However, the Commission found that the scheme unduly exempted certain multinational groups from these UK rules targeting tax avoidance. This is illegal under EU State aid rules. The UK must now recover the illegal State aid from the multinational companies that benefitted from it.
Commissioner Margrethe Vestager in charge of competition policy said: "Anti–tax avoidance rules are important to ensure that all companies pay their fair share of tax. But they must apply equally to all taxpayers. The UK gave certain multinationals a selective advantage by granting them an unjustified exemption from UK anti–tax avoidance rules. This is illegal under EU State aid rules. The UK must now recover the undue tax benefits."
Controlled Foreign Company (CFC) rules
The general purpose of the UK's Controlled Foreign Company (CFC) rules is to prevent UK companies from using a subsidiary, based in a low or no tax jurisdiction, to avoid taxation in the UK. They allow the UK tax authorities to reallocate all profits artificially diverted to an offshore subsidiary back to the UK parent company, where it can be taxed accordingly.
CFC rules in general are an effective and important feature of many tax systems to address tax avoidance. UK CFC rules establish two tests to determine how much of the financing profits from loans granted by an offshore subsidiary are to be reallocated to the UK parent company and, hence, taxed in the UK (“CFC charge”), namely:
- The extent to which lending activities, which are most relevant to managing the financing activities and thus generating the financing income, are located in the UK (“UK activities test”); or
- The extent to which loans are financed with funds or assets, which derive from capital contributions from the UK (“UK connected capital test”).
Between 2013 and 2018, the UK's CFC rules included a special rule for certain financing income (i.e. interest payments received from loans) of multinational groups active in the UK – the Group Financing Exemption.
The Group Financing Exemption provided a derogation from the general CFC rules. It partially (75%) or fully exempted from taxation in the UK financing income received by an offshore subsidiary from another foreign group company, even if this income is derived from “UK activities” or the capital being used is “UK connected”. Therefore, a multinational active in the UK using this exemption was able to provide financing to a foreign group company via an offshore subsidiary paying little or no tax on the profits from these transactions.
The Commission's State aid investigation does not call into question the UK's right to introduce CFC rules or to determine the appropriate level of taxation. The role of EU State aid control is to ensure Member States do not give some companies a better tax treatment than others. The case law of the EU Courts makes clear that an exemption from an anti-avoidance provision can amount to such a selective advantage.
The Commission's investigation
In October 2017, the Commission opened an in-depth investigation to verify whether the Group Financing Exemption complied with EU State aid rules.
The Commission's investigation has concluded that the Group Financing Exemption and, hence, the different treatment, was partially justified. At the same time, the exemption grants a selective advantage to certain multinational companies.
Financing with UK connected capital (“UK connected capital test”).
In particular, the Commission found that when financing income from a foreign group company, channelled through an offshore subsidiary, is financed with UK connected capital and there are no UK activities involved in generating the finance profits, the Group Financing Exemption is justified and does not constitute State aid under EU rules.
This is because such an exemption avoids complex and disproportionately burdensome intra-group tracing exercises that would be required to assess the exact percentage of profits funded with UK assets. The Commission therefore acknowledges that, in line with UK arguments, the Group Financing Exemption in these cases provides for a clear proxy that is justified to ensure the proper functioning and effectiveness of the CFC rules.
Managing the financing activities from the UK (“UK activities test”)
Conversely, the Commission found that when financing income from a foreign group company, channelled through an offshore subsidiary, derives from UK activities, the Group Financing Exemption is not justified and constitutes State aid under EU rules.
This is because the exercise required to assess to what extent the financing income of a company derives from UK activities is not particularly burdensome or complex. Thus, the use of a proxy rule in these cases is not justified. Moreover, the Group Financing Exemption does not seek to address any possible complexity related to the allocation of financing income to UK activities nor has the UK claimed it does.
The Commission therefore concluded that multinationals claiming the Group Financing Exemption while meeting the “UK activities test” received an unjustified preferential tax treatment that is illegal under EU State aid rules (Article 107 of the Treaty on the Functioning of the EU).
Background on CFC rules and the Group Financing Exemption
The UK's Group Financing Exemption was introduced with the reform of the UK CFC regime under the Finance Act 2012. In order to benefit from the tax exemption, companies do not need a tax ruling. The scheme was in force from 1 January 2013 until the end of 2018.
Following the adoption of the Anti-Tax Avoidance Directive (ATAD), all EU Member States had to introduce CFC rules in their legislation as of 1 January 2019. In line with ATAD, as of 1 January 2019, the Group Financing Exemption applies only where a CFC charge on financing income from foreign group companies would otherwise apply exclusively under the UK connected capital test (i.e. not also or exclusively under the UK activities test). The CFC rules as currently applied therefore no longer raise concerns under State aid rules.
As long as the UK is an EU Member State, it has all the rights and obligations of the membership. In particular, EU competition law, including EU State aid rules, continue to apply in full to the UK and in the UK, until it is no longer a member of the EU.
As a matter of principle, EU State aid rules require that illegal State aid is recovered in order to remove the distortion of competition created by the aid. There are no fines under EU State aid rules and recovery does not penalise the companies in question. It simply restores equal treatment with other companies.
When State aid takes the form of tax measures or other levies, the amount to be recovered should be calculated based on a comparison between the amount of tax actually paid and the amount which should have been paid if the generally applicable rule had been applied.
In this case, the UK should reassess the tax liability of the UK companies that have illegally benefitted from the Group Financing Exemption as it was applied to profits derived from UK activities. The precise number of beneficiaries affected and the exact recovery amount can only be determined by the national authorities based on a case-by-case examination.
Background on the Commission's State aid investigations on tax
Since June 2013, the Commission has been investigating individual tax rulings or rulings granted under tax schemes of Member States under EU State aid rules. It extended this information inquiry to all Member States in December 2014.
The following investigations concerning tax rulings have already been concluded by the Commission:
- In October 2015, the Commission concluded that Luxembourg and the Netherlands had granted selective tax advantages to Fiat and Starbucks, respectively. As a result of these decisions, Luxembourg recovered €23.1 million from Fiat and the Netherlands recovered €25.7 million from Starbucks.
- In January 2016, the Commission concluded that selective tax advantages granted by Belgium to at least 35 multinationals, mainly from the EU, under "excess profit" tax rulings are illegal under EU State aid rules. On 14 February 2019, the General Court of the European Union annulled the Commission decision. The Commission is currently reflecting on next steps.
- In August 2016, the Commission concluded that Ireland granted undue tax benefits to Apple, which led to a recovery by Ireland of €14.3 billion.
- In October 2017, the Commission concluded that Luxembourg granted undue tax benefits to Amazon, which led to a recovery by Luxembourg of €282.7 million.
- In June 2018, the Commission concluded that Luxembourg granted undue tax benefits to Engie of around €120 million. The recovery procedure is still ongoing.
- In September 2018, the Commission found that the non-taxation of certain McDonald's profits in Luxembourg did not lead to illegal State aid, as it is in line with national tax laws and the Luxembourg-US Double Taxation Treaty.
- In December 2018, the Commission concluded that Gibraltar granted undue tax benefits of around €100 million to several multinational companies, through a corporate tax exemption scheme and through five tax rulings. The recovery procedure is ongoing.
The Commission also has two ongoing in-depth investigations concerning tax rulings issued by the Netherlands in favour of Inter IKEA and Nike and an investigation concerning tax rulings issued by Luxembourg in favour of Huhtamäki.
The non-confidential versions of the present decisions will be made available under the case number SA.44896 in the State Aid Register on the Commission's competition website once any confidentiality issues have been resolved. New publications of state aid decisions on the internet and in the Official Journal are listed in the State Aid Weekly e-News.