Spanish system for the taxation of companies and, more

specifically, the rules relating to the tax treatment of financial goodwill”

25

inasmuch as it differentiates between economic actors who are in a comparable factual

and legal situation, in light of the objective assigned to the Member State’s tax system

(i.e the reference system). The CJEU, however, rejected General Court’s reasoning for

the need of the identification of the particular category of undertakings that is

exclusively favored. Thirdly, selectivity may be ruled out if the derogation can be

justified by the internal logic of the reference system.

v. The Selectivity criterion in Banco Santander50

In “Banco Santander” under Commission’s scrutiny is a provision granting tax benefits

to Spanish enterprises for cross border activities exclusively. In this case Spanish

corporate taxpayer acquired shares in foreign companies and made use of the provision

to fully deduct the acquisition costs in the first year. Commission’s point of view was

that selectivity was present because there was an exclusion to all companies investing

in the domestic territory. Nonetheless, the General Court’s judgement was that the full

depreciation of acquisition costs does not constitute State Aid because although a clear

advantage was granted to companies operating internationally, this advantage was not

considered available solely to “certain enterprises” or “certain branches of activity” (as

the selectivity criterion requires) but, on the contrary, the findings were in the direction

that any company could perform such an activity51.

vi. The selectivity criterion in Finanzamt Linz Case52

In “Finanzamt Linz” case the Austrian tax provisions under assessment provided partial

impairment on the goodwill of acquired companies only for domestic investments. The

Federal Administrative Court in Vienna questioned the CJEU apart from the issue

concerning the potential violation of the freedom of establishment also the

compatibility of the provisions with State Aid law. In this case Advocate General

Kokott despite the Court’s prior practice in many cases was in favor of a restrictive

notion of selectivity compatible with the national sovereignty in taxation. Therefore

50 Richelle, I., Schön, W., Traversa, E. (Edoardo), State aid law and business taxation, Berlin: Springer,

2016, Series title: MPI Studies in Tax Law and Public Finance; 6, p .19 51 Luja, R.H.C. Do state aid rules still allow European Union Member States to claim fiscal sovereignty?,

EC tax review. - Alphen aan den Rijn. - Vol. 25 (2016), no. 5/6; p. 312-324, 2016, p.316 52 Richelle, I., Schön, W., Traversa, E. (Edoardo), State aid law and business taxation, Berlin: Springer,

2016, Series title: MPI Studies in Tax Law and Public Finance; 6, p .19, 20

26

according to her the mere distinction between foreign and domestic shareholdings does

not fulfill the criterion of selectivity”.53

Additionally, another important element to be examined here is the fact that in the above

cases the advantage of impairment was granted only to corporate taxpayers. Given the

usual different national tax treatment of corporations and individuals, Schon wonders

whether such a differentiation constitutes State Aid, as the Commission sees “all

undertakings having an income (...) to be in a similar legal and factual situation” to

conclude that there is no selectivity to advantages granted to some legal forms whereas

selectivity is present for benefits granted to a particular legal form which itself is

materially related to a certain sector of the economy.

vii. Barcelona Football Club v Commission

In the recent case “Fútbol Club Barcelona v European Commission” (T-865/16), the

General Court annulled the Commission’s decision which had concluded State aid

infringement for Spain regarding the tax treatment of its four well known football clubs.

In particular, the latter clubs had managed to keep their legal status as non-profit

organizations when the legislation in Spain changed and all the rest football clubs were

liable to Corporate Income Tax as companies. The lower tax rate for the four football

clubs was considered as “an advantage” in the context of art. 107 TFEU.

Barcelona’s two arguments were on the one hand that the Commission should have

applied Article 49 TFEU (as the legislation obliged for a specific legal form the

professional sports clubs54 ) and on the other hand that when the Commission assessed

the advantage criterion had to take into account the cumulative effect (net positive or

net negative) of different tax rules.

After rejecting the first, the General Court examined the advantage criterion; it

concluded that the Commission should assess the net effect for the beneficiary

(favorable minus unfavorable measures) of a state’s interventions. Therefore, the whole

Spanish tax system for non-profit organizations had to be assessed; so analyzing it

found that although the tax rate for non-profit organizations was lower than for sports

companies, non-profit organizations were eligible to deduct reinvested profits from

53 the Court did not dealt with this point in the final judgment in October 2015 for procedural reasons 54 Article 49 refers to the right of undertakings to establish commercial presence on a market in any form

they choose.

27

their tax liability at a lower rate than that which applied to sports companies. Therefore,

according to the general Court, the Commission incorrectly ignored the effect of the

lower tax deductibility of reinvested profits and found an advantage by considering only

the lower tax rates.

Finally, the Court also rejected the argument of the Commission that the treatment of

the four football clubs constituted a special regime and thus, could be assessed on its

own or independently from the other provisions.55

viii. Poland v Commission 56

Facts and Commission’s argumentation:

In 2016 the Polish government introduced a new tax legislation for the retail sector.

The scope of the law covered all retailers, regardless of their legal status, and was

progressively calculated on the basis of the turnover of the retailer (and therefore its

size). In 2017, the Commission decided that the new tax legislation was selective as

discriminated against larger companies. According to the Commission’s syllogism the

turnover tax could not be progressive as the companies with the higher turnover paid

tax at higher average rates, in addition to higher marginal rates, and could also have

higher costs. And since, in the Commission’s view, a turnover tax could not be

progressive, the latter defined the reference system to be a turnover tax with a single

rate.

Poland applied for annulment arguing that the tax legislation was a general measure,

the different rates were an integral part of the reference system (which includes the tax

base, taxable persons and tax rates) and, thus, the progressivity of the rates could not

be considered as a derogation from the reference system. Poland defended the structure

of its new tax legislation by invoking its objective for raising the tax revenues while

distributing the tax burden more equally according to the ability to pay.

55 General Court of the European Union, Cases T-679/16 Athletic Club v Commission and T-865/16

Fútbol Club Barcelona v Commission / https://curia.europa.eu/jcms/upload/docs/application/pdf/2019-

02/cp190017en.pdf; Phedon Nicolaides “Spanish Football Clubs Score against the Commission: a)

Linked Advantages and Disadvantages Must be Assessed Together b) In Determining the Existence of

an Advantage, the Commission Must Explain both what it Takes into Account and what it

Ignores”,16.04.2019/ StateAidHub.eu 56 Joined Cases T-836/16 and T-624/17 – Poland v Commission; Sylvia de Mars, 2019 CJEU Judgments

in Summary, Number 8573, The House of Commons Library, 8 August 2019; Phedon Nicolaides, Is it

OK to Tax Company Size?, 18.06.2019/ StateAidHub.eu

28

The selectivity test by the General Court:

According to the Court’s analysis a tax measure is selective when it favours certain

undertakings in relation to others which, in light of the objective pursued by the tax

system, are in a comparable factual and legal situation.

Then follows the well-known three-step test for the selectivity criterion: namely, 1. the

identification of the common, normal or reference system of taxation; 2. the existence

of a derogation from the common, normal or reference system for certain tax payers

which are in a comparable situation to others; 3. the assessment of whether the

derogation or differentiation is justified by the nature or economy of the system.

At this point the Court cited case C-88/03, Portugal v Commission, paragraph 81, and

case T-210/02, RENV, British Aggregates v Commission in order to interpret the word

“nature” of the normal system as “its objective or purpose” and word “economy” as

“the normal system that encompasses its tax rules”. Even further, the Court explains

that the concept of the objective or nature of the normal tax system refers to the

fundamental or guiding principles of the tax system and does not refer to policies

which may be financed from the tax revenue, nor to the aims of the exceptions,

deviations or derogations from the tax system.

Regarding the reference system:

The Court clearly stated that the level of the rate (single or multiple) is of the

fundamental characteristics of the tax, invoking, Commission’s own Notice par.

134. The Court, subsequently, characterized as hypothetical (and beyond the legal text)

the Commission’s identification of the normal system and emphasized that the analysis

of selectivity had to be conducted using the actual characteristics of the tax system

under scrutiny. The only normal system for the Court was the tax in the retail sector

itself, with its progressive rates and its turnover bands and the Commission errored of

law.

Regarding the objectives of the system:

The next Court’s assessment was whether the structure of the tax on the retail sector,

with its progressive rates and its brackets, was contrary to the objective pursued by that

tax and had thus the effect of discriminating between undertakings in that sector (as it

is possible for the tax rules of a system of taxation to be inherently discriminatory with

29

regard to the objective that that system is supposed to pursue). First, the General Court

argues that the objective of raising revenues is common to all taxes and is not sufficient,

in itself, to determine the nature of the various taxes. Moreover, the progressive

structure of the rates of a given tax cannot, in itself, be contrary to the objective of

collecting revenue for the budget. And second, the objective of taxing the turnover of

all the undertakings in the sector concerned, could not be relied on either. Indeed, the

aim of the Polish authorities was to introduce a sectoral tax in line with a principle of

tax redistribution and the General Court agrees that the progressive structure of the tax

was a priori consistent with that objective. Therefore, the Commission was also wrong

to consider that the objective of the tax on the retail sector was different to that put

forward by the Polish authorities.

Regarding the progressive tax rates:

The Court concluded that starting progressive taxation from a high threshold does not

imply a ‘selective advantage’ without taking into consideration other parameters.

Summarizing the above analysis the Commission, according to the General Court’s

decision, erroneously defined the normal tax system, the objective of the tax system

and the existence of selective advantages in the structure of progressive taxation of

turnover.

30

3.2 The Arm’s Length Principle & OECD’s Transfer Pricing Guidelines

3.2.1 Legal Nature, implementation and effectiveness Τhe aim of Transfer Pricing laws and the Principle of Arm’s Length is to tackle

practices with which Multinational Group of Companies shift their profits from

jurisdictions with high corporate income tax rates to low tax jurisdictions, eroding thus

significantly the taxable bases of the relevant states.

So, in accordance to the arm's length principle, affiliated companies, should apply the

same prices as non - affiliated companies. Article 9 par. 1 of the OECD Model Tax

Convention provides that: “[Where] conditions are made or imposed between the two

[associated] enterprises in their commercial or financial relations which differ from

those which would be made between independent enterprises, then any profits which

would, but for those conditions, have accrued to one of the enterprises, but, by reason

of those conditions, have not so accrued, may be included in the profits of that

enterprise and taxed accordingly”. Additionally, OECD’s Transfer Pricing Guidelines,

as part of the OECD’s Commentary on Article 9 of the OECD M.C57, provide the

required guidance as mere interpretation instruments for article’s proper and consistent

application.

Article 9 OECD’s Model Tax Convention as well as their Guidelines are soft law legal

instruments; that is they are not legally binding and their consistent implementation is

based on good faith and is just desirable by countries that agreed on them. In fact there

are substance variations from country to country with regard to their interpretation and

yet none have been judged as a violation of international law.58

Moreover, they have an additional weakness, namely, the lack of legitimacy as OECD

is not a state legislative and regulatory authority and taxation presupposes the existence

of public authority (Maurice Duplessis: “The power to tax is the power to govern”).

This questionable legal status leaves plenty of space to the judges to use it or reject it

as a source for interpretation. And of course, each country’s judicial handling differs

significantly.

57 OECD Commentary (2014, Art.9 s.1) 58 Monsenego, J. (Jérôme), Selectivity in State aid law and the methods for the allocation of the corporate

tax base, Alphen aan den Rijn: Kluwer Law International, 2018, Series title: Eucotax series on European

taxation; volume 60, p.36

31

Yet, the aforementioned legal status creates one more issue. That is the lack of

enforceability followed by remedies in case of a breach, which also allows the states to

conduct their own path with regard to taxation when that is more advantageous for their

domestic interests. Historically the latter situation happened when the United States

unilaterally withdrew its support without any consequences from the OECD’s Harmful

Tax Practices initiative of the late 1990s59. As counter arguments to the enforceability

defect two theories have been supported, but both are not substantiated enough and

therefore not convincing enough: the first one, the Market Enforcement of Network

Rules, suggests that market itself will enforce the network’s principles while the

second, the Sociological theory of compliance, suggests that repetitive global

coordination could “socialize” the parties involved into collective norms beyond the

traditional legal systems60.

Taking all the above mentioned into account we can conclude that Article 9 of the

OECD’s Model Tax Convention is not considered as a self – executing provision,

therefore, national transfer pricing legislation of each Member State is needed prior to

any transfer pricing adjustment performed. The same thus applies for the OECD

Guidelines (as the article’s interpretation instruments); each Member State should

implement them in its national law - all of them or part of them – (formally or through

practice) for them to be applicable.61

3.2.2 The Arm’s Length Principle in European Law In European Law there is no reference to the notion of “Arm’s Length Principle” or

even more to methods of Transfer Pricing. Thus, Member States are not legally obliged

to adopt any relevant transfer pricing provision (and its methods). To be more precise

the ALP is mentioned twice in European level, first in the Code of Conduct for Business

taxation and second, in Art 4 of the Multilateral Arbitration Convention. Yet, the former

has to do with a gentlemen’s agreement, therefore not legally binding, and the latter is

59 Allison Christians, 'BEPS and the New International Tax Order' 2016 BYU Law Review 1603 (2017) 60 Pierre-Hugues Verdier, Transnational Regulatory Networks and Their Limits THE YALE JOURNAL

OF INTERNATIONAL LAW [Vol. 34:113} 61 Gunn, A. Luts, J. Tax rulings, APAs and state aid: legal issues, EC tax review. - Alphen aan den Rijn.

- Vol. 24 (2015), no. 2; p. 119-125, 2015, p. 123

32

between Member States, thus not an European law tool, additionally, both not

containing and grading methods applicable to ALP. 62

The commission, nevertheless, in its Notice on the notion of State aid as referred to in

Article 107(1) of the Treaty on the Functioning of the European Union (2016/C 262/01)

stated that the principle of Arm’s Length, irrespective of whether or not it has been

implemented into national law, and in what form, is necessarily taken into account

whenever the application of state aid law is under scrutiny63 introducing thus a different

content at the reference system and deviating from its own precedents; for instance, in

Case {2004} OJ L 23/1, para. 45 for a French aid to headquarters and logistics centres,

the Commission took as benchmark Member State’s national law and tax treaty law

without extending it to non - binding rules beyond the domestic legislation.

According to Professor E. Kemmeren's analysis64, the abovementioned Commission's

position (that the Arm’s Length Principle applies irrespective of the domestic law of

the Member States) is not only inconsistent with the case law of the European Court of

Justice, and thus triggers legal uncertainty, but also entails a number of chain effects

which jeopardize the growth of the European Union’s internal market: first, does not

level the playing field for companies as it provides for different treatment between

transnational and national situations; second, by taxing the transnational more than the

national, it is inconsistent with the principle of International Tax Neutrality and Capital

Import Neutrality and as a result, the ability - to - pay principle is not followed and

third, it doesn’t allow the establishment of the origin-based principle for the allocation

of taxing rights to jurisdictions.65

Furthermore, the Commission falls into another serious error when being of the opinion

that the principle of Arm’s Length is in fact an application of Article 107 TFEU itself,

which incorporates the principle of equal treatment for economic operators in a

comparable legal and factual situation. The Commission, thus, considers the Arm’s

Length principle as a European principle established in Article 107 TFEU: ‘When

62 Schön W., Tax Legislation and the Notion of Fiscal Aid- A review of Five Years of European

Jurisprudence, Max Planck Institute for Tax Law and Public Finance-Working Paper 2015-14, p.186 63https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:52016XC0719(05)&from=EN

Par.172 64 Lang, M. Pistone, P. Rust, A. Schuch, J. Staringer, C. Storck, A., Wien : Linde, 2017, Series on

International Tax Law ; vol. 103CJEU - recent developments in direct taxation 2016 65 See Kemmeren, E. C. C. M. (2001). Principle of Origin in Tax Conventions: A Rethinking of Models.

Dongen: Mr. Eric C.C.M. Kemmeren/Pijnenburg vormgevers.uitgevers

33

examining whether a transfer pricing ruling complies with the arm's length principle

inherent in Article 107(1) of the Treaty, the Commission may have regard to the

guidance provided by the Organization for Economic Cooperation and Development

(‘OECD’), in particular the ‘OECD Transfer Pricing Guidelines for Multinational

Enterprises and Tax Administrations’66. Similarly, in the Decision on Fiat Finance and

Trade the Commission clarified: ‘…Thus, for any avoidance of doubt, the arm’s length

principle that the Commission applies in its State aid assessment is not that derived

from Article 9 of the OECD Model Tax Convention, which is a non-binding instrument,

but is a general principle of equal treatment in taxation falling within the application

of Article 107(1) of the TFEU, which binds the Member States and from whose scope

the national tax rules are not excluded’.67

Yet, the Commission has not demonstrated the existence of the Arm’s Length principle

in Article 107 TFEU so that will inevitably prevail over any national provision, and the

paradox here is that also in its case law for state aid, OECD’s T.P Guidelines are used

as the legal basis of the Arm’s Length Principle and not the Article 107.68 What is more,

there are strong arguments supporting that the principle of equal treatment and the arm’s

length principle are not necessarily identical.

I. The commission’s conclusion that article 107 TFEU incorporates the principle of

equal treatment that requires the Arm’s length principle has its justification in ECJ’s

case law “Forum 187”. Yet, from an analysis of the decision there are strong arguments

supporting that there is no such requirement (although it does not rule it out) to apply

the Arm’s length principle as defined in the OECD T.P Guidelines deriving from this

judgement69.

In this case law regarding Transfer Pricing methods for the profit calculation of certain

Belgian multinational companies, the Court ascertained violation of art. 107 TFEU due

to the use of the cost plus method with exclusion from the cost base of some expenses,

and an unjustified 8% profit margin. In addition, according to the Court each Member

66 Par. 173 Notice 2016 67 Luxembourg v Commission COMP/SA.38375/2015 / Fiat Case 68 Offermanns R.H.M.J., Symposium on State Aid, 57 Eur. Taxn. 4 (2017), Journals IBFD, p.149 69 Monsenego, J. (Jérôme), Selectivity in State aid law and the methods for the allocation of the corporate

tax base, Alphen aan den Rijn: Kluwer Law International, 2018, Series title: Eucotax series on European

taxation; volume 60, p.31

34

State has the right to apply the Arm’s Length principle in the way the latter is

implemented by its domestic tax legislation.

To begin with the argumentation against the Commission’s assumptions regarding this

case firstly, “the measure was found selective because of its limited scope to certain

types of undertakings not because of an inherent deviation from the arm’s length

principle or from the treatment of independent enterprises”. Secondly, the method used

to assess the Belgium’s allocation rules was “the difference between profits and

outgoings of an undertaking carrying on its activities in conditions of free competition”.

First note here is that the difference between profits and outgoings is equivalent to the

principle of net taxation which does not necessarily demand the application of the arm’s

length principle since there are other allocation methods which perfectly fitting in this

concept. Second note, is that the CJEU did not interpreted the meaning of the phrase

“activities in conditions of free competition”. Therefore, we can deduct from this

omission that the allocation of taxes between multinationals is not necessarily based on

the conditions applicable to standalone entities as multinationals could also perform

their activities in conditions of free competition. In addition to these notes, the CJEU

did not referred to the preferable profit mark up for this case nor based its conclusions

for the profits of the multinational on data from the market namely, the Court does not

seem to demand exclusively the arm’s length principle.70

II. Τhe Commission, does not support its argumentation solely in the case “Forum 187,

but also in a twofold argument: first that the TFEU requires the principle of equal

treatment and second that the equal treatment is fully satisfied by the application of the

Arm’s Length principle. While the first part of the argument is irrefutable the second

one needs further examination for its validity:

Τhe Arm’s length principle has indeed in its scope the equal treatment between

associated undertakings and independent undertakings that are in comparable situation.

Moreover both adopt the concepts of ‘comparability’ and ‘effects of the market forces’.

But the wording of the article 107 TFEU does not refer anywhere about an obligation

70 Monsenego, J. (Jérôme), Selectivity in State aid law and the methods for the allocation of the corporate

tax base, Alphen aan den Rijn: Kluwer Law International, 2018, Series title: Eucotax series on European

taxation; volume 60, p.33

35

to apply the arm’s length principle and beyond the wording neither the European courts

have accurately interpreted how the equal treatment will be achieved.

What we know on the contrary from the OECD’s transfer pricing guidelines in par. 3.55

...”because transfer pricing is not an exact science, there will also be many occasions

when the application of the most appropriate method or methods produces a range of

figures all of which are relatively equally reliable. In these cases, differences in the

figures that comprise the range maybe caused by the fact that in general the application

of the ALP only produces an approximation of conditions that would have been

established between independent enterprises. It is also possible that the different points

in a range represent the fact that independent enterprises engaged in comparable

transactions under comparable circumstances may not establish exactly the same price

for the transaction.71 Subsequently, this approximate and subjective character of the

arm’s length principle does not guarantee the full equality between independent and

associated undertakings required by the article 107 TFEU. 72

In addition, another problem arises from the fact that it not always easy to find perfect

independent comparable on the market. This becomes more apparent in the case of

transactions carried out solely by multinationals companies. For instance, the economic

rents and the cost savings achieved through economies of scale and synergies cannot

by nature be produced by independent entities and therefore the latter cannot provide a

reliable benchmark.

The OECD’s guidelines provide for the above case to make a hypothesis about how

independent entities would have acted or would have allocated the contributions of each

part, recognizing thus the inevitable differences between independent and associated

transactions.73

71 https://read.oecd-ilibrary.org/taxation/oecd-transfer-pricing-guidelines-for-multinational-enterprises-

and-tax-administrations-2017_tpg-2017-en#page166 72 Monsenego, J. (Jérôme), Selectivity in State aid law and the methods for the allocation of the corporate

tax base, Alphen aan den Rijn: Kluwer Law International, 2018, Series title: Eucotax series on European

taxation; volume 60, p.38 73 Monsenego, J. (Jérôme), Selectivity in State aid law and the methods for the allocation of the corporate

tax base, Alphen aan den Rijn: Kluwer Law International, 2018, Series title: Eucotax series on European

taxation; volume 60, p.39

36

Summarizing the above analysis the conclusions reached are as follows: The TFEU

provides for equal treatment but not for an obligation to establish equal treatment by

adopting the arm’s length principle for integrated companies. This is due to the fact that

the Arm’s length principle does not provide full equality between associated and

independent enterprises, or between different associated enterprises. In the case

especially of synergies where independent and integrated companies are in non-

comparable situations equal treatment has to be avoided.

37

3.3 Tax Rulings

3.3.1 Definitions, Legal Nature and Typology According to the definition provided by the OECD in its Glossary, tax rulings are

defined as: “Decisions or opinions of the tax authorities in respect of actual fact

situations which come before it as part of an assessment procedure or in response to

taxpayer questions.”74 Τhe prevalent opinion characterizes them as acts of the Public

Administration; when the Tax Administration issues one is not entering into a

contractual relationship with the taxpayer, whose consent is not required for the validity

of the act. Further, tax rulings can take the form of an “Advance Tax Ruling”, an

“Advance Pricing Agreement” or (the form of) “other arrangement”.75

With regard to the first type of Tax Rulings, the Advance Tax Ruling, the latter is

defined by the OECD as: “A letter ruling, which is a written statement, issued to a

taxpayer by tax authorities, that interprets and applies the tax law to a specific set of

facts” 76 and is qualified as unilateral administrative act of the Public Administration

according to the prevalent opinion; for the jurisdictions in which Tax Rulings have a –

to a certain extent – binding effect on the taxpayers, it might be argued that they are

unilateral acts of the Public Administration with bilateral effects. The Advance Tax

Rulings are issued either before the relevant transaction or the submission of the tax

return– related to the period in which that transaction has taken place.77

The second type, the Advance Pricing Agreements, are a type of tax rulings which

interpret and apply the transfer pricing rules. According to the OECD’s glossary

definition, an APA is: “An arrangement that determines, in advance of controlled

transactions, an appropriate set of criteria (e.g. method, comparables and appropriate

adjustments thereto, critical assumptions as to future events) for the determination of

the transfer pricing for those transactions over a fixed period of time. An advance

pricing arrangement may be unilateral involving one tax administration and a taxpayer

or multilateral involving the agreement of two or more tax administrations. As to their

legal nature – whereas the Advance Tax Rulings are considered one-sided statements

74 https://www.oecd.org/ctp/glossaryoftaxterms.htm#R 75 Dario Castoldi, Are you concerned about the State aid compliance of your Tax Ruling? An analysis of

the requirements that a Tax Ruling must fulfill to be regarded by the Commission as “State aid-proof”,

Tilburg University AY 2016/2017, p. 8 76 https://www.oecd.org/ctp/glossaryoftaxterms.htm#R 77 Ibid. Dario Castoldi, p. 9

38

issued by the Tax Administration – the Advance Pricing Agreements are considered as

administrative acts between one or more Tax Administrations and the taxpayers.

The third type of tax rulings are included in administrative acts such as policy

guidelines, resolutions, letters and circulars and guide all the taxpayers on the

interpretation of tax provisions. In this category are also included tax arrangements

concluded between the Tax Administrations and the taxpayers before a certain

transaction or the filling of the tax return, or after a tax mediation procedure, or within

the context of a tax audit or the process of an horizontal supervision. The latter

arrangements are called “informal Tax Rulings”, are substantially district from the other

two types (since they are issued outside a specific administrative or legal regulation

framework) according to many scholars and are legally characterized as unofficial

covenants.78

3.3.2 Advance Pricing Agreements in the EU According to the EC’s proposal for a Council Directive amending Directive

2011/16/EU the ‘advance pricing agreements’ are defined as following:

‘any agreement, communication or any other instrument or action with similar effects,

including one issued in the context of a tax audit, given by, or on behalf of, the

government or the tax authority of one or more Member States, including any territorial

or administrative subdivision thereof, to any person that determines in advance of

cross-border transactions between associated enterprises, an appropriate set of

criteria for the determination of the transfer pricing for those transactions or

determines the attribution of profits to a permanent establishment.

Enterprises are associated enterprises where one enterprise participates directly or

indirectly in the management, control or capital of another enterprise or the same

persons participate directly or indirectly in the management, control or capital of the

enterprises.

Transfer prices are the prices at which an enterprise transfers physical goods and

intangible property or provides services to associated enterprises, and ‘transfer

pricing’ is to be construed accordingly’.79

78 Ibid. p. 14 79 http://www.europarl.europa.eu/RegData/etudes/STUD/2015/563451/IPOL_STU(2015)563451_EN.p

df, p. 31

39

Further, the EU APA Guidelines80 provide the exact procedure which an advance

pricing agreement application should follow that consists of four steps: a pre-filing

stage/informal application, a formal application, an evaluation and negotiation of the

advance pricing agreement and a formal agreement. While in terms of duration, an

advance pricing agreement is more time-consuming than an advance tax ruling.

In the European Union the system of tax rulings is not harmonized, therefore 28

different tax rulings schemes are in force81. Countries such as Finland have a long

tradition with them (first ruling issued in 1/1/1940) while other countries such as Greece

adopted the APA system only in 2014.

In the Netherlands an administrative (not a legal one) framework for advance pricing

agreements is in force. In 2004, its guidelines were issued in policy decrees, whereas in

2014 the substance requirement was the most important issue revised. The Dutch

competent tax authorities may consult a specialized in advance pricing agreements team

based in Rotterdam. The latter’s opinions may be binding. Yet, mandatory opinion

should be asked and given in the following situations:

- for participation exemption when none of the subsidiaries of a holding performs

business activities in the country

-for international structures that involve hybrid financing or hybrid legal entities;

-for absence or presence of a permanent establishment in the country for tax liability

purposes.

Exclusive competence of the specialized team is provided for cases requiring increased

attention. These cases include group financing companies and entities with limited to

no real economic activity in the country performing IP-management and also entities

with mere holding, financing and licensing functions within international groups.82

3.3.3 Advance Pricing Agreements within the framework of EU’s State Aid

Legislation The Commission explicitly approves the granting of APA’s and recognizes that it

constitutes a very important tool providing legal certainty to taxpayers. It determines in

80 Not binding but still an important framework 81 http://www.europarl.europa.eu/RegData/etudes/STUD/2015/563451/IPOL_STU(2015)563451_EN.p

df 82 http://www.europarl.europa.eu/RegData/etudes/STUD/2015/563451/IPOL_STU(2015)563451_EN.p

df

40

advance the transfer pricing methodology thus saving time and money for tax audits on

the transactions included in the APA.

The problem for the Commission arises when they grant “a selective advantage” to

certain undertakings breaching, thus, the State Aid Law.83 In particular according to the

Commission unilateral APAs (which are mostly chosen by the taxpayers) are

considered to be more risky from state aid perspective compared to bi - laterals 84‘…A

care must be taken that unilateral APAs are consistent with the arm's length principle

in the same way as bilateral or multilateral APAs…Tax administrations are entitled to

turn down requests for unilateral APAs where the tax administration feels that a

bilateral or multi-lateral APA is more appropriate, or feels that no APA at all is

appropriate.’ 85

Further, according to its Notice 1998 (in paragraph 22) the commission states that the

mere interpretation of the domestic legislation by the administration when issuing the

APA’s does not violate state aid law (to be more accurate the exact phrase is they do

not give rise to a presumption of aid), on the contrary, any deviation from the general

tax legislation does give rise to a presumption of State Aid Law breach.

For the identification of the reference system in par. 132-134 the Commission’s Notice

of 2016 provides that the reference system constitutes the benchmark for the assessment

of the selectivity and is composed of a consistent set of rules that generally apply — on

the basis of objective criteria — to all undertakings falling within its scope as defined

by its objective. For the taxes in particular, the reference system is based on such

elements as the tax base, the taxable persons, the taxable event and the tax rates.

For the next step, namely the assessment of whether a measure differentiates between

undertakings in derogation from the system of reference, the Commission provides that

it is necessary to determine whether the measure is liable to favor certain undertakings

or the production of certain goods as compared with other undertakings which are in a

83 DG Competition working paper on state aid and tax rulings, 3-06-2016, par.5, p. 2 84 http://www.europarl.europa.eu/RegData/etudes/STUD/2015/563451/IPOL_STU(2015)563451_EN.p

df 85Communication from the Commission to the Council, the European Parliament and the European

Economic and Social Committee on the work of the EU Joint Transfer Pricing Forum in the field of

dispute avoidance and resolution procedures and on Guidelines for Advance Pricing Agreements within

the EU {SEC(2007) 246} /* COM/2007/0071 final */ para 8.5 (63,65)

41

similar factual and legal situation, in the light of the intrinsic objective of the system of

reference. And if a measure favors certain undertakings or the production of certain

goods which are in a comparable legal and factual situation, then the measure is prima

facie selective.

Again, in par.170 the Commission clarifies: “Where a tax ruling endorses a result that

does not reflect in a reliable manner what would result from a normal application of

the ordinary tax system, that ruling may confer a selective advantage 86 upon the

addressee, in so far as that selective treatment results in a lowering of that addressee's

tax liability in the Member State as compared to companies in a similar factual and

legal situation”. By continuing the clarifications in paragraph 174, the Committee

“sees” a “selective advantage” particularly in the following situations:

‘(a) the ruling misapplies national tax law and this results in a lower amount of tax;

(b) The ruling is not available to undertakings in a similar legal and factual situation;

or

(c) The administration applies a more ‘favorable’ tax treatment compared with other

taxpayers in a similar factual and legal situation. This could, for instance, be the case

where the tax authority accepts a transfer pricing arrangement which is not at arm's

length because the methodology endorsed by that ruling produces an outcome that

departs from a reliable approximation of a market-based outcome. The same applies if

the ruling allows its addressee to use alternative, more indirect methods for calculating

taxable profits, for example the use of fixed margins for a cost-plus or resale-minus

method for determining an appropriate transfer pricing, while more direct ones are

available’.

According to authors Anna Gunn & Joris Luts87 in order to assess a tax ruling from

state aid perspective it is imperative to follow consistently the next syllogism: Are the

underlying provisions of domestic legislation sound from the perspective of Article

107(1) TFEU?

a. If “No” then the application of these rules gives rise to State aid

86 It is worth noting that the committee treats the two criteria, selectivity and advantage, as one, not

consistently following its precedents as analyzed previously. 87 Gunn, A. Luts, J. Tax rulings, APAs and state aid: legal issues, EC tax review. - Alphen aan den

Rijn. - Vol. 24 (2015), p. 120

42

b. If “Yes” then a further two-fold assessment should be done on how the rules

have been applied in concreto: (1) Is there a derogation from the normal application

of the rules (advantage), and (2) Does this derogation lead to a favoring of certain

undertakings (selectivity)?

At the same time, according to the Commission in particular the discretionary power of

the Tax authorities to decide whether to issue an advance pricing agreement or not and

deviate from the provisions of the domestic tax system fulfills the selectivity criterion:

“General measures which prima facie apply to all undertakings but are limited by the

discretionary power of the public administration are selective. This is the case where

meeting the given criteria does not automatically result in an entitlement to the

measure. Public administrations have discretionary power in applying a measure, in

particular, where the criteria for granting the aid are formulated in a very general or

vague manner that necessarily involves a margin of discretion in the assessment….”88

And this is exactly the case of transfer pricing rules.

Summarizing the aforementioned, a unilateral advance pricing agreement issued by the

Tax Authorities does not constitute by itself State aid since it includes exclusively an

interpretation or a guidance for the mere application of the general rules of the domestic

tax system. 89 Nonetheless, where the exercise of the discretionary power by the

administration is possible, selectivity arises.

3.3.3.1 The Selectivity criterion in APA’s – Case law a. The Reference System

Regarding the reference system the US treasury department ascertains that the

Commission never challenged in the past member state’s right to apply its transfer

pricing rules when issuing a ruling. Accordingly, in Technolease Case the ruling was

not found selective as the Netherlands “merely…applied general tax rules” without

examining the ruling’s transfer pricing methodology.

88 Commission Notice on the notion of State aid as referred to in Article 107(1) of the Treaty on the

Functioning of the European Union (2016/C 262/01) Para. 123, 124 89 Yet there is the opinion expressed by Keyln Bacon that an aid to an individual undertaking is inherently

selective. Kelyn Bacon, European Union Law of State Aid (2nd edition), Oxford University Press, 2013

43

b. Benchmark group (Integrated – Non- integrated Companies)

After the general tax system, the Commission claims that non-integrated and integrated

companies form part of that general tax system deviating from its precedents. “EU

Courts have long established that under EU State aid rules Member States cannot give

multinational groups a more favourable tax treatment than standalone companies”.

The reasoning has as follows: Because integrated undertakings apply TP rules can also

apply for an APA; an advantage granted from a misapplication of TP rules is at the

same time and selective because it is not available to non-integrated entities being in

similar legal and factual situation with the integrated.

Nonetheless, in relation to the selectivity, after the examination by the U.S’s

Department of the Treasury of 65 cases with regard to Tax Rulings it concludes that the

Commission carries out a case by case assessment. Below I will refer to some of the

decisions - counter-arguments to the above statement that “EU Courts have long

established that under EU State aid rules Member States cannot give multinational

groups a more favourable tax treatment than standalone companies”.

In Dutch Groeprentebox Scheme90 standalone companies were not in a comparable

situation as groups since “a different rate of taxation for debt financing between related

parties merely reflects objective differences and does not affect tax neutrality. Also, in

Irish Company Holding Regime Irish enterprises with foreign subsidiaries were favored

by the measure, thus not the standalone entities. The commission concluded that the

measure was not selective examining whether the measure was available to all the

integrated companies and ascertaining that it applied “[…] without distinction to all

firms and to the production of all goods within the regime”.

In Autogrill Espana the EU General Court argued that the measure under scrutiny was

not selective. Although a clear advantage was granted to companies operating

internationally, this advantage was not considered available solely to “certain

enterprises” or “certain branches of activity” (as the selectivity criterion requires) but,

on the contrary, the findings were in the direction that any company including stand-

90 COMMISSION DECISION of 8 July 2009 on the Groepsrentebox scheme which the Netherlands is

planning to implement (C 4/07 (ex N 465/06))

44

alone companies could benefit from the measure simply acquiring shares of a foreign

enterprise.

In Lico Leasing the Commission ascertained that the measure was selective because it

required a prior authorization from the Spanish Tax Authority in order to benefit from

the Spanish Tax Lease System. According to the EU General Court the Commission

Decision errored and such a requirement is not discretionary and thus not selective as

its purpose was the “[…] definition of the type of operation eligible to benefit from the

tax advantages at issue” which was only “[…] a condition for the application of the

advantage, from which any undertaking active in any sector of the economy could

benefit”.

In Hungarian Intra-Group Interest Decision the Commission argued that ‘non-

integrated’ undertakings are not necessarily a suitable basis of comparison (being not

in a comparable legal and factual situation) for the selectivity assessment of a measure

available only to ‘integrated’ undertakings, because inter-company loans are not

comparable to loan with third independent parties.

45

CHAPTER 4 - CHALLENGING THE COMMISSION’S ARGUMENTS BASED ON

CHAPTER 3

4.1 Integration of the advantage and selective criterion.91 The Commission integrates the ‘selectivity’ and the ‘advantage criterion in one

assessment, so a tax ruling fulfilling the ‘advantage’ criterion does not need to be

assessed under the ‘selectivity test. Yet, this new analysis is deviating from its own

precedents.

Regarding the above issue, the U.S. Department of the Treasury investigated the

Commission’s stance in 65 State aid cases of Tax Rulings. The outcome of this

investigation was that the two criteria, ‘advantage’ and ‘selectivity have always been

scrutinized separately.

Moreover, the U.S. Department of the Treasury points out that in the Belgian regime

for Coordination Centres upon which the Commission bases its new practice, the

commission’s separate scrutiny was methodologically correct; only after first verifying

the advantage, examined the existence of the selectivity.

4.2 Which reference system - which benchmark group? The Commission ascertained as inappropriate the TNM method applied to Starbucks’

coffee roasting function, or at least, to have been incorrect. Therefore, the commission

requires the Netherlands on the one hand to apply a certain method, even though the

OECD transfer pricing guidelines are soft law instruments and do not give priority to

any of its five methods and on the other hand, to have specific transfer pricing

adjustment legislation consistent with the Commission’s idea of EU law’s arm’s length

principle ,‘which incorporates the principle of equal treatment for economic operators

91 Richelle, I., Schön, W., Traversa, E. (Edoardo), State aid law and business taxation, Berlin: Springer,

2016, Series title: MPI Studies in Tax Law and Public Finance; 6, p .8; also Micheau, State Aid, subsidy

and tax incentives, (Kluwer, 2014), p.266; Gunn, A. Luts, J. Tax rulings, APAs and state aid: legal issues,

EC tax review. - Alphen aan den Rijn. - Vol. 24 (2015), no. 2; p. 119-125, 2015,p.121; Commission

Notice on the application of the State aid rules to measures relating to direct business taxation (98/C

384/03), OJ C 384 (10 Dec. 1998); Gunn, A. Luts, J. Tax rulings, APAs and state aid: legal issues, EC

tax review. - Alphen aan den Rijn. - Vol. 24 (2015), no. 2; p. 119-125, 2015, p.122; Schön W., Tax

Legislation and the Notion of Fiscal Aid- A review of Five Years of European Jurisprudence, Max Planck

Institute for Tax Law and Public Finance-Working Paper 2015-14, p.11; Micheau, State Aid, subsidy

and tax incentives, (Kluwer, 2014), p. 268; https://www.treasury.gov/resource-center/tax-

policy/treaties/Documents/White-Paper-State-Aid.pdf, p. 7,8

46

in a comparable legal and factual situation’, ‘independently of whether a Member State

has incorporated this principle into its national legal system and in what form’.

Commission’s argument is not convincing for the reasons below:

a. The legal basis for applying the OECD Guidelines has not been proved – the idea

that the Guidelines represent international standards does not suffice, their invocation

is thus arbitrary.

b. According to OECD’s, Transfer Pricing Guidelines for Multinational Enterprises

and Tax Administrations: “As a result, taxpayers, tax advisors and tax authorities can

legitimately reach different conclusions as to the ‘correct’ transfer price (as evidenced

by the many transfer pricing disputes). It is therefore recognized that the appropriate

transfer price may need to be established somewhere on a range of potential outcomes92

‘[there] may be a genuine difficulty in accurately determining a market price’. Meaning

that transfer pricing has a flexible and relative character, is not a science with just one

valid result; the process of finding the proper arm’s length price by applying the

methods of the OECD Guidelines is not always sharply defined. Transfer pricing is not

effortless as beyond the legal interpretation problems one can confront it also demands

a complete examination of the facts. As recalled by the OECD Guidelines, a transfer

pricing analysis furthermore ‘[requires] the………93

In our case, the fact that the use by Starbucks of the transactional net margin method

(TNMM) is not approved by the Commission as a proper method does not result in it

being the wrong method. But in the extreme case the method or its implementation by

the Dutch authorities was indeed wrong or even its implementation was wrong, that is

not State aid, but a mistake.94

Further, I share the same view with Pr. C. Peters regarding the “passive”

implementation of “imperfect rules” 95 in a ruling by the Dutch tax authorities; I agree

that it is a different situation than the “active” participation of the tax authorities to give

92 http://www.oecd-ilibrary.org, / OECD Publishing, 22 Jul. 2010, s. 1.2. 93 Gunn, A. Luts, J. Tax rulings, APAs and state aid: legal issues, EC tax review. - Alphen aan den Rijn.

- Vol. 24 (2015), no. 2; p. 119-125, 2015,p.124 94 Schön W., Tax Legislation and the Notion of Fiscal Aid- A review of Five Years of European

Jurisprudence, Max Planck Institute for Tax Law and Public Finance-Working Paper 2015-14, 95 The concepts of “passive” and “imperfect rules” are used to express the mere application of a flexible

principle such as the ALP in a tax ruling

47

a tax favor to a certain taxpayer and that above all, ‘the decisive question should be to

what extent the tax authorities have been actively and intentionally engaged in strategic

rent-shifting.’96

c. There is no reference to EU Arm’s length principle in binding EU law.

c.1. The commission is based in ECJ’s case law “Forum 187”, however, according to

the judgement, each Member State has the right to apply the Arm’s Length principle in

the way the latter is implemented by its domestic tax legislation; moreover the method

used to assess the Belgium’s allocation rules was “the difference between profits and

outgoings of an undertaking carrying on its activities in conditions of free competition”.

Nevertheless, the original judgement did not interpreted what free competition meant;

that drives me to conclude that the allocation of taxes between multinationals is not

necessarily based on the conditions applicable to standalone entities, as multinationals

could also perform their activities in conditions of free competition.

c.2. The Commission’s baseline that the equal treatment is fully satisfied by the

application of the Arm’s Length principle has not been proved valid either because the

approximate and subjective character of the arm’s length principle does not guarantee

the full equality between independent and associated undertakings required by the

article 107 TFEU. 97 What’s more, in the case of economic rents and cost savings

achieved through synergies and economies of scale where by nature independent and

integrated companies are not in a similar situation 98 , equal treatment has to be

avoided.99

Therefore, the right benchmark for the Commission’s assessment of the advantageous

nature of the measure at issue is not a derogation from the tax standards as determined

by the EU Commission itself but the tax rules of the Netherlands. This was also repeated

in Advocate General’s Opinion in Gibraltar (Joined Cases C‑106/09 P and C‑107/09

P), confirming that there is no default tax system under EU law and thus the reference

96 C. Peters, Tax policy Convergence and EU fiscal State Aid (EC Tax Review, 2018) 97 Monsenego, J. (Jérôme), Selectivity in State aid law and the methods for the allocation of the corporate

tax base, Alphen aan den Rijn: Kluwer Law International, 2018, Series title: Eucotax series on European

taxation; volume 60, p.38 98 Luja, R.H.C. Do state aid rules still allow European Union Member States to claim fiscal sovereignty?,

EC tax review. - Alphen aan den Rijn. - Vol. 25 (2016), no. 5/6; p. 312-324, 2016, 323 99 Monsenego, J. (Jérôme), Selectivity in State aid law and the methods for the allocation of the corporate

tax base, Alphen aan den Rijn: Kluwer Law International, 2018, Series title: Eucotax series on European

taxation; volume 60,

48

framework must be the national framework, understood in light of the objectives

pursued by the national legislator. Otherwise I totally agree with E. Fort’s opinion that

we have the case of the Directorate’s General for competition “implicitly expanding its

role beyond its legal prerogatives by acting as a supranational tax authority that reviews

Member States’ tax measures”.100

4.3 Which Dutch tax provisions? The Commission considers the non-arm’s length transfer pricing of Starbucks as a

deviation from the Dutch corporate tax system as a whole (as in Paint Graphos).

However it could consider it as a deviation from the specific Dutch transfer pricing

provisions following its precedent in P Oy.101

4.4 Are MNE’s and standalone companies comparable102? As a consequence of characterizing the whole Dutch tax system as the reference system,

which is very broad, we must examine all the corporate taxpayers of that reference

system and thus assess whether the ruling granted (that breached the arm's length

principle lowering of the tax base) to the integrated beneficiary gives it a “selective

advantage” compared to an hypothetical standalone - which by nature do not use

Transfer Pricing rules.103

As analyzed in the relevant chapter above, the U.S. Department of the Treasury

investigated many previous cases in which it was judged existence of selectivity. In

these cases selectivity was present when the measure was only available to certain intra-

group transactions or when an ‘integrated’ company had to attain a monetary threshold,

satisfy some ownership requirements, be active in a minimum number of foreign

jurisdictions. Both the Commission and the ECJ regard as selective a tax measure only

because it differentiates the tax treatment of ‘integrated’ companies being able to

benefit from it compared to ‘integrated’ which were not entitled to benefit.

100 Edouard Fort, EU State Aid and Tax: An Evolutionary Approach, European Taxation September

2017, IBFD, 375,376 101 See 1.4.4.2 102 Richelle, I., Schön, W., Traversa, E. (Edoardo), State aid law and business taxation, Berlin: Springer,

2016, Series title: MPI Studies in Tax Law and Public Finance; 6, p.114 103 Verschuur, S., Stroungi, M., State aid and tax rulings - the Commission's approach to virtual

payments: equal treatment of multinationals? European State aid law quarterly. - Berlin. - Vol. 16 (2017),

no. 4; p. 598-606, 2017, p.600-601

49

In my opinion the Commission erroneously considered with its decision that the

advance pricing agreement which favored the integrated but not the standalone is

selective since multinational and standalone enterprises are not in a “comparable legal

and factual situation”. The Commission with its decision has broadened the selectivity

test and restricted a state's sovereignty.

Implementing the above conclusions in our Case: the Dutch Transfer Pricing Decree

should be the reference system. With regard to the choice made by SMBV to use the

TNMM method with a profit mark-up on the costs, I agree with the Dutch

argumentation that the Dutch tax authorities couldn’t do otherwise than accepting in

the SMBV APA the TNMM with the profit level indicator proposed by SMBV since

the Dutch tax administration always evaluates the transfer prices from the perspective

of the method chosen by the taxpayer and chapter 2 of the Dutch Decree also provides

that the Netherlands does not apply a “best method-rule” 104

104 COMMISSION DECISION of 21.10.2015 ON STATE AID SA.38374 (2014/C ex 2014/NN)

implemented by the Netherlands to Starbucks, p. 45

50

CONCLUSIONS105

A few years ago state aid rules didn’t substantially influence core elements of a Member

state’s tax sovereign system but they would get involved with it, only with respect to

special extraordinary cases and as a means to deal with extreme exceptions. Today’s

Commission’s practice is not only putting under scrutiny transfer pricing methods

included in tax rulings but it also introduces its own newly adopted notions such as the

‘EU’s Arm’s Length Principle’, new approaches such as the integration of the

selectivity and the advantage criterion, the comparison between integrated and not

integrated companies (which by nature are not in a similar legal and factual situation),

in its assay to tackle tax avoidance.

However, EU’s State Aid regulation purpose is not tackling tax evasion (i.e the

exploitation of domestic tax loopholes or the differences between national tax systems);

admittedly it is an otherwise worthwhile goal, yet with the aid of the right legal

instruments. Towards this direction, we must enhance our national tax systems and our

bilateral or even multilateral coordination106; the utilization of state aid regime to

change tax systems or, even further to harmonize them clashes profoundly with the still

retained fiscal sovereignty of the Member States.

In this regards, the Commission has the right to intervene and impose the recovery

penalty provided for the breach of article 107(1) TFEU to the cases in which tax rulings

(or any other tax measures) violate the correct application of the general national laws

diverging thus from the normal tax scheme of the country to the benefit of certain

companies but to the detriment of free competition and EU’s internal market.

In conclusion, the ECJ’s decision for the Starbucks and similar cases will be decisive

for the settlement of the battle of power between on one hand the Member States’

demand for fiscal autonomy and on the other hand the European Commission.

However, the McDonalds case and the respective final decision of the Commission

showcased no desire from the latter’s part to notably expand the limits of its role by

further extending its influence within the existing framework of tax policy relations

105 Luja, R.H.C. Do state aid rules still allow European Union Member States to claim fiscal sovereignty?,

EC tax review. - Alphen aan den Rijn. - Vol. 25 (2016), no. 5/6; p. 312-324, 2016 106 Richelle, I., Schön, W., Traversa, E. (Edoardo), State aid law and business taxation, Berlin: Springer,

2016, Series title: MPI Studies in Tax Law and Public Finance; 6-p.114

51

inside the EU and therefore destabilize existing norms and relations in the fiscal state

aid field.107

107 C. Peters, Tax policy Convergence and EU fiscal State Aid (EC Tax Review, 2018)

52

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