State aid: what it is, and how it may affect multinationals and tax departments; European Commission's actions against member states bear close scrutiny.

AuthorDeNovio, Nicholas J.
PositionCover story

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Never before has international taxation been in such a spotlight in the business press. Cross-border mergers, international tax policy, and base erosion and profit shifting (BEPS) have each been the subject of major front-page articles in the financial news. Over the last two years another topic has increasingly been in focus: the "state aid" cases being brought by the European Commission (EC) against various European Union (EU) member states with respect to tax rulings issued by those member states to multinational corporations.

EU state aid is a European concept that prohibits EU member states from providing impermissible aid to companies, which, as these cases have demonstrated, may be in the form of tax treatment or benefits. The notion of a government providing improper tax benefits may remind U.S. tax practitioners of the debate between the United States and the World Trade Organization (WTO) relating to whether the United States was providing an export subsidy to manufacturers by means of the foreign sales corporation (FSC) regime. (1) The WTO eventually found that the FSC regime provided such a subsidy. But the WTO's challenge to the FSC regime focused on trade law, while the state aid challenges are based on competition and European internal market law. Additionally, the WTO struck down the FSC regime as itself inappropriate. Here, the EC is focused both on the legitimacy of a tax regime itself and on how the regime is being applied--for example, through the issuance of tax rulings such as advance pricing agreements (APAs)--by the EU member state in a manner that the EC considers to distort competition. (2)

The recent state aid cases represent the first time the EC has exercised state aid control to address corporate tax practices on an EU scale. (3) If the EC is successful, companies that received these rulings and APAs may be forced to repay up to ten years of "tax savings" to the very EU member state that granted the ruling in the first place. As discussed below, one key question for multinationals is the degree to which the EC will challenge rulings, APAs, and, potentially, settlements with various EU member states. A multinational may have hammered out the terms of a ruling or APA with a country such as the Netherlands or Ireland years or even decades ago and, having followed its terms, used the APA as a basis for further tax planning. The actions of the EC might well now upend that planning on a retroactive basis, with consequences beyond anything a taxpayer might have considered possible under the typical challenges a multinational faces due to having tax years that remain open under the relevant statute of limitations.

Moreover, the EC has made clear its state aid investigations are focused not just on whether a ruling or APA process itself constitutes state aid but also on whether the substantive tax treatment applied to particular taxpayers constitutes state aid. This raises the question of how far the EC's actions might go. Would the EC review settlements between taxpayers and an EU member state, other tax cases in the EU, or even simply informal agreements reached between taxpayers and a taxing jurisdiction in the course of day-to-day compliance and examinations? The audit of a recurring issue between an EU member state and Taxpayer A may have resulted in a datente between the two on how to treat the particular intercompany pricing of an item.4 Are those types of settlements, based in part on substantive tax issues and, as is often the case, in part on the mutual administrative benefits of settling audits and providing consistency to the taxpayer and the tax examiner, now subject to EC challenge?

This article outlines the historical background of the state aid issue and the technical process behind the recent EC actions. While there has been considerable attention in the press and seminar circuit on the various EC cases and the specific companies involved, the focus here is on the general issue of EU state aid as applied by the EC to tax rulings and APAs, along with the EC's overall initiative. Included are brief and high-level summaries of two published EC cases and the rulings at issue, merely to illustrate the type of routine rulings under EC scrutiny. Summaries of the various reactions to the EC's initiative follow, including very strong responses from Congress and the U.S. Department of the Treasury. The conclusion discusses the potential for obtaining a U.S. foreign tax credit for amounts paid a result of state aid decisions.

Key Questions and Actions for Multinationals

The corporate and adviser communities and the U.S. government will continue to watch the unfolding actions initiated by the EC. As discussed below, while one cannot consider the use of state aid in a tax context unprecedented, there is no doubt the last two or three years have seen a relatively new phenomenon of EU-wide targeting of seemingly routine tax rulings and APAs. There is no set playbook for the taxpayer community to handle state aid investigations, unlike in the case of a typical EU member state tax audit.

The best that a taxpayer and its advisers can do as these cases continue to unfold may be to:

  1. Continue to monitor where the EC is focused.

  2. Assess the status of all current rulings, APAs, and other formal or informal agreements with EU member states over tax issues.

  3. Assemble documentation as best as possible to support the correctness of the actions taken by the EU member state.

  4. Continuously determine with the help, if available, of an EU member state whether any such agreement or ruling is the subject of an EC investigation. Unfortunately, there may not be a set process or obligation of the member state to do so.

  5. Intervene before the EC, to the extent that a ruling or agreement is being investigated, represent its own position and, to the greatest extent possible, advocate for the correctness of the EU member state's actions. This will both support the original positions taken and, as importantly, demonstrate that any eventual payment by a taxpayer under an EC decision was made after seeking all effective and practical remedies. (5)

Historical Background on Application of State Aid in Tax Context

PRE-2012 APPLICATION OF STATE AID CONTROL TO TAX ISSUES

State aid law prohibits EU member states from granting aid in a manner that distorts competition and the European internal market. (6) The application of state aid control to tax issues represents a unique intersection between competition law and tax law and is likely new for many U.S. tax practitioners. There appears to be no direct parallel in domestic U.S. law.

As the broad description of state aid law suggests, state aid control is by no means geared solely toward tax regimes or practices. (7) Over the decades, the EC has examined whether various EU member state actions have constituted impermissible state aid in a wide variety of areas such as transport, energy, and agriculture. In a more traditional direct economic benefit situation, the EC has routinely assessed and approved aid for the purposes of coordinating the transport and shifting of freight from road to rail, such as by providing incentives for private investment. (8)

The application of state aid rules to tax law is built upon the concept that a reduced tax burden may constitute an impermissible advantage provided by an EU member state to a beneficiary. The EC, the sole body charged with state aid enforcement, has in the past applied its authority to challenge an EU member states tax regime or a specific application of the tax regime as anticompetitive when it provides a "selective advantage" to certain taxpayers. (9) The EC has found that tax measures can provide an "advantage" because the "loss of tax revenue is equivalent to consumption of State resources in the form of fiscal expenditure." (10)

RECENT FOCUS OF STATE AID CONTROL TO TAX RULINGS

While the EC has in the past used state aid control to address individual EU member state tax issues, (11) recently the EC has begun to rely more heavily on state aid to address tax practices it perceives as harming the distribution of tax revenues among the member states. After the Great Recession, in a period of tight public budgets and sluggish growth, the EC considered its two options to attempt to reduce the effects of a lack of unified tax treatment of company profits throughout the EU: tax harmonizing legislation (which requires unanimity by the EC and thus is very difficult to reach) or state aid control (for which the EC has exclusive competence). As described below, the EC has begun focusing on the latter option while continuing to pursue options for introducing tax harmonizing legislation.

On December 6, 2012, the EC laid the framework for using state aid to challenge tax rulings when it issued two formal recommendations: one on "aggressive tax planning," which it described as "taking advantage of the technicalities of a tax system or of mismatches between two or more tax systems for the purpose of reducing tax liability" (12) and the other regarding "measures intended to encourage third countries to apply minimum standards of good governance in tax matters." (13) The latter recommendation explained that a number of tax measures "are subject to scrutiny under the rules on state aid." (14) The EC has also stated its concern that some rulings may be misusing international tax treaties to permit double nontaxation: "The purpose of Double Taxation treaties between countries is to avoid double taxation--not to justify double nontaxation." (15)

In February 2014, the EC launched an inquiry into the tax rulings practice of six EU member states: Luxembourg, Ireland, the Netherlands, the UK, Cyprus, and Malta. Joaquin Almunia, then commissioner for competition, stated that "[a] limited number of companies actually manage to avoid paying their proper share of taxes by reaching out to certain countries...

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