A selective tax reduction does not constitute State aid if it does not confer an advantage that is proportionately larger than the magnitude of the tax reduction. A complete exemption of insignificant amounts of the taxable volume can be justified on the grounds of reducing administrative burden.
As described in the Commission decision, “(18) the entirety of the tax was to be collected from owners of public utilities. Holders of permits for extraction from their own facilities would only pay one third of the tax, calculated on the basis of the annual permissible extraction volume. If the permit concerned a volume above 25 000 m3, […] the owner paid one third of the tax on 25 000 m3. […] holders of extraction permits for a maximum of 6 000 m3 per year were entirely exempted from the tax.”
In other words, there were three types of derogation from the tax:
- A two-thirds reduction of the tax paid on for water extracted from own facilities up to 25 000 m3.
- No additional tax for water exceeding 25 000 m3.
- Exemption for extraction below 6 000 m3.
The Commission also noted that “(19) […] 85 000 private extraction permits have been issued in Denmark. The vast majority of these concern the agricultural sector. The number of permits for a maximum of 6 000 m3 is estimated at 75 000. The Danish authorities cannot guarantee that all agricultural enterprises hold private extraction permits and are therefore not dependent on public utilities, but point out that those farms that are able to connect to a public utility generally hold an extraction permit and only use the public supply for household needs.” “(20) … 12 275 permit holders obtained a tax reduction equivalent to an average of EUR 1 080 annually for extraction permits on an average of 35 500 m3 of water. The figures for 2009-2011 show that 1 091 agricultural enterprises obtained tax reductions, which exceeds the de minimis ceiling. […] 106 permit holders are registered as food-processing enterprises.”
The Commission opened the formal investigation procedure because it considered that the tax reduction, tax ceiling and tax exemption constituted State aid. They favoured primarily agricultural undertakings with permits for private extraction, in particular those undertakings that benefitted from the exemption (small extraction) and from the ceiling (very large extraction).
The Commission also had doubts that the derogations could be justified by the internal logic of the tax system.
In addition, it appeared that the aid did not comply with the relevant de minimis rules in agriculture, nor with the State aid guidelines on agriculture, nor with the environmental guidelines.
Do you know we also publish a journal on State aid?
The European State Aid Law Quarterly is available online and in print, and our subscribers benefit from a reduced price for our events.
Existence of State aid
Before proceeding, it is worth pointing out that primarily for two reasons the Commission rejected the Danish argument that the aid fell below the de Minimis ceiling. First, on average terms the aid appeared not to exceed the de minimis ceiling. But it could not be proven that it remained below the ceiling for all aid recipients. Second, it could not be proven that the aid recipients had not received other de minimis aid that brought the total de minimis amount in the same three fiscal-year period above the maximum allowable.
Since tax reductions/exemptions represent forgone revenue for the state and since in this case the tax derogations benefitted agricultural products which are widely traded across the EU, there was no doubt that there was transfer of state resources and hardly any doubt that trade was affected and competition was distorted. The decisive questions in this case were, first, whether the reduction, ceiling and exemption conferred an advantage and, second, whether it was selective.
As explained by the Commission, “(65) in the context of tax measures, the selectivity is constituted by a derogation from a reference system. (This case) […] constitutes special tax treatment (a tax reduction or exemption) for holdings with extraction permits for volumes above or below specific levels.”
“(67) In order to determine whether a measure constitutes State aid or not under Article 107(1) TFEU, it is necessary to determine the common scheme (the reference system), that afterwards it should be examined whether the measure concerned constitutes a derogation from that scheme by distinguishing among different economic operators which are in a comparable factual and legal situation in light of the scheme’s intrinsic objective, and finally that it should be determined whether the derogation is justified by the common scheme’s nature and overall structure.”
“(68) In this case, therefore, it must be determined whether the enterprises with extraction permits (primarily active in the agricultural sector) that had the advantage of a tax reduction […] were in a factual or legal situation comparable to that of enterprises that were connected to a public utility and paid an indirect tax passed on to them by the owners of the public utility which, […], were required to pay the full tax […].”
“(69) The Commission notes that the objective of the tax was to collect sufficient revenue for surveys in preparation of management planning for areas that are particularly important to the drinking water supply in Denmark. All enterprises that consume water ought therefore in principle to be subject to the same payment obligation.”
“(70) Any selectivity needs to be assessed at two levels: firstly in the context of payment of a third of the tax […] and secondly in the context of the tax reduction that follows from the ceiling set on a volume of 25 000 m3 together with the exemption for permits for a maximum of 6 000 m3.”
The Commission noted that the Danish measure had two distinct tax targets. The first was the taxation of effective consumption (for consumers who were connected to public utilities), whereas the second was based on the volume permitted to be extracted (for consumers who extracted their own water).
The Commission went on to reiterate that “(73) a measure’s selective character should, however, be assessed in light of the objective to be achieved, which in the present case is to carry out surveys in preparation of management planning for areas that are particularly important to the drinking water supply. It can therefore be determined that, in consideration of the established objective, all enterprises ought to be subject to the same taxation in order for the measure not to be considered as selective. The Commission can therefore only conclude that reducing the tax by two thirds […] is selective.”
In this connection, the Commission rejected several arguments advanced by Denmark:
“(74) The difference in the number of owners of public water utilities and owners of private water supply systems is not sufficient in and of itself to justify the differences in the legal and factual situation covered by the two tax systems, given that in both cases it is the consumers who pay the tax”. And, “the argument that owners of public water utilities are not undertakings because they do not exercise an economic activity […] is not applicable either, given that […] an economic activity is defined as offering goods or services, and that water extraction and supply are indeed constituted by offering a service, i.e. they constitute an economic activity.”
Then came the most extraordinary part of the Commission’s analysis. “(75) It should therefore be examined whether the measure, despite the selectivity that follows from its application to specific enterprises, confers an economic advantage on those enterprises. Regarding this, the Commission notes that the enterprises that pay only one third of the tax are taxed on theoretical consumption as indicated in the extraction permit, whereas the enterprises that pay the full tax are taxed on the basis of actual water consumption. It also points out that according to the Danish authorities, the owners of private systems have only consumed one third (34% — see recital 34) of the water volumes that are covered by the extraction permit. In consideration of this fact, the Commission finds that the reduction by two thirds of the tax serves to compensate for the effects of the difference between taxation of actual consumption and taxation on the basis of the volume listed in the extraction permit. Without this reduction, moreover, the amount collected would have far exceeded the funding needs in connection with surveys of and management planning for areas that are particularly important to the drinking water supply. In consideration of this, the Commission concludes that the reduction by two thirds of the tax […] does not constitute an economic advantage for the enterprises concerned and therefore does not constitute State aid under Article 107(1) TFEU.”
The above paragraph contains four statements that deserve comment. First, the Commission concludes that there is no advantage for the companies that extract their own water partly because they are taxed on a hypothetical water consumption while others are taxed on actual consumption. But from this statement one cannot infer that the hypothetical amount is always larger than the actual amount. Even if that is true at some point in time, it does not follow that the actual consumption of own water will always be two thirds lower than the hypothetical so that it will always deserve a two-thirds reduction of taxation.
Second, even if the Danish authorities could show ex post that the actual consumption of own water was only 34% of the hypothetical amount, how did they establish that on an ex ante basis when they set up the tax. And did they also establish administrative mechanisms for preventing consumption above that threshold or for checking actual consumption?
Third, if without the reduction the amount of revenue would have exceeded the funds needed, why did the Danish authorities not simply reduce the tax rate and apply it uniformly to all water consumers?
Fourth, if one retorts that Denmark does not have to answer the questions posed above because it has discretion to tax whatever it wants to tax, then it is no so obvious that the actual tax reductions and ceilings stem from the logic of the system which is to generate revenue for surveys and water management.
The only way that this reasoning can be justified is that the tax was abolished in the meantime and it could be shown ex post that the undertakings extracting their own water did not derive any advantage for as long as they were subject to that selective treatment. But if this is the real explanation then the Commission should have been more explicit about it.
Tax ceiling of 25 000 m3
Then the Commission turned its attention to the fact that the tax was not levied on water exceeding 25 000 m3 and considered whether it could be justified by the tax system’s inherent logic.
It recalled that “(79) according to point 23 of the former Notice, the differential nature of some measures does not necessarily mean that they must be considered to be State aid. This is explained in more detail in point 24, which states that the progressive nature of an income tax scale or profit tax scale is justified by the redistributive purpose of the tax. The Danish authorities state that establishing the ceiling at 25 000 m3 follows this logic.”
The Commission disagreed. “(80) Introducing a tax ceiling for the largest volumes certainly does not bring about a higher tax rate for those holding permits to extract the largest volumes of water. On the contrary, due to the ceiling they can pay an amount that is lower (even significantly lower) than what they would have paid without the ceiling. The redistributive purpose is more or less turned on its head, even if it is interpreted mutatis mutandis, because it is ultimately those holding extraction permits for more than 6 000 m3 and less than 25 000 m3 that pay the most proportionately. Therefore, in this case there is no progressive tax scale.”
The Commission also rejected the argument that the ceiling was applied without discretion on behalf of the tax authorities. “(81) The absence of a discretionary element does not automatically mean that there is no selectivity. […] Therefore the Commission concludes that the tax ceiling […] is not justified as a consequence of the system’s nature or inherent logic, and that it is therefore selective.”
Tax exemption of permits for a maximum of 6 000 m3
The Commission reached the opposite conclusion with respect to extracted water of less than 6 000 m3. It noted that “(82) the Danish authorities themselves acknowledge that the measure is selective in the sense that it confers an advantage on certain enterprises. The Danish authorities emphasise, however, the insignificant size of the amount that would have to be paid in the absence of this exemption (see recital 35) and therefore they justify the exemption on the grounds of the scheme’s administrative management. The Commission notes that the unpaid amounts are very modest, and also acknowledges that collecting insignificant amounts, such as the amounts in this case, would have resulted in a significant administrative burden with disproportionately high costs (administrative measures would have to be taken in connection with approximately 75 000 permits in order to collect individual amounts of approximately EUR 40 per year (see recitals 19 and 35). The very objective of a tax scheme, however, is to give a State the opportunity to create revenue, and not to squander resources only to end up not collecting any or even registering a loss. At the same time, the absence of a reporting obligation for smaller permits would have made it necessary to carry out full administrative checks, which, again, would have resulted in significant costs. On that basis, the Commission can conclude that the full tax exemption on extraction permits for a maximum of 6 000 m3 is justified by the Danish tax system’s nature and inherent logic, and that it therefore does not entail selectivity nor does it constitute State aid under Article 107(1) TFEU.”
Compatibility of the aid involved in the tax ceiling at 25 000 m3
Regardless of whether the granted aid was illegal, the Commission still had to assess its compatibility with the internal market. It found that the aid was not compliant with any of the guidelines that were in force at the time.
The Commission decided that the reduction by two thirds of the tax did not constitute State aid. The aid that followed from the tax exemption for extraction permits for a maximum volume of 6 000 m3 also did not constitute State aid. However, the ceiling on the calculation base for the tax, set at 25 000 m3 of water did constitute State aid. Therefore, the Commission instructed Denmark to recover the aid.
 The full text of the decision is published in OJ L157, 20/6/2018, and can be accessed at: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32018D0884&from=EN.