As many potentially-affected UK multinationals are well aware, there is an ongoing EU state aid investigation into the UK’s controlled foreign company (CFC) rules – in particular the finance company exemption / partial exemption within the CFC regime. The European Commission published an opening decision last year in which it suggested that that “scheme” constitutes illegal state aid. The Commission’s final decision is expected soon.
Taxpayers potentially affected by the CFC state aid investigation might feel encouraged by the recent Advocate-General’s (AG) opinion in the German real estate transfer tax (RETT) case. Following a thorough review of the emerging case law in this area, the AG makes a powerful case for a retreat to more ‘traditional’ methodology in fiscal state aid cases. It seems clear that this particular AG would be sceptical about the Commission’s use of the ‘reference framework’ method to support its opening decision in the CFC state aid investigation.
The RETT case is unusual in that it is a referral from the federal German court direct to the CJEU, rather than the more traditional appeal to the General Court following a decision by the Commission. The question posed is whether an exemption from the German RETT rules for certain types of intra-group reorganisation constitutes state aid. The Commission argues that it does, whereas the German government, the taxpayer and the referring court all say that it does not.
The ‘reference framework’ and ‘traditional’ approaches
The AG starts by highlighting the importance in fiscal state aid cases of the selectivity requirement – the point being that all the other state aid conditions will typically be met by any measure conferring a tax benefit.
The AG recommends that the Commission and EU courts move away from assessing selectivity in a tax context using the ‘reference framework’ method. This method (which emerged from Paint Graphos and was confirmed in World Duty Free) is based on a discrimination test, and starts by asking whether a measure constitutes a derogation from the relevant reference framework. If it does, and if the measure is not open to all undertakings in comparable legal and factual situations, then it will constitute state aid unless it can be justified by the nature or overall structure of the system in question. The AG is critical of this approach, on the basis that the discrimination test casts the net too broadly, and that the approach overall leads to significant subjectivity and legal uncertainty.
Indeed, the AG goes further and (risking controversy) suggests this method affords the Commission “the power to ‘smooth out’ the national tax systems by requiring the removal of those differentiations legitimately established for social, economic, environmental or other reasons”. This would, in his view, be “difficult to reconcile with the principle of the fiscal autonomy of the Member States.”
The AG favours instead using a ‘traditional’ method of analysis, which considers whether there is an advantage which is not generally available to all undertakings present in the national territory. Under this approach, the key question is whether all undertakings may benefit from the measure rather than whether they have actually done so. Applying the traditional method to the German RETT exemption, the AG finds it easy to conclude that it is not state aid, because it is a general measure from which all undertakings may benefit, regardless of their business sector.
In the alternative, the AG goes on to consider the ‘reference framework’ method and concludes that, even under that approach, the RETT exemption is not selective:
- The Commission argues that the reference framework is the broad taxing rule, which is intended to tax all transfer transactions which result in legal or economic transfer of ownership. On that basis, it seems the Commission thinks that the exemption is a derogation.
- But the AG prefers the taxpayer’s interpretation – under which the exemption is viewed as correcting the scope of the general rule, which would otherwise tax transactions involving no economic transfer of the relevant property. On that basis, the exemption should be taken into account as part of the reference framework.
- The AG goes on to consider the position if the reference framework is the broad taxing rule. In that context, he concludes that intra-group transactions are not comparable with external transactions.
Of course we will need to wait and see what the CJEU makes of these arguments when it releases its decision in this case. But following on the heels of the CJEU decision against the Commission in Heitkamp (dealing with a restructuring exception to a German rule denying loss carry-forward where there is a change of ownership), the Commission may need to rethink its approach in the UK CFC state aid investigation and in tax-related “scheme” cases more generally.
The Commission’s opening decision in the CFC state aid investigation is available here.