Commission finds mismatch in US and European laws isn’t state aid

There will be a collective sigh of relief from many UK and US multinationals at the European Commission’s ruling in favour of Luxembourg and McDonald’s.  The US-parented group held intellectual property rights in a Luxembourg company, which assigned them to a US branch.  The Luxembourg tax authority agreed that the income from the rights (intragroup royalties) should be allocated to the US, under the Luxembourg-US tax treaty.  However, as the branch’s presence did not amount to a taxable presence under US law, no actual tax arose. 

The Commission finally agreed that the US presence did amount to a foreign branch or permanent establishment, as defined in Luxembourg law.   In this case (and many others like it) the effective non-taxation of almost all the profits arose from the US definition of taxable presence, which does not follow the OECD standard.

Luxembourg, like many other countries, is taking steps under the BEPS project to modify its law, such that non-taxation may not arise in the future.  The US has a new model treaty, which would do the same thing – although the Senate has not ratified any US Double Tax Treaties for many years.

The ruling may cause the UK to be more optimistic about the outcome of its own state aid enquiry into the finance company exemption, under controlled foreign companies’ legislation.  For the first time in recent years, the Commission has acknowledged that low, or even no, taxation isn’t necessarily state aid.

More than £4 billion saved

Supreme Court
Judges rule against compound interest claims

The Treasury should be pleased by the Supreme Court’s decision in the Prudential case. The case is one of the long-running claims that the UK’s tax treatment of foreign dividends broke EU free movement of capital rules.  The UK changed the law in 2009 – but there’s still plenty of money involved in claims for back years.

This particular case is about portfolio dividends, typically held by investment funds, where the shareholding is less than 10% and usually much less.  The UK used to levy corporation tax on such dividends, whereas equivalent dividends from UK investments were exempt.  The European Court of Justice decided this was unlawful many years’ ago – but this case was about the exact method of allowing relief for overseas tax.  The Supreme Court has decided that relief should be given by reference to the foreign nominal rate, irrespective of whether this was actually paid by the underlying company.  It’s a sensible, pragmatic answer.

The element of the case which has the biggest impact is the Court’s ruling on compound interest.  Prudential – and many other claimants – have argued that they should be given compound interest on their tax refunds, which could easily double or triple the value of a claim.  HMRC have estimated that paying compound interest on all claims could cost the Exchequer some £4-5 billion.

However, the Supreme Court ruled that a 2007 case, Sempra Metals, had been wrongly decided by the House of Lords.  The Supreme Court has followed its recent decision in Littlewoods and decided that the EU principle of effectiveness (requiring an effective remedy for breach of EU law) did not require compound interest. 

UK law similarly does not require the payment of compound interest.  The Supreme Court noted that there is symmetry between taxpayers and the Exchequer, with tax law setting simple interest for both.   

The result is that the Exchequer will save over £4 billion, which will no doubt come as a relief in these times of deficits.

Another state aid case

On 20 June, the European Commission announced it had found Luxembourg had granted unlawful state aid to French energy giant Engie, worth about €120 million.  As is usual in these cases, Luxembourg must recover this amount from the company even if Luxembourg and the company appeals the decision to the European General Court.   

The problem, in the Commission’s view, is that Luxembourg allowed Engie to use a domestic hybrid instrument to reduce its Lux tax bill.  Essentially the same instrument gave one group member a tax deduction for financing costs, whilst the equivalent income received by another group member was tax-exempt.  The result, said the Commission, was that “LNG Supply only paid taxes on about 1% of its profits”. 

Which side is the tax liablity?

It may sound remarkable that Luxembourg gave rulings from 2008 to permit this treatment.  In the UK, HMRC has challenged vigorously similar structures put in place by companies, winning almost all cases.  The dispassionate observer may think that this does indeed sounds like a case of unlawful state aid.

However, the company may feel rather hard done by, as Luxembourg commonly allowed multinationals to use financing structures leaving profits of 1% taxed in the Grand Duchy.   The logic behind this approach is that most of the risks are borne outside the country, with the result that a 1% profit offers a fair return.  No doubt this will form part of the argument put forward at the General Court. 

Who will disclose?

The EU’s Mandatory Disclosure Rules will take effect on 25 June 2018, following political agreement in March and final approval on 25 May.  The Directive must be transposed into national law by 31 December 2019, to take effect from 1 July 2020.  The ‘gotcha’ built into the Directive, though, is that arrangements from 25 June 2018 must be disclosed to national tax authorities in August 2020.  Cue a certain amount of concern amongst the adviser and taxpayer communities, which suddenly find themselves potentially liable to collect data based on rather unclear rules, before they have sight of local law. The UK is expected to introduce an enabling provision into Finance Act 2019 – and then introduce the rules as regulations – with a draft only available in 2019.

The UK introduced disclosure rules in 2004, when the emphasis was very much on making sure that tax authorities understood what planning was being undertaken.  Today, though, most taxpayers will not enter into arrangements requiring early disclosure.

The EU’s Directive seems to be mainly about information.  Several of the hallmarks cover arrangements where the tax implications look straightforward.  For example, a transfer of more than half the business of a company from one state to another needs to be disclosed.  Similarly, the transfer of a ‘hard to value’ intangible asset must be notified.

The Directive starts by presuming that an adviser or facilitator will be the prime discloser of information.  However, there’s an exemption for advice covered by legal privilege, as defined in each Member State. Initial comment suggests that German French, Italian and Spanish advisers expect to qualify for exemption.  This will leave the burden on taxpayers, as well as on UK advisers.   Quite how taxpayers – corporate and individual – will feel about making disclosures remains to be seen.  UK advisers find their customers prefer the adviser to manage the process.