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EU – state aid and other developments18 November 2016

► This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances.

► These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice.

► The views expressed by the presenters are not necessarily those ofErnst & Young LLP.

► This presentation is © 2016 Ernst & Young LLP. All Rights Reserved.

EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms, of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com.Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US.

Disclaimer

Today’s presenter

C. Jurjan Wouda KuipersPartner, International Tax ServicesErnst & Young LLP +1 212 773 [email protected]

Agenda

► Key developments in fiscal state aid over the last 12 months:

► Background on state aid control ► Transfer pricing decisions ► Mismatch cases► Impact

► Other EU developments

Timeline

Red = Reality

Green = Very high likelihood

Blue = Possibility

Yellow = Uncertain

2016 2017 2018 2019 2020 2021► State aid actions,

targeting:

► Transfer pricing, using new EU TP concept

► Mismatches (double non-taxation, deduction/no inclusion)

► Rulings and regimes

► Parent Subsidiary Directive changes

► Intra-EU anti hybrid rule

► GAAR

► “Old” EU IP regimes

► No new entrants

► Phase out (July 2021)

► Exchange of ruling summaries started

► Country-by-Country reporting introduced in all EU MS

► Exchange of tax ruling summaries

► UK Anti-Hybrid rules:

► Applies to interest royalties, service fees, cost of goods sold.

► No deduction for payments made to disregarded havens; CV/BV and similar reverse hybrid structures and certain variants of “Double Irish”.

► Publication of List of tax havens

► First exchange of CbC reports

► Anti-Tax Avoidance Directive (ATAD):

► Interest limitation rules (30% EBITDA)

► EU-wide CFC rules

► EU GAAR

► ATAD 2: addressing mismatches with third countries (hybrid entities, hybrid instruments / hybrid branches, )

► EU-wide Common Corporate Tax Base (CCTB)

► Mandatory for groups with turnover of EUR 750M

► Broadly defined tax base (participation exemption, switch-over rules, NOL c/f, R&D deduction, NID regime)

► TP (upward adjustments only)

► Includes ATAD and ATAD 2’s measures

► ATAD:

► New exit rules

► “Old” EU IP regimes no longer applicable

► Common Consolidated Corporate Tax Base (CCCTB)

► Single tax return for all EU operations

► Taxable profits shared between Member States based on apportionment formula (1/3 sales, 1/3 labor, 1/3 assets (excluding intangible assets))

9 November 2016

State aid

Key developments in Fiscal State Aid over the last 12 months

► Final Commission decisions:► 21 October 2015: Netherlands case and Luxembourg finance company

case► 21 January 2016: Belgian excess profit case► 30 August 2016: Irish case (not yet published)

► New cases opened:► 3 December 2015: Luxembourg US branch case► 19 September 2016: Luxembourg domestic mismatch case (not yet

published)► New Commission papers:

► 19 May 2016: Commission Notice on Notion of State Aid► 3 June 2016: Working Paper on State Aid and Tax Rulings

► Expected 2016: Final decision in Luxembourg intellectual property (IP) case

State aid control

► Rules to prevent member states from subsidizing their industries:► Any selective advantage granted by member states through

state resources (effect-based approach) ► Including tax measures and tax rulings► Commission has exclusive competence to enforce► If State aid: Commission must in principle order recovery

of unlawful aid (10 years back with compounding interest)

Enhanced state aid approach: A powerful tool for the European Commission (EC) to

pursue a variety of policy objectives?

Types of rulings investigated

► Three individual transfer pricing rulings► One scheme ruling involving TP► One ruling on profit allocation head-office /

branch► Two “confirmatory rulings” on application of

specific tax provisions:► Cross-border mismatch► Domestic mismatch

What triggers state aid investigations?

► Parliamentary discussions (US, UK, etc.)► Reaction to trade unions/non-governmental

organizations/media► LuxLeaks► Disgruntled employees leaking information

Implications of individual decisions on other cases

► Commission decision in individual investigations in principle only applicable to the specific case:► No obligation for member state to recover taxes from

other companies with similar facts► Risk of Commission opening investigation into a

“scheme”?► Scheme investigation applicable to all beneficiaries

Assessment of state aid

1. What is the reference system?► Which tax

rule/ system is the “benchmark”?

2. Does a measure derogate from the reference system?► Comparison with

other undertakings in similar situation

► “De jure” or “de facto” selectivity

Three-step test to assess selectivity

3. Is the measure justified by the nature and logic of the reference system?

State aid: advantage in any form whatsoever conferred on a selectivebasis to undertakings by national public authorities.

Transfer pricing decisions according to the Commission

► Luxembourg case:► Intra-group financing, holding and treasury company► External and internal financing► Capital base lower than the company’s actual capital► Remuneration applied to capital base lower than market rates

► Netherlands case:► BV sells and distributes roasted coffee and coffee-related products

to group companies► “Inflated price” for green coffee beans paid to group company► Size of royalty paid to UK LP that holds know-how:

► Determined as residual profit


► Belgian case:► Provision of Belgian code de facto only applicable to certain

multinationals► Application arguably a violation of the Belgian tax code► Selective even if TP was correct► Transfer pricing criticism:

► Inconsistency in approach► Creates an “untaxed tax base in contravention of the arm’s-length

principle”► No general recognition of excess profit from “synergies,” needs to be

supported by evidence


► Irish case:► Two Irish non-resident companies have operating branches in

Ireland.► Companies hold IP under cost-sharing agreement with US.► According to the commission, there is an “artificial internal

allocation of profits” between head office and branches:► Head offices had no premises or employees.► Commission would only attribute interest income to head offices.

Transfer pricing cases: EU arm’s-length principle

► Are transfer pricing rules part of the reference framework?► If TP rules are applied in the same way to all concerned taxpayers, can

there be selectivity?► Arm’s-length principle comes from principle of equal treatment, which

is embodied in art. 107(1) Treaty on the Functioning of the European Union (TFEU):► “Establish whether the taxable profit of a group company has been

determined on the basis of a methodology that approximates market conditions, so that that company is not treated favourably under the general corporate income tax system as compared to non-integrated companies whose taxable profit is determined by the market.”

► Applies even if member state has no TP rules► Challenges “artificial and complex methods”► A tax ruling that leads to a reliable approximation of a market-based

outcome that is in line with the arm’s-length principle

Transfer pricing cases: EU vs Organisation for Economic Co-operation and Development (OECD)?

► Commission “may” have regard to OECD guidelines:► OECD Guidelines “useful guidance”► If TP arrangement complies with the OECD TP guidelines,

tax ruling “unlikely to give rise to State aid”► Reference to statistics

… for any avoidance of doubt, the arm’s length principle that the Commission applies in its State aid assessment is not that derived from Article 9 of the OECD Model Tax Convention, […] but is a general principle of equal treatment in taxation falling within the application of Article 107(1) of the TFEU, which binds the Member States and from whose scope the national tax rules are not excluded.” (SA.38375 October 21, 2015)

Transfer pricing rulings: Selectivity according to Commission NoticeTransfer pricing rulings: selectivity according to Commission Notice

Ruling not selective if it► Complies with the OECD TP guidelines► Gives guidance on the choice of the most appropriate method► Leads to a reliable approximation of a market based outcome

Ruling selective if it► Reduces tax burden by misapplying the national tax regime► Is not available to undertakings in a similar factual and legal situation► Derogates from the arm’s length principle because the endorsed

methodology produces a more favorable result than a market-based outcome

Transfer pricing rulings: Selectivity according to Commission Notice

“Any deviation from the best estimate of a market-based outcome must be limited and proportionate to the uncertainty inherent in the transfer pricing method chosen or the statistical tools employed for that approximation exercise.”(Commission Notice)

Transfer pricing rulings: Selectivity according to Commission Notice

Examples of non-selective rulings:► Intra-group transactions between two different member states, where

both companies carry out “genuine economic activities” on which they are taxed

► Remuneration of finance companies based on a margin which is calculated based on a clear economic analysis

► Rulings based on a two-sided approach, where both companies to the intragroup transaction are analyzed

Transfer pricing cases: Implications

► Strong preference for direct TP methods:► But transactional net margin method (TNMM) accepted in Luxembourg

case► Commission analyzes comparables in detail:

► Not necessarily applying OECD TP methods► DG Competition’s focus on cases where there is “a manifest breach of

the arm’s length principle”► One-sided TP challenged:

► Need to add benchmarking for payments?► More scrutiny as regards operating costs as performance indicator

► Economies of scale or synergy arguments rejected► Avoid inconsistencies in TP reports► Are payments to untaxed recipients more likely to attract scrutiny?

Mismatch cases: US branch investigation according to the Commission

► Facts:► Luxco with US and Swiss branches► IP licensed by US branch to Swiss branch, which licenses to group

companies► Profits of US branch exempt in Luxembourg even though untaxed in US

► Commission:► Exemption “neither faithful to the wording of its provisions nor their

objective” ► “Erroneous” interpretation of tax treaty► Luxembourg required to also determine whether activities constitute PE

under US domestic law► Reference to OECD commentaries to argue that Luxembourg should not

exempt (“qualification conflict doctrine”)

Mismatch cases: US branch investigation —criticism

► International standard does not refer to domestic law of treaty partner for treaty application:► Administrative burden and knowledge of foreign tax?

► Does state aid control require application of subject-to-tax test for treaty exemptions?► Scholars and courts require explicit subject-to-tax clause► Tax treaties

► Rules on qualification conflict not in point► Are member states’ tax treaties overruled by state aid?

Mismatch cases: domestic case

► Facts:► Zero-interest loan that is convertible into equity between two

Luxcos► Borrower Luxco obtains deduction► Lender Luxco not taxed considered on “dividend-like payment”

► Does state aid control require application of anti-abuse provisions to tackle mismatch cases?

Impact: Commission’s view on corporate tax

► Reference system is domestic system ► But that system must contain:

► Arm’s-length pricing: ► With particular focus on untaxed

recipients► Subject-to-tax tests for exemptions (or

credit method):► Cross-border activity may be taxed at

higher rates than domestic?► Agressive application of anti-abuse

provisions ► Are measures that can only apply to

multinational corporations (MNCs), by definition, selective?

Member States are free to decide on the economic policy which they consider most appropriate and, in particular, to spread the tax burden as they see fit across the various factors of production. Nonetheless, Member States must exercise this competence in accordance with Union law

(Commission Notice)

Impact: nothing new?

► “… We have been doing it for decades” (Vestager, 19 September, Washington, DC)

► But gap between 1998 and 2016 notices: ► If “equal treatment” is part of state aid control – why wasn’t it

applied earlier?► Legitimate expectations?

► Fundamental change to tax codes and tax treaties?

Impact: state aid investigations as a policy tool?

► “Fair taxation” – fairness as a competition criterion?► Concern about base erosion and profit shifting (BEPS)?

► Anti-Tax Avoidance Package► Concepts applied in state aid investigations vs BEPS?

► Greater transparency:► Exchange of information on tax rulings► Country-by-country reporting (even public?)

► Broader impact on regimes:► E.g., changes announced to co-op regime► Possible changes to S.110?

► Common Consolidated Corporate Tax Base (CCCTB)

Impact: uncertainty

► New concepts but no clarification► Decisions that cannot be relied upon► Inconsistencies: determine the amount due but invite

others to take a piece of the pie► New rules are not applied consistently (e.g., IP boxes)

Impact on investment climate

► “Tax war” with US?► Confrontational approach to US multinationals?► US Treasury white paper► Cases triggered by US check-the-box (CTB) rules?► US reaction – retaliation?

► Impact on investment climate in EU

Impact on ruling practice

“We've looked at more than a thousand different rulings in the last three years. And most of them give us no concern at all. Rather than allowing them to avoid tax, most rulings are just designed to give companies clarity about how the tax laws will be applied.”

“The thing about tax rulings [is] that they are, by nature, selective”

Continue filing rulings?

M. Vestager on rulings (September 2016):

Impact: general recommendations

► Ruling review (also in light of exchange and country-by-country (CbC)

► Consider renewal, amendment or withdrawal of rulings► Review of TP documentation”

► Enhancement needed?► Regular reviews and updates

► Quantification of possible state aid exposures

“…This does not absolve companies from themselves double-checking any special tax treatment. If the actual amount of tax paid looks too good to be true, then it may well be problematic under State aid rules.”

(M. Vestager speech, September 2, 2016)

Other EU developments

2016 Anti-Tax Avoidance Directive (ATAD)

► Contains five anti-avoidance measures

► Several exceptions for financial undertakings

► May result in:► Higher effective tax rate (ETR), e.g., due to

a cap on interest deductions and direct taxation of profits realized by foreign subsidiaries and branches

► Challenges as a result of the introduction of anti-hybrid rules and General Anti-Avoidance Rule (GAAR)

► Effective 1 January 2019 (exit tax: 1 January 2020)

Intangible property

and supply chain

Holding

► Interest deduction limitation rules

► Anti-hybrid rules

► Controlled foreign company rules

► Rules on cross-border transfers of assets, businesses and tax residence

► Anti-hybrid rules

Financing

Gen

eral

ant

i-abu

se ru

le

ATAD 2

► October 25, 2016: Draft ATAD 2 published by the EU Commission► Addresses hybrid mismatches involving third countries:

► Hybrid instruments► Hybrid entities► Hybrid permanent establishments► Hybrid transfers► Imported mismatches► Dual resident mismatches

► Member state to neutralize these mismatches by:► Denying the deduction (in case of double deduction)► Including the payments in the taxable base (in case of deduction without inclusion)► Including the income in the taxable base (in case of non-taxation without inclusion)

Or► Limiting the benefit of the credit (in case of double tax credit)

► Targeted effective date: 1 January 2019

Common (consolidated) corporate tax base

► October 25, 2016: EU Commission published:► Draft Directive on Common Corporate Tax Base (CCTB);► Draft Directive on Common Consolidated Corporate Tax Base (CCCTB).► Two-staged approach, first CCTB (targeted effective date 1 January 2019), then CCCTB

(targeted effective date 1 January 2021).► Directives contain a set of rules to create a CCTB, mandatory for groups with

consolidated turnover in the preceding year greater than €750m.► CCTB will have a broadly defined tax base, with all revenues taxable unless expressly

exempted, and business expenses generally deductible, subject to specific exceptions: ► Also incorporate the ATAD measures

► The CCCTB enables businesses to file a single tax return for all of their EU activities: ► Taxable profits are shared between the member states in which the company is active using an

apportionment formula.► Each member state can then tax its share of the company’s profits at its own national tax rate.

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About EYEY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com.

Ernst & Young LLP is a client-serving member firm ofErnst & Young Global Limited operating in the US.

© 2016 Ernst & Young LLP.All Rights Reserved.

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This material has been prepared for general informational purposesonly and is not intended to be relied upon as accounting, tax or otherprofessional advice. Please refer to your advisors for specific advice.

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