On 8 November 2022, the Court of Justice of the European Union (CJEU) published its decision in the joined cases C‑885/19 P and C‑898/19 P, better known as the “Fiat case.” Significantly, the CJEU set aside the EU General Court’s judgment of 2019 and annulled the European Commission’s (EC) decision of 2015, both of which had determined that Luxembourg violated EU state aid rules in granting a ruling to the taxpayer that allowed Fiat to effectively determine its tax burden in Luxembourg. The CJEU found that the EC had wrongly defined the rules against which the relevant measure must be evaluated to determine whether the measure confers “a selective advantage on the beneficiary.” The CJEU decision is particularly important, as it is final, and with the EC adopting a similar approach and reference framework in pending state aid cases, the decision could further weaken the EC’s position in those cases (such as the Apple, Amazon and ENGIE state aid cases).
Fiat Finance and Trade Ltd. (FFT), which is part of the Fiat/Chrysler group, provided financing and treasury services to European group companies from Luxembourg. For these services, FFT was remunerated with a return on capital. In 2012, Fiat obtained an advance transfer pricing ruling from the Luxembourg tax authorities that set out how intragroup financing transactions should be priced to determine FFT’s taxable Luxembourg income.
The EC challenged the Luxembourg ruling and launched a formal investigation in 2015, ultimately concluding that the ruling conferred illegal state aid. The EC stated that the ruling effectively enabled Fiat to determine its tax as it could lower its capital base whilst using a lower rate than the market rate on that reduced capital. As a result, FTT’s Luxembourg tax liability under the ruling deviated from the liability that would have existed under the standard Luxembourg tax system. The EC used, inter alia, the arm’s length principle from uncodified international standards, i.e. the OECD Transfer Pricing Guidelines, as a benchmark to determine whether selective aid was granted under the EU state aid rules; the EC concluded that the transactional net margin method (TNMM) would be the appropriate transfer pricing method to use. Both Luxembourg and Fiat appealed to the EU General Court, requesting that the EC ruling be annulled. The General Court, however, confirmed the EC’s decision.
The EU state aid rules, as set out in article 107(1) of the Treaty on the Functioning of the EU, aim to ensure a level playing field for businesses in the EU. If aid is determined to be illegal, the EC can require an EU member state to recoup the subsidy. Four conditions must be fulfilled for illegal state aid to exist:
At issue in the Fiat case was whether the third condition, i.e., whether a selective advantage was conferred, was fulfilled. A “reference framework” is needed to determine whether a selective advantage exists, i.e., what are the “normal” tax rules against which the tax measure in question must be evaluated and whether that national measure “favours” certain undertakings, because to be “selective,” the benefit must only be granted to specific taxpayers (for example, businesses in a certain area/region, etc.) and not to all businesses. As noted above, a member state that grants unlawful state aid must recoup the advantage provided.
The EC concluded in the Fiat case that Luxembourg “misapplied the rules that normally apply” with respect to the arm’s length principle and the calculation of a transfer pricing methodology by granting a ruling that allowed for a return on capital whereas, according to the EC, the arm’s length standard required the TNMM to be used to determine the remuneration.
In setting aside the General Court’s decision and annulling the EC’s decision, the CJEU concluded that the EC incorrectly defined the reference framework and the General Court erred in endorsing the EC’s approach. That approach consisted of applying an arm’s length principle different from that prescribed under Luxembourg law, confining itself to identifying the abstract expression of that principle without taking into account how the arm’s length principle was actually incorporated into Luxembourg law. In other words, the EC should have taken Luxembourg’s specific transfer pricing rules relating to group financing into account.
The CJEU said that to determine whether unlawful state aid was provided, the EC should show that the relevant Luxembourg tax provision systematically led to an undervaluation of the transfer prices applicable to group companies compared to market prices for comparable transactions carried out by non-group companies.
As a result of the CJEU Fiat decision and the conclusion that no state aid was granted, Luxembourg will not have to repay EUR 30 million in challenged tax advantages. The decision may not bode well for the EC in other state aid cases, as the reference framework in these cases also relied on the interpretation of arm’s length principle neglecting the prevalence of a member states’ implementation and interpretation of that principle.