On September 24, 2019, the General Court of the European Union released its decisions on two major State Aid cases. In the first case, dealing with Fiat Chrysler Finance Europe (FFT) in Luxembourg1, the General Court upheld the European Commission's decision that the Luxembourg tax authority's ruling granted to FFT constituted State Aid. However, in the second case2, the General Court concluded that the Commission was unable to demonstrate that the Dutch tax authority's ruling for Starbucks Manufacturing EMEA BV (SMBV) constituted an advantage, and therefore, annulled the Commission's decision on SMBV. As both Fiat and Starbucks employed a Transaction Net Margin Method (TNMM) for determining arm's length remuneration for the entities in question, an exploration of why the taxpayer's application of TNMM was upheld in one instance but overruled in the other is instructive. While other legal issues were debated, this article will be concerned only with the transfer pricing issues.
In both cases, the Court noted that pricing of intra-group transactions does not follow market prices. That said, the Court noted in both decisions that the arm's length principle gives the Commission discretion "to check that intra-group transactions are remunerated as if they had been negotiated between independent companies."3 In Fiat, the Luxembourg tax authority granted FFT an advance pricing agreement (APA) ostensibly based on a TNMM approach. The Commission took issue not with the TNMM approach per se, but with the fact that the TNMM was based on a return on capital profit level indicator for FFT and the analysis calculated an artificially low capital base for FFT. The Court noted that:
"the Commission also correctly considered that the method consisting, on the one hand, in using FFT's hypothetical regulatory capital and, on the other, in excluding FFT's shareholdings in Fiat Finance North America (FFNA) and Fiat Finance Canada (FFC) from the amount of the capital to be remunerated could not result in an arm's length outcome."
The Court concluded that the TNMM as applied by Fiat to FFT, and as agreed by the Luxembourg authorities, could not have produced an arm's length outcome, and thus constituted an advantage not available to other taxpayers, i.e. State Aid.
The Starbucks cases appears somewhat more complicated. SMBV, the Starbucks manufacturing entity in the Netherlands, purchased coffee beans from a related party, roasted and processed those beans, sold them on to related parties, and paid royalty to a related entity (Alki) which owned the roasting IP. Alki was an entity outside of the Netherlands tax net. The Dutch tax authorities agreed with Starbucks via an APA that SMBV's taxable income would be determined using a TNMM approach where any profit in excess of the amount indicated by the TNMM (a "routine" manufacturing and distribution profit) resulting from the purchase of unroasted beans and the sale of roasted beans would be paid to Alki as a royalty. The Commission objected to Starbucks' use of the TNMM and proposed instead a comparable uncontrolled price (CUP) approach to determine that the royalty should have been zero, i.e. SMBV should not have paid any royalty to Alki, and thus should have retained all its taxable profit in the Netherlands.
The Court did not take issue with the Commission's CUP analysis per se, but found that:
"the Commission did not invoke any element to support as such the conclusion that that choice had necessarily led to a result that was too low, without a comparison being carried out with the result that would have been obtained using the CUP method. The Commission therefore wrongly found that the mere choice of the TNMM, in the present case, conferred an advantage on SMBV."
Given the outcome of the Fiat case, it is hard to say how The Court's findings might have differed if the Commission had examined the TNMM results and were able to provide an analysis showing that the results were inconsistent with the arm's length principle? That said, if the Commission were able to demonstrate such a result in the Starbucks case, they likely would have submitted that analysis to the Court. The Commission still has two months to appeal the decision, so this latest decision on Starbucks may not be the final one.
1. General Court of the European Union PRESS RELEASE No 118/19 Luxembourg, 24 September 2019: Judgment in Cases T-755/15 Luxembourg v Commission and T-759/15 Fiat Chrysler Finance Europe v Commission. https://curia.europa.eu/jcms/upload/docs/application/pdf/2019-09/cp190118en.pdf
2. General Court of the European Union PRESS RELEASE No 119/19 Luxembourg, 24 September 2019 Judgment in Cases T-760/15 Netherlands v Commission and T-636/16 Starbucks and Starbucks Manufacturing EMEA v Commission. https://curia.europa.eu/jcms/upload/docs/application/pdf/2019-09/cp190119en.pdf
3. Starbucks, note 2, p.2.
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