News Update Tax
11 November 2022
The EU Court's ruling of 7 November 2022 is a major victory for Fiat and the fiscal autonomy of the EU Member States. It rejects the European Commission's ("Commission") assessment of the application of the arm's length principle ("ALP") under Luxembourg law that had previously been upheld by the General Court ("GC"). More importantly, it dismisses the Commission's plea for an autonomous interpretation and application of the ALP under the EU State aid rules, and as such the judgment is likely to affect the pending investigations into other tax rulings.
The judgment of the Grand Chamber of the Court of Justice of the EU ("CJEU") in joined Cases C-898/19 P and C-885/19 P concerns the appeal of Ireland and of Fiat Chrysler Finance Europe ("FCFE") against the GC's judgments in cases T-755/15 and T-759/15. Those judgments upheld the Commission's State aid assessment of a tax ruling issued in 2012 by Luxembourg in favour of Fiat Finance and Trade ("FFT"). FFT, a former subsidiary of FCFE established in Luxembourg, was responsible for the provision of financial services to companies in the Fiat group.
By its decision of 2015, the Commission found that the tax ruling constituted unlawful and incompatible State aid under Article 107(1) of the Treaty on the Functioning of the European Union ("TFEU") and ordered Luxembourg to recover EUR 30 million in unpaid taxes. According to the Commission the tax ruling granted a selective economic advantage to FFT in the form of a lower tax burden than would follow from application of the normal tax rules of Luxembourg law. In the Commission's view, the deviation from the normal tax rules was not in line with the ALP, which it considered to be part of Luxembourg tax law.
The GC upheld the Commission's decision in its judgment of 24 September 2019, dismissing the separate challenges lodged against the decision by FCFE and Luxembourg. FCFE and Ireland, which acted as an intervener in the proceedings before the GC, filed an appeal to the CJEU on different grounds.
The CJEU's landmark ruling
Member State's fiscal autonomy is the starting point for the State aid assessment
The Grand Chamber of the CJEU starts its ruling with a reminder of the Member State's fiscal autonomy that applies in the absence of harmonisation of direct taxation rules at EU level. This autonomy is crucial for the State aid assessment of the tax rulings under the 'three step-test', since that assessment must be based exclusively on the normal tax rules laid down by the legislature of the Member State concerned. The first step in this test is the establishment of the reference system, i.e., the normal tax system applicable in the Member State. The second step is to assess whether a tax ruling deviates from the normal tax system and results in a selective advantage. Such advantage results in State aid, unless the deviation can be justified by the Member State on the basis of the nature or general structure of the tax system (the third step). It is up to the Commission to apply the first two steps and to carefully determine the reference system following the objective assessment of the content, the structure and the effects of the tax rules. An incorrect determination of the reference system vitiates the whole analysis of the selective nature of a tax ruling in the second step.
No autonomous interpretation of ALP
The CJEU emphasises that Member States have discretion to decide if and how the ALP is applied in their tax laws. The principle of legality of taxation opposes an autonomous interpretation of the ALP following from the international standards (i.e., OECD transfer pricing guidelines) by the Commission. In that regard, the CJEU also rejects the Commission's interpretation of the judgment in case C-182/03 (Belgium and Forum 187 v Commission) underlying its general State aid assessment of tax rulings, according to which the ALP could be applied irrespective of its incorporation into national law. The CJEU considers that an autonomous application of the ALP cannot be inferred from the Forum 187 judgment because the application of the ALP in that judgment followed from the Belgian tax rules.
Error in the determination of the normal Luxembourg tax rules
The CJEU dismisses the Commission's broad definition of the Luxembourg reference system, i.e., general corporate income tax, which did not distinguish between integrated companies and non-integrated companies. According to the CJEU, the Commission, backed by the GC, ignored the specific implementation of the ALP in Article 164(3) of the Tax Code and Circular No 164/2. It moreover "confined itself to identifying (…), the abstract expression of that principle and to examining the tax ruling at issue without taking into account the way in which the said principle has actually been incorporated into that law with regard to integrated companies in particular."
However, the CJEU considers that the ALP may be used to determine the existence of a selective advantage resulting from a tax ruling, only if and to the extent that it is part of the normal tax rules of the Member State. Consequently, the CJEU sides with FCFE and Ireland and concludes that the selective nature of the FFT tax ruling must be assessed against the much narrower reference system of Article 164(3) of the Tax Code and Circular No 164/2. Therefore, the CJEU concludes that the GC erred in law in upholding the Commission's assessment.
The CJEU annuls the Commission's decision in full, although it also contained a secondary line of reasoning based on the narrower reference system. According to the CJEU this subsidiary reasoning is also vitiated by the erroneous determination of Luxembourg's normal tax system.
The CJEU's ruling confirms that the State aid assessment of national tax measures is primarily a legal assessment, placing a heavy burden of proof on the Commission. Moreover, the ruling emphasises that the application of the State aid rules must take account of the division of competences between the EU and the Member States and is subject to general legal principles such as legal certainty for taxpayers and the principle of legality of taxation.
Although, the CJEU confirms in general the Commission's competence to apply the State aid rules to tax rulings, the boundaries imposed by its ruling are a sensitive setback for the Commission's approach regarding tax rulings and its ongoing investigations into tax rulings (concerning, amongst others Nike, IKEA and Huhtamäki).
Next steps & consequences
- The consequence of the CJEU's final judgment by setting aside the GC judgment and annulling the Commission decision in full is that the Commission has been set back to its first phase decision with the preliminary assessment of the FFT tax ruling.
- To implement the judgment, the Commission must adopt a new decision taking into account the CJEU's definition of the reference system.
- Given the CJEU's rejection of the Commission's secondary line of reasoning based on the application of the ALP in Luxembourg tax law (i.e., Article 164(3) of the Tax Code and Circular No 164/2), it seems unlikely that the Commission will reopen the investigation to substantiate that line of reasoning with additional arguments. However, in theory it is still possible that, in a new decision, the Commission maintains its conclusion that the FFT tax ruling resulted in illegal State aid. It is yet to be seen whether FCFE's victory will be lasting.
- The CJEU's judgment is likely to impact the other cases pending before the CJEU (i.e., Apple, Amazon, Engie and the Belgian Excess profit rulings). In particular, the Commission's determination of the reference framework will be tested against the CJEU's premise that the implementation of the ALP in national legislation prevails over the Commission's interpretation thereof as laid out in the OECD transfer pricing guidelines.