In 2018, the European Commission (EC) concluded two more investigations into whether the tax ruling practices of Member States breached European Union (EU) State aid rules: the first, a finding of unlawful State aid resulting from tax rulings by Luxembourg in favor of Engie; the second, a rare finding of no aid in respect of the treatment by Luxembourg of McDonald's under the Luxembourg-U.S. double taxation treaty. These decisions are discussed below.

The Increasing Link Drawn by Regulators Between State Aid & Taxation Systems

The EC also had a success in the General Court, which ruled in a series of cases that the EC was right to find that a particular measure for the amortization of financial goodwill under the Spanish tax regime was selective in nature and amounted to incompatible State aid.1


State aid is defined as an advantage in any form (including tax measures) conferred on a selective basis to businesses by public authorities. General measures open to all businesses do not constitute State aid. Since tax rulings are available to any tax payer who needs them they are not a problem per se; however, where they — or any other taxation measure — result in favorable treatment vis-a-vis the general taxation regime, they will fall foul of the State aid rules. Navigating this distinction in practice is difficult especially for tax rulings which are by definition individual.


The Luxembourg-U.S. double taxation treaty provided that Luxembourg cannot tax the profits of a company that can be taxed in the U.S. by virtue of them having a 'permanent establishment.' McDonald's Europe Franchising — a Luxembourg based corporation with two branches, one in the U.S. and one in Switzerland — received royalties from franchisees using the McDonald's brand in Europe, Russia and Ukraine. The Swiss branch licensed the franchise rights and the royalty profits were sent from Luxembourg to the U.S. branch.

Under Luxembourg tax law, the U.S. branch was considered a 'permanent establishment,' so its revenues could not be taxed by Luxembourg. However, under U.S. tax law the same branch was not considered a 'permanent establishment,' meaning the profits from the royalties were not subject to taxation in the U.S. either. Luxembourg granted tax rulings in favor of McDonald's Europe Franchising, which confirmed the profits were not taxable in Luxembourg, while removing any obligation to prove that they were taxable in the U.S., with the effect that McDonald's paid no tax on certain royalty payments.

The EC opened an in-depth State aid investigation to assess whether the tax rulings gave McDonald's a selective advantage by derogating from the provisions of national tax law and the Luxembourg-U.S. double taxation treaty. However, the EC's investigation found that "the reason for double non-taxation in this case is a mismatch between Luxembourg and US tax laws, and not a special treatment by Luxembourg. Therefore, Luxembourg did not break EU State aid rules."

This decision is significant because it is the first time that an EC investigation into alleged aid by virtue of tax rulings by a Member State has resulted in a finding of no aid. However, the outcome that McDonald's will not pay tax anywhere on these revenues is unpalatable for the EC since opposing aggressive tax avoidance was a big part of the motivation for and communication strategy around the EC's case against Apple's Irish tax treatment for example. The EC's approach does show some belated deference to the Organization for Economic Co-operation and Development's (OECD) base erosion and profit shifting (BEPS) project, which is a much more coherent way to tackle tax avoidance strategies that exploit gaps and mismatches in tax rules than State aid.

The frustration, however, was expressed by Commissioner Vestager, who noted "the fact remains that McDonald's did not pay any taxes on these profits — and this is not how it should be from a tax fairness point of view." However, she has got her way indirectly. Luxembourg has already tabled draft legislation to amend its tax code to bring the relevant provision into line with the BEPS project to prevent future double non-taxation.


Engie had established intra-group financing structures involving its subsidiaries in Luxembourg, which enabled two companies, LNG Supply S.A. (LNG Supply) and GDF Suez Treasury Management S. a r. l. (GSTM) (each a 'Relevant Company') to pay corporate tax at an effective tax rate of 0.3%.

According to the EC, the financing structure was similar in both cases. A convertible loan was provided by an Engie lender subsidiary to a Relevant Company (via an intermediary). The Relevant Company used the loan to justify making deductions from its taxable profits, which reduced its tax burden. However, the Relevant Company did not in fact make any interest payments under the loan to justify the deductions. The Relevant Company retained its profits until Engie converted the loan, at which point the profits passed to the Engie lender subsidiary (via the intermediary) in the form of shares. The Engie lender subsidiary later cancelled the shares and instead received the value of the profits in cash, which is exempted from tax under Luxembourg law. This arrangement was endorsed by Luxembourg in a series of tax rulings.

The EC's in-depth investigation found that the tax rulings endorsed tax treatment that allowed for a reduction of the tax base of the Relevant Companies in Luxembourg, such that they paid lower tax on their profits. The EC found this amounted to more favorable treatment than would otherwise be the case under the general rules of taxation; therefore, Engie received a selective advantage that amounted to State aid. The EC has ordered Luxembourg to recover from Engie €120 million in unpaid taxes (plus interest). The decision has been appealed by Luxembourg.


The general Spanish tax regime only allowed for the amortization of goodwill for tax purposes in the event of mergers. The Spanish government subsequently introduced a measure that enabled companies resident in Spain for tax purposes to treat as tax deductible the amortization of financial goodwill arising from the acquisition of shareholdings of at least 5% in a foreign company.

At issue was whether the measure was selective in nature. The European Courts have struggled to arrive at a coherent approach to selectivity in tax cases and have applied different methods for determining selectivity. The General Court had originally applied a 'general availability' test and considered that the measure was not selective because it did not exclude any category of undertakings in the national territory because it was aimed at a category of economic transactions (even if not all national undertakings would benefit from the measure).

However, the Court of Justice of the European Union (CJEU) ruled that the assessment of selectivity in this case must be based on a three-step analysis: first is to determine the 'normal' tax regime as a reference framework. Second, determine whether the measure derogates from the normal tax regime insofar as it differentiates between economic operators that are in a comparable factual and legal situation in light of the objectives pursued by the tax regime. Third, establish if the tax differentiation is justified by the nature and logic of the tax regime.

Following referral back from the CJEU, the General Court applied the threestep test and confirmed the EC's original assessment that the measure should be considered in light of the general provisions of the corporate tax system, specifically the rules on the tax treatment of the financial goodwill. Against this reference system, the General Court concluded that the measure could be selective even if it was available to all companies resident in Spain for tax purposes; the basis for the selectivity is the difference in treatment depending on the company's commercial decision-making (i.e., acquiring a foreign company vs. acquiring a domestic company).

This is a significant development in the application of the three-step test because it confirms that selectivity can be established on the basis of the commercial behavior of undertakings. This approach will give the EC more flexibility in establishing selectivity in future cases — and increases the encroachment of State aid rules into Member States fiscal power.


State aid enforcement does — and will continue — to have a role to play in achieving reform of tax planning by multinational companies. The EC has concluded seven high profile investigations in this area and has found unlawful State aid in six of them, resulting in recovery orders totaling over €14 billion (plus interest) in respect of 40 companies — the most high-profile being the €13 billion (plus interest) recovery order in the Ireland/Apple case. Companies cannot negotiate tax rulings with EU Member State tax authorities as they do with sovereign states elsewhere in the world. They must take into account that the EC has the power and desire to use State aid rules for ex post supervision. The boundaries of this supervision are slowly becoming clear.

The Luxembourg/McDonald's decision is interesting as for the first time it illustrates a limit of State aid enforcement in this area. It is encouraging that the EC chose not to stretch these rules forever to advance policy objectives that may be better achieved through alternative mechanisms, such as legislative change or international cooperation, such as through the work of the OECD.

The EC still has two ongoing investigations in this field. One in respect of possible State aid resulting from tax rulings issued by the Netherlands in favor of Inter IKEA and another concerning a U.K. tax scheme for multinationals.

The judgment of the General Court in the Spanish tax scheme case will strengthen the EC's hand in these cases. In particular, it makes it easier for the EC to define the 'reference' system — the starting point for selectivity assessments — in a way that shows the beneficiaries' position as differentiated.


1. Case T-207/10, Deutsche Telekom v. Commission (EU:T:2018:786), Case T-227/10, Banco Santander v. Commission (EU:T:2018:785), Case T-239/11, Sigma Alimentos Exterior v. Commission (EU:T:2018:781), Case T-405/11, Axa Mediterranean v. Commission (EU:T:2018:780), Case T-406/11, Prosegur Compañia de Seguridad v. Commission (EU:T:2018:793), Case T-219/10, RENV World Duty Free Group v. Commission (EU:T:2018:784) and Case T-399/11, RENV Banco Santander and Santusa Holding v. Commission (EU:T:2018:787).

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