Starbucks win and Fiat lose: first judgments on legality of tax rulings

On 24 September 2019, the European General Court ("GC") handed down its judgments in the first two individual tax rulings cases involving transfer pricing within multinationals. It overturned the European Commission's ("Commission") decision ordering the Netherlands to recover illegal State aid from Starbucks but rejected the appeal against the decision ordering Luxembourg to obtain reimbursement of unpaid taxes from Fiat. 

Background

In October 2015, the Commission found that a 2012 tax ruling issued by Luxembourg granted a selective advantage to Fiat Finance and Trade ("FFT"), a Luxembourg-based holding which was also providing financial services to other companies of the Fiat group. It concluded that, as regards this specific financing activity, the ruling endorsed a transfer pricing method that was  inappropriate to establish taxable profits reflecting market conditions. Its criticisms revolved essentially around the capital base used to that effect, which it regarded as being too low. For these intragroup financing activities, the transfer price was determined, not on the basis of the whole capital of FFT which mainly consisted in shareholdings in the group and which was subject to a different tax regime, but on the basis of required regulatory capital for banks. However, the Commission considered that the entire capital of the company should have been taken into account for the purposes of establishing the profits of the financing activity under the transactional net margin method of transfer pricing ("TNMM").

On the same day, the Commission found that a 2008 tax ruling issued by the Netherlands selectively favoured a Starbucks coffee roasting company, Starbucks Manufacturing. The decision claimed that the tax ruling artificially lowered taxes paid by this company by endorsing the payment of:

• a substantial royalty to a Starbucks' UK-based company for coffee roasting know-how; and
• an inflated price for green coffee beans to a Starbucks company based in Switzerland.

As a result, the Luxembourg and Dutch government were ordered to recover between €20 million and €30 million from Fiat and Starbucks respectively.¹ Both Member States and tax payers appealed the decisions before the GC. 

Endorsement of the Commission's approach

The GC's judgments find that the Commission is competent to verify, under State aid rules, whether an individual tax ruling granted an advantage to the concerned tax payer as compared to the 'normal' taxation system.

In this respect, the judges found that the Commission may use an 'arms-length principle', even if undefined in national law, as a 'tool' to screen whether a given tax measure is in line with market conditions. To this end, the Court accepts that the Commission can apply the OECD Guidelines which, in the Court's words, reflect the 'international consensus' and thus have 'real practical significance in the interpretation of issues relating to transfer pricing'. The implications of this is that the Commission may now verify, in light of OECD guidelines and other principles found appropriate by the Commission, whether Member States tax rulings are in line with the 'arms-length principle' as understood by the Commission. Although the judgments are not entirely clear in this regard, they seem to take the view that the Commission may do so at least if national rules provide that integrated companies are to be taxed on the same terms as stand-alone companies.

The GC also ruled in Fiat that an individual tax ruling, involving the application of a transfer pricing method that deviates from the 'arm's length principle' (as defined by the Commission), is 'presumed' to be selective. The Commission no longer has to establish that such rulings 'derogate' from the reference framework (i.e. national law) but only has to prove the existence of an 'advantage'.

This said, the judgments do draw some limits to the Commission's action. They acknowledge that Member States have a margin of appreciation in the approval of transfer pricing, given the 'approximate nature' of the arms-length principle. Therefore, the Commission can only make a finding of advantage where the tax authorities made errors going beyond the 'inaccuracies inherent in the application of a method designed to obtain a reliable approximation of a market-based outcome'.

Application of the 'arm's length principle' in the Fiat and Starbucks cases

In the Fiat judgment, the GC, considering that "capital is fungible", upheld the Commission's findings that an incorrect application of the TNMM had been approved by the tax ruling as the latter based itself on the required regulatory capital for banks and not the whole capital of FFT. It would have thus lowered FFT's intra-group remuneration for services rendered to other companies of the group. This, in turn, would have lowered FFT's tax burden, thereby resulting in an 'advantage' for the latter. 

In contrast, in the Starbucks judgment, the GC considered that the Commission had failed to prove the existence of an 'advantage'. In particular, the Court found that the 'mere non-compliance with methodological requirements' does not necessarily lead to a reduction of the tax burden. This entails that the Commission cannot simply criticise the choice of a given transfer pricing method but has to demonstrate why this method results in an incorrect transfer price. Moreover, this judgment finds that the Commission cannot base its analysis on information that was not available or reasonably foreseeable when the tax ruling was issued. 

Conclusion

These judgments, which may still be appealed before the Court of Justice, endorse an extension of the Commission's approach as regards the 'arms-length principle'. However, they do not prejudge the outcome of pending appeals in parallel cases, notably where transfer pricing methods are not at issue. 

1. These cases have been followed by three findings of aid in the Apple, Amazon and Engie cases. Annulment actions against all these decisions are pending before the GC. Formal investigations are still ongoing in the Ikea, Nike and Huhtamaki cases.