Commission Investigate McDonald’s Tax Arrangements in Luxembourg

The EU’s Directorate-General for Competition (DG COMPETITION) announced on December 3rd 2015 that it has opened an in-depth investigation into rulings by the Luxembourg tax authorities with regard to McDonald’s corporate income tax.¹ The McDonald’s investigation is the sixth case the Commission has launched challenging tax rulings under the EU State aid rules. The Commission’s use of EU State aid rules in this way is highly controversial, and legal challenges to the Commission’s position are likely to run for years.

The Commission argues that a Luxembourg tax ruling in September 2009 allowed McDonald's Europe Franchising to avoid tax in Luxembourg even though the relevant income was also not taxable in the United States. Commissioner Margrethe Vestager stated: "A tax ruling that agrees to McDonald's paying no tax on their European royalties either in Luxembourg or in the US has to be looked at very carefully under EU state aid rules. The purpose of Double Taxation treaties between countries is to avoid double taxation – not to justify double non-taxation."

The Commission’s stress on whether the McDonald’s franchising income was taxable in the United States is surprising. The legal test, as the Commission’s press release indicates, is whether Luxembourg authorities selectively derogated from the provisions of their national tax law and the Luxembourg-US Double Taxation Treaty and thereby gave McDonald's an advantage not available to other companies in a comparable factual and legal situation. The Commission gave no indication whether it has evidence of such positive discrimination or what companies might be considered to be in a comparable situation to McDonald’s, but in any case the relevance of McDonald’s US tax payments is unclear.

The McDonald’s case is the first such case that does not concern related to intra-group tax arrangements. Four previous cases involve alleged aid to specific companies – Amazon, Apple, Fiat Finance and Trade (FFT), and Starbucks – and one involves potential aid granted under the Belgian ”excess profit” tax regime.²    The Commission has already adopted negative decisions finding that Luxembourg and Dutch rulings in favor of FFT and Starbucks, respectively, amounted to illegal State aid.³   A decision on the Belgian case is expected soon.

DG COMPETITION’s State aid investigations reflect the current Commission’s increased focus on taxation. DG COMPETITION is also conducting a wider inquiry into tax practices of several Member States, which in December 2014 was extended to all Member States. In June 2015, the Commission unveiled a series of initiatives to tackle tax avoidance, secure sustainable tax revenues and strengthen the Single Market for businesses. ⁴ In October 2015, the Member States agreed to the automatic exchange of information on their tax rulings as of 1 January 2017.⁵ The Commission is expected to announced additional tax-related proposals in early 2016.

Commissioner Vestager’s comments on McDonald’s US tax rates can be seen as part of a broader Commission tax initiative and legally questionable in the State aid context. These comments may reinforce concerns that the Commission’s State aid investigations disproportionately target US-based companies.

Background

Although the Commission has no direct authority over national tax systems, it can investigate whether certain fiscal regimes, including in the form of tax rulings, would constitute “unjustifiable” State aid to companies. The EU’s State aid rules are set out in the Treaty on the Functioning of the European Union (TFEU) and constitute part of the TFEU’s provisions on competition law. In general, Member States are prohibited from granting financial assistance in a way that distorts competition, unless the aid measure has been notified to and authorized by the Commission. The prohibition applies to any form of financial aid. Although not problematic in themselves, tax rulings may amount to unlawful State aid if they provide selective advantages to a specific company or group of companies that are not approved under EU State aid rules.

Article 107(1) TFEU prohibits “any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods, in so far as it affects trade between Member States.” Article 108(3) TFEU requires Member States to notify non-exempted State aid measures, including in the form of tax measures, to the Commission before their implementation, and to await the Commission’s approval before implementing such measures (the so-called “standstill obligation”). If either of those obligations are not fulfilled, the State aid measure is considered to be unlawful.

When can tax rulings constitute unlawful state aid?

Measures taken to exempt a company from pay taxes can amount to unlawful State aid if the following conditions are met:

• First, the tax measure must grant an economic advantage. In the case of tax rulings, an advantage could arise where the ruling results in lower effective tax rates than would otherwise have to be paid under the normally applicable tax system.
• Second, the advantage must be financed through State resources, including where a tax authority lowers the effective tax rate that would otherwise be payable.
• Third, the tax measure must distort or threaten to distort trade and competition between Member States.
• Finally, the tax measure must be specific, or selective. A tax ruling that merely interprets general tax rules or manages tax revenue based on objective criteria will generally not constitute State aid.

Conclusion

The McDonald’s investigation opens a new front in the Commission’s attack on tax rulings under the EU State aid rules, since it is the first not to involve intra-group taxation. The Commission will need to show that McDonald’s has received a benefit Luxembourg does not make available to similarly situated companies. The Commission’s press release does not indicate how it intends to meet this test. The Commission has so far focused more on McDonald’s US tax rates, which are of questionable relevance to the State aid case. Publication of the Commission’s decision opening the investigation should shed more light on this highly controversial case.

Footnotes

1. See Commission’s press release IP/15/6221 (03/12/2015).
2. See Commission’s press release IP/15/4080 (03/02/2015).
3. See Commission’s press release IP/15/5880 (21/10/2015).
4. See Commission’s press release IP/15/5188 (17/06/2015).
5. See Commission’s press release IP/15/4610 (18/03/2015) and Commission’s press release IP/15/5780 (06/11/2015).

Jay Modrall