State Aid & Transfer Pricing
22 September 2021
In its ruling of 16 September, the Court of Justice of the EU ("CJEU") set aside the General Court's ("GC") judgment annulling the Commission's decision of 2016 declaring the Belgian excess profits regime as an unlawful State aid scheme. According to the CJEU, the GC misapplied the concept of 'aid scheme', as this may also refer to a consistent administrative practice of the competent national authorities where that practice reveals a systematic approach.As a consequence of the CJEU's confirmation of an aid scheme, the Commission is not required to continue the 39 separate in-depth investigations into individual rulings it opened following the GC's judgment.
Since the GC in its 2019 judgment did not take a position on whether the “excess profit” tax exemptions gave rise to illegal State aid, the CJEU referred the case back to the GC to assess whether the tax exemption regime provided a selective advantage to the companies that applied for a ruling.
In this State Aid & Transfer Pricing News Update, we outline the most important considerations of the CJEU's ruling of 16 September. We also look at the material transfer pricing considerations to be decided on by the GC now that the case has been referred back by the CJEU.
FactsThe Belgian excess profits regime aims to ensure that a Belgian multinational group entity is only taxed on its arm's length profits. The regime exempts profits arising from synergies, economies of scale and other benefits, allegedly due to the entity being part of a multinational group (the "excess profit").
The excess profit is determined using a two-step approach, where both steps rely on a one-sided transfer pricing method. In most cases, this is the transactional net margin method ("TNMM"). Step 1 determines the arm's length remuneration for intercompany transactions between the Belgian group entity and its related entities based on a transfer pricing analysis prepared by the Belgian taxpayer, with the Belgian group entity being considered the 'central entrepreneur'. Consequently, Step 1 leads to a remuneration for the Belgian group entity equal to the residual profit arising in the intercompany transactions. Step 2 helps to determine the excess profit based on a second transfer pricing analysis prepared by the taxpayer. Once again, this involves applying the TNMM but now for determining an average profit for the Belgian group entity, being the tested party this time. The amount of the excess profit then amounts to the difference between the residual profit as calculated under Step 1 and the arm's length profit as calculated under Step 2, both averaged over a projected time horizon. Subsequently, the difference is translated into an exemption percentage of pre-tax profit over the projected period, which is confirmed by the tax rulings. As a result, Belgian group entities which have obtained a ruling under the contested regime may apply an annual pro-active downward adjustment of their Belgian corporate income tax base in accordance with the amount of the alleged excess profit, irrespective of whether the related group entities were subject to a corresponding upward adjustment in their respective countries of residence.
According to the Commission, the two-step approach cannot be considered to be in line with the arm's length principle. The Commission argues that if Step 1 considers the Belgian group entity as the 'central entrepreneur', the full residual profit resulting from the intercompany transactions should be considered the central entrepreneur's arm's length profit, in line with the entrepreneurial functions performed, assets used and risks assumed. Hence, if Step 1 is assumed to have been properly applied in line with the arm's length principle, it is not in line with the arm's length principle to decrease this residual profit with the excess profit determined under Step 2. After all, the excess profit is in fact just part of the residual profit attributed to the Belgian group entity as the central entrepreneur within the group. In other words, the Commission found the argument unfounded to consider the Belgian group entity as entrepreneur (i.e. performing the more complex functions and assuming higher risks) in Step 1, while considering it as the tested party (i.e. performing less complex functions and assuming limited risks) in Step 2.
Therefore, the Commission considered the Belgian excess profits regime to depart from the arm's length principle. In so far as the regime reduces the Belgian corporate income tax base as compared to entities in a comparable legal and factual situation, the Commission considered the regime as an unlawful 'aid scheme'.
Background: the Commission's appeal against the GC's rulingWith its 2019 judgment, the GC ruled that the Commission incorrectly qualified the Belgian system at issue as an unlawful 'aid scheme'. It rejected all the Commission's arguments relating to the existence of an alleged 'systematic approach' by the Belgian tax authorities. Consequently, the GC annulled the Commission decision in its entirety.
The Commission based its appeal on the grounds that the GC made errors in interpreting the definition of 'aid scheme', as laid down in Article 1(d) of Regulation 2015/1589.
CJEU's judgment of 16 SeptemberAccording to the CJEU, the three cumulative conditions for the existence of an aid scheme were met. First, the aid must be granted based on an 'act'. Second, no further implementation measures are required. Third, the potential beneficiaries of the aid must be defined in a general and abstract manner. The CJEU clarified that an act may also refer to a consistent administrative practice by the authorities where that practice reveals a systematic approach – although the GC acknowledged this. Subsequently, it incorrectly concluded that the fact that certain key elements of the scheme were evident from the individual rulings and not from the legal provisions meant that those provisions needed further implementing measures.
Furthermore, the CJEU emphasised that the three cumulative conditions were intrinsically linked to each other. The misapplication of the first condition thus led to the misapplication of the following conditions. Regarding the condition that no further implementing measures are required, the GC failed to take into account that one of the essential elements of the aid scheme at issue lays in the fact that the Belgian tax authorities systematically granted the excess profit rulings when all conditions were met. According to the CJEU, such a systematic approach demonstrated that the tax authorities did not have discretion concerning the granting of a ruling.
Since the GC annulled the Commission's decision only for failing to prove the existence of an aid scheme, the CJEU referred the case back to the GC to rule on the remaining grounds of appeal regarding, among other things, the incorrect classification of the excess profit exemption as State aid in view of the absence of any advantage or selectivity against the Commission's decision.
Commentary on formal considerationsThe CJEU's ruling closes the formal debate on qualifying the Belgian excess profits regime as an aid scheme. The material debate on whether this regime results in a selective advantage will now have to be resumed.
It will be the first time in the context of the Commission's State aid investigations into tax rulings that the GC will assess the Commission's analysis of a scheme. The Belgian excess profits regime, together with the UK tax scheme for multinationals, are the only tax ruling schemes the Commission found to qualify as unlawful State aid so far.
Whereas the GC in its previous rulings imposed a heavy burden of proof on the Commission regarding the selective advantage following from the individual tax rulings in favour of various companies, including Starbucks and Fiat, Apple, and Amazon, the Commission's burden of proof regarding aid schemes is considerably lower. In a recent judgment, the CJEU confirmed that, in the case of an aid scheme, the Commission is not required to demonstrate at the level of the individual beneficiaries that the aid scheme actually resulted in an economic advantage. The Commission is merely required to demonstrate that the arrangements provided for in the scheme give an appreciable advantage to beneficiaries in relation to their competitors and are likely to benefit in particular undertakings engaged in trade between Member States. In case of an aid scheme, it is only at the stage of recovery of the aid that it is necessary for the national authorities to look at the individual situation of each undertaking concerned.
Commentary on transfer pricing considerationsAmong other considerations, there are two key aspects which could have an impact on how the case under review could be decided on by the GC, being (i) the temporal relevance of the OECD Transfer Pricing Guidelines ("OECD Guidelines") and (ii) the determination of the jurisdiction which is entitled to the residual profits.
(i) Temporal relevance of the OECD Guidelines
In the Commission's decision of January 2016, reference is made to the 2010 OECD Guidelines. However, some of the contested rulings also relate to years prior to 2010. For the cases dating prior to 2010, the GC may take the position to not allow using the 2010 OECD Guidelines to the extent that the provisions have evolved significantly when compared to the 1995 OECD Guidelines, as was decided in the recent Amazon case. In this respect, we note that the concept of synergies was only briefly mentioned in the 1995 OECD Guidelines where it provides guidance on the incidental benefits resulting from intragroup services. However, the 1995 OECD Guidelines did not elaborate on how synergies should be considered from a pricing perspective. In the 2010 OECD Guidelines (Para. 9.57), it is mentioned that it would be a good practice for taxpayers to document the impact of anticipated synergies at the entity level in applying the arm’s length principle, while providing more detailed explanation throughout the rest of Chapter IX of the OECD Guidelines. The OECD went even further in the 2017 OECD Guidelines to provide additional guidance on how group synergies should be considered for comparability purposes (see Paras 1.163 and 6.30), where it also elaborates on assessing synergies in the context of synergies resulting from concerted action vis-à-vis resulting in incidental benefits.
(ii) Determination of the jurisdiction which is entitled to the residual profits
While the case under review relates to various taxpayers and these may have different fact patterns, it would be important for the GC to assess whether the Belgian entities eligible under the excess profits scheme can indeed be considered as true entrepreneurs. If it could be established that the Belgian entities are fully or partially entitled to the residual profits because of its functional profile, this case could be viewed differently from the earlier State aid cases ruled in favour of taxpayers, such as Starbucks and Apple. In those cases, it was decided that the tax authorities of the respective countries, i.e. the Netherlands and Ireland, taxed these companies according to their functional profiles, and thus, in line with the arm's length principle. In this respect, if the Commission could successfully substantiate with regard to the companies eligible under the Belgian excess profits scheme that at least part of the residual profits was resulting from synergies contributed by the Belgian entities (assuming that the 2010 OECD Guidelines can be relied on), the GC may eventually rule in favour of the Commission.