The basic tool for determining whether there is a grant of state aid is Art. 107 of the Treaty on the Functioning of the European Union. One of the ways a member state may be found to violate state aid rules is through its tax laws.
In recent months, there has been a lot of comment about cases where the wording and application of tax laws raise concerns about potential violation of state aid rules.
In Poland, these doubts have concerned for example the planned introduction of two new taxes, under the Act on the Tax on Certain Financial Institutions and the Act on the Retail Sales Tax. Similar legislative initiatives have come under investigation by the European Commission in other EU member states.
In terms of application of tax law, the Commission, the media and the broader public have focused on cases involving huge multinational groups enjoying favourable tax treatment. These include the broad scale of awarding tax advantages revealed in the Lux Leaks affair and more recently the income tax paid in Ireland by one of the world’s most famous producers of electronic devices.
As far back as 1998, in the Commission notice on the application of the State aid rules to measures relating to direct business taxation (98/C 384/03), the European Commission indicated that state aid can be granted “as much through tax provisions of a legislative, regulatory or administrative nature as through the practices of the tax authorities.”
Bank tax and state aid
The compliance of Poland’s tax on certain financial institutions (popularly known as the “bank tax”) with EU law has been examined by the country’s competition regulator, the president of the Office of Competition and Consumer Protection (UOKiK). An opinion dated 21 December 2015, issued at the stage of legislative work on the tax, focused on aspects of the bill that could potentially contain an element of state aid.
One of them that was pointed out by the regulator was Art. 10 of the act, which exempts state banks (within the meaning of the Banking Law) from the tax. The drafters of the bill based this exemption on the notion that state banks pursue the goals of the state’s economic policy. Nonetheless, the president of UOKiK pointed out that as a rule, banking activity is regarded as a form of commercial activity for purposes of state aid regulations, and there are no regulations excluding the possibility for Poland’s state banks to conduct commercial activity.
Consequently, as a state bank enjoys an exemption from the bank tax on all of its assets (including assets used for conducting commercial activity), this exemption may be regarded as state aid insofar as the state bank is exempt from tax on its commercial activity. The regulator said that to rule out state aid under this exemption, the exemption should be limited to the portion of a state bank’s assets that are not used for commercial activity.
A selective subjective tax exemption is the simplest form of awarding a tax advantage which may be found to be state aid. An element of public assistance may also be found in objective exemptions. The president of UOKiK pointed out that under the Act on the Tax on Certain Financial Institutions, such an exemption for entities covered by a special procedure pursuant to a decision by the Polish Financial Supervision Authority also results in preferential treatment with regard to consumers insofar as it applies to entities continuing to conduct commercial activity. Thus this objective exemption, like the subjective exemption for state banks, could be a means for delivering state aid.
In the opinion, the regulator mentioned that issues such as the scope of entities covered by the bill, the amount of the tax-exempt threshold, the level of the tax itself and the possibility for selected entities to obtain a reduction of the tax basis were beyond the scope of the analysis because they were not discussed in the justification for the proposed act.
Retail sales tax carries risk of state aid
The forms of awarding state aid via taxation were also discussed in the opinion by the president of UOKiK of 11 February 2016 concerning the Retail Sales Tax Act.
Citing the 1998 Commission notice, the Polish regulator pointed out that state aid may be found in an advantage provided to a firm, in the form of tax exemption, a reduction in tax rates, a reduction of the tax basis, a total or partial reduction in the amount of the tax, or a deferment, cancellation or rescheduling of payment of the tax obligation.
Under the Retail Sales Tax Act, the controversy surrounds the application of a progressive tax rate (effectively from zero to 1.4%). While a progressive tax scale itself is generally not contrary to state aid rules, differentiation in the situation of taxpayers must be justified by the nature or general structure of the tax system. Otherwise tax progression may be found to violate competition law.
Examples of application of a tax scale in a form that could be found to violate state aid principles were outlined when the European Commission examined Hungarian regulations assessing progressive taxes on turnover. The risk of violating competition law was found in the fact that entities generating relatively lower turnover were subject to a lower tax rate than others in a similar factual and legal situation. Moreover, the progression was steep and sudden, which in the view of the European Commission could indicate intentional discrimination in the treatment of undertakings.
In the case of Poland, the aspect that will determine how controversial the retail sales tax is from the perspective of state aid principles is which group of retailers effectively end up paying the tax, and at what rate. If there are major aberrations, it will increase the odds that the tax will be challenged by the European Commission.
State aid in certain individual interpretations of tax law
Interpretations of tax law can also be a source of state aid. For several years the Commission has been taking measures to verify the practices of member states in awarding selective tax advantages. Among other countries, suspicion fell on Luxembourg, which lent its name to the Lux Leaks scandal when over 500 tax interpretations were disclosed that could award enterprises benefits deemed to be state aid pursuant to EU competition law.
Similarly, on 30 August 2016 the Commission issued a press release describing the case of the prominent manufacturer of electronic equipment, stating that the Commission “has concluded that two tax rulings issued by Ireland to Apple have substantially and artificially lowered the tax paid by Apple in Ireland since 1991.” The benefit was found in the allocation of profit, confirmed in individual tax rulings, which resulted in the company paying income tax at an effective rate that fell from 1% in 2003 to 0.005% in 2014.
The Commission explained that individual rulings as such are not unlawful. Nonetheless, it found that in this case there was “an artificial internal allocation of profits” within group companies with “no factual or economic justification.” Consequently, the company was ordered to reimburse unjustified tax advantages in an amount of up to EUR 13 billion.
In light of these practices of granting individual tax rulings, the Commission set forth guidelines for ensuring that individual interpretations of tax law issued by the member states comply with state aid rules, in the Commission Notice on the notion of State aid as referred to in Article 107(1) of the Treaty on the Functioning of the European Union (2016/C 262/01).
In the recent notice, the Commission recognised that tax rulings play an important role in providing legal certainty and predictability in the application of general tax rules, including in determining proper arm’s-length arrangements within groups of related companies. But this does not alter the fundamental requirement that tax rulings must comply with state aid rules: “Where a tax ruling endorses a result that does not reflect in a reliable manner what would result from a normal application of the ordinary tax system, that ruling may confer a selective advantage upon the addressee”.
The Commission places particular importance on compliance with arm’s-length market principles in tax rulings issued in the area of transfer pricing. When examining whether a ruling awards an undue advantage, the Commission recommends relying on the guidance provided by the Organisation for Economic Cooperation and Development, in particular the “OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.” Compliance with these guidelines should eliminate the element of state aid.
The Commission notice also provided two examples of situations where a solution accepted for transfer prices may not be compliant with state aid rules. One is a situation where a tax ruling endorses a transfer pricing methodology that departs from a reliable approximation of an achievable market-based outcome. “The same applies if the ruling allows its addressee to use alternative, more indirect methods for calculating taxable profits, for example the use of fixed margins for a cost-plus or resale-minus method for determining an appropriate transfer pricing, while more direct ones are available.”
The examples of possible state aid mentioned above are just a few of the many that can arise in the context of tax law in legal and economic reality. Although EU member states generally are given the freedom to establish their own tax laws, it is apparent from these examples that the involvement of the European Commission in the shaping of national tax systems is steadily growing. The measures now being pursued by the Commission suggest that this trend will continue for the foreseeable future.
Wojciech Marszałkowski, Tax Practice, Wardyński & Partners