Introduction
The favourable tax treatment of multinational companies has long been in the sights of the Commission. However, the recent judgments on Fiat [C‑885/19 P, Fiat v Commission] and Engie [C‑454/21 P, Engie v Commission] have made it clear that Commission may not rely on principles which are not recognised in the tax laws of Member States. This fundamental rule was reiterated in the judgment of 14 December 2023, in case C‑457/21 P, European Commission v Luxembourg & Amazon.[1] This rule is the consequence of the fact that Member State enjoy wide discretion in designing their tax systems.
The judgment in Amazon confirmed the finding of the Court of Justice in Fiat [paragraph 104] that the arm’s length principle is not an independent principle that can be applied at will by the Commission. Several of the earlier judgments of the General Court acknowledged that prices charged in intra-group transactions could be compared with market prices charged between autonomous or unrelated companies. So, even if the Commission lost those cases on technicalities, it was considered that it won on principle. Well, this is no longer true. Regardless of what the OECD recommends or what reasonable economists and tax experts believe, the only decisive element is the rules that are recognised in national tax systems.
Background
The Commission had appealed against the judgment of the General Court of 12 May 2021, in cases T-816/17 & T-318/18, Luxembourg & Amazon v European Commission, by which the General Court annulled Commission decision 2018/859 concerning a measure implemented by Luxembourg in favour of Amazon.
Amazon US established in Luxembourg, Amazon Europe Holding Technologies SCS [LuxSCS] and Amazon EU Sàrl [LuxOpCo]. The former licensed Amazon’s technology, trade marks and know-how [in general, intellectual property rights (IPRs)] to the latter which carried out retail operations in Europe through subsidiaries in other EU Member States. LuxSCS did not have any physical presence or employees in Luxembourg.
In 2003, Amazon asked Luxembourg for an advance tax ruling [ATR] on the method of calculating the rate of the royalty that LuxOpCo was to pay to LuxSCS. That request by Amazon was accompanied by a transfer pricing report prepared by its tax advisers. The tax ruling was granted and applied from 2006 to 2014.
In October 2017, after a formal investigation, the Commission concluded, in decision 2018/859, that Luxembourg, through the ATR, granted State aid to LuxOpCo because the royalty payments made by LuxOpCo to LuxSCS were not determined at an arm’s length basis. In particular, the Commission considered that the royalties paid by LuxOpCo over-estimated the value of the IPRs licensed to it by to LuxSCS. By contrast, the ATR assumed that LuxOpCo carried out routine operations that could be remunerated at a low profit rate. According to the Commission, LuxOpCo in fact carried out the most important revenue-generating operations in Europe and should have kept a larger share of that revenue. Consequently, it should have paid more taxes in Luxembourg. In the opinion of the Commission, the Luxembourg tax administration should have concluded that LuxSCS did not perform any unique and valuable functions in relation to the intangible assets for which it merely held the legal title.
On appeal, the General Court disagreed with the Commission’s conclusion that the royalties paid to LuxSCS were excessive. The gist of the reasoning of the General Court was that Amazon’s competitiveness and its ability to generate revenue depended on its technology, know-how, website, business model, etc. All these assets belonged to Amazon US and LuxSCS. LuxOpCo would not have been able to earn the same revenue without those assets.
The concept of selectivity and the reference system
The Court of Justice began its analysis by recalling the wide discretion of Member States to design their tax systems. However, the Court, first, warned that “(31) action by Member States in areas that are not subject to harmonisation by EU law is not excluded from the scope of the provisions of the FEU Treaty on monitoring State aid. The Member States must thus refrain from adopting any tax measure liable to constitute State aid that is incompatible with the internal market”.
“(33) So far as concerns the condition relating to selective advantage, it requires a determination as to whether, under a particular legal regime, the national measure at issue is such as to favour ‘certain undertakings or the production of certain goods’ over other undertakings which, in the light of the objective pursued by that regime, are in a comparable factual and legal situation and which accordingly suffer different treatment that can, in essence, be classified as discriminatory”.
“(34) In order to classify a national tax measure as ‘selective’, the Commission must begin by identifying the reference system, that is the ‘normal’ tax system applicable in the Member State concerned, and demonstrate, as a second step, that the tax measure at issue is a derogation from that reference system, in so far as it differentiates between operators who, in the light of the objective pursued by that system, are in a comparable factual and legal situation. The concept of ‘State aid’ does not, however, cover measures that differentiate between undertakings which, in the light of the objective pursued by the legal regime concerned, are in a comparable factual and legal situation, and are, therefore, a priori selective, where the Member State concerned is able to demonstrate, as a third step, that that differentiation is justified, in the sense that it flows from the nature or general structure of the system of which those measures form part”.
“(35) The determination of the reference system is of particular importance in the case of tax measures, …, since the existence of an economic advantage for the purposes of Article 107(1) TFEU may be established only when compared with ‘normal’ taxation.”
“(36) Thus, determination of the set of undertakings which are in a comparable factual and legal situation depends on the prior definition of the legal regime in the light of whose objective it is necessary, where applicable, to examine whether the factual and legal situation of the undertakings favoured by the measure in question is comparable with that of those which are not”.
“(37) For the purposes of assessing the selective nature of a tax measure, it is, therefore, necessary that the common tax regime or the reference system applicable in the Member State concerned be correctly identified in the Commission decision and examined by the court hearing a dispute concerning that identification. Since the determination of the reference system constitutes the starting point for the comparative examination to be carried out in the context of the assessment of selectivity, an error made in that determination necessarily vitiates the whole of the analysis of the condition relating to selectivity”.
“(38) In that context, it must be stated, in the first place, that the determination of the reference framework, which must be carried out following an exchange of arguments with the Member State concerned, must follow from an objective examination of the content, the structure and the specific effects of the applicable rules under the national law of that State”.
“(39) In the second place, outside the spheres in which EU tax law has been harmonised, it is the Member State concerned which determines, by exercising its own competence in the matter of direct taxation and with due regard for its fiscal autonomy, the characteristics constituting the tax, which define, in principle, the reference system or the ‘normal’ tax regime, from which it is necessary to analyse the condition relating to selectivity. This includes, in particular, the determination of the basis of assessment, the taxable event and any exemptions that may apply”.
“(40) It follows 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, that identification being itself an essential prerequisite for assessing not only the existence of an advantage, but also whether it is selective in nature”.
Transfer pricing
Then, the Court of Justice turned its attention to the pricing of the royalties paid by LuxOpCo to LuxSCS.
“(41) The present case, in common with the case that gave rise to the judgment of 8 November 2022, Fiat Chrysler Finance Europe v Commission (C‑885/19 P and C‑898/19 P, EU:C:2022:859), concerns the question of the legality of a tax ruling adopted by the Luxembourg tax administration and based on the determination of the transfer price in the light of the arm’s length principle.”
“(42) It is clear from that judgment, in the first place, that the arm’s length principle can only be applied if it is recognised by the national law concerned and in accordance with the detailed rules defined by it. In other words, as EU law currently stands, there is no autonomous arm’s length principle that applies independently of the incorporation of that principle into national law for the purposes of examining tax measures in the context of the application of Article 107(1) TFEU”.
“(43) On that matter, the Court held that, while the national law applicable to companies in Luxembourg is intended, as regards the taxation of integrated companies, to bring about a reliable approximation of the market price and while that objective corresponds, in general terms, to that of the arm’s length principle, the fact remains that, in the absence of harmonisation in EU law, the specific detailed rules for the application of that principle are defined by national law and must be taken into account in order to identify the reference framework for the purposes of determining the existence of a selective advantage”.
“(44) In the second place, it must be recalled that the OECD Guidelines are not binding on the Member States of that organisation. As the Court pointed out, even if many national tax authorities are guided by those guidelines in the preparation and control of transfer prices, it is only the national provisions that are relevant for the purposes of analysing whether particular transactions must be examined in the light of the arm’s length principle and, if so, whether or not transfer prices, which form the basis of a taxpayer’s taxable income and its allocation among the States concerned, deviate from an arm’s length outcome. Parameters and rules external to the national tax system at issue, such as the OECD Guidelines, cannot be taken into account in the examination of the existence of a selective tax advantage as provided for in Article 107(1) TFEU and for the purposes of establishing the tax burden that should normally be borne by an undertaking, unless that national tax system makes explicit reference to them”.
“(45) In this case, it must be stressed that, in paragraphs 121 and 122 of the judgment under appeal, the General Court held as follows:
‘121 It should also be noted that when the Commission uses the arm’s length principle to check whether the taxable profit of an integrated undertaking pursuant to a tax measure corresponds to a reliable approximation of a taxable profit generated under market conditions, the Commission can identify an advantage within the meaning of Article 107(1) TFEU only if the variation between the two comparables goes beyond the inaccuracies inherent in the methodology used to obtain that approximation …
122 Even though the Commission cannot be formally bound by the OECD Guidelines, the fact remains that those guidelines are based on important work carried out by groups of renowned experts, that they reflect the international consensus achieved with regard to transfer pricing and that they thus have a certain practical significance in the interpretation of issues relating to transfer pricing […]’”
“(46) It follows from paragraph 121 of the judgment under appeal that, in finding that the Commission could, in a general manner, apply the arm’s length principle in the context of implementing Article 107(1) TFEU, even though that principle has no autonomous existence in EU law, without stating that that institution was required, as a preliminary step, to satisfy itself that that principle was incorporated into the national tax law concerned, in the present case Luxembourg tax law, and that express reference was made to it as such in that law, the General Court committed a first error of law. That error is not remedied by the fact that the General Court, in paragraph 137 of the judgment under appeal, considered, moreover wrongly, for the reasons set out in paragraphs 54 and 55 of the present judgment, that Luxembourg law enshrined that principle at the time of the facts of the case.”
“(47) Likewise, by stating, in paragraph 122 of the judgment under appeal, that, despite their lack of binding force for the Commission, the OECD Guidelines have a ‘certain practical significance’ in the assessment of whether that principle has been observed, the General Court failed to recall that those guidelines were also not binding on the member States of the OECD and that, therefore, they have practical importance only to the extent that the tax law of the Member State concerned makes explicit reference to them. Hence, it did not review whether the Commission had satisfied itself that that was actually the case in Luxembourg tax law and the General Court itself took for granted that those guidelines applied, thus committing a second error of law.”
“(48) It follows that, …, as is clear from paragraph 132 of the judgment under appeal, that the arm’s length principle lacked any foundation in EU law, the General Court, which dismissed that argument as inadmissible and consequently did not examine it, whilst, on the substance, it put at issue the accuracy of the reference system used by the Commission in order to determine normal taxation and, consequently, whether there was an advantage for the benefit of the Amazon group, upheld an interpretation of the arm’s length principle contrary to EU law, as recalled, in particular in paragraphs 96 and 104 of the [Fiat] judgment … and thus wrongly confirmed the Commission’s determination of the reference system.”
“(49) The whole of the General Court’s analysis …, in so far as it concerns the condition of the existence of a selective advantage within the meaning of Article 107(1) TFEU, is based on the application, for the purposes of determining whether there is such an advantage, of the arm’s length principle pursuant to the OECD Guidelines irrespective of the incorporation of that principle into Luxembourg law.”
“(50) Consequently, since it rests on an incorrect determination, by the General Court, of the relevant reference system for the purpose of determining whether there is a selective advantage within the meaning of Article 107(1) TFEU, that analysis is, in accordance with the case-law referred to in paragraph 37 of the present judgment, also incorrect.”
Final judgment
Because the Court of Justice had all the necessary information before it, it decided to proceed to final judgment, instead of returning the case to the General Court.
It observed, first, that “(53) the Commission applied the arm’s length principle as if it had been recognised as such in EU law, […] However, it is clear from paragraph 104 of the [Fiat] judgment …, that, as EU law currently stands, there is no autonomous arm’s length principle that applies independently of the incorporation of that principle into national law.”
“(54) Secondly, it considered, …, that Article 164(3) of the Law on income tax was interpreted by the Luxembourg tax administration as enshrining the arm’s length principle in Luxembourg tax law. However, as is clear from paragraphs 96 and 104 of the [Fiat] judgment …, only the incorporation of that principle as such into national law, which as a minimum requires that that law refer explicitly to that principle, would permit the Commission to apply it in the determination of the existence of a selective advantage within the meaning of Article 107(1) TFEU.”
“(55) As the Commission itself recognised …, it is only since 1 January 2017, namely after the adoption and extension of the tax ruling at issue, that a new article of the Law on income tax ‘explicitly formalises the application of the arm’s length principle under Luxembourg tax law’. It is therefore established that the requirement recalled by the case-law cited in the preceding paragraph was not satisfied at the time of adoption, by the Member State concerned, of the measure that the Commission found to be State aid, such that that institution could not apply that principle retroactively in the decision at issue.”
“(56) Thirdly, by applying, …, the OECD Guidelines on transfer pricing without having demonstrated that they had been, wholly or in part, explicitly adopted in Luxembourg law, the Commission breached the prohibition, recalled in paragraph 96 of the [Fiat] judgment …, on taking into account, in the examination of the existence of a selective tax advantage within the meaning of Article 107(1) TFEU and for the purposes of establishing the tax burden that should normally be borne by an undertaking, parameters and rules external to the national tax system at issue, such as those guidelines, unless that national tax system makes explicit reference to them.”
Conclusion
In view of this foregoing analysis, the Court of Justice inevitably concluded that “(57) such errors in determining the rules actually 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 invalidate the entirety of the reasoning relating to the existence of a selective advantage”.
“(58) It follows from all those considerations that the General Court was fully entitled to find, …, that the Commission had not established the existence of an advantage for the benefit of the Amazon group, within the meaning of Article 107(1) TFEU, and to annul, therefore, the decision at issue.”
[1] The full text of the judgment can be accessed at:
