By: Diane Ring
As I blogged last week, the ABA Tax Section Teaching Tax Committee held a panel discussion Friday on the EU State Aid investigations on advance tax rulings. As I’ll discuss below, the panel was every bit as interesting as forecast. But first, a quick overview of what EU State Aid is all about:
EU State Aid Doctrine and Recent Controversy
Under Art. 107(1) of the Treaty on the Functioning of the European Union (as interpreted by the ECJ), if a member state provides state aid that distorts competition in the EU then the member must recover that aid from the benefiting entity to undo the distortive effects. Although this competition doctrine developed outside the tax context, it has previously been applied to tax benefits granted by a member state to a taxpayer. The European Commission oversees the investigation of state aid cases and issues the decisions.
Recently, though, application of the state aid doctrine to tax rulings issued by member states to multinationals has become a subject of tremendous controversy. In the past two years, the EC has been investigating tax rulings granted by member states to multinationals, including U.S. multinational taxpayers. The concern is that the multinationals receiving these rulings are not getting “mere” clarification of the law, but rather are securing a distinct advantage that creates distortion in the market. The U.S., along with various commenters, has expressed concern that these investigations might be disproportionately targeting U.S. businesses. Others have questioned whether the state aid rules are the most appropriate tool for combatting transfer pricing and/or double nontaxation situations that the EU finds problematic.
The Panel Discussion
During the discussion, it became apparent that there was a notable gap between the way many (but not all) in the U.S. view the European Commission’s recent state aid investigations involving U.S. taxpayers, and the EC’s vision of the role of the state aid doctrine in addressing potential harm caused by tax rulings granted to U.S. multinationals with very low effective tax rates. Thus, I was not surprised to hear these divergent positions characterized during the panel as “ships passing in the night”. What I did not anticipate was hearing the phrases “legal science fiction” (applied to certain suggested challenges to EC state aid decisions) or “a horror movie” (applied to the unfolding state aid investigations and decisions).
But the energy in the room was only part of the story. The panel provided very rich insights into the many complicated issues surrounding the current state aid investigations. I could not do them all justice here but thought I would highlight those that were mentioned by various panelists that really caught my attention:
- Wait and read the decisions, not the media: We don’t actually know that much yet about where the EC is heading with the content of final decisions (as contrasted with the announcement of the decisions) on the tax rulings cases that have been the focus of much attention. Although some decisions have been announced, during the panel the U.S. audience was urged to have patience until the redacted decisions have been released and everyone has had an opportunity to review the reasoning.
- More in the pipeline: Also, during the panel, we were informed that the EC, which has been gathering extensive files on tax rulings, is focusing on a 100 or so serious cases, and the implication was that they are not all U.S. companies–so we should hold judgment until they work through the investigatory process. Thus, while the first rulings may have mostly involved U.S. businesses, whether that was disproportionate depends on what kinds of rulings have been granted to other taxpayers and what decisions the EC reaches on those cases. And that we do not know yet.
- Status of EU law: A recurring and unresolved issue in EU law that surfaces in the state aid debate as well is whether EU law supersedes international law and/or international agreements of the member states. During the panel, the state aid version of this problem was noted: Specifically, if the application of state aid doctrine finds that a tax ruling violates the doctrine and that recovery of the benefit is required, this could result in the state aid decision itself effectively triggering violation of a treaty or other international agreement (by having EU law override the other agreement).
- Judicial review: A member state whose ruling is declared to be impermissible state aid may challenge that finding in the courts. However, the panel clarified that the courts have a binary option, either accept the EC state aid decision in its entirety (i.e., agree with both the legal conclusion that there was a violation and with the determination of how much aid must be recovered), or reject it in its entirety. Thus, for example, if a tax ruling (and note that tax rulings include advance pricing agreements, or APAs) on transfer pricing was the subject of a state aid determination, the court could either accept the finding that there was a state aid violation and accept the pricing allocation specified by the EC–or reject the determination. What is not an option for the court is to accept the finding of violation, but then adjust the amount of the aid that must be “recovered”. By way of contrast, generally when a court hears a transfer pricing case, it has the ability to address both the conclusion that the pricing was not arms’s length and the actual dollar amount subject to reallocation. Whether this feature of judicial review of EC determinations on state aid helps member states and taxpayers, or the EC, is not yet clear.
- Tax treatment of repaid tax benefits: If a U.S. taxpayer must repay certain tax benefits it received “improperly” under an advance tax ruling, how will that amount be characterized? Panelists considered some of the outcomes that could result depending on the answer to this question. If the repayment is characterized as a tax, then there is a chance of getting a foreign tax credit in the U.S. Such an outcome would be good for the U.S. taxpayer, but could be a significant amount of money (given the dollar amounts at stake) from the perspective of the U.S. fisc. However, if the repayment is not formally called a tax in the member state that is recovering the funds, it is less clear that a foreign tax credit is possible. That result could effectively produce double taxation. A taxpayer in that scenario might be better off having paid the tax in the original year and secured a U.S. foreign tax credit (instead of relying on the ruling).
- State aid, the Directorate-General for Competition, and transfer pricing: To the extent a number of EU state aid cases involving U.S. multinationals are transfer pricing cases, several interesting issues arise. These issues seemed to be at the top of the U.S. government’s list of concerns. First, the body in the EC tasked with investigating state aid is the Directorate-General for Competition. This is not a body with tax expertise as its focus, although one imagines the staff has become quite immersed in tax law as a result of the recent forays into advance tax rulings. If a tax ruling is found to be in violation of state aid rules by having permitted aggressive and inappropriate transfer pricing, then the amount to be recovered must be determined. Essentially, this body must determine what the appropriate transfer pricing should have been in order to determine the amount to be recovered. This is hard enough for tax lawyers—it is not clear how easily a nontax body will arrive at an appropriate number. For example, it is much easier to determine that a tax ruling issued by a member state allowing zero profits to be reported might be inappropriate, than it is to actually ascertain the proper price or profit allocation. Second, the U.S. has expressed concern that given the amount of untaxed profits held offshore by some of these U.S. multinationals, there will be a temptation to grab a chunk of it through the state aid process in an amount far exceeding the portion properly attributed to the entity/activity in the EU member state. This risk could be compounded by the reality that the traditional methods for challenging a country’s transfer pricing position (via competent authority), appears to be unavailable if the income reallocation is implemented via competition law and not tax law.
- A new source of transfer pricing law?: A very new state aid decision generated significant interest during the panel. In a state aid tax decision released May 4, 2016 (the decision had been announced in January 2016, but the redaction process delayed public release until May), the EC concluded that Belgium’s tax rulings granted under its excess profits tax regime violated the state aid doctrine. What was particularly interesting about the decision was a statement in Paragraph 150 of the decision regarding the arm’s length standard (this sentence was read out loud during the panel):
“Thus, for any avoidance of doubt, the arm’s length principle that the Commission applies in its State aid assessment is not that derived from Article 9 of the OECD Model Tax Convention and the OECD TP Guidelines, which are non-binding instruments, but a general principle of equal treatment in taxation falling within the application of Article 107(1) of the Treaty, which binds the Member States and from whose scope the national tax rules are not excluded.”
A couple of observations about this very interesting statement: First, the Commission is saying that it can make transfer pricing decisions in the state aid context, but when it does so (and remember making a decision also includes a determination of how much money must be repaid by the taxpayer), it will be using a standard for arm’s length that is not the OECD standard, nor is it from the member state’s domestic law or treaties. Instead, it is derived from some general principle. The source and content of this principle is not explained. Given how difficult it has been in international tax law to reach any understanding on transfer pricing at the OECD level or on a bilateral basis, and how much detail is involved in trying to identify an appropriate allocation of profit, this vague statement seems problematic. This point was raised but never really resolved during the panel.
Second, given the controversial nature of the assertion in this quoted paragraph, its inclusion is surprising as it did not seem necessary to the decision. The real problem with Belgium’s excess profits regime was not the precise price/allocation of profit but the decision to effectively exempt a portion of profits.
Third, one possibility that occurred to me and others in attendance in our own conversation following the panel is that the inclusion of this quoted language is a space holder, staking out some flexibility for the EC in challenging transfer pricing rulings under state aid doctrine. This possibility, however, would likely generate significant reaction in the U.S. because it suggests planned deviations from standard transfer pricing principles, and because (as noted above) EC state aid decisions though reviewable in court would appear to cut the Competent Authority role out of transfer pricing disputes. During the panel discussion, the EC representative seemed to smooth over any gap between the EC view on the arm’s length standard and that espoused by the OECD. Nonetheless, he did not directly answer why the EC sought to include this clearly controversial language in the opinion. Either they intend to approach transfer pricing differently from the OECD and member states, or the language was superfluous. In my view the latter scenario seems most unlikely.
Clearly there is much more to come on the state aid story.