Amazon.com Inc. has won the latest stage in a legal battle with the EU over whether it was given 250 million euros ($303 million) of illegal subsidies by the Luxembourg authorities through a tax ruling.
Wednesday’s judgment—issued by the European Union’s second-highest court—is another loss for the European Commission’s years-long effort to clamp down on past transfer pricing practices—how companies value intercompany transfers— multinational companies have used in Europe.
The Commission has argued favorable tax agreements from some governments have given companies an unfair tax advantage in tax planning. Changes in rules in the EU and worldwide have closed down many of the tax structures the state aid cases tackled.
The EU General Court vindicated the terms of a transfer pricing tax agreement between Amazon and Luxembourg as legal at the time it was issued, arguing that the Commission failed to prove that the company’s treatment constituted an illegal subsidy.
The Commission must prove that the outcome under a particular method of transfer pricing creates a selective advantage for it to be a state aid violation—not merely that the method was incorrect, the court said.
Tax rulings let authorities sign off on a company’s tax arrangements to provide certainty to both the government and the company. But the practice has earned the Commission’s scrutiny with mixed results. Last year it lost at the General Court a 2016 case involving 13 billion euros of tax the Commission said Apple Inc. had underpaid to Ireland. The Commission is appealing the decision to the EU’s highest court.
Wednesday’s Amazon decision could also be appealed by the Commission.
“We will carefully study the judgment and reflect on possible next steps,” Margrethe Vestager, the EU’s competition commissioner, said in a statement.
What’s at stake?
The European Commission challenged a transfer pricing ruling that Luxembourg gave Amazon that applied from 2006 until 2014, when the Commission opened an investigation into the ruling.
Transfer pricing rules govern the prices a multinational sets for transactions between its related entities, which companies can use to reduce taxes. Under transfer pricing rules, companies are required to price transactions with related parties as if they were unrelated entities—known as the arm’s length principle.
The Commission said in 2017 that Luxembourg offered Amazon illegal state aid by allowing the company to underpay 250 million euros in tax by using royalty payments to attribute European profits to an entity that wasn’t taxable in Luxembourg.
EU law prohibits member states from giving certain kinds of selective advantages to one company, or group of companies, which aren’t available to others. Those advantages can include applying a different tax treatment to one company over another by means of agreements the tax authority makes with a company to pre-approve the way it structures its international taxes.
What did the European Commission argue?
The case involves two of the company’s entities in Luxembourg: An operating company that the Commission said was the only entity “actively taking decisions” related to the company’s retail business; and a holding company that licensed the intellectual property rights to the operating company.
Amazon used the royalty payments for the IP rights to shift profits into the holding company, which took advantage of a mismatch in tax laws at the time to avoid tax, the Commission said. The holding company’s profits weren’t taxable under Luxembourg law, which saw them as foreign, while under U.S. tax law at that time, tax on those profits could be indefinitely deferred.
The holding company received royalties that weren’t taxed in Luxembourg because it was a tax-transparent entity, and weren’t taxed in the U.S. because there weren’t distributions to the U.S., said Leopoldo Parada, a lecturer in tax law at the University of Leeds.
Since then, anti-hybrid legislation in the EU and an overhaul of U.S. tax rules has made such “mismatch” structures obsolete.
The Commission challenged the transfer pricing method that Amazon used, and Luxembourg endorsed, under the ruling.
What did Amazon and Luxembourg argue?
The Grand Duchy of Luxembourg and Amazon challenged the Commission’s ruling.
“Amazon strongly rejects the Decision’s assessment that this ruling accepted a royalty that was too high, improperly reducing LuxOpCo’s tax base,"—that of the operating company—"and conferring on it a selective advantage,” Michel Petite, avocat of counsel at Clifford Chance, said in the company’s March 2020 appeal before the European court.
The Commission failed to establish that the tax ruling conveys an advantage for the company, and ignored the fact that the operating company paid an arm’s length price for the royalties, Amazon said in its appeal. Luxembourg’s appeal also argued that the royalties were priced correctly.
The Commission’s analysis of the functions performed by the operating and holding companies are based on “fundamental errors of law and fact” which invalidate the Commission’s “application of the transactional net margin method and the resulting primary finding of advantage,” Amazon said.
The company also argued that the Commission applied OECD transfer pricing guidelines from 2017 to a tax ruling made in 2003.
The commission didn’t just err in applying guidelines that didn’t exist at the time of the ruling, it also overstepped its bounds, Luxembourg said in its appeal.
“The Commission in fact exploited the rules on State aid in order to undertake covert fiscal harmonisation on transfer pricing, thereby infringing the exclusive competence of the Member States in the area of direct taxation,” Luxembourg said.
What did the court decide?
The court on Wednesday sided with the company and Luxembourg, saying the Commission hadn’t proved the tax ruling constituted an advantage for Amazon under EU state aid law.
To find an advantage, the Commission must demonstrate that methodological errors in a tax ruling don’t reach an arm’s-length price, and instead reduce a company’s taxable profit compared to the result under normal tax rules.
The Court said the Commission’s analysis of the transfer pricing was flawed in several areas: It misunderstood the functions of the holding company in exploiting its intangible assets—a key factor in determining how much profit should be attributed to an entity. And it didn’t prove that the Luxembourg tax authorities shouldn’t have chosen the operating company as the tested party for assessing the royalty payments.
The Commission didn’t prove that there was an advantage in the use of transfer pricing method because it didn’t take into account the increase in the value of the intangible assets, the court said.
The Commission’s assertions about the mark-up due to the holding company were also incorrect, the court said.
The Commission also failed to show that methodological errors meant that less profit was attributed to the operating company than there would be under normal market conditions—which would prove 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 is in line with our long-standing position that we followed all applicable laws and that Amazon received no special treatment. We’re pleased that the Court has made this clear, and we can continue to focus on delivering for our customers across Europe,” the company said.
Luxembourg said in a statement it welcomed the judgment.
The Court didn’t challenge the Commission’s right to bring state aid cases against tax rulings, but criticized the analysis it used to make its determinations in the case.
“Given how extensive such criticism is, it might be tempting for the Commission to decide to focus its resources on fighting other tax rulings cases, mindful of the need to be carrying out more thorough economic analyses, rather than pursue this further in the courts,” said Totis Kotsonis, partner and head of subsidies, procurement, trade agreements, and trade remedies at Pinsent Masons.
The fact that the commission lost on the facts of the case and not the law shows just how difficult it is to win these types of dispute, said Tove Maria Ryding, policy and advocacy manger for tax justice at the European Network on Debt and Development.
“That the Court rejected the Commission’s decision regarding Amazon is a stark 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.”