On 8 November 2022 the Court of Justice of the European Union (CJEU) delivered a significant body blow to the European Commission in the Fiat / Luxembourg State aid case [1]. The decision is likely to have wide-reaching ramifications for other State aid cases which are currently under appeal and other ongoing investigations which have been initiated by the Commission. The CJEU decision also calls into question the approach taken by the Commission with respect to its utilisation of the State aid rules, in the absence of harmonisation of direct tax laws at EU level, to tackle what it perceives to be unfair or aggressive tax practices.
1. Background
The Commission had determined in 2015 that the Luxembourg tax authorities had provided a tax ruling to Fiat which amounted to unlawful State aid under EU law. At the first stage of Fiat's appeal, the General Court of the EU endorsed the Commission's decision and dismissed the appeal. The CJEU has now set aside the lower court's ruling and annulled the Commission's original finding. In so doing, the CJEU determined that the Commission erred in its use of an incorrect reference framework to demonstrate a selective advantage was conferred on Fiat by Luxembourg. Although the case concerned State aid granted to Fiat by the Luxembourg tax authorities, Ireland also joined the appeal as an intervener, given its own State aid case and similarity of the issues raised.
2. What was the basis for annulling the Commission's finding?
The CJEU determined that the Commission had failed to apply the correct "reference framework" when analysing whether the ruling issued to Fiat departed from the general Luxembourg corporate income tax system and thereby conferred a selective advantage on Fiat. In other words, the rules, which the Commission used to determine "normal taxation" for the purposes of evaluating if the ruling in question granted a selective advantage to the beneficiary, were incorrectly defined.
The CJEU found that the Commission had erroneously found that the arm’s length principle necessarily formed part of its assessment, under Article 107(1) TFEU, of tax measures granted to group companies, irrespective of whether a Member State had incorporated that principle into its national legal system. Although the Luxembourg law did in fact include the arm's length principle in the relevant measure, the Commission ignored how that principle applied pursuant to Luxembourg law. In dismissing the relevance of how Luxembourg law actually incorporated the arm's length principle in favour of its more abstract approach, the Commission applied an arm’s length principle different from that defined by Luxembourg law. The CJEU held that by validating the examination by the Commission of the tax ruling at issue, without taking into account the way in which the arm's length principle actually applied in Luxembourg law, the General Court erred and therefore its decision should be set aside.
The CJEU emphasised that as taxation is a prerogative of individual Member States, and is not harmonised at EU-level, the existence of State aid must be evaluated by reference to national tax systems alone.
The CJEU therefore confirmed that only national laws applicable in the relevant Member State should be taken into account to identify the appropriate reference system for direct taxation. This importantly rejects a trend which the Commission have followed in State aid investigations into tax arrangements of using an abstract concept of the arm's length principle, in preference to the manner in which domestic tax legislation applies.
The CJEU determined that the Commission's error invalidated "the entirety of the reasoning relating to the existence of a selective advantage".
3. What now for other State aid cases and future Commission investigations?
The Judgment marks a significant blow to the Commission's ongoing attempt to attack certain tax measures through its investigations into unlawful State aid.
The Judgment should have far-reaching consequences given that it is a final judgment and the Commission has used similar reasoning in other cases pending appeal before the CJEU. In these other cases the Commission adopted a similar approach and referenced its own interpretation of the arm's length principle to demonstrate that a selective advantage existed (which in some cases was at odds with domestic laws then in force). Thus, the CJEU's decision may diminish the strength of the Commission's arguments in these pending cases and impact its approach to utilising the State aid rules to tackle what it perceives to be unfair tax practices by Member States generally.
4. What happens next?
The message is simple: the Commission is permitted to investigate tax measures to ensure they are compatible with State aid rules. However, it is not permitted to simply apply its own form of the arm's length principle, and is not permitted to apply the arm's length principle to tax measures in Member States, unless the law of the particular Member State incorporates the arm's length principle in the relevant tax measures. The Commission must have regard to national tax law in order to determine whether a measure grants a selective advantage for State aid purposes. This is the approach which the Commission must take in future investigations into potentially unlawful State aid, including in its current investigations and raises the threshold to determine that unlawful aid was granted by a Member State. As the decision was issued by the highest court in the EU it also casts significant doubt on the Commission's previous determinations that a selective advantage was granted in each of the cases currently under appeal.
[1] Fiat Chrysler Finance Europe v Commission, Joined Cases C‑885/19 P and C‑898/19 P.