On 8 November 2022, the Court of Justice of the European Union (the “CJEU”) set aside the EU General Court’s judgment of 2019 and annulled the European Commission’s State aid decision of 2015, which held that Luxembourg granted illegal State aid to Fiat Chrysler Finance Europe (“Fiat”).

Legal background

Under current EU law, taxation is a prerogative of the Member States, which is not subject to EU harmonisation. In other words, the Member States have exclusive discretion to exercise their own competence in the field of direct taxation. However, the EU still has the competence if a Member State’s tax measure constitutes State aid that is incompatible with the internal market, notwithstanding that direct taxation is not subject to EU harmonisation.

To establish that a measure is “State aid,” the following four conditions must be satisfied:

1. there must be an intervention by the Member State or through State resources;
2. the intervention must be liable to affect trade between the Member States;
3. it must confer a selective advantage on the beneficiary; and
4. it must distort or threaten to distort competition.

In respect of the third condition, and in order to classify a national tax measure as “selective,” the Commission must begin by identifying the “reference system,” which is the “normal” tax system applicable in the Member State concerned. Only then can the European Commission demonstrate whether the tax measure in question constitutes a derogation from such “reference system.”

This case is about the delimitation of this “reference system.”

Factual background

Fiat provided treasury services and financing to the other members in the Fiat group. Fiat requested the Luxembourg tax administration to approve an advance transfer pricing agreement. The Luxembourg tax administration accepted Fiat’s transfer pricing report and granted a tax ruling on the basis of the Luxembourg Income Tax Code (the “Lux Tax Code”).

The European Commission concluded that Luxembourg had granted unlawful aid to Fiat. The European Commission essentially argued that since the objective of the general Luxembourg corporate income tax system was to tax the profits of all companies resident in Luxembourg (whether they are stand-alone companies or within a group), the “normal” tax system is one where the arm’s length principle is respected. The European Commission then applied its own criteria, ignoring the specific criteria in the Lux Tax Code, to “verify” whether the arm’s length analysis in the tax ruling in question derogated from the “normal” tax system.

The European Commission argued, to which the EU General Court agreed, that since the “normal” tax system is defined by national tax law (i.e., the objective of the general Luxembourg corporate income tax system), it is not harmonisation in disguise. However, no explanation was given as to why the imposition of the European Commission’s own criteria, in place of Luxembourg’s own arm’s length rules, is not harmonisation in disguise, other than arguing that the European Commission is merely using its own arm’s length principle as a “tool” to “verify” if there is any derogation from the “normal” tax system that they defined (deliberately not taking into account of the specific criteria within the Luxembourg national tax system).

CJEU’s ruling

The CJEU rejected the European Commission’s approach.

Based on previous case law, the CJEU held that, in areas that are not subject to EU harmonisation (such as direct taxation), only the national law applicable in the Member States concerned must be taken into account in order to identify the reference system. In other words, in the absence of EU harmonisation, the specific detailed rules for the application of the rule in question (e.g., the arm’s length principle in this case) are defined by national law and must be taken into account in order to identify the “reference system.”

Therefore, the EU General Court erred in law in defining the “normal” tax system, as the European Commission failed to take into account Luxembourg’s specific arm’s length principle in defining the reference system, while applying its own arm’s length principle. The CJEU held that this is an infringement of Article 114 of the TFEU and, therefore, a harmonisation in disguise (to use the terminology in the EU General Court’s judgment).

Conclusion

This is a landmark case, given there are a number of pending State aid cases where the Commission has taken a similar approach. As such, this may weaken the European Commission’s case in these pending proceedings.

This judgment clarified the extent to which the European Commission can introduce its autonomous principles in the State aid analysis in areas not subject to EU harmonisation. However, what this judgment has not done is to say that the EU cannot monitor State aid in areas not subject to EU harmonisation (e.g., where the four conditions for State aid are satisfied). The CJEU also noted that where the national tax law explicitly refers to principles extraneous to such national tax law, the European Commission is entitled to use such extraneous principles to verify if there is any derogation from the “normal” tax system.