Amazon.com Inc. has won the latest stage in a legal battle with the EU over whether the Luxembourg authorities received € 250 million ($ 303 million) in illegal subsidies through a tax ruling.
Wednesday’s ruling – passed by the European Union’s second highest court – is yet another loss to the European Commission’s longstanding efforts to crack down on past transfer pricing practices – how companies value intra-group transfers – that multinational corporations have used in Europe.
The Commission has argued that favorable tax treaties by some governments have given companies an unfair tax advantage in tax planning. Rule changes in the EU and worldwide have closed many of the tax structures that were dealt with in the aid cases.
The EU court upheld the terms of a transfer pricing agreement between Amazon and Luxembourg as lawful at the time of its conclusion, arguing that the Commission had not demonstrated that the company’s treatment constituted an illegal subsidy.
The commission must prove that the outcome of a particular transfer pricing method creates a selective advantage for a state aid violation – not just that the method was wrong, the court said.
Tax rulings allow authorities to sign a company’s tax agreements to give reassurance to both the government and the company. But practice has earned the Commission’s scrutiny with mixed results. Last year, it lost a case in court from 2016 that involved € 13 billion in taxes. The commission said Apple Inc. paid too little to Ireland. The Commission is appealing the decision to the highest court in the EU.
The Amazon decision on Wednesday could also be challenged by the Commission.
“We will carefully examine the ruling and consider possible next steps,” said EU Competition Commissioner Margrethe Vestager in a statement.
What’s at stake?
The European Commission has challenged a transfer pricing ruling issued by Luxemburg to Amazon, which was in effect from 2006 to 2014 when the Commission opened an investigation into the ruling.
Transfer pricing rules govern the prices that a multinational company sets for transactions between its affiliates that companies can use to lower taxes. Under transfer pricing rules, companies are required to value transactions with related parties as if they were independent companies – known as the arm’s length principle.
The Commission said in 2017 that Luxembourg offered illegal state aid to Amazon by allowing the company to underpay € 250 million in taxes by using royalty payments to match European profits to a Luxembourg non-taxable company.
EU law prohibits member states from granting a company or group of companies certain types of selective advantages that are not available to others. These benefits may be for a company to take tax treatment differently than another through agreements the tax authority enters into with a company to pre-approve the way it structures its international taxes.
What did the European Commission argue?
The case concerns two of the company’s Luxembourg companies: an operating company that the Commission said was the only one “actively taking decisions” in relation to the company’s retail business; and a holding company that has licensed the intellectual property rights to the operating company.
Amazon used the license payments for the IP rights to divert profits to the holding company, which at the time exploited a discrepancy in tax laws to avoid taxes, the commission said. The holding company’s profits were not taxable under Luxembourg law as they were considered foreign, while under US tax law at the time, taxation of those profits could be deferred indefinitely.
The holding company received royalties that were not taxed in Luxembourg because it was a tax-transparent company and not taxed in the US because there were no distributions to the US, said Leopoldo Parada, a lecturer in tax law at Leeds University.
Since then, anti-hybrid laws in the EU and a revision of US tax regulations have made such “mismatch” structures obsolete.
The Commission contested the transfer pricing method used by Amazon, which Luxembourg advocated in the judgment.
What did Amazon and Luxembourg argue?
The Grand Duchy of Luxembourg and Amazon have challenged the Commission’s decision.
“Amazon firmly rejects the assessment of the decision that in this judgment an excessively high license fee was accepted, which inappropriately reduces the tax base of LuxOpCo” – that of the operating company – and gives it a selective advantage “, Michel Petite, legal advisor at Clifford Chance, said the company in March 2020 on appeal to the European Court.
The Commission did not find that the tax ruling gave the company an advantage and ignored the fact that the operating company paid a market price for the license fees, Amazon said in its appeal. The Luxembourg appeal also argued that the royalties were correctly assessed.
The Commission’s analysis of the functions performed by the operating and holding companies is based on “fundamental errors of law and fact” which invalidate the “application of the transactional net margin method and the resulting primary benefit determination by the Commission,” said Amazon.
The company also argued that the Commission applied the 2017 OECD Transfer Pricing Guidelines to a 2003 tax ruling.
The Commission not only made mistakes in applying directives that did not exist at the time of the judgment, but also exceeded its limits, Luxembourg said in its appeal.
“The Commission has actually exploited the state aid rules to undertake a covert tax harmonization of transfer pricing, thereby violating the exclusive competence of the Member States in the area of direct taxation,” said Luxembourg.
What did the court decide?
The court sided with the company and Luxembourg on Wednesday, saying the commission had failed to prove that the tax bill constitutes an advantage for Amazon under EU state aid law.
In order to find an advantage, the Commission has to demonstrate that methodological errors in a tax ruling do not reach a market price and instead reduce the taxable profit of a company compared to the profit made under normal tax rules.
The court found that the Commission’s transfer pricing analysis was flawed in several areas: It misunderstood the holding company’s functions in the recovery of its intangible assets – a key factor in determining how much profit should be attributed to a company. And it has not proven that the Luxembourg tax authorities should not have selected the operating company as the audited party for the calculation of the license payments.
According to the Court of First Instance, the Commission has not shown any advantage in using the transfer pricing method as it did not take into account the increase in the value of the intangible assets.
According to the court, the Commission’s allegations about the holding’s surcharge are also wrong.
Nor has the Commission shown that methodological errors resulted in the operating company being assigned less profit than under normal market conditions – which would prove to be an advantage, the court said.
The tax structure used in Luxembourg is no longer in place, Amazon said in a statement.
“We welcome the court’s decision, which reflects our longstanding position that we followed all applicable laws and that Amazon received no special treatment. We are pleased that the Court of Justice made this clear and we can continue to focus on serving our customers across Europe, ”said the company.
Luxembourg said in a statement that it welcomed the ruling.
What’s next?
The General Court did not question the right of the Commission to bring state aid actions against tax rulings, but criticized the analysis it used in its rulings in this case.
“Given the scope of this criticism, it might be tempting for the Commission to focus its resources on combating other tax rulings, given the need to conduct more thorough economic analysis rather than pursue it in court. “Said Totis Kotsonis, Partner and Head of Subsidies, Procurement, Trade Agreements and Trade Defense Measures at Pinsent Masons.
The fact that the Commission lost the facts, not the law, shows how difficult it is to win such disputes, said Tove Maria Ryding, policy and legal manager for tax justice at the European Network on Debt and Development.
“The court’s denial of the Commission’s decision on Amazon is a strong reminder of how difficult it is to use state aid rules to collect taxes,” she said. “We urgently need to start treating the underlying disease which is a deeply outdated and ineffective corporate tax system.”
The cases are: T-318/18, Amazon EU and Amazon.com v Commission, T-816/17, Luxembourg v Commission, T-525/18.