Compensation for Universal Service Provision

As long as the compensation does not exceed the net extra costs of the universal service activities, it may be used to offset other costs.

Introduction

The rules on State aid for services of general economic interest [SGEI] are very generous because they allow both investment and operating aid. Yet, it is not easy to comply with those rules because the calculation of the compensation for the net extra costs of the SGEI is a difficult and tricky task.

On 5 May 2021, the General Court, in case T‑561/18, ITD, Brancheorganisation for den danske vejgodstransport & Danske Fragtmænd v European Commission, had to examine several measures in favour of Post Danmark which is required to supply of postal services that are classified as SGEI.[1]

ITD is a trade association of transport companies. Danske Fragtmænd is active in the transportation of goods and parcel distribution services. They applied for annulment of Commission decision SA.47707 which approved aid granted to PostNord for the provision of the universal postal service in Denmark. Post Danmark is entrusted with a universal service obligation [USO]. It is 100% owned by PostNord which is itself 40% owned by Denmark and 60% owned by Sweden.

The applicants argued that the Commission should have opened the formal investigation procedure because it should have had serious doubts as to the existence and/or compatibility of the aid with the internal market.

The Commission had examined several separate measures: compensation for the net extra costs of the USO, the allocation of Post Danmark’s costs to USO and non-USO activities, a state guarantee, a VAT exemption and a capital increase. The first three measures were considered to constitute compatible State aid, while the last two measures were found by the Commission not to constitute State aid.

Because the judgment is very long [close to 400 paragraphs spanning over 50 pages], this article ignores procedural issues and reviews only the most important parts of the judgment that either clarify the application of State aid principles or identify faults in the Commission’s analysis.

Calculation of the compensation and the credibility of the counterfactual scenario

The applicants claimed that the Commission erred in its assessment of the calculation of the compensation for the public service obligation [PSC].

The General Court, first, reiterated that “(107) in allowing derogations to be made from the general rules of the Treaty in certain circumstances, Article 106(2) TFEU seeks to reconcile the Member States’ interest in using certain undertakings, in particular in the public sector, as an instrument of economic or social policy with the EU’s interest in ensuring compliance with the rules on competition and preserving the unity of the internal market. What Article 106(2) TFEU seeks to prevent, through the assessment of the proportionality of the aid, is that the operator responsible for the public service benefits from funding which exceeds the net costs of the public service.”

Then the Court linked the proportionality of the aid to the net avoided cost [NAC] methodology. “(109) That is the objective pursued by the NAC methodology”. Since the NAC includes the cost in a counterfactual scenario, the Court also examined the credibility of the counterfactual scenario in the case of Post Danmark.

The Court noted that “(114) it follows from paragraphs 21 to 23 of the SGEI Framework, that the Member States, who are required to notify the Commission of their plans to grant aid, have a certain margin of discretion in choosing the data relevant to calculating the NAC and that, where such a calculation is based on provisional data”. “(115) Provisional data, by its very nature, includes a margin of error”.

In the absence of the USO, Denmark claimed that Post Danmark would discontinue the distribution of single-piece letters or parcels, of registered or insured items, of the free service for the blind, of newspapers, magazines and catalogues, and of international letter post and parcel post items. The applicants argued that those services were profitable in urban areas and therefore, the counterfactual scenario presented to the Commission was not credible.

The Court observed that “(123) as the Commission points out, the inclusion of profitable activities in the counterfactual scenario would have had the effect of increasing Post Danmark’s profits in such a scenario and thus of increasing the difference, necessary for calculating the NAC, between the revenue derived from the USO and that which Post Danmark would have generated in the absence of the USO.”

This is mathematically correct, but so what? The counterfactual scenario is supposed to identify, as realistically as possible, what the service provider would be willing to offer without any compulsion by the state. If Denmark would consider the compensation to be excessive, because the provider would make huge profits in the absence of a USO, then it could reduce it, without manipulating the items that are included in the counterfactual scenario.

Nonetheless, the Court went on to stress that “(125) it must be borne in mind that the NAC calculation, which seeks to isolate the cost of providing the universal service, requires the development of a counterfactual scenario, that is to say, a hypothetical situation in which the provider of such a service is no longer responsible for it. That methodology consists, first of all, in assessing whether, in the absence of the USO, the operator initially responsible for that USO would change behaviour and cease to provide the loss-making services or would change the way in which the loss-making services are provided and, subsequently, in assessing the impact of that change of behaviour on its costs and revenues in order to deduct from them, and calculate, any NAC. In other words, it is a question of estimating the USO’s net cost by assessing the extent to which the operator responsible for the USO would increase its profits if it were not obliged to provide the universal service”.

In the end, the Court agreed with the Commission that the counterfactual scenario was credible.

Intangible benefits

The NAC methodology also requires that in the counterfactual scenario the intangible benefits of an undertaking from being a universal service provider are subtracted. The applicants argued that not all intangible benefits had been deducted, in particular those related to Post Danmark’s reputation and presence throughout the country.

The Commission routinely notes that intangible benefits in the postal sector include economies of scale and scope, advertising effects, publicity effects, demand effects due to the VAT exemption of postal items, and advantages linked to full territorial coverage.

The Court concluded that the Commission assessed the various intangible benefits correctly.

Efficiency incentives

Next the applicants claimed that the Commission erred in its assessment of the efficiency incentives which are required by the 2012 SGEI Framework and that efficiency gains could be achieved at the expense of quality of service.

The Court rejected those claims and observed that “(162) the Commission found that the Danish authorities had introduced sufficient incentives for the efficient provision of the universal service. First, the Commission found that a significant efficiency incentive could be inferred from the fact that the compensation at issue would be paid upfront and that it represented 46% of the NAC, which allowed Post Danmark to retain all efficiency gains on condition that it did not lead to overcompensation. Secondly, the Commission noted that the quality standards laid down in relation to Post Danmark in the universal service entrustment act and the penance system established in the event of non-compliance with those standards were such as to ensure that those efficiency gains would not prejudice the quality of the universal service provided.”

The Court also rejected the claim that the benchmark for the efficiency gains must be the costs of an efficient provider. “(165) The question whether the level of compensation needed must be determined on the basis of an analysis of the costs that an efficient service provider would have incurred in performing the USO is not relevant when assessing the compatibility of the aid in the context of the application of Article 106(2) TFEU. Taking into account the economic efficiency of the universal service provider would be tantamount to requiring that such a service always be provided under normal market conditions, which could potentially obstruct the fulfilment, in law or in fact, of the particular task assigned to undertakings entrusted with the operation of an SGEI. Article 106(2) TFEU is specifically intended to prevent such a situation”.

Allocation of compensation to USO costs

Then the applicants raised an important point. They contended that the compensation was not solely used to cover the cost of the USO [Post Danmark used part of the compensation to pay for the redundancy costs of employees who used to be civil servants when Post Danmark was part of the public administration].

The General Court responded that “(169) the objective underlying Article 106(2) TFEU is to prevent the competition rules obstructing undertakings entrusted with a public service from performing their tasks by allowing Member States to grant them financing, provided that it does not exceed the net costs attributable to that public service, taking into account a reasonable profit.”

“(170) Accordingly, an assessment by the Commission as to whether public service compensation is compatible with the internal market consists in verifying, irrespective of whether the corresponding amount is actually allocated to it, whether such a public service exists and imposes a net cost on the undertaking responsible for providing it.”

“(173) Consequently, the fact that the sum granted by way of the compensation at issue may be used for a purpose other than the USO does not in itself demonstrate that the Commission encountered serious difficulties in assessing the compatibility of such a measure”.

The Court also rejected the argument of the applicants that the aid was “misused” because “(175) it is apparent from Article 1(g) of Regulation 2015/1589 [the procedural regulation] that misused aid means aid used by the beneficiary in contravention of a Commission decision.”

On the basis of the above reasoning, the General Court concluded that the applicants failed to prove the existence of serious difficulties with respect to the compatibility of the compensation with the internal market. “(187) That conclusion is supported by the fact, […] that the NAC amount calculated, namely DKK 2.571 billion (approximately EUR 345 million), was significantly higher than the maximum amount of the compensation at issue, of DKK 1.192 billion (approximately EUR 160 million).”

VAT exemption

The applicants argued that an exemption from VAT enjoyed by Post Danmark constituted State aid. The Commission had concluded in its decision that the exemption was not State aid because it was mandated by Article 132 of the VAT Directive.

The Court recalled that “(241) as regards the condition that a measure of aid be imputable to the State, this requires an examination of whether the public authorities must be regarded as having been involved in the adoption of the measure at issue”.

Then the Court made a distinction between exemptions authorised by the EU and exemptions mandated by the EU.

“(243) As regards a national measure adopted to transpose into national law an obligation under a directive, it cannot, a priori, be excluded that such a measure is imputable to the State. It has already been held that a decision of an institution authorising a Member State to introduce, in accordance with a directive, a tax exemption could not have the effect of preventing the Commission from exercising the powers conferred on it by the Treaty and, consequently, setting in motion the procedure laid down in Article 108 TFEU in order to review whether that exemption constituted State aid”.

“(244) However, the situation is different in the case of a tax exemption provided for by a national measure which implements a provision of a directive imposing on Member States a clear and precise obligation not to levy tax on a particular transaction. In such a case, the transposition of the exemption into national law merely fulfils the obligations incumbent on States under the Treaties. It follows that a measure adopted pursuant to a clear and precise obligation laid down in a directive is not imputable to the Member State, but arises, in actual fact, from an act on the part of the EU legislature”.

Then the Court held that in fact the VAT exemption was imputed to Denmark because it widened the exemption permitted by the VAT Directive to cover mail-order companies, not just USO activities. As a result, Post Danmark enjoyed an indirect advantage because transportation of items shipped by mail-order companies was exempt from VAT, while mail-order companies charged VAT to their customers when they invoiced them in order to recover the costs of transportation of the items by Post Danmark.

Consequently, the Court concluded that “(268) the Commission could not exclude the existence of serious difficulties as regards the imputability to the Danish State of the effects of the administrative practice at issue in increasing demand for Post Danmark’s services, by confining itself to recalling the VAT exemption for services supplied by public postal services laid down in Article 132(1)(a) of the VAT Directive. In particular since it has been established that that exemption was not applicable to the transport costs of goods where those services were invoiced by a mail-order company to its end customers”.

Capital increase

The applicants claimed that the Commission was wrong to find that an injection of capital by PostNord into Post Danmark in February 2017 did not constitute State aid. As mentioned in the introduction PostNord which owns Post Danmark is itself owned by Denmark and Sweden.

Imputability of the capital increase to the state

“(330) The imputability of a measure to the State cannot be inferred from the mere fact that the measure at issue was taken by a public undertaking”. “(331) 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.”

The Commission argued that PostNord was a normal company. “(335) However, the mere fact that a public undertaking has been constituted in the form of a capital company under ordinary law cannot, having regard to the autonomy which that legal form is capable of conferring upon it, be regarded as sufficient to exclude the possibility of an aid measure taken by such a company being imputable to the State. The existence of a situation of control and the real possibilities of exercising a dominant influence which that situation involves in practice makes it impossible to exclude from the outset any imputability to the State of a measure taken by such a company, and hence the risk of an infringement of the Treaty rules on State aid, notwithstanding the relevance, as such, of the legal form of the public undertaking as one indicator, amongst others, enabling it to be determined in a given case whether or not the State is involved”.

“(340) Thus, in the present case, since it found that PostNord was an undertaking over which the Danish and Swedish States might exercise a dominant influence, the Commission could not merely conclude that it was not in a position to presume that the capital increase of 23 February 2017 was imputable to the State. […] it was for the Commission, as the case may be, to establish specifically, on the basis of indicators which it was to identify according to the information available to it, whether or not it was likely that the capital increase of 23 February 2017 was imputable to the Danish and Swedish States.”

“(341) It follows that, by merely stating that PostNord was a public undertaking, the Commission carried out an insufficient analysis of the State’s involvement in the adoption of the contested act. That approach amounts, in effect, to excluding the imputability to the State of the increase in capital of 23 February 2017 on the sole ground that PostNord was incorporated as a commercial company”.

The private investor test

Once the Court found that the capital increase could have been attributed to the state, it went on to examine whether PostNord acted as a private investor.

“(355) It is important to note that the conduct of a private investor with which the conduct of a public investor must be compared need not be the conduct of an ordinary investor laying out capital with a view to realising a profit in the relatively short term, but must, at least, be that of a private holding company or a private group of undertakings pursuing a structural policy, whether general or sectorial, and be guided by prospects of profitability in the longer term […] Thus, when contributions of capital by a public investor disregard any prospect of profitability, even in the long term, such contributions must be regarded as aid within the meaning of Article 107 TFEU, and their compatibility with the internal market must be assessed on the basis solely of the criteria laid down in that provision”.

“(356) In particular, the Court of Justice has held that a private shareholder may reasonably provide the capital necessary to secure the survival of an undertaking which is experiencing temporary difficulties but is capable of becoming profitable again, possibly after restructuring. Accordingly, a parent company may also, for a limited period, bear the losses of one of its subsidiaries in order to enable the latter to close down its operations under the best possible conditions”.

“(360) When faced with a number of alternatives before carrying out a transaction, a rational private investor must weigh up the advantages and disadvantages of each of them in order to choose the most advantageous option”.

The Commission had considered that a private investor would have made the capital injection because “(364) Post Danmark’s bankruptcy would have had a number of negative consequences for the PostNord group.”

“(365) In that regard, it cannot be ruled out that the negative consequences of the bankruptcy of a subsidiary may lead a private investor, acting on the basis of economic rationale, to make capital contributions to ensure the survival of that subsidiary.”

“(366) Nevertheless, in order to reject, at the stage of the preliminary examination, the classification as State aid of a public investment intended to ensure the survival of a subsidiary, on the ground that that investment is consistent with the conduct of a rational private investor, the Commission must, […] be able to establish that that investment was preferable to any of the alternative measures, such as the bankruptcy of that subsidiary. In order to do so, […] the Commission must carry out a meticulous examination, on the basis of reliable evidence available to it, of the advantages and disadvantages, first, of the option of filing for the bankruptcy of the subsidiary and, secondly, of the option of making a public investment in order to ensure the survival of the undertaking, examining, in particular, in the latter case, the prospects of profitability for the public investor.”

“(367) In the present case, even though the Commission found that the cost of the capital increase of 23 February 2017 was lower for PostNord than Post Danmark’s bankruptcy, it is apparent from the contested decision that it in fact relied exclusively on the negative consequences of the bankruptcy of Post Danmark, without excluding the possibility that such bankruptcy could, in spite of everything, be more advantageous than a capital increase which, for example, offered no prospects of profitability, even in the long term.”

“(375) As the applicants claim, the approach adopted by the Commission in the contested decision is analogous to accepting that any capital contribution made by a publicly owned company to its subsidiary faced with a sudden risk of bankruptcy, satisfies in principle, the private investor in a market economy test.”

Consequently, the General Court annulled Commission decision SA.47707 in relation to the VAT exemption and the capital increase.


[1] The full text of the judgment can be accessed at:

https://curia.europa.eu/juris/document/document.jsf?text=&docid=240821&pageIndex=0&doclang=en&mode=lst&dir=&occ=first&part=1&cid=24627

Tags

Über

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 is professor at the University of Maastricht and the University of Nicosia. 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.

Zusammenhängende Posts

09. Nov 2021
State Aid Uncovered von Phedon Nicolaides

Compensatory Payments and State Resources

Funds used in compensation mechanisms mandated by the state become state resources Introduction The Court of Justice has stressed repeatedly that any resource over which the state can exercise control becomes a state resource, regardless of whether it is managed by a public authority or a private entity. Member States, however, keep inventing novel and complicated arrangements in which mandated […]
12. Okt 2021
State Aid Uncovered von Phedon Nicolaides

Security of Supply May Justify a Deviation from Public Procurement Rules

Security of supply justifies a deviation from the normal procurement procedures as long as the same security cannot be achieved through a competitive selection of suppliers. Introduction Point 19 of the 2012 SGEI Framework requires that the assignment of a public mission to an undertaking must comply with the applicable public procurement rules. It does not impose an obligation for […]
07. Sep 2021
State Aid Uncovered von Phedon Nicolaides

Assignment of Public Service Obligations

The compensation for public service obligations may include reasonable profit and incentives for cost reduction. Introduction Member States have discretion to define services they consider to be in the general economic interest [SGEI]. However, they need to justify that definition. The Court of Justice has ruled on numerous occasions that an SGEI has “special characteristics” that set it apart from […]
27. Jul 2021
State Aid Uncovered von Phedon Nicolaides

A Rare Commission Decision on an SGEI Measure that Could Have Been Exempted from Notification

A public service obligation must be imposed by an act of entrustment that describes in detail the terms of the obligation, identifies the undertaking that offers the service and lays down procedures for preventing over-compensation. Introduction The purpose of Commission Decision 2012/21 on services of general economic interest [SGEI] is, like the GBER, to exempt certain aid measures from prior […]
28. Dez 2020
State Aid Uncovered von Phedon Nicolaides

The Time Horizon of a Private Investor

A public authority that claims that it invests for the long term, must still prove that its investment is likely to be profitable. Introduction Public authorities may invest in private companies. However, they need to behave as private investors otherwise they confer an advantage that constitutes State aid. In their defence, public authorities claiming that they act as private investors, […]
15. Dez 2020
State Aid Uncovered von Phedon Nicolaides

The Law, Economics and Art of Compensation for Public Service Obligations

State aid in the form of compensation for public service obligations must exclude any intangible benefits from the obligation, but may include reasonable profit. The Commission guidelines for State aid in agriculture and forestry, the block exemption regulations covering agriculture, forestry, fishery and aquaculture, and the Regulation on de minimis aid for fishery and aquaculture have been prolonged to 31 […]
20. Okt 2020
State Aid Uncovered von Phedon Nicolaides

Employees’ Social Security Contributions and Compensation for Damage

Fiscal benefits to employees do not constitute State aid as long as they do not confer a direct or indirect advantage to their employers. Update on Temporary Framework: Number of approved and published Covid-19 measures, as of 16 October 2020: 302* Legal basis: Article 107(2)(b): 32; Article 107(3)(b): 255; Article 107(3)(c): 23 Average number of measures per Member State: 11 […]
15. Sep 2020
State Aid Uncovered von Phedon Nicolaides

Non-economic Activities and Services of General Economic Interest

Non-economic tasks and economic activities which are inseparable from those non-economic tasks are together, as a bundle, non-economic in nature. Public compensation for the extra costs of services of general economic interest [SGEI] may not cross-subsidise activities that fall outside the scope of the SGEI. Update on Temporary Framework: Number of approved and published covid-19 measures, as of 11 September […]
04. Feb 2020
State Aid Uncovered von Phedon Nicolaides

How to Compensate for the Extra Cost of Public Service Obligations: Step-by-Step Guidance on a Complex Calculation

The “net avoided cost methodology” takes into account only incremental costs. Introduction The two most difficult issues in the design of State aid measures to support services of general economic interest [SGEI] are the proper definition of the public service obligation [PSO] and the identification of the “counterfactual” on the basis of which the public service compensation [PSC] is calculated. […]
07. Jan 2020
State Aid Uncovered von Phedon Nicolaides

Bail-in Is the Responsibility of Member States

Commission approval of State aid to bail-out a bank does not give rise to right for compensation for creditors who are bailed-in. Introduction Investors in banks who lost their money have sought compensation both at EU and national level. So far, claims for damages at EU level have been unsuccessful. In some instances, the cases before EU and national courts […]