Since June 2013, the European Commission has been investigating the tax ruling practices of EU member states, with a view to detecting potential state aid concerns. As part of these investigations, the commission reviewed tax rulings granted to members of several—mostly US—multinational groups. The Fiat case was one of the first state aid cases investigated by the commission, with a positive decision being released on Oct. 21, 2015.
Now, after more than seven years of legal uncertainty, the Court of Justice of the European Union concluded that the commission erred in its decision. This article provides an overview of the Fiat case, the decision of the commission, and the decisions of the General Court of the European Union and the CJEU.
On Nov. 8, 2022, the CJEU rendered its judgment regarding the appeals filed by Fiat Chrysler Finance Europe (formerly Fiat Finance and Trade Ltd, FFT, C-885/19 P) and Ireland (C-898/19 P). In their respective appeals, FFT and Ireland had requested to have set aside the judgment of the General Court of the European Union of Sept. 24, 2019, by which the court dismissed their actions for annulment of the final state aid decision of the European Commission of Oct. 21, 2015 on Fiat (SA.38375).
The state aid decision of the European Commission concerned a tax ruling issued by the Luxembourg tax authorities on Sept. 3, 2012, which confirmed that the underlying transfer pricing analysis had been realized in accordance with the tax authorities’ Circular 164/2 of Jan. 28, 2011 and respected the arm’s-length principle.
With its decision, the European Commission requested Luxembourg to reclaim an amount of around 30 million euros ($31 million) from the taxpayer.
Fiat Case at a Glance
FFT is a Luxembourg subsidiary of Fiat S.p.A., the Italian parent company of the Fiat group, which is one of Italy’s largest industrial enterprises. FFT provided treasury services and financing to Fiat group companies based mainly in Europe (excluding Italy), and also managed several cash pool structures for Fiat group companies. FFT operated from Luxembourg, where its head office is located, and through two branches, one based in London and one in Madrid.
Fiat decided to centralize its financial and treasury functions, where all funding, corporate finance, bank relationship, foreign exchange and interest rate risk management, cash pooling, money market operations, cash balances management, collection, and payment initiation were performed by FFT and the other treasury companies. FFT performed treasury functions for Fiat Group companies in Europe.
The transfer pricing analysis prepared for FFT was based on the guidelines and methodologies set out in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, which reflect the international consensus on the interpretation and application of the arm’s-length principle.
The transfer pricing analysis relied on the determination of the amount of capital at risk in line with the Basel II criteria. Moreover, FFT was meant to realize an arm’s-length risk remuneration in regard to its capital at risk (by using the capital asset pricing model) and an arm’s-length remuneration for its functions performed. The transfer pricing method which was applied to determine an arm’s-length risk premium was the transactional net margin method.
Concept of State Aid
According to Article 107(1) of the Treaty on the Functioning of the European Union, any aid granted by a member state or through state resources in any form whatsoever, including tax measures, which distorts or threatens to distort competition by favoring certain undertakings or the provision of certain goods shall be incompatible with the internal market, in so far as it affects trade between member states.
According to settled case law of the CJEU, for a measure to be categorized as aid within the meaning of Article 107(1) of the TFEU, all conditions set out in that provision must be fulfilled. Hence, for a measure to be categorized as state aid, the following cumulative conditions must be met:
- The measure has to be granted by state resources;
- It has to confer an advantage to undertakings;
- The advantage must be selective; and
- The measure must affect trade between member states and distort or threaten to distort competition.
State aid cases in tax matters usually fail because it cannot be evidenced that an advantage granted to an undertaking is of a selective nature.
The CJEU developed the following three-step analysis to determine whether a tax measure is selective:
- Identification of the reference legal system (in the present case, the Luxembourg corporate income tax system);
- Assessment whether the measure derogates from that common regime in as much as it differentiates between economic operators who, in the light of the objective assigned to the tax system, are in a comparable factual and legal situation (comparability test). Hence, it needs to be analyzed whether the tax rulings granted by the Luxembourg tax authorities to FFT entail an advantage that is not consistent with Luxembourg corporate income tax law; and
- Justification by the logic of the tax system (justification test)—should there be a measure found to be selective on the basis of the comparability test, it can still be found to fall outside the scope of the state aid rules if it is justified by the nature or the general scheme of the system.
State Aid Decision of the European Commission
On Oct. 21, 2015, the European Commission adopted the decision that the tax ruling granted to FFT fulfilled all the conditions set out in Article 107 (1) of the TFEU for being classified as state aid within the meaning of that provision.
With regard to the condition relating to the existence of a selective advantage, the commission considered the tax ruling to confer such an advantage on FFT in so far as it had resulted in a lowering of FFT’s tax liability in Luxembourg by deviating from the tax which FFT would have been liable to pay under the ordinary corporate income tax system.
More precisely, the commission considered that it was required to verify whether the methodology accepted by the Luxembourg tax authorities in the tax ruling at issue departed from the methodology that leads to a reliable approximation of a market-based outcome, and thus the arm’s-length principle. Here, the commission disregarded the guidance provided in Circular 164/2 and called for an autonomous interpretation of the arm’s-length principle.
In its decision, the commission concluded that certain methodological choices approved by the Luxembourg tax authorities and underlying the transfer pricing analysis in its tax ruling resulted in a lowering of FFT’s tax liability compared to the amount which would have been payable by a standalone company.
Decision of the General Court of the EU
The General Court confirmed that the commission has the right, under EU law, to verify whether the tax ruling granted to FFT conferred an advantage as compared to the “normal” taxation as defined by Luxembourg national law. Moreover, the court confirmed that the commission was entitled to analyze the tax ruling in light of the arm’s-length principle, which is deemed to be a tool that allows the commission to test whether intra-group transactions are remunerated as if they had been negotiated between independent companies.
With regard to the existence of an advantage, the court stated that the commission was right to find that the methodology for calculating FFT’s remuneration did not comply with the arm’s-length standard. In this regard, the application of the transactional net margin method as set out in the tax ruling was incorrect, as all FFT’s capital (rather than merely that part of capital being the equity at risk linked to the group financing activity) should have been included in the calculation and only one single rate should have been applied.
On this basis, the court concluded that the methodology approved in the tax ruling reduced FFT’s remuneration, which led to a lower tax liability for FFT in comparison to the tax that would have been paid under Luxembourg tax law, resulting in an advantage. According to the court, this advantage was selective in nature and the three-step test of selectivity had been met.
Finally, the court held that the advantage led to a restriction of competition, given that the corresponding tax reduction improved the financial position of FFT and the Fiat Group, to the detriment of its competitors.
Decision of the CJEU
The CJEU held that the decision of the commission must be annulled, as the commission erred in law in finding that there was a selective advantage in the light of a reference framework comprising an arm’s-length principle, which does not derive from a full examination of the relevant national framework.
The CJEU further stated that the error of the commission in determining the rules applicable under the relevant national law (and, therefore, in identifying the “normal” taxation in the light of which the tax ruling at issue had to be assessed) necessarily invalidates the entirety of the reasoning relating to the existence of a selective advantage. In other words, the commission did not have the right to disregard Luxembourg transfer pricing rules and replace them with some kind of European interpretation of the arm’s-length principle.
Instead, the commission must be able to establish that the parameters laid down by national law are manifestly inconsistent with the objective of non-discriminatory taxation of all resident companies (integrated or not) pursued by the national tax system, by systematically leading to an undervaluation of transfer prices applicable to integrated companies as compared to market prices for comparable transactions carried out by non-integrated companies.
According to the CJEU, the commission did not carry out such an examination in its decision, since its analytical framework did not include all the relevant norms implementing the arm’s-length principle under Luxembourg law. Therefore, the state aid decision of the commission must be annulled.
Conclusion and Outlook
The decision of the CJEU in the Fiat case is a bombshell that gives an indication as to how the court may decide in other state aid cases.
It is particularly important that the CJEU clarified that only the national law applicable in the member state concerned must be taken into account in order to identify the reference system for direct taxation. This is relevant for both the assessment of the existence of an advantage, and the question of whether an advantage is selective in nature.
Hence, the European Commission cannot simply disregard (part of) the domestic tax law of a member state with a view to establishing that a selective tax advantage has been granted to a taxpayer.
Ultimately, the decision of the CJEU contributes to legal certainty for taxpayers and may be seen as a bad omen for the commission as other decisions in state aid investigations may share the same fate as the Fiat case.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Oliver R. Hoor is a Tax Partner (Head of Transfer Pricing and the German Desk) with ATOZ Tax Advisers.
The author may be contacted at: firstname.lastname@example.org
The author wishes to thank Marie Bentley (Knowledge Director) for her assistance in relation to the review of this article.