This week, the so-called "International Consortium of
Investigative Journalists" ("ICIJ"), on its website,
leaked a total of 548 tax rulings that multinational companies
obtained in Luxembourg in the period from 2002 to 2010.
The list of companies whose rulings were disclosed includes some of
the largest multinationals not only from the U.S. and Europe but
also Japan, China, Russia, Brazil, and other countries. The ICIJ
alleges that these companies "have channelled hundreds of
billions of dollars to Luxembourg and saved billions of dollars in
taxes." Some companies are alleged to have enjoyed effective
tax rates of less than one percent. The ICIJ claims that in many
cases, "Luxembourg subsidiaries handling hundreds of billions
of dollars in business maintain little presence and conduct little
economic activity in Luxembourg."
The ICIJ does not state how it obtained copies of the rulings;
however, the documents disclosed on the website all originate from
PricewaterhouseCoopers in Luxembourg, which apparently acted as tax
advisor to the companies affected.
Potential Legal Risk for Companies Affected by
Leaks
The ICIJ itself stresses that the companies that obtained the
rulings did not act illegally. Many countries around the globe
issue tax rulings to companies seeking advance confirmation of the
tax consequences of transactions. Unless tax rulings are obtained
through misrepresentations or other illegal means, they are legal
and fully enforceable.
Both the OECD and the European Union have developed general
frameworks to limit "harmful tax practices" or "base
erosion and profit shifting." In particular, the Code of
Conduct for Business Taxation agreed upon by the Council of
Economic and Finance ministers of the European Union
("ECOFIN") of December 1, 1997, and the OECD Action Plan
on Base Erosion and Profit Shifting, as well as the OECD's
Transfer Pricing Guidelines, contain rules that seek to prevent
Member States from engaging in what are regarded as unfair taxation
practices. One of the criteria of the EU Code of Conduct that
supports a finding of a harmful tax practice is a Member
State's beneficial treatment of a company in the absence of any
real economic activity in the territory of that Member State.
Another criterion is a departure from internationally accepted
rules of transfer pricing, in particular, the arm's-length
standard. Some of the Luxembourg rulings leaked to the ICIJ might
be looked on as violating one of more of these principles.
Both the Code of Conduct and the OECD rules, however, are
"soft" law that is neither binding on the Member State
nor on individual companies applying for a tax ruling. In
particular, these rules cannot be used to invalidate tax rulings
that have been legally obtained.
The direct legal risk for companies whose tax rulings have been
made public is that the European Commission might review individual
rulings under the so-called "State aid" rules.
Over the past few months, the Directorate General Competition of
the European Commission has commenced State aid proceedings
concerning individual tax rulings that four multinationals, three
U.S. and one European, had obtained in Ireland, Luxembourg, and The
Netherlands. The Commission has recently published details of its
preliminary judgments, which led to the commencement of proceedings
involving Ireland and Luxembourg.
Independent of the State aid proceedings, companies with what are
now publicly disclosed Luxembourg tax rulings may be at increased
risk of audit in other jurisdictions, as local tax authorities
review such rulings. Further, such companies may consider whether
the release of the Luxembourg tax rulings implicates possible
changes in accounting treatment or additional disclosures of
uncertain tax risks under GAAP or IFRS.
EU State Aid Rules as Applied to Tax
Benefits
The State aid rules prevent Member States of the EU from conferring
selective economic benefits on individual companies or groups of
companies without obtaining prior approval from the European
Commission. The rules are applicable to all companies with
activities in the EU.
In the tax sector, the Commission can attack selective tax
advantages that are conferred on individual companies or distinct
groups of companies if those advantages exempt such companies from
taxes that would normally be imposed on them under the tax rules of
the Member State in question. Once a Member State has established
the level of corporate taxation it deems appropriate, it must apply
those taxes to all companies that are within its jurisdiction on a
consistent basis. Thus, the State aid rules allow the Commission to
sanction the nonapplication or unequal application by a Member
State of its own rules while otherwise leaving differences in
taxation between Member States unaffected.
The current Commission investigations are different from prior
cases as the Commission is now questioning the legality of
individual tax rulings as opposed to general tax
schemes.1 This strategy is potentially risky for the
Commission, as it will have to explain how each company in question
received a special advantage when these sorts of tax rulings were
open to many other firms to obtain, and many did. Further, the very
nature of a tax ruling in the transfer pricing field, in
particular, is to apply the law to the specific facts of each
taxpayer's inevitably specific circumstances.
Luxembourg Cases Opened to Date
Two of the cases opened by the Commission concern Luxembourg.
Luxembourg first resisted the European Commission's request for
access to its tax rulings. On March 24, 2014, the Commission issued
a formal decision requiring Luxembourg to provide all the
information requested. Luxembourg has challenged this decision
before the European Court of Justice, alleging a violation of the
rights of defense and the principle of proportionality as well as
the allocation of competences in tax matters between the Commission
and the Member States. Luxembourg's judicial appeal is still
pending but will have no impact on the cases regarding individual
rulings that have already begun. As a matter of fact, in August of
2014, Luxembourg has provided further information on a number of
cases requested by the Commission.
The first of the announced Luxembourg cases concerns Fiat Finance,
a subsidiary of the Fiat Group. In this case, the Commission
criticizes the Luxembourg tax authorities for accepting that a
subsidiary of the Fiat Group based in Luxembourg, which provided
financing and banking services to other subsidiaries, received too
little a remuneration for those services, thereby deflating its
taxable profits. The Commission analyzes the transfer pricing
methodology applied to Fiat and accepted by the Luxembourg
authorities in great detail and questions a number of judgments
made by the Luxembourg authorities during the process of
negotiating and issuing the ruling.
Little is known so far about the second Luxembourg investigation
that the Commission recently opened concerning Amazon. According to
the Commission press release, the relevant tax ruling dates back to
2003 and ratifies a practice by which the Luxembourg entity that
reports much of the taxpayer's European profits pays a
"tax deductible royalty to a limited liability partnership
established in Luxembourg but which is not subject to corporate
taxation in Luxembourg."
Specific State Aid Risk for Companies with Leaked
Rulings
Following the disclosure of the tax rulings by ICIJ, the Commission
will have a large number of additional Luxembourg tax rulings that
it can review under the State aid rules. It might elect to conduct
further reviews and proceedings concerning those rulings.
Typically the Commission will start its review with a request for
information addressed to the Member State. The Member State
consults with the company concerned (this is the first time the
company learns that its ruling is the subject of a Commission
review) and provides the requested information to the Commission.
Based on its recent experience, going forward Luxembourg is likely
to adopt a more cooperative approach vis-à-vis the
Commission and is not likely to withhold information on individual
taxpayers' files.
Once it has completed its initial review and concluded that State
aid is likely to be present, the Commission opens a formal in-depth
review and grants the Member States, the companies concerned, and
other interested parties (including competitors) the opportunity to
comment. This is normally followed by several rounds of further
questions and meetings between the Commission, the Member State,
and the company concerned. There is no fixed timeframe for this
phase of the review. The relevant procedural regulation merely
provides that the Commission will attempt to conclude any such
reviews within a period of 18 months.
Normally, when the Commission, in its final decision, finds that a
measure has constituted State aid, it must order the repayment of
the aid going back 10 years, plus interest. There have been
instances in which the Commission did not order a repayment in
order to protect the aid recipient's legitimate expectations.
This has particularly been the case in instances where more
generally available tax schemes were found to constitute State aid;
it may become a more complex (and "political") issue in
cases where individual rulings are being challenged.
Since the Commission has elected to conduct this initiative as a
review of individual rulings, the merits of each case will very
much depend on the solidity of the transfer pricing arrangements
and other facts underlying the specific tax structure chosen by the
individual companies. In the case of an eventual negative ruling by
the Commission, consequences for the individual companies may
include a retroactive payment of taxes with interest for a period
of up to 10 years.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.