Amazon.com Inc. won the final stage of a legal battle with the EU over whether the Luxembourg authorities received illegal subsidies of 250 million euros (US $ 303 million) through a tax ruling.
Wednesday's ruling, delivered by the European Union's second highest court, is yet another loss to the European Commission's years of efforts to curb previous transfer pricing practices – how companies rate intra-group transfers – that multinational corporations have deployed in Europe.
The Commission has argued that favorable tax arrangements by some governments have given companies an unfair tax advantage in tax planning. Changes in regulations in the EU and around the world have closed many of the tax structures that have been the subject of state aid cases.
The EU court upheld the terms of a transfer pricing agreement between Amazon and Luxembourg as legal at the time it was granted, claiming that the Commission had failed to show that the company's treatment constituted an illegal subsidy.
The Commission must demonstrate that the outcome of a particular transfer pricing method represents a selective advantage for the violation of State aid – not just that the method was wrong, the court said.
Tax rulings allow authorities to sign a company's tax rules to keep both the government and the company safe. Practice, however, has earned the Commission's scrutiny with mixed results. Last year, it lost a 2016 case in court that collected € 13 billion in taxes. The Commission stated that Apple Inc. paid too little to Ireland. The Commission is appealing the decision to the EU Supreme Court.
Wednesday's Amazon decision could also be challenged by the Commission.
"We will carefully examine the ruling and consider possible next steps," said Margrethe Vestager, the EU's competition commissioner, in a statement.
What's at stake?
The European Commission challenged a transfer pricing decision made by Luxemburg to Amazon from 2006 to 2014 when the Commission opened an investigation into the decision.
Transfer pricing rules govern the prices that a multinational company sets for transactions between related companies that allow companies to reduce taxes. According to the transfer pricing rules, companies must value transactions with related parties as if they were not affiliated companies – the so-called arm's length principle.
The Commission said in 2017 that Luxembourg was offering illegal state aid to Amazon by allowing the company to underpay € 250 million in taxes by using royalties to match European profits to a company that was not taxable in Luxembourg.
EU law prohibits Member States from granting a company or group of companies certain selective advantages that are not available to others. These benefits may include a company applying a different tax treatment to another company based on agreements the tax authority makes with one company in order to pre-approve the way it structures its international taxes.
What has the European Commission argued?
The case concerns two of the company's companies in Luxembourg: an operating company that the Commission said is the only company "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 intellectual property rights royalties to shift profits to the holding company, which at the time was benefiting from a mismatch in tax laws to avoid taxes, the commission said. The holding company's profits were not taxable under Luxembourg law, which it regarded as foreign, while under US tax law, at that time, taxes on those profits could be accrued for an indefinite period.
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 the University of Leeds.
Since then, anti-hybrid laws in the EU and a revision of US tax regulations have made such “mismatch” structures superfluous.
The Commission challenged the transfer pricing method used by Amazon in the judgment and approved by Luxembourg.
What did Amazon and Luxembourg argue?
The Grand Duchy of Luxembourg and Amazon have challenged the Commission's decision.
"Amazon strongly disapproves of the decision that this decision is accepting an excessively high license fee that unfairly lowers LuxOpCo's tax base – that of the operating company – and gives it a selective advantage," said Michel Petite, Avocat of Counsel at Clifford Chance, said in the company's March 2020 appeal to the European Court.
The commission failed to demonstrate that the tax rule was beneficial to the company and ignored the fact that the operating company was paying a market price for the royalties, 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 fact and law" which invalidate the commission's "application of the transaction net margin method and the resulting primary benefit determination," Amazon said.
The company also argued that the Commission applied the OECD's Transfer Pricing Guidelines to a 2003 tax ruling from 2017.
In its appeal, Luxemburg said in its appeal that the Commission was wrong not only in applying guidelines that did not yet exist at the time of the judgment, but also exceeded its limits.
"The Commission has actually used the state aid rules to undertake a covert fiscal harmonization of transfer pricing, thereby violating the exclusive competence of 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, stating that the Commission had not proven that the tax ruling was an advantage for Amazon within the meaning of EU state aid law.
In order to gain an advantage, the Commission must demonstrate that methodological errors in a tax decision do not reach a market price and instead reduce a company's taxable profit compared to normal tax profit.
The Court stated that the Commission's analysis of transfer pricing was flawed in several areas: It had misunderstood the functions of the holding company in the recovery of its intangible assets – a key factor in determining how much profit should be imputed 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 assessing the license fees.
The commission has not demonstrated that using the transfer pricing method is beneficial as it did not take into account the increase in the value of the intangible assets, the court said.
The Commission's claims about the holding company surcharge are also false, the court said.
The commission was also unable to demonstrate that methodological errors resulted in the operating company being attributed 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, according to a statement from Amazon.
“We applaud the ruling by the Court of Justice, which reflects our longstanding position that we have followed all applicable laws and that Amazon has not received any special treatment. We are pleased that the court made this clear and we can continue to focus on delivering for our customers across Europe, ”said the company.
Luxembourg welcomed the judgment in a statement.
What's next?
The Court of Justice did not contest the right of the Commission to bring State aid cases against tax rulings, but rather criticized the analysis with which it made its decisions in this case.
“Given the scope of this criticism, it may be tempting for the Commission to focus its resources on combating other tax rulings, as it is aware of 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 Remedies 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 tax justice advocate for the European Network on Debt and Development.
"The fact that the Court of Justice denied the Commission's decision on Amazon is a strong reminder of how difficult it is to apply 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.