On 8 November 2022, the CJEU issued its judgment on the Luxembourg State aid case concerning a financing company which formed part of a multinational enterprise (MNE) group. The CJEU set aside the judgment of the European Union (EU) General Court (GC) and annulled the decision of the Commission. The CJEU concluded that the Commission did not establish that Luxembourg granted a selective tax advantage to the financing company by agreeing, in the context of an Advance Pricing Agreement (APA) concluded on 9 June 2016, to transfer prices that according to the Commission deviated from market practices.
State aid is defined as an advantage in any form granted by an EU Member State or through a Member State’s resources to certain undertakings on a selective basis. State aid is generally prohibited by article 107 of the Treaty on the Functioning of the European Union (TFEU) unless exceptionally justified. Where the Commission has doubts as to the compatibility of a measure taken by a Member State (e.g., through a tax ruling granted to a specific taxpayer), it performs a formal investigation. Where the Commission finds that a measure constitutes State aid, the Member State has to recover the unlawful aid with interest from the beneficiary.
The decision at stake concerns an APA issued by the Luxembourg tax authorities to a Luxembourg member of an MNE group. This company provided financial services, such as intra-group loans, as well as treasury services, including management of cash pools, to other group companies. In addition, the company held two participations in group companies. The activities of the company were financed with equity, third-party debt and intra-group debt.
The Luxembourg entity’s fact pattern was very specific, in that it raised funds on the market, distinguishing the company from most of the Luxembourg group finance companies that provide intra-group loans out of funds provided by other group companies. In addition, the company’s method of calculating profitability by applying specific equity returns to each pre-determined category of equity (regulatory capital, equity used to finance shareholdings, equity to perform functions) is not a commonly used approach to measure the remuneration of a company performing intra-group financing and treasury activities.
The case concerns an operation prior to the adoption of more detailed transfer pricing legislation in Luxembourg with effect from 2015 and 2017.
In its judgment of 24 September 2019, the GC confirmed the Commission’s statements on a number of grounds, validating notably the Commission’s methodology not to take into account the specific Luxembourg provisions relating to group companies engaged in financing activities and to examine the tax ruling using methodological standards for determining taxable profit that do not appear in national legislation.1
The CJEU recalled that the classification of a national measure as State aid requires the fulfillment of four conditions, among which is that the intervention by the State or through State resources must confer a selective advantage on the beneficiary. For purposes of analyzing if a national tax measure is selective, the Commission must carry out a two-step analysis that consists first in identifying the reference system, i.e., the tax system normally applicable in the Member State concerned, and subsequently in demonstrating that the tax measure at issue derogates from that reference system by differentiating between undertakings which, in the light of the objective pursued by the normal tax regime, are in a comparable factual and legal situation.
The CJEU noted that Luxembourg law incorporated specific rules which apply to companies belonging to the same MNE group and that carry on intra-group financing activities. More specifically, article 164(3) of the Income Tax Law established the arm’s-length principle under Luxembourg law, according to which intra-group transactions are to be remunerated as if they had been agreed to by independent companies (stand-alone companies) negotiating under comparable circumstances at arm’s length. In addition, Circular No 164/2 of 28 January 2011 explained how to determine an arm’s-length remuneration specifically in the case of intra-group financing companies.
The CJEU also observed that the Commission considered that these specific rules were not to be considered, asserting that the general Luxembourg corporate income tax system, which pursues the objective of taxing the profits of all resident companies without distinguishing between companies belonging to an MNE group and stand-alone companies, should be considered as the reference system. To establish whether the company in question was treated similarly as stand-alone companies, the Commission applied an arm’s-length principle in accordance with the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines, which was not part of the Luxembourg law and which is different from the principle set forth in national law.
The CJEU held that Member States are entitled to exercise their own competence in the matter of direct taxation in matters for which there is no harmonization of EU law, which is the case in direct tax, including transfer pricing matters. The OECD Transfer Pricing Guidelines provide for several methods for approximating an arm’s-length pricing of transactions and profit allocation between companies of the same corporate group, and they are used by many national tax authorities in the preparation and control of transfer prices. Nevertheless, the CJEU noted that there are significant differences on how the different EU Member States apply these methods. Therefore, by virtue of the principle of legality of taxation according to which a taxable person must be in a position to foresee and calculate the amount of tax due and determine the point at which it becomes payable, the OECD Transfer Pricing Guidelines can only be taken into account in the examination of the existence of a selective advantage if a national system makes explicit reference to them.
According to the CJEU and based on the own competence of Member States in the matter of direct taxation, where specific national rules exist, only the national law applicable in the Member State concerned should be considered to identify the reference system.
On these grounds, the CJEU concluded that the GC erred in law by validating the Commission’s approach to set aside the national law and by upholding the reference system adopted by the Commission. Accordingly, the CJEU set aside the judgment of the GC and annulled the Commission decision that Luxembourg granted a selective tax advantage through an APA adopted in favor of the financing company. As a result, it was not established that Luxembourg had granted illegal State aid.
The CJEU decision is the first final EU court decision in the recent wave of Commission investigations into alleged State aid granted by EU Member States in the area of direct tax. Investigations started in 2014 with the commencement of the Commission’s formal investigation procedure in the case at hand. The question of determining the reference system is key to all these cases, several of which are currently pending with the GC or the CJEU. The CJEU judgment in the instant case is an indication that the Commission may have applied the State aid rules incorrectly in other cases as well by establishing a wrong reference system.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Tax Advisory Services Sàrl, Luxembourg City
- Bart Van Droogenbroek, Luxembourg Tax Leader | email@example.com
- Christian Schlesser, International Tax and Transaction Services Leader | firstname.lastname@example.org
- Dietmar Klos, Real Estate Sector Leader | email@example.com
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- Jacques Linon, Banking & Insurance Tax Leader | firstname.lastname@example.org
- Nicolas Gillet, Transfer Pricing Leader | email@example.com
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Ernst & Young LLP (United States), Luxembourg Tax Desk, New York
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Ernst & Young LLP (United States), Luxembourg Tax Desk, Chicago
- Alexandre J. Pouchard | firstname.lastname@example.org
- Andres Ramirez-Gaston | email@example.com
- See EY Global Tax Alert, EU General Court rejects appeal in Luxembourg State aid case concerning financing company (ey.com), dated 2 October 2019.