A tax measure may be selective in relation to both intermediate and final beneficiaries. An undertaking may enjoy a selective advantage even if it passes all tax benefits to other parties.
A measure that is not selective at one level may be selective at another level and a measure that is selective at one level can also be selective at another. The existence of selectivity at different levels was the core issue in the judgment of the Court of Justice of the European Union of 25 July 2018 in case C‑128/16 P, Commission v Spain. The Commission appealed against the judgment of the General Court in cases T‑515/13 and T‑719/13, Spain and others v Commission. The General Court had annulled Commission decision 2014/200 on a Spanish tax scheme concerning finance lease agreements, also known as the Spanish Tax Lease System (STL system). The judgment of the General Court was reviewed here on 5 January 2016 and you can find it on our State Aid Hub Blog
In December 2014 in the Autogrill and Banco Santander cases (T‑219/10 and T‑399/11, respectively) and again in December 2015 in the STL cases, the General Court advanced a new approach to determining whether a tax derogation or exception was selective. It held that an exception from a tax system was not necessarily selective if it was open to any undertaking that wanted to benefit from it. In addition, the General Court deduced from this new approach that if the Commission wanted to prove that the derogation or exception was selective, it was obliged to demonstrate that it was available only to certain rather than all undertakings.
We now know that this approach is not correct. It was rejected by the Court of Justice in its World Duty Free and Banco Santander judgment (C‑20/15 P and C‑21/15 P). That judgment was reviewed here on 24 January 2017 and you can find it at our State Aid Hub Blog.
The Court of Justice ruled that, regardless of whether a derogation or exception was open to any undertaking from any sector, it was selective if it differentiated between undertakings which were in a comparable situation. Consequently, the Commission was not obliged to identify undertakings that were explicitly excluded from the measure in question. Therefore, it came as no surprise that on 25 July the Court of Justice also annulled the judgment of the General Court on the Spanish Tax Lease.
As we will see below, the Court of Justice found the Spanish Tax Lease to be selective after it established that although any undertaking could be the final beneficiary, only certain undertakings could be the intermediate beneficiaries through which tax advantages flowed to the final beneficiaries. This shows that selectivity can arise at different levels and the fact that a measure appears to be general at one level does not guarantee that it is not selective at another. In addition, it reiterated the principle established in the World Duty Free case that a measure is selective, even if it is in principle open to all undertakings, when it differentiates between participating and non-participating undertakings. All that is needed is for the Commission to establish that the measure is a derogation from the reference system, which cannot be justified by the nature or internal logic of that system.
A Spanish tax measure (the Spanish Tax Lease system in question) applied to finance agreements for the purchase of ships and made it possible for shipping companies to purchase ships built by Spanish shipyards at a 20%-30% discount.
The STL system was based on a complex arrangement. For each ship contract, the STL system involved, a shipping company, a shipyard, a bank, a leasing company and an Economic Interest Grouping (EIG) made up of investors who purchased shares in the EIG. The EIG took a lease on the ship from a leasing company as soon as construction began. Then it leased the ship to the shipping company under a bareboat charter. The EIG was committed to buy the vessel at the end of the leasing contract while the shipping company undertook to buy it at the end of the bareboat charter. This complex arrangement generated tax benefits for investors in the EIG which transferred part of those benefits to the shipping company in the form of a discount on the price of the vessel agreed by the shipyard. For further details see the article of 5 January 2016 and you can find it at our State Aid Hub Blog.
The Commission found the STL system to constitute State aid incompatible with the internal market. On appeal, the General Court accepted Spain’s argument that under the STL system EIGs were “transparent” for tax purposes in the sense that they passed on any tax benefits to their investors. Any investor, from any sector and of any size, could invest in an EIG. Therefore, the General Court concluded that the measure was not selective and proceeded to annul Commission decision 2014/200.
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Who were the beneficiaries?
An issue that was contested at the outset before the Court of Justice was whether the beneficiaries of the STL system where the EIGs themselves or the shareholders of EIGs.
The Court first recalled that Article 107(1) TFEU applies to undertakings and that any entity engaged in an economic activity, regardless of its legal status and the way in which it is financed is an undertaking. It also reiterated that an economic activity is the offering of goods or services on a market.
It went on to explain that “(36) interventions which, in any form whatsoever, are liable to favour undertakings directly or indirectly, or which must be regarded as economic advantages which the recipient undertaking would not have obtained under normal market conditions, are considered to be State aid. Thus, measures which, in various forms, mitigate the charges that are normally included in the budget of an undertaking and which therefore, without being subsidies in the strict meaning of the word, are similar in character and have the same effect are considered to constitute aid”.
It then focused on the concept of selectivity. “(37) A measure […] which, […], places the recipients in a more favourable position than other taxpayers is capable of procuring a selective advantage for the recipients and, consequently, constitutes State aid, within the meaning of Article 107(1) TFEU. On the other hand, a tax advantage resulting from a general measure applicable without distinction to all economic operators does not constitute such aid […] Similarly, the term ‘State aid’ does not refer to State measures which differentiate between undertakings and which are, therefore, prima facie selective where that differentiation arises from the nature or the overall structure of the system of which they form part”.
Having identified the relevant principles, the Court proceeded to apply them to the STL system. “(38) In the present case, […], the General Court, in paragraph 116 of the judgment under appeal, found that, although the EIGs had benefited from the three tax measures […], it was the members of the EIGs who had benefited from the economic advantages arising from those three measures as a result of the tax transparency of the EIGs, and who were, moreover, referred to in the order for recovery imposed in Article 4(1) of that decision. In paragraph 117 of that judgment, it held that, in the absence of an economic advantage in favour of the EIGs, the Commission was wrong to conclude that they had benefited from State aid within the meaning of Article 107(1) TFEU. Therefore, in paragraph 118 of that judgment, it concluded that, ‘since it is the investors, and not the EIGs, that benefited from the tax and economic advantages resulting from the STL system, it is appropriate to examine […] whether the advantages obtained by the investors are selective, are liable to distort competition and affect trade between Member States and whether the [decision at issue] contains a sufficient statement of reasons concerning the analysis of those criteria.’”
“(39) Having recalled in paragraph 164 of the judgment under appeal that the analysis of the advantages arising from the tax measures at issue in the decision at issue was also based on the finding that the STL system favoured certain activities, namely the acquisition of vessels through leasing contracts, in particular with a view to their bareboat chartering and subsequent resale, the General Court stated in paragraphs 171 and 176 of that judgment that that finding referred to the activities of the EIGs set up for the purposes of the STL system but did not relate to the industrial or economic activities of the members of the EIGs, who take shares in the EIGs as investors. It concluded in paragraphs 176 and 180 of that judgment that the selectivity of the tax measures at issue could not be established on the basis of that finding.”
“(40) It appears from those considerations that, […], the General Court concluded that the EIGs could not be the beneficiaries of State aid solely on the ground that, as a result of the tax transparency of those groupings, it was the investors, and not the EIGs, who had benefited from the tax and economic advantages resulting from those measures.”
“(41) In addition to the fact that it contradicts the finding in paragraph 116 of the judgment under appeal that the EIGs had benefited from the three tax measures referred to in Article 1 of the decision at issue, that conclusion incorrectly applies Article 107(1) TFEU.”
“(42) According to the description of the STL system, the EIGs carried on an economic activity, namely the acquisition of vessels through leasing contracts, in particular with a view to their bareboat chartering and subsequent resale, from which it follows that they were undertakings within the meaning of Article 107(1) TFEU”.
“(43) It was the EIGs which, first, applied to the tax authority, […], for the benefit of early depreciation of leased assets, which they were granted, and, secondly, left the normal corporate taxation system and opted for the tonnage tax system, […] It was also the EIGs which collected the tax benefits in two stages, […], by the combination of the tax measures at issue.”
“(44) The resulting economic advantages, […], corresponded to the advantages which the EIGs would not have achieved in the same operation by the sole application of general measures, namely the interest saved on the amounts of tax payments deferred by virtue of early depreciation, the amount of tax avoided or interest saved on tax deferred by virtue of the tonnage tax system and the amount of tax avoided on the capital gain made on the sale of the vessel. The STL system therefore involved the use of public resources in the form of lost tax revenue and unpaid interest”.
“(45) It is true that those advantages were transferred in full to the members of the EIGs because, with the EIGs being fiscally transparent as regards the members residing in Spain, the profits or losses made by the EIGs were automatically transferred to their members residing in that Member State pro rata to their shares. Nevertheless, the fact remains that the tax measures at issue were applied to the EIGs and that they were the direct beneficiaries of the advantages arising from those measures. Those advantages, […], favoured the activity of acquiring vessels through leasing contracts, in particular with a view to their bareboat chartering and subsequent resale, carried on by the EIGs.”
“(46) It follows that the tax measures at issue were such as to constitute State aid in favour of the EIGs and that therefore, by not acknowledging that the EIGs were beneficiaries of those measures on the ground that those entities were fiscally transparent, the General Court held that they could not be the beneficiaries of State aid solely because of their legal form and the relevant rules on the taxation of profits. Such an exclusion is not in keeping with the case-law […], from which it follows that the classification of a measure as ‘State aid’ cannot depend on the legal status of the undertakings concerned or the techniques used.”
This is an important conclusion. Of course the EIGs were undertakings and of course they obtained an advantage in relation to other undertakings which may have wanted to buy a ship (such as, obviously, a bona fide shipping company). The Court is telling us that it is irrelevant that they passed on all benefits to shareholders. This makes sense and is in line with the recent judgment on aid (in the form of a reduction from an Irish air travel tax) that was to be recovered from Ryanair and Air Lingus despite their claims that they had passed it on to passengers through lower prices. However, this judgment also messes up the Commission’s practice of considering that no aid is received by certain risk capital funds which are set up for the purpose of channelling aid to SME final beneficiaries and by certain research organisations which offer services to third parties on behalf of a public authority. The passing on of all benefits to third parties may not be sufficient to eliminate State aid to funds and research organisation if such funds and research organisations enjoy a selective advantage.
The Court of Justice also examined whether the alleged absence of administrative discretion was capable of converting the measure from selective to general. It first recalled that “(55) in order to establish the selective nature of a tax advantage, it is not necessary for the competent national authorities to have the discretionary power to grant the benefit of that measure. However, the existence of such a discretion may be such as to enable those authorities to favour certain undertakings or the production of certain goods to the detriment of others and therefore establish the existence of aid, within the meaning of Article 107(1) TFEU […] That is so, in particular, where the competent authorities have a discretionary power to determine the beneficiaries and the conditions of the measure granted on the basis of criteria unrelated to the tax system. On the other hand, the application of an authorisation system in which the competent authorities only have a latitude limited by objective criteria which are not unrelated to the tax system established by the legislation in question could not, in principle, be regarded as selective”.
In other words, checks aimed at enforcing the applicable tax rules do not amount to administrative discretion. However, checks aimed at authorising or identifying eligible beneficiaries do correspond to the exercise of administrative discretion.
“(56) In the present case, in order to find that the Commission had wrongly considered, […], that the advantages resulting from the STL system as a whole were selective because they were dependent on the discretionary power conferred on the tax authority, the General Court, in paragraph 158 of the judgment under appeal, found that, despite the existence of an authorisation system involving alleged discretionary elements, those advantages remained open under the same conditions to any investor who decided to participate in the transactions within the STL system, aimed at financing ships through the purchase of shareholdings in the EIGs created by the banks.”
“(57) Having stated in paragraph 159 of that judgment that the conditions for authorising early depreciation concerned, de jure, only the characteristics of the asset which may be depreciated early, that the Commission had indicated in the decision at issue that the exercise of the discretionary power had led the tax authority to accept the early depreciation only for a specific category of assets and that the advantages at issue had not been refused for any operation under the STL system, the General Court, in paragraphs 160 and 162 of the judgment under appeal, held that, even if it were established, that discretionary power would have resulted, de jure and de facto, only in defining the type of operation capable of benefiting from the tax advantages at issue, that is to say, STL operations to finance vessels, to the exclusion of other assets, and that it remained the case that the possibility of taking part in those transactions and accessing the advantages in question was open to any undertaking. It concluded that the existence of an authorisation system does not mean, in the present case, that the advantages from which the investors benefited may be considered selective.”
“(58) It must be pointed out that those considerations are based on the incorrect premise that only the investors, and not the EIGs, could be regarded as the beneficiaries of the advantages arising from the tax measures at issue and that it was therefore by reference to the investors, and not the EIGs, that the condition relating to selectivity had to be examined. Therefore, in failing to examine whether the system for authorising early depreciation, […], conferred on the tax authority a discretionary power such as to favour the activities carried on by the EIGs involved in the STL system or having the effect of favouring such activities, the General Court erred in law.”
It is evident that the General Court did not examine in sufficient detail the question whether the tax authorities exercised administrative discretion because it thought that even if there was State aid, it was passed on to EIG investors. The General Court did not consider the benefits for EIG investors to be selective. We will see below that the Court of Justice annulled the judgment of the General Court and referred it back to the General Court. Unavoidably, the General Court will have to assess more carefully whether tax authorities could favour a particular set of assets over another.
A derogation can be selective even if it has a general application
The Court of Justice also commented on the case law that was used by the General Court as the basis for its finding that benefits for EIG investors were general rather than specific or selective. In particular the General Court relied on the judgments in cases Banco Santander v Commission (T‑399/11) and Autogrill España v Commission (T‑219/10) [the so-called Spanish goodwill cases] in which it had been found that a derogation from the reference system of taxation was not selective when any operator could benefit from it. Those judgments were reviewed here on 9 December 2014 and you can find it at our State Aid Hub Blog.
In this connection, the Court of Justice recalled paragraph 67 of the judgment in case Commission v World Duty Free Group and Others (C‑20/15 P and C‑21/15 P) and stated that “(69) with regard to a national measure conferring a tax advantage of general application, the condition relating to selectivity is satisfied where the Commission is able to demonstrate that that measure is a derogation from the ordinary or ‘normal’ tax system applicable in the Member State concerned, thereby introducing, through its actual effects, differences in the treatment of operators, although the operators who qualify for the tax advantage and those who do not are, in the light of the objective pursued by that Member State’s tax system, in a comparable factual and legal situation. In paragraphs 70 and 71 of that judgment, the Court stated that the supplementary requirement to identify a particular category of undertakings which are exclusively favoured by the measure in question and which may be distinguished by reason of specific properties, common to them and characteristic of them, cannot be inferred from the case-law of the Court of Justice.” “(70) In addition, in paragraphs 80 and 81 of the judgment (in case) Commission v World Duty Free Group and Others … the Court recalled that the fact that the recipient undertakings belong to various economic sectors is not sufficient to call into question the selective nature of the measure concerned and held that the potentially selective nature of the measure at issue is in no way called into question by the fact that the essential condition for obtaining the tax advantage conferred by that measure is that there should be an economic transaction, more particularly an entirely financial transaction, which is available regardless of the nature of the business of the recipient undertakings.”
The Court of Justice concluded its analysis of derogations of general application by referring back to the STL system and found that the General Court “(71) by holding, […], that the advantages obtained by the investors which participated in the STL operations could not be regarded as selective, since those operations were available, on the same terms, to any undertaking, without distinction, without ascertaining whether the Commission had established that the tax measures at issue, by their practical effects, introduced differentiated treatment of operators, where the operators which benefited from the tax advantages and those which were excluded from it, were, in view of the objective pursued by that tax system, in a comparable factual and legal situation, the General Court committed an error of law.”
Lastly, the Court of Justice examined whether the STL system affected trade and concluded that indeed it did affect trade.
Given that it had already found that the STL system was selective, at least at the level of EIGs, it proceeded to annul the judgment of the General Court and refer the case back to the General Court for a fresh assessment.
A concluding comment
This judgment is important for three reasons. First, it directs us to examine the existence of selective advantages both at the level of intermediate and final beneficiaries. Second, it requires us to ignore the fact that benefits may be fully passed on from intermediate to final recipients. What is relevant is whether the first recipients of such benefits are undertakings and whether the benefits are selective. Third, the Court of Justice reiterated and confirmed the approach it had adopted in the World Duty Free case. The first two reasons are useful clarifications of the concept of State aid. The third reason is troubling because it perpetuates an approach that undermines the principle of the tax autonomy of Member States.
This is because, despite its acknowledgment that Member States are free to design their tax system as they wish as long as they do not contain State aid, the Court does not seem to appreciate that tax systems necessarily have to contain exceptions of general application. Taxes are not just for raising revenue or redistributing income. Taxes are also tools for broader policy objectives and can be intended to penalise socially harmful activities while tax exemptions can aim to incentivise socially beneficial activities. For example, the purpose of an increase of tax credit or a decrease of tax rate for research activities can be to stimulate more research output which benefits society. By classifying exceptions of general application as selective, EU law encroaches into the prerogatives of Member States and limits their ability to design tax measures which do not aim to raise revenue or redistribute income.
The Court seems to conflate ex ante with ex post “differentiated treatment”. In its very sound and innovative judgment in case C‑106/09 P, Commission v Gibraltar, the Court of Justice found that, although the tax rules at hand appeared to be general, in reality offshore companies were granted a selective advantage. Their escape from taxation was not a “random consequence” of those tax rules but an “inevitable consequence” because they “excluded from the outset” offshore companies. The STL system did not exclude from the outset any undertaking that wished to participate in an EIG. Of course, once an investor chose to participate in an EIG, it received ex post a tax treatment which was different from that accorded to non-participating investors. Similarly, if a company chooses to do research it can obtain tax benefits not available to companies not carrying out research. This is inherent in the application of any rule. What matters is not the differentiation that comes after companies exercise their choice, but the differentiation that results when some of them are not allowed to exercise beforehand a choice that is open to others.
This is not really a novel idea. The Commission, in its Notice on the Notion of State Aid, explains at point 116 that all State aid creates secondary benefits which, however, do not constitute indirect selective advantages because they are not channelled towards ex ante “identifiable” undertakings. In the Commission’s own words, “indirect advantages should be distinguished from mere secondary economic effects that are inherent in almost all State aid measures (for example through an increase of output). For this purpose, the foreseeable effects of the measure should be examined from an ex ante point of view. An indirect advantage is present if the measure is designed in such a way as to channel its secondary effects towards identifiable undertakings or groups of undertakings. This is the case, for example, if the direct aid is, de facto or de jure, made conditional on the purchase of goods or services produced by certain undertakings only (for example only undertakings established in certain areas).” (p. 26)
The Court has repeatedly referred to the need to disregard the form of a measure and focus instead on its effects when determining whether the measure constitutes State aid. Yet, in the World Duty Free judgment and in the present judgment on the STL system it seems to focus solely on the fact that the measures in question were in the form of a derogation and to ignore that those measures were not capable of according ex ante “differentiated treatment” to operators.
 The full text of the judgment can be accessed at: http://curia.europa.eu/juris/document/document.jsf?text=&docid=204400&pageIndex=0&doclang=EN&mode=lst&dir=&occ=first&part=1&cid=251765.