European Commission determines state sponsored tax avoidance schemes illegal

Today the European Commission is expected to announce that the ‘comfort letters’ signed between European tax havens and companies are a form of illegal state aid.

These comfort letters, or tax rulings, are agreements between companies and countries as to how a government will treat subsidiaries of a specific multinational corporation in their jurisdiction for tax purposes. The idea is to give companies certainty over their tax affairs, but they can also be used to create company specific tax loopholes.

In many cases the rulings have been sought by companies seeking to set up a tax avoidance scheme and are used ensure that those schemes will not be attacked by the government. The tax rulings can include how specific transfers in and out of the company are treated, or look at what activities will be taxed.

Frequently these agreements will have the effect of radically reducing the amount of tax a company would normally have to pay in a country, and have a knock on effect in other countries.

The commission’s investigation looked into three specific tax rulings in three countries. These were agreements between Ireland and Apple Computers, Fiat and Luxembourg and Starbucks and the Netherlands. Today the Commission is expected to announce its rulings on Fiat and Starbucks but not Apple.

The agreement between Starbucks and the Netherlands concerned the profits which would be taxed by the country. The Netherlands agreed with Starbucks that a subsidiary, Starbucks Manufacturing EMEA would only be charged corporation tax on a much smaller amount of profit than would normally be the case.

In addition Starbucks had another tax ruling from the Dutch government which allowed it to pay a very low rate of taxation on intellectual property, although this ruling was not investigated by the commission. These payments, mainly for the use of the Starbucks brand, meant that Starbucks’ coffee chains in countries such as the UK declared low or zero taxable profits.

The accusation from the European Commission is that governments have used tax rulings as mechanism to provide benefits to multinational companies and incentivise specific corporations to invest in their countries. This use of tax rulings in this way has been deemed to be an unfair and unlawful form of state aid which undermines free and fair competition within the European economy.

An important role for Europe
The announcement demonstrates the positive role the European Union can play in ensuring fair competition across the continent.

Multinational companies have become very skilled at playing countries against each other. Seeking tax breaks and deregulation in one country, and then threatening to leave others if they do not offer the same.

This ‘tax competition’ has been championed by come countries such as Luxembourg and Britain, but has driven the race to the bottom with effective tax rates on corporate profits plummeting in many countries.

At the same time as corporate profits have become relatively less taxed the public have carried a heavier burden. Many countries have increased taxes on consumption, and introduced radical cuts to public spending in order to pay for the cuts in corporation tax.

By intervening the European Union is trying to create a fair playing field and empower nation states to raise revenue from corporations.

What happens now?
Although today is a positive announcement it is certainly not the end of the road. The countries involved could appeal to the European Court of Justice, and any case is unlikely to be straightforward.

Tax agreements deal with transfer pricing rules which are highly subjective and require a significant amount of judgement to be applied by tax authorities. In order to successfully defend a legal challenge the Commission has to show that the agreements that countries came to with companies were so extreme that they went beyond a reasonable application of judgement within the existing international transfer pricing rules.

In any event today’s announcement was always more likely to be more important as a political signal. The amounts being claimed back are relatively small, and smaller than originally anticipated. The European Commission only chose to investigate three tax rulings when there are currently thousands in place throughout Europe, the Lux leaks project released hundreds from Luxembourg alone. Although EU officials are saying that the three decisions today are just the tip of the iceberg, it is unlikely to challenge every tax ruling currently in place. However, the Commission is sending a clear message to nation states and multi-national companies that agreeing preferential deals on tax is unacceptable and the commission is ready and willing to take action.

Further action required
Many of the so called “comfort letters” that the Commission is today calling unlawful were negotiated in secret. Behind closed doors governments colluded with companies to cut their tax payments. The lack of transparency of the process is one reason how it has been allowed to grow unchecked over many years.

Now the Commission should introduce new rules to compel nation states to fully disclose the tax deals it has come to with companies, so that the public can know what is being negotiated away in their name. The Commission has said in the past that it will consider publication.

Comment
Commenting on today’s announcement from the European Commission, John Christensen, Director of the Tax Justice Network said:

“Citizens from throughout Europe should be pleased that the European Commission has today intervened to try to stop the race to the bottom on corporation tax.

“With so many people suffering from cuts to public services and increases in taxes on people, it is vital that multinational corporations pay their fair share.

“The European Commission must go further than these three tax rulings and make sure that all tax rulings are made public. It is only right that the public know when their politicians are selling them short.”