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State Aid &Corporate Taxation:The State of Play
EY Seminar | Amsterdam | 8 June 2015
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Contents
3Introduction
4The state aid framework
8State aid and BEPS
10State aid and transfer pricing rulings
12State aid and tax accounting
13State aid and R&D regimes
14Final remarks
During this lively EY seminar, a panelof EY and non-EY professionalsdiscussed in depth the potentialimpact of the European state aidrules on corporate taxation fromdifferent perspectives.
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Currently, existinginternational tax systems arebeing reevaluated at theinternational level in anunprecedented fashion. TheOECD has launched itsproject on Base Erosion andProfit Shifting (BEPS) inFebruary 2013. This projectfocuses on what is called“aggressive tax planning” bymultinationals. Likewise, acouple of months before,the European Commissionpublished an action plan tostrengthen the fightagainst tax fraud and taxevasion. In the wake ofthese tax policydevelopments,the European Commissionhas also decided to startevaluating certaininternational tax planningstrategies on the basis ofthe EU state aid rules. Forexample, the commissionhas opened thoroughinvestigations into rulingsgranted by Ireland,Luxembourg and theNetherlands, with respectto potentially unlawfulstate aid. Also, thecommission started toassess R&D tax regimesthat are in place in certainmember states.
In the current BEPSclimate where the EU stateaid rules have gainedmomentum, EY organized
a seminar on 8 June 2015 inthe Netherlands. During thislively EY seminar, a panel ofEY and non-EY professionalsdiscussed in depth thepotential impact of theEuropean state aid rules oncorporate taxation fromdifferent perspectives. KeyEY speakers at the seminarwere Daniel Smit (BEPS),Danny Oosterhoff (Transfer
pricing), Leen Wesdorp (Taxaccounting), Marcus Mayer(Procedural issues), BenKiekebeld (IP-regimes) andMisha Lutje Beerenbroek(State aid law). This paperprovides you an easilyaccessible and completeoverview of thepresentations anddiscussions that took placeduring the seminar.
1 Introduction
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Substantive aspectsof state aid
The Treaty on theFunctioning of the EuropeanUnion (TFEU) provides for aprohibition on unlawful stateaid. This prohibition aims atremoving or abolishing stateaid incompatible with theEuropean internal market.The European Commission isthe exclusive administrativebody competent to assesswhether a state aid measureis incompatible with theEuropean internal market,subject to legal supervisionby the General Court and theCourt of Justice of theEuropean Union (CJEU).
The EU state aid provisionsalso aim at restoring to asituation where state aid hasnot been granted. To that
end, the beneficiary of theaid is required to repay theaid received, includinginterest. The recovery of theaid is subject to a limitationperiod of 10 years.
A tax measure constitutesstate aid when the followingfour criteria are met:i) There is an advantage to
the recipientii) The advantage is granted
by intervention of amember state or throughstate resources
iii) The advantage distorts orthreatens to distortcompetition by favoringcertain undertakings orthe production of certaingoods
iv) The advantage is liable toaffect trade between themember states
From the CJEU case law andstate aid practice of theEuropean Commission, it
follows that any tax measureby the public authorities thatplaces the beneficiaries in amore favorable financialsituation than othertaxpayers may constitute anadvantage. According to thecase law of the CJEU, thedefinition of an aid is moregeneral than that of asubsidy. It not only includespositive benefits, such assubsidies but also carriesadvantages in the form of areduction in the tax burdenof a taxpayer, either bymeans of a reduction in thetax base, a reduction in thetaxable amount or by meansof a relief with respect to thecollection of taxes due.
An advantage is granted bythe intervention of a state orthrough state resources notonly in the case of an actualtransfer of state resources,but also in the case of loss oftax revenue by a memberstate. It follows that, forinstance, a waiver of tax debtby the national taxauthorities constitutes anadvantage within themeaning of the EU state aidprovisions.
The advantage has to beconferred to a specificrecipient. This selectivitycriterion is met if a measurefavors certain undertakingsor the production of certain
2 The state aidframework
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goods. Selectivity may turnout to exist in the case ofsectorial, regional orindividual differentiation. Atax measure is selective if itdeviates from the commontax system applied by amember state. Under thistest, it thus must bedetermined whether thegranting of a tax advantageis the exception to the mainrule. This can be the casewhen a tax measure favorscertain undertakings incomparison with otherundertakings which are in alegal and factual comparablesituation in the light of theobjective pursued by themeasure in question. Not theform, but the actual effect ofa measure is decisive.
Tax measures that areeffectively open to alleconomic agents operatingwithin a member state areregarded as generalmeasures and are thereforenot selective. Only inexceptional cases, the mereapplication of the general taxsystem may still result inselectivity. In a recent caseregarding the proposedGibraltar corporate taxregime, the CJEU found thatthe reference system asdefined by Gibraltar wasfounded on criteria that wereof a general nature, but itdiscriminated factually
between companies thatwere in a comparablesituation, resulting in aselective advantage beinggiven to offshore companies.It is noted, however, that thefact that offshore companieswould not be taxed was not arandom consequence of theregime at issue, but followedprecisely from thecontemplated criteria forcorporate tax liability(premises, employees).
Finally, a measure is liable toaffect trade between themember states if thebeneficiary carries on aneconomic activity involvingtrade between memberstates. The relatively smallsize of the recipient or thesmall amount of the aidgranted is not relevant.Nevertheless, the
commission applies a deminimis rule on the basis ofwhich aid not exceeding aceiling of EUR200,000 overany period of three yearsdoes not distort competitionand trade between memberstates.
A measure constituting stateaid may be justified, but onlyon the basis of the limitedgrounds listed in the TFEU orby the nature or generalscheme of the tax system. Inthe latter respect, adistinction must be madebetween the objectivesattributed to a particular taxscheme which are extrinsic toit, on the one hand, and themechanisms inherent in thetax system which arenecessary for theachievement of suchobjectives, on the other.
The European Commission is theexclusive administrative bodycompetent to assess whether astate aid measure is incompatiblewith the European internal market,subject to legal supervision by theGeneral Court and the Court ofJustice of the EU.
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Procedural aspectsof state aidIn case of potential new stateaid measures, a memberstate is obliged to follow theprocedure of priornotification to the EuropeanCommission. The procedureand decisions of thecommission are thus onlydirected at the particularmember state and not at thebeneficiaries of the potentialstate aid. However, acompany that benefited fromthe state aid could not arguein case of recovery that itwas not aware of thepossibility of state aid of acertain measure introducedby a member state. In thisrespect, it is a steady CJEUcase law that each enterpriseis under the obligation toexamine whether theprocedural rules have beenfollowed once it receives astate-granted advantage.
Each notification itselftriggers a preliminaryinvestigation. The EuropeanCommission has to ensurewithin two months that (i)there is no aid within themeaning of the EU rules, (ii)the aid is compatible with theEU rules, or (iii) the state aidbut is considered to becompatible with the commonmarket subject to certainconditions, or (iv) there are
serious doubts that the aid iscompatible with the EU rules.
In case the commission hasserious doubts, it will initiatea formal investigation. In theformal investigationprocedure, the particularmember state and otherinterested parties (othermember states, thebeneficiary or competitors)may submit comments withinthe first month. Thecommission shall then decidewithin 18 months (not to bequalified as a legal timeperiod) whether the notifiedmeasure is (i) not state aid,(ii) state aid but is compatiblewith the common market, (ii)state aid but is considered tobe compatible with thecommon market subject tocertain conditions, or (iii)state aid that is notcompatible with the commonmarket.
When the member state didnot meet its notificationobligation regarding possiblenew state aid measures, thiswill be automatically unlawfulaid. The EuropeanCommission has anobligation to immediatelyexamine all information itreceives concerning allegedunlawful aid.
Recovery of stateaidThe beneficiary of anunlawful state aid is requiredto repay the aid received,including interest.The powers of the EuropeanCommission to recover aidare subject to a limitationperiod of 10 years from thedate it officially publishes itsdecision to close the formalinvestigation. It is importantto note that recovery in caseof state aid should not bequalified as a penalty or a taxpayment (back taxes). From alegal perspective, this meansthat human right argumentsdo not apply; insofar, itconcerns objecting therecovery of state aid as suchand also raises difficultcrediting issues.
The decision by the EuropeanCommission to recover thebenefit of illegal state aid isaddressed to the particularmember state, which isordered to recover the aidfrom thebeneficiary/beneficiaries.Although the member statesare obliged to implement therecovery decision, theyremain free to choose themeans by which theyimplement the recoverydecision. However, theEuropean Commission setsonly one requirementregarding the method of
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recovery: the method chosenby the member state mustlead to an effective andimmediate execution of thecommission’s decision. Themember state has thepossibility to appeal against arecovery decision. Othermember states and thebeneficiaries can appeal aswell.
A possible defense may beabsolute impossibility torecover the benefits grantedby the illegal state aid. Bycontrast, difficulties of atechnical and administrativenature — e.g., the absence ofa legal recovery title undernational law or a largenumber of beneficiariesinvolved — do not result inabsolute impossibility.Also, legal impossibility isno ground to abstainingfrom recovery. It is, forexample, irrelevantwhether national lawdoes not include anexplicit provision for therecovery procedure.Furthermore, thepossibility of bankruptcyof the aid recipientcannot justify abstainingfrom recovery.
In case the particularmember state fails torecover the aid, theEuropean Commissioncould start an
infringement procedure withthe CJEU. When the CJEUdecides that the memberstate has failed to fulfil itsobligation to recover the aidand the member state hasstill not recovered in light ofthe infringement procedure,the European Commissioncould start a penaltyprocedure.
An exception for recoveryapplies if recovery would becontrary to the principle ofthe protection of legitimateexpectations, that is to say,legitimate expectationsraised by Europeaninstitutions and not, forexample, by the national
legislator or taxadministration.
A final question is whetherthe beneficiary could rely onnational rules to preventrecovery of illegal state aid.As there is currently noharmonization of theprocedural rules in Europe,national courts have certainautonomy in deciding innational cases, as long asthey observe the principles ofequivalence andeffectiveness. This meansthat national courts shouldrespect EU rules in giving adecision in a specific case.
An exception for recovery applies if recoverywould be contrary to the principle of theprotection of legitimate expectations, that is tosay, legitimate expectations raised by Europeaninstitutions and not, for example, by the nationallegislator or tax administration.
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From the discussions inAmsterdam it emerged thatthe current state aid work bythe commission has not onlya legal but also a politicaldimension. It is well knownthat the OECD launched itsproject on BEPS in February2013. This project, whichhas the international politicalsupport by the G-20ministers, focuses on what iscalled “aggressive taxplanning” by multinationalsand has developed 15 keypressure areas in whichcoordinated action by bothOECD and non-OECDcountries in the near futureis required. Also, within thecontext of the EU, thecommission launched anaction plan on tax fraud andtax evasion in December2012.
In the wake of the aboveinternational tax policydevelopments, thecommission has decided tostart evaluating certaininternational tax planningstrategies on the basis of theEU state aid rules.Algirdas Semeta (formerCommissioner for Taxationand Customs) confirmed in aspeech on 11 February2014, that the commission“is gathering information ontax planning strategies underState aid rules.” MargretheVestager (currentCommissioner forCompetition) reaffirmed on 2October 2014 that she isgoing “to continue the workthat (Joaquín) Almuniastarted in order to throw lighton some of these (special)
arrangements if possible.”
The seminar speakers agreedthat in the current state aidinvestigations, thecommission seems to deviatefrom the traditional state aidassessment as depictedearlier. Rather thanbenchmarking against thelocal country rules andpractices, the commissionappears to replace localcountry rules and practiceswith newly constructedterminology andmethodology (for example,through the concept of a“prudent independentmarket operator”). Insubstance, it seems that thecommission is trying tocombat internationalmismatches by means ofstate aid rules.
However, tax measureseffectively open to alleconomic agentsoperating within amember state areregarded as generalmeasures and aretherefore not selective.The fact that corporatetax systems within the EUare not harmonized andmay therefore confer onmultinationals either abilateral benefit orbilateral burden (e.g.,double taxation).
3 State aid andBEPS
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These bilateral benefits,however, are not imputableto an individual memberstate, and can therefore notbe considered falling withinthe scope of the state aidprovisions. In fact, theEuropean Commissionaccordingly accepted in itsdecision in the Dutch groupinterest box investigation in2009 that “any advantageresulting from aninternational context owingto a low taxation rate in theNetherlands which is notmirrored by a low rate ofdeduction in the Netherlandsbut instead corresponds to anormal deduction rateabroad, is not imputable tothe Netherlands.”
The panel concluded that ifthe commission were toeventually prevail in its newapproach (which mayultimately require a decisionby the CJEU), it may meanthat state aid elements couldbe deemed to exist whichwere, in the view of thetraditional state aidassessment as depictedearlier, state aid compliant.
The seminar speakersagreed that in the currentstate aid investigations,the commission seems todeviate from thetraditional state aidassessment as depictedearlier.
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Individual state aid casesinvolving Luxembourg,Ireland and the Netherlandswere announced in June2014. They are all focusedon transfer pricing rulings.The European Commissionhas specifically stated that itis examining whether thecontested rulings complywith the arm’s-lengthprinciple and confer anadvantage to the taxpayers.
In order to examine whetherthe contested rulings complywith the arm’s-lengthprinciple and confer anadvantage to the taxpayers,the European Commission
stated in its opening decisionthat “multinationalcorporations have a financialincentive when allocatingprofit to the differentcompanies of the corporategroup to allocate as muchprofit as possible to low taxjurisdictions and as littleprofit as possible to high taxjurisdictions.” Such a phraseis not included, however, inthe OECD Transfer PricingGuidelines. As the EuropeanCommission relies on theOECD Transfer PricingGuidelines to determinewhether the agreed-upontransfer price is at arm’slength, it is unclear why the
European Commission isusing the aforementionedphrase in its openingdecisions. Besides, transferpricing is a tool to determinethe arm’s-length pricebetween affiliatedenterprises. Transfer pricingshould not be confused withthe consideration ofproblemsof tax avoidance. Transferpricing is thus generally notmeant to be an instrument todisallow taxable income to beshifted to low-tax countries.
According to the EuropeanCommission, “an approval ofa transfer pricing
arrangement which doesnot reflect a marketoutcome and which favorsa particular undertakingmust be considered asprima facie selective.” Inother words, if transferpricing is not consideredto be at arm’s length, thenthere is a selectiveadvantage for thetaxpayer. In the vision ofthe European Commission,this may, for example, bethe case when the rulinghas been agreed upon anarrangement without an(documented) analysis ofthe arm’s length nature.The arm’s length naturewas then not assessed andthis constitutes a certainlevel of selectivity.
4 State aid and transferpricing rulings
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Based on the openingdecisions of the EuropeanCommission in the individualstate aid cases, it seems thatthe European Commission“selectively” adopts newtransfer pricing conceptsthat link to the BEPSinitiative despite the fact thatsuch concepts were notincluded in both nationalrules and/or relevant OECDGuidelines when the rulingswere granted. The EuropeanCommission focuses on allaspects in its investigations,like the overall tax structure,the intentions of thetaxpayer and the alternativeoptions. This indicates thatthe individual investigationsof the European Commissionare above and beyondtransfer pricing issues. Thecommission does not seem tofocus on how countries haveimplemented the arm’s-length principle and how it isapplied under nationalsystems.
Transfer pricing shouldnot be confused with theconsideration of problemsof tax avoidance.
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For tax accounting purposes,a state aid risk may qualify asan income tax risk. In fact thetax accounting implicationsof state aid were a majorissue of interest to theseminar participants. Thediscussion focused on thedifferent approaches used byIFRS and US GAAP whenreporting uncertain incometax positions which includestate aid risk.
IFRS makes a distinctionbetween the following typesof risk to determine theimpact on the annualaccounts regarding uncertaintax positions (IAS 12 and37): remote risk, possiblerisk, probable risk andvirtually high risk.
A remote risk is a risk lessthan 5%. No accrual anddisclosure in the annualaccounts is required in thatsituation.
A possible risk means a riskhigher than 5% but less than50%. No accrual is required ifsuch a risk is at hand.However, mandatorydisclosure of an estimate ofthe financial effect, anindication of amount andtiming, and the possibility ofany reimbursement apply.When this disclosure isharmful for the particularentity, there is an exemptionthat indicates that thedisclosure is not obliged.
A probable risk is a risk thatis more than 50% but lessthan 95%. In that situation,accrual based on “bestestimate, average weighted,most likely outcome” shouldbe included in the annualaccounts. No furtherdisclosures in the annualaccounts are required.
A virtually certain risk is arisk more than 95%. In such acase, accrual based on “best
estimate, average-weighted,most likely outcome” shouldbe included in the annualaccounts. No furtherdisclosures in the annualaccounts are required.
Under US GAAP — formerlyknown as FIN 48 — one firstneeds to determine what thelikelihood of the tax benefitbeing sustained is. In casethis is not more likely thannot (i.e., less than 50%), thecompany should include anaccrual of 100% of the taxposition and the disclosure isrequired in the annualaccounts. When theaforementioned tax benefitwill more likely than not (i.e.,50% or more) be sustained,then it should be determinedwhether or not it is highlycertain that the tax positionwill arise. In case this ishighly certain, the entity isnot required to include anaccrual in its annualaccounts. When it is highlyuncertain, the entity shouldinclude an accrual based onthe largest tax benefit that ismore than 50% likely of beingrealized and is required to bedisclosed in its annualaccounts.
To determine if there is a riskon state aid, one shouldassess all available positiveand negative evidenceregarding that risk.
5 State aid andtax accounting
For tax accountingpurposes, a state aidrisk may qualify as anincome tax risk.
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Within Europe, different R&D-regimes are in place in thevarious member states. Thediscussion on this topicmentioned the Dutchinnovation box, the UKpatent box and the IP box inLuxembourg as examples ofR&D regimes. In 2008, theEuropean Commissiondecided in the case of theSpanish R&D credit that it didnot contain any state aid.The reasoning given by thecommission was that theSpanish R&D credit was openfor every taxpayer (therewas, for example, nopreference included for aspecific sector)and that themeasure was inline with thecommission’scommunicationregarding theeffectivestimulation of R&Dwithin Europe.
The seminarspeakers noted achangingenvironment withregard to the roleof the EuropeanCommission in theinvestigations oftax rulings whichmay extend to R&Dregimes as well. InBEPS action item5, one can see that
a so called “modified nexusapproach” has beendeveloped for R&D regimes,which requires a certainnexus in the country wherethe entity operates, wherebythe benefits of R&D regimeswill be limited to certaintypes of R&D. The questionthen raised by the seminarspeakers was whether theEuropean Commission maystart challenging memberstates that decide tocontinue with their old IPregimes and thus refrainfrom implementing themodified nexus approach.The European Commission
seems to set a moreinternational standard todetermine if there is state inthe current investigations ontransfer pricing rulings.Therefore, the commissionmay believe that due to thenew international standard ofthe “modified nexusapproach”, old R&D regimesare no longer an efficientway of stimulating R&Dincentives and thus no longerjustified under the state aidrules. This would then makethe soft law side of the BEPSa part of the hard lawdiscussion of state aid withinEurope.
6 State aid andR&D regimes
The question raised by the seminarspeakers was whether the EuropeanCommission may start challengingmember states that decide tocontinue with their old IP regimesand thus refrain from implementingthe modified nexus approach.
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State aid is increasinglygetting intertwined withpolitical developments, andthe future is thereforedifficult to predict. The EYseminar, nonetheless, madeclear that the European stateaid impacts the corporatetaxation of multinationalsfrom many differentperspectives.
7 Finalremarks
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