EU Gets Green Light to Continue Fight Over Favorable Tax Rulings

The EU’s lower appeals court signaled its support for European Union regulators’ efforts to police favorable tax rulings multinationals get from individual countries.

Europe’s General Court validated the European Commission’s use of transfer pricing principles to evaluate tax rulings in two cases Sept. 24, involving Starbucks Corp. and Fiat Chrysler Automobiles NV. Transfer pricing determines the value of a multinational group’s intercompany transactions.

The court upheld the commission’s decision that Fiat should have paid more tax in Luxembourg—that is, it received about 30 million euros ($33.1 million) in illegal state aid from that country—even as it overturned the commission’s ruling that Starbucks hadn’t paid enough to the Netherlands.

The decisions could make it harder for companies facing similar cases to argue that the commission is overstepping its authority by enforcing a European tax principle at the level of member countries.

But the decisions weren’t all bad news for companies. In overturning the commission’s ruling against Starbucks, the court may have reassured other companies with tax rulings from individual countries that as long as their transfer pricing is sound, they aren’t in violation of state aid rules.

Fiat said while it’s disappointed with the ruling and considering its next steps, the decision isn’t material to the group. Starbucks said it welcomed the decision and that it pays all taxes wherever they are due.

The judgments confirm that while EU countries have their own tax laws, the laws have to work within EU law, including state aid rules, Margrethe Vestager, the EU’s competition commissioner, said in a Sept. 24 statement.

She also said the court confirmed the commission’s “approach to assess whether a measure is selective and if transactions between group companies give rise to an advantage under EU State aid rules based on the so-called ‘arm’s length principle.’”

Both decisions could be appealed to the European Court of Justice.

State Aid and Transfer Pricing

The commission had argued that tax rulings granted by the Netherlands and Luxembourg to Starbucks and Fiat, respectively, constituted state aid—a selective advantage given to one company over others. The commission said the rulings deviated from the arm’s length standard, a bedrock of transfer pricing that dictates that related entities in a group should transact business as if they were unrelated.

Despite the court’s split verdict on Fiat and Starbucks, “the Commission secured a victory, which is the court accepting that the Commission is allowed to scrutinize tax rulings based on the arm’s length principle,” said Dimitrios Kyriazis, head of the law faculty at the New College of the Humanities London, who focuses on state aid law.

“I think the Commission will still crack the champagne open,” he added.

The commission had argued that Fiat’s Luxembourg entity, which provided financial services such as loans to other entities in the group, deviated from the arm’s length standard. Fiat didn’t calculate returns on capital as an independent third party would, the commission said in its 2015 state aid finding. As a result, less profit accumulated in Luxembourg. “The taxable profits declared in Luxembourg would have been 20 times higher” if Fiat had operated under market conditions, the commission said.

In the Starbucks case, the commission said the company’s Dutch entity inflated royalty costs paid to a U.K. company in its group, for “coffee-roasting know-how.” The royalty payments shifted profits that went largely untaxed in both the U.K. and the Netherlands, the commission said in 2015.

The court said the commission can apply the arm’s length standard in evaluating tax rulings even when the principle doesn’t appear in the country’s domestic legislation, said Han Verhagen, director at KPMG Meijburg & Co. in the Netherlands, focusing on European tax law.

“Where the legislation of a member state aims to tax companies as separate legal entities, then it follows from that observation that they need to make sure those companies are taxed on profits that are determined as if negotiated on market conditions,” he said.

Good News for Companies?

The commission has been using state aid investigations to target what it sees as sweetheart tax deals some European countries are granting to multinationals.

For companies that have had a tax ruling in Europe anytime in the last 10 years, a state aid investigation remains a threat. But the fact that Starbucks won when the commission failed to prove that its transfer pricing arrangement was incorrect could be a bright spot.

“The good news for companies is that the burden of proof for the explaining why something is an incorrect price is with the Commission, and experience has shown that those who have to prove a price was right or wrong often lose these cases,” said Hans Mooij, independent international tax counsel and a former tax official in the Netherlands.

For companies with Dutch structures, the Starbucks ruling could be good news because it validates the Dutch approach to transfer pricing, said Harmen van Dam, a partner at Loyens and Loeff, who advises clients in the Netherlands.

Van Dam said he advises clients “to try to get as close to what unrelated parties would do” and steer close to the Organization for Economic Cooperation and Development’s transfer pricing guidelines, which the court referenced in its rulings.

While the court confirmed the commission’s authority to compare countries’ tax rulings to the arm’s length principle, it also made clear that the burden of proof is on the commission to show that the rulings don’t comply.

The court’s message for the commission: Pick your battles carefully, said Jose Luis Buendia, a partner at Garrigues in Brussels who focuses on EU law.

The court’s decision confirms the commission’s perspective “that there are state aid problems, and they were right,” Buendia said. “But it also sends a clear message that they have to do a very detailed investigation.”

“If the Commission found enough evidence they will win the case,” he added. “If not, if they just speculated and said, ‘We don’t like your method'—that’s not enough.”

The cases are: T-636/16 - Starbucks and Starbucks Mfg. Emea v. Comm’n, Ct. of First Instance (EU), 9/24/19, T-755/15 - Luxembourg v. Comm’n, Ct. of First Instance (EU), 9/24/19, T-759/15 - Fiat Chrysler Fin. Europe v. Comm’n, Ct. of First Instance (EU), 9/24/19, T-760/15 - Netherlands v. Comm’n, Ct. of First Instance (EU), 9/24/19.

— With assistance from Stephanie Bodoni and Tommaso Ebhardt (Bloomberg); and Hamza Ali (Bloomberg Tax).