Public Service Compensation

Compensation for the provision of public services may not exceed the avoidable cost minus any forgone revenue from not having to provide those services. The VAT exemption for postal services is not State aid because it is laid down in the EU VAT directive and therefore cannot be attributed to Member States.

 

Introduction

This article reviews Commission decision on measure SA.47707 concerning compensation for public services entrusted to Post Danmark, the incumbent postal operator in Denmark.[1] The case is rather unusual for several reasons. First, the compensation would be paid to PostNord which then would pass it to Post Danmark. Post Danmark is a wholly owned subsidiary of PostNord. Second, PostNord is owned jointly by Denmark and Sweden. Third, the public service compensation (PSC) was notified to the Commission for its approval, as it feel outside the scope of Commission decision 2012/21 which functions like a block exemption regulation for SGEI. At the same time, the Commission received a complaint about other aid that had been granted or would be granted to Post Danmark. Therefore, in the same decision the Commission examined both the compatibility of the PSC and the contents of the complaint.

Postal services in Denmark have been liberalised since 2011 and Post Danmark has been entrusted with universal service obligations (USO). In order to meet the costs of the USO, Post Danmark receives PSC. For the period 2017-19, Denmark notified to the Commission a PSC amount of DKK 1.7 billion. The complainant also alleged that Post Danmark benefited from the following aid measures: 1) Unlimited state guarantees, 2) an exemption from VAT on transport services offered to mail-order companies, 3) a capital injection of DKK 1 billion. These three alleged aid measures were also examined in the Commission decision.

 

Non-compliance with Altmark

The Commission, first, considered whether the PSC could escape from being classified as State aid if it could satisfy the Altmark criteria. Since the Altmark criteria are cumulative and since the entrustment of the USO to Post Danmark was not done after a competitive selection procedure, nor was there any evidence that Post Danmark’s costs were equal to or lower than those of a “typical, well-run and adequately provided” undertaking, the Commission concluded that the 4th Altmark condition was not satisfied and therefore the PSC conferred an advantage to Post Danmark. As all of the other criteria of Article 107(1) TFEU were fulfilled, the PSC was State aid.

 

Compatibility

The compatibility of the PSC with the internal market was assessed on the basis of the 2012 SGEI Framework and according to the following indicators.

Genuine SGEI: Although Member States have considerable discretion in determining their SGEI, they still have to show that such services meet the needs of citizens and that the market alone does not sufficiently provide them in terms of price, quality, area, etc. In the case of postal services, the USO is defined in an EU directive. For this reason, Denmark did not have to provide any additional justification.

Entrustment: The USO must be assigned through an act of entrustment that must contain the following:

  1. The precise nature of the public service obligation and its duration.
  2. The undertaking and territory concerned.
  3. The nature of the exclusive rights, if any, assigned to Post Danmark.
  4. The description of the compensation mechanism and the parameters for calculating, monitoring and reviewing the compensation.
  5. The arrangements for avoiding and repaying any overcompensation.

The Commission found that all five conditions were satisfied.


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Duration of entrustment: The period of entrustment should not exceed the period needed for amortisation of fixed assets or the depreciation of the most significant assets. In this case, the entrustment was only for 3.5 years which was acceptable to the Commission.

Compliance with Directive 2006/111 on financial transparency: The notification identified the following eligible costs and outlined how costs were to be allocated. (paragraph 135 of the Commission decision)

– Separately incurred costs: These are costs that can be directly assigned to a particular service or product.

– Common costs: These are costs which cannot be directly assigned to a particular service or product. They are assigned as follows:

  1. whenever possible, common costs are allocated on the basis of direct analysis of the origin of the costs themselves;
  2. when direct analysis is not possible, common cost categories are allocated on the basis of an indirect linkage to another cost category or group of cost categories for which a direct assignment or allocation is possible; the indirect linkage is based on comparable cost structures;
  3. when neither direct nor indirect measures of cost allocation can be found, the cost category is allocated on the basis of a general allocator computed by using the ratio of all expenses directly or indirectly assigned or allocated, on the one hand, to each of the universal services and, on the other hand, to the other services;
  4. common costs, which are necessary for the provision of both universal services and non-universal services, are allocated appropriately; the same cost drivers must be applied to both universal services and non- universal services.

Compliance with public procurement rules: According to the EU postal directive, Member States may, without a tendering procedure, designate directly the USO operator, which in this case was Post Danmark.

Net avoidable cost: The PSC must be calculated on the basis of the net avoidable cost (NAC) methodology. The NAC is the difference between the net cost for the provider of operating with the public service obligation and the net cost or profit for the same provider of operating without that obligation. Therefore, in order to calculate the NAC it is necessary to determine the “factual” scenario with the PSO or USO and the “counterfactual” scenario without the PSO or USO. In essence the counterfactual scenario reflects the state of Post Danmark without loss-making operations. It follows that the NAC is the avoided costs minus the lost revenue from discontinued operations. At the same time, any intangible benefits linked to the PSO/USO must not be taken into account in the counterfactual scenario. Such benefits include economies of scale and scope, advertising effects from intellectual property, demand effects due to VAT exemptions (Post Danmark benefits from a 25% VAT exemption on the postal services covered by the USO), universal coverage advantages, bargaining power and better customer acquisition.

To summarise, the PSC must be equal or less than the NAC which is  equal to (C2 – (R2 + IB)) – (C1 – R1), where “2” is the cost or revenue with the PSO/USO and “1” is the cost or revenue without the PSO/USO and IB is intangible benefits. By rearranging, NCA = (C2 – C1) – (R2 – R1) – IB, which means that NCA = cost difference or avoided cost – lost revenue – intangible benefits.

Paragraph 160 of the Commission decision shows that indeed NAC = avoided costs – lost revenue – intangible benefits = DKK 2.571 billion. As it transpired, the NAC was considerably higher than the notified PSC.

Reliability of the NAC calculation: The next step in the Commission’s assessment was a test of the reliability of the NAC calculation and in particular the profit margin for Post Danmark. The estimated counterfactual earnings before interest and taxes [EBIT] margin was 2.5%. This was compared to the EBITs of other postal operators and was found to be above the 1.7% of Posten Norge but below the 5.1% of Deutsche Post.

The Commission also examined the labour productivity of Post Danmark in the counterfactual scenario and was found to be DKK 0.78 million per FTE (there is no explanation how it was calculated). It was benchmarked against those other operators such as Posten Norge with DKK 1.01 million and Deutsche Post with DKK 0.86 million. The Commission considered the indicators for Post Danmark to be within the range of figures for the sector and therefore reliable.

 

Efficiency incentives: The Commission noted that Post Danmark would appoint an independent external market analyst to monitor the quality of its services subject to the USO. This analyst would report on a monthly basis to the Danish postal regulator who could impose penalties in case of substandard services.

More importantly the Commission noted that “(168) the Danish State will pay a fixed, upfront USO compensation to Post Danmark of at most SEK 1.683 billion / DKK 1.192 billion. The net cost of discharging the public service obligations has been calculated at DKK 2.571 billion (see Table 2). The maximum compensation to be paid to Post Danmark amounts to only 46% of the NAC of the USO. As long as it does not lead to overcompensation, Post Danmark is allowed to absorb all the efficiency gains achieved which constitutes a strong incentive for efficiency. The Commission also notes that due to the quality standards and penance system described above, these efficiency gains should not prejudice the quality of the service provided.”

Lastly, the Commission was satisfied that the entrustment conformed with the requirements for transparency and that it would not cause serious competition distortions.

A comment is in order before proceeding to the next section. It is has become the standard practice of the Commission to accept that when the PSC is lower than the forecast next extra costs it provides sufficient incentives for the SGEI providers to reduce their costs. On the face of it, this is true. However, if the SGEI provider can reduce its costs so substantially, the question that arises is how reliable are the cost and revenue calculations. This is not the case of unforeseen changes of a couple of percentage points. Post Danmark accepts an obligation that a rational investor would not. Of course, what we do not know is whether other sources of income were available to Post Danmark. Perhaps, like the UK’s Royal Mail, Post Danmark had other income that could cover the next extra costs of the USO even if the efficiencies it would gain would not by enough on their own to eliminate the difference between the costs of the USO and the corresponding revenue.

 

Assessment of the complainant’s claims

State guarantees: When Post Danmark was converted to a limited liability company in 2002, the then employees with a civil service status were given state guarantees covering their pensions and possible redundancy compensation.

The Commission considered that although the direct beneficiaries were employees, Post Danmark also enjoyed an indirect benefit that satisfied all of the criteria of Article 107(1). However, the Commission considered the aid to be existing and non-recoverable because it was granted in 2002, more than 10 years before it first examined it in 2017.

VAT exemption: The exemption from VAT that applied to postal services covered by the USO was indeed an advantage that benefited indirectly Post Danmark because it increased consumer demand for those services.

However, as the Commission decision explained, “(194) this indirect advantage to Post Danmark derives primarily from the existence of the mandatory VAT exemption on USO postal services which is laid down in Article 132(1)(a) of the EU VAT Directive [no. 2006/112]. Post Danmark benefits from a similar advantage regarding final consumers and all other VAT exempted customers such as banks and insurance companies. To the extent that the USO VAT exemption has never been considered to involve State aid by the Commission as it is not imputable to any Member State, the VAT exemption granted to mail order companies, which only indirectly benefits Post Danmark due to that USO VAT exemption, can also not be considered to be imputable to the Danish State.” Therefore, it was found not to constitute State aid.

 

Capital injection: In February 2017, PostNord injected DKK 1 billion into Post Danmark to provide it with liquidity to carry out its business plans. The Commission first recalled an important principle from the judgments in cases C-482/99, France v Commission (Stardust Marine), paragraph 52, and T-442/03, SIC v Commission, paragraphs 93-100. “Even if the State is in a position to control a public undertaking and to exercise a dominant influence over its operations, actual exercise of that control in a particular case cannot be automatically presumed. A public undertaking may act with more or less independence, according to the degree of autonomy left to it by the State. […] Therefore, the mere fact that a public undertaking is under State control is not sufficient for measures taken by that undertaking […] to be imputed to the State. It is also necessary to examine whether the public authorities must be regarded as having been involved, in one way or another, in the adoption of those measures.”

Then it explained that “(201) the ownership structure and way of appointing the Board of Directors show that Sweden and Denmark might be in a position to control and have a dominant influence over PostNord. However, they do not show that Sweden and Denmark had actual control when the capital injection of 23 February 2017 took place. Nor does it show that the public authorities were involved, in one way or another, in the adoption of the capital injection.”

It also considered that “(203) a private investor in PostNord’s circumstances would have most likely made a similar capital injection instead of letting its subsidiary go bankrupt. First, based on the available information, there is little doubt that Post Danmark would have gone bankrupt absent the intervention of PostNord group. At the time of the capital injection, Post Danmark’s equity had gone down to DKK 108 million from DKK 1.29 billion at the end of 2015, with a further forecast loss for 2017 of DKK […]. As the complainant has also stated, ‘it is an acknowledged fact that currently Post Danmark only survives through means granted by PostNord.’ Second, as the Danish and Swedish authorities have explained in section 5.1, not making the investment and accepting the bankruptcy of Post Danmark, would have had a much higher cost for PostNord group than making it.”

All this may be true, but it must be said that the analysis in this part of the decision is rather superficial and seems to accept at face value the claims advanced by Sweden. If Post Danmark was losing money of that magnitude, a rational operator would have gotten rid of it. The analysis is superficial because a rational operator would not only have considered the cost of liquidation but also the possibility of not being able to achieve the necessary operating efficiencies in order to cover the difference between the net extra costs of the USO and the much smaller PSC. At any rate, the end result was that the capital injection was determined not to constitute State aid.

Conclusion

The Commission found the PSC to be compatible with the internal market while it rejected all of the claims of the complainant.

———————————————————————

[1] The full text of the Commission decision can be accessed at: http://ec.europa.eu/competition/state_aid/cases/273321/273321_1994495_61_2.pdf.

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About

Phedon Nicolaides

Dr. Nicolaides was educated in the United States, the Netherlands and the United Kingdom. He has a PhD in Economics and a PhD in Law. He presently holds positions at the College of Europe and the University of Maastricht. He has published extensively on European integration, competition policy and State aid. He is also on the editorial boards of several journals. Dr. Nicolaides has organised seminars and workshops in many different Member States, and has acted as consultant to several public authorities.

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