On September 19, European Commission announced through a press release, that it has decided that the non-taxation of certain McDonald’s profits by Luxembourg did not constitute State aid.
On December 2015, the European Commission started an in-depth investigation on whether Luxembourg was misapplying its national laws and the Luxembourg-US double taxation treaty thus not complying with EU State Aid rules.
This particular case involves McDonald’s Europe Franchising, a Luxembourg-based subsidiary of McDonald’s Corporation and also a branch of McDonald’s Europe Franchising in the US.
McDonald’s Europe Franchising is the owner of McDonald’s brand and other related rights and it licenses such rights to third parties, who operate the McDonald’s fast food outlets, receiving the correspondent fees.
McDonald’s Europe Franchising decided to ask to the Luxembourgish tax authorities for a tax ruling to confirm that profits from its franchise rights would not be taxable in Luxembourg.
McDonald’s claim was based on the fact that those rights were attributed to its US branch and that the Luxembourg – US double taxation treaty exempts from taxation in Luxembourgish territory any income that may be taxed in the US territory, if the company has a taxable presence in Luxembourg, for instance a branch – which was the case.
Initially, the Luxembourgish tax authorities ruled in favor of McDonald’s but also stated that for such exemption to be granted, McDonald’s would have to provide proof that the income of the US branch had been declared and could be effectively taxed in the US.
6 months later, Luxembourgish tax authorities revised the first ruling, this time disregarding the mentioned proof of effective taxation in the US. It was their opinion that the Luxembourg-US tax treaty only required that the income “may be taxed” in the US and not that the income must be effectively taxed.
The issue with this ruling was the fact that due to a mismatch in Luxembourg and US law – which we will analyze bellow – it resulted in a paradox: a double taxation treaty – which was meant to avoid double taxation – was actually allowing double non-taxation (as in many other well know cases).
It is no surprise that this second ruling (the revised ruling) raised some question regarding the possibility of Luxemburg being in breach of the Treaty on the Functioning of the European Union (TFEU), inter alia, article 107, which states that “Save as otherwise provided in the Treaties, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favoring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market.”.
Article 107 defines what is considered illegal State Aid, which, in less complex terms, is an advantage conferred on a selective basis to certain undertakings by public authorities that may distort competition and may affect trade between Member States.
Considering the mentioned concept of State Aid, was Luxembourg breaching the TFUE or just correctly applying its national laws and the Luxembourg-US double taxation treaty?
To better understand this question, it is also important to address the concept of “permanent establishment”.
It is crucial to understand that US and Luxembourgish laws have different assessments on whether a permanent establishment exists or not in their territory.
The US tax law did not consider the US branch of McDonald’s Europe Franchising to be a permanent establishment by contrast to Luxembourgish tax law that looked at that same branch as filling all the conditions to be considered as a permanent establishment, which was enough for possible taxation.
The Commission considered that this interpretation was the cornerstone for the exemption granted by the Luxembourgish tax authorities and not any special treatment regarding McDonald’s, and consequently, this was not a case of state aid and thus not illegal but rather an interpretation of its national laws and the treaty with the US.
We are still to see the final decision text but the Commission’s decision on this case shall be seen as a landmark. It is the first time that the EU Commission concludes that there is an absence of State Aid regarding this matter and it is, certainly, a light in the dark of uncertainty regarding State Aid, the application of double taxation treaties and the mismatches that may arise between legislation of different states.
It is also worth mentioning the fact that the Luxembourgish Government is taking the necessary legislative steps to avoid these double non-taxation situations.
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