globaltaxnews.ey.comSign up for tax alert emailsForwardPrintDownload |
25 September 2018 European Commission holds that Luxembourg exemption for US branch profits does not constitute State aid On 19 September 2018, the European Commission (the Commission) announced that the Luxembourg corporate tax exemption of profits attributable to a United States (US) branch did not lead to illegal State aid, as it is in line with national tax laws and the Luxembourg-United States Double Taxation Treaty. This concludes the investigation started in December 2015 into two Luxembourg rulings of a multinational company (MNC) involving a Luxembourg company with US and Swiss branches. The Commission's decision is the first in the recent investigations into fiscal State aid that resulted in the Commission confirming that there is no State aid. It confirms that exemptions granted by properly applying the provisions of tax treaties do not constitute illegal State aid even if this results in double non-taxation and is therefore relevant for all Luxembourg (and European Union (EU)) companies that benefit from an exemption under a tax treaty. The investigation concerned two rulings granted by the Luxembourg tax authorities in 2009 to a Luxembourg company with branches in the US and in Switzerland. The US branch holds franchise rights, which are licensed to the Swiss branch. The Swiss branch licenses the franchise rights to franchisors in various European countries. The US branch did not fulfil the relevant provisions under the US tax code to be considered a permanent establishment (PE) and was therefore not effectively taxed in the US. The first ruling confirmed that the profits attributable to the US and Swiss branches are exempt from Luxembourg tax on the basis of the tax treaties with the US and Switzerland, respectively, provided that proof is submitted on an annual basis that those profits have been declared and are subject to tax in the US and Switzerland, respectively. The second (revised) ruling request was submitted in response to the first ruling and deals with the US branch only. It confirms that such proof of effective taxation of the profits in the US is not needed as art. 25 (2) a of the Luxembourg-US tax treaty (the Treaty) only requires that income "may be taxed" in the US in order for Luxembourg to exempt the income and does not impose the condition that the income be effectively subject to tax. Luxembourg argued that the exemption is fully in line with Luxembourg law and the Luxembourg tax administration did not deviate from the generally applicable tax provisions. In the view of Luxembourg, there could only be State aid if a tax ruling deviates from the tax ruling practice of the tax administration, international fiscal conventions or OECD1 principles, or the tax administration has committed a manifest error in its analysis, which is not the case in the two rulings concerned. The presence of the Luxembourg company in the US and Switzerland constitutes PEs in the two jurisdictions and the exemption of profits attributable to these PEs is in line with the provisions of the applicable tax treaties. The Commission opened the investigation to determine whether Luxembourg might have misapplied the Treaty by selectively derogating from the provisions of Luxembourg domestic law and the Treaty and providing the MNC an advantage not available to other companies subject to the same tax rules. However, the investigation concluded that the reason for double non-taxation in this case is a mismatch between Luxembourg and US tax laws, and not a special treatment by Luxembourg. Therefore, Luxembourg did not break EU State aid rules. In particular, it could not be established that the Luxembourg tax authorities interpreted the Treaty incorrectly. The business carried on by the US branch of the Luxembourg company fulfilled all the conditions of a PE under Luxembourg tax law. As a result, the Commission found that the Luxembourg authorities could exempt the profits attributable to the US branch without violating the Treaty. Therefore, the Commission found that the Luxembourg authorities did not misapply the Treaty and that the tax advantage conferred to the Luxembourg company cannot be considered State aid. The decision confirms that double non-taxation as a result of an exemption on the basis of an autonomous and proper interpretation of a tax treaty does not per se constitute State aid. Therefore, the decision may be relevant for a number of Luxembourg and EU companies that benefit from exemptions based on tax treaties despite the fact the profits attributable to the source country are not subject to tax based on the domestic law of the other country. Margrethe Vestager, EU Commissioner in charge of competition policy, stated that the MNC's situation of double non-taxation is not a matter of illegal State aid but of tax fairness. Possibly to address the Commission's concern around "tax fairness" the draft law implementing the EU Anti-Tax Avoidance Directive2 that was submitted to the Luxembourg Parliament on 20 June 2018 contains an amendment to the Luxembourg domestic PE definition. According to this amendment, the recognition of a PE in a treaty country will be based exclusively on the criteria set forth by the double taxation treaty concluded with that country. A taxpayer will be considered as having a PE in the other Contracting State if the activity that is exercised in the other country constitutes an independent activity and represents a participation in the general economic life in that other country. For more details on the provision, see EY Global Tax Alert, Luxembourg's draft law implementing EU Anti-Tax Avoidance Directive: A detailed review, dated 9 July 2018. The impact of this new provision will have to be analyzed in further detail on a case-by-case basis, taking into account all relevant facts and circumstances. 2 Council Directive (EU) 2016/1164 of 12 July 2016 setting forth rules against tax avoidance practices that directly affect the functioning of the internal market.
Document ID: 2018-6113 |
