On 3 June 2016, the European Commission published a non-confidential version of its decision of 3 December 2015 (‘the decision’) to open a formal investigation with respect to two tax rulings issued by the Luxembourg tax administration, aiming to determine whether the second of them constitutes state aid.
The first tax ruling, dated 30 March 2009, confirmed, in particular, that the royalties received by the US branch of McD Europe Franchising S.à.r.l. (McDonald’s) were tax exempt in Luxembourg, based on articles 7 and 25 of the Luxembourg/US treaty, provided that those profits were subject to tax in the US.
The second tax ruling (amending the first one) issued on 17 September 2009, confirmed that even if the US branch did not constitute a permanent establishment from a US tax perspective, and hence was not actually taxable in the US, the US branch did nevertheless constitute a permanent establishment in the US from a Luxembourg tax perspective, and profits in relation to that US branch should still be tax exempt in Luxembourg.
Luxembourg considers that the second tax ruling is fully in line with Luxembourg law and does not constitute state aid. In addition, the ruling only provides an interpretation of the relevant provisions of Luxembourg law and hence cannot trigger discriminatory treatment of the taxpayer. According to Luxembourg, the US branch constitutes a permanent establishment in the US pursuant to the Luxembourg/US treaty and therefore income in relation to the permanent establishment is tax exempt in Luxembourg.
The decision confirms the Commission’s expected arguments with respect to the second ruling (which was not completely in line with the first ruling).
In effect, the Commission considers that the ruling dated 17 September 2009 may constitute state aid. Of the conditions necessary to amount to state aid, only the condition of a ‘selective advantage’ is at stake and is analysed in detail, through a three steps analysis. First, the ‘reference system’ of the member state needs to be analysed. Second, it needs to be determined whether the tax measure constitutes derogation from that system, granting an advantage to economic operators who are in a ‘comparable legal and factual situation’ (see the decision of the European General Court in the Banco Santander SA (Case T-399/11) para 48). If a derogation exists, then the member state can evidence that the measure is justified by the nature of the general scheme of the reference system.
The Commission considers that the reference system is the Luxembourg corporate income tax law system, including its tax treaties.
The Commission also considers that the revised tax ruling contradicts both the Luxembourg/US treaty and also the Luxembourg law which transposes the treaty into national law and which is subject to a guiding principle requiring worldwide taxation of profits.
The Commission acknowledges that the requirement for taxation in article 25 of the Luxembourg/US treaty (i.e. ‘may be taxed’) does not mean that the US permanent establishment needs to be ‘effectively taxed’ to fall within that article, but rather that the US ‘may tax the income in question under the tax treaty’. Nevertheless, since on the facts, it clearly was not possible for the US to tax the profits of the US branch in the US, the Commission considers that the Luxembourg tax administration should not have granted an exemption for the income of the US branch in the second tax ruling, an interpretation it argues is based on the commentary of the OECD Model. By doing so, Luxembourg allegedly granted a selective advantage to McDonald’s. The Commission states that Luxembourg has not provided any justification for the said tax treatment at this stage.
However, if it can be demonstrated that Luxembourg has consistently interpreted the provisions of the Luxembourg/US treaty in the same way with respect to all taxpayers in a ‘comparable legal and factual situation’, it seems questionable that the selectivity criterion would be met.
It should be noted that this decision is just the beginning of the Commission’s formal investigation and it is expected that both Luxembourg and McDonald’s will oppose the Commission’s arguments.
Pierre-Régis Dukmedjian, partner (pierre-regis.dukmedjian@simmons-simmons.com) & Alejandro Dominguez, associate (alejandro.dominguez@ simmons-simmons.com), Simmons & Simmons Luxembourg LLP
On 3 June 2016, the European Commission published a non-confidential version of its decision of 3 December 2015 (‘the decision’) to open a formal investigation with respect to two tax rulings issued by the Luxembourg tax administration, aiming to determine whether the second of them constitutes state aid.
The first tax ruling, dated 30 March 2009, confirmed, in particular, that the royalties received by the US branch of McD Europe Franchising S.à.r.l. (McDonald’s) were tax exempt in Luxembourg, based on articles 7 and 25 of the Luxembourg/US treaty, provided that those profits were subject to tax in the US.
The second tax ruling (amending the first one) issued on 17 September 2009, confirmed that even if the US branch did not constitute a permanent establishment from a US tax perspective, and hence was not actually taxable in the US, the US branch did nevertheless constitute a permanent establishment in the US from a Luxembourg tax perspective, and profits in relation to that US branch should still be tax exempt in Luxembourg.
Luxembourg considers that the second tax ruling is fully in line with Luxembourg law and does not constitute state aid. In addition, the ruling only provides an interpretation of the relevant provisions of Luxembourg law and hence cannot trigger discriminatory treatment of the taxpayer. According to Luxembourg, the US branch constitutes a permanent establishment in the US pursuant to the Luxembourg/US treaty and therefore income in relation to the permanent establishment is tax exempt in Luxembourg.
The decision confirms the Commission’s expected arguments with respect to the second ruling (which was not completely in line with the first ruling).
In effect, the Commission considers that the ruling dated 17 September 2009 may constitute state aid. Of the conditions necessary to amount to state aid, only the condition of a ‘selective advantage’ is at stake and is analysed in detail, through a three steps analysis. First, the ‘reference system’ of the member state needs to be analysed. Second, it needs to be determined whether the tax measure constitutes derogation from that system, granting an advantage to economic operators who are in a ‘comparable legal and factual situation’ (see the decision of the European General Court in the Banco Santander SA (Case T-399/11) para 48). If a derogation exists, then the member state can evidence that the measure is justified by the nature of the general scheme of the reference system.
The Commission considers that the reference system is the Luxembourg corporate income tax law system, including its tax treaties.
The Commission also considers that the revised tax ruling contradicts both the Luxembourg/US treaty and also the Luxembourg law which transposes the treaty into national law and which is subject to a guiding principle requiring worldwide taxation of profits.
The Commission acknowledges that the requirement for taxation in article 25 of the Luxembourg/US treaty (i.e. ‘may be taxed’) does not mean that the US permanent establishment needs to be ‘effectively taxed’ to fall within that article, but rather that the US ‘may tax the income in question under the tax treaty’. Nevertheless, since on the facts, it clearly was not possible for the US to tax the profits of the US branch in the US, the Commission considers that the Luxembourg tax administration should not have granted an exemption for the income of the US branch in the second tax ruling, an interpretation it argues is based on the commentary of the OECD Model. By doing so, Luxembourg allegedly granted a selective advantage to McDonald’s. The Commission states that Luxembourg has not provided any justification for the said tax treatment at this stage.
However, if it can be demonstrated that Luxembourg has consistently interpreted the provisions of the Luxembourg/US treaty in the same way with respect to all taxpayers in a ‘comparable legal and factual situation’, it seems questionable that the selectivity criterion would be met.
It should be noted that this decision is just the beginning of the Commission’s formal investigation and it is expected that both Luxembourg and McDonald’s will oppose the Commission’s arguments.
Pierre-Régis Dukmedjian, partner (pierre-regis.dukmedjian@simmons-simmons.com) & Alejandro Dominguez, associate (alejandro.dominguez@ simmons-simmons.com), Simmons & Simmons Luxembourg LLP
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