The case concerned the arm’s length nature of a royalty paid by a Luxembourg operating company (LuxOpCo) to a Luxembourg partnership (LuxSCS) – a tax transparent entity in Luxembourg – for the use of certain intangibles (technology, marketing-related intangibles and customer data).
In the 2003 tax ruling, the Luxembourg tax authorities had confirmed the arm’s length nature of the deductible royalty payments. The supporting transfer pricing analysis applied the transactional net margin method (TNMM), a one-sided transfer pricing method, with LuxOpCo as tested party. Hence, it determined an arm’s length remuneration for LuxOpCo and any business income in excess of that remuneration served to pay the royalty.
The European Commission disagreed and considered that LuxOpCo’s tax base was unduly reduced. It relied on two lines of reasoning:
- Primary line: LuxSCS does not (and is not able to) perform any significant people function and bear any risk in relation to the intangibles. By contrast, LuxOpCo has numerous employees and operates Amazon’s EU business. Accordingly, LuxOpCo must be the entity entitled to the IP income and LuxSCS should just be entitled to recover its limited operating costs, as well as the intangibles development costs it incurred on a pass-through basis.
- Secondary line: even if LuxSCS were found to perform some significant people functions and bear some risks related to the intangibles, a profit split would be more appropriate than using the TNMM transfer pricing method with LuxOpCo as tested party. Moreover, even if the TNMM with LuxOpCo as tested party were appropriate, LuxOpCo should earn a mark-up on the royalty expense. Finally, even if that were not required under transfer pricing rules, the fact that the 2003 ruling applied a "cap and a floor" to LuxOpCo’s income (without such cap-and-floor mechanism being backed up by the transfer pricing analysis) also resulted in a selective advantage.
Motives for the annulment by the General Court
The General Court, after confirming that group companies may be taxed in accordance with the arm’s length principle, rejected all of these different lines of reasoning on the basis that the existence of a selective advantage was not demonstrated to the requisite standard:
- The functional analysis of the European Commission wrongly depicted LuxSCS as merely a passive holder of intangibles, thereby ignoring the functions and risks borne by LuxSCS in exploiting them.
- The choice of LuxOpCo as tested party was also not wrong, given it was not easier to find comparables for LuxSCS than for LuxOpCo.
- Furthermore, LuxSCS should not earn a mere reimbursement of the intangibles development costs, as such an approach ignores the posterior increase in value of the intangibles. Also, LuxSCS’s services were not low value-adding services.
- The subsidiary lines relied on the same erroneous functional analysis (for the first part) and did not show the requisite standard of evidence that the choice of the profit level indicator or the application of the cap-and-floor mechanism reduced LuxOpCo’s tax base.
Impact on other taxpayers
Although transfer pricing is highly dependent on the specific facts of each case, this judgment provides several key lessons on transfer pricing matters:
- It is possible to have key functions and bear risks in relation to intangibles even without having "employees" under pre-2017 OECD transfer pricing guidelines.
- The OECD transfer pricing guidelines may serve to apply the arm’s length principle, but the European Commission is not entitled to retrospectively apply the 2017 OECD transfer pricing guidelines; for the period covered by the 2003 tax ruling, the 1995 OECD transfer pricing guidelines were the sole version applicable.
- As already indicated in the Apple case, the mere finding of methodological errors in the transfer pricing analysis cannot lead to the automatic conclusion that the tax liability was reduced and a selective advantage arises.
Moreover, the Nike and Inter IKEA cases, which are still in the phase of the formal State aid investigation conducted by the European Commission, do bear factual similarities (deductible royalties paid to beneficiaries not taxed anywhere). The Amazon judgment may influence the final decision of the European Commission in these pending cases.
More generally, taxpayers engaged in intragroup transactions in the EU should review the General Court’s positions, as the reasoning may affect transfer pricing analyses and audits going forward. The judgment should also be considered in the context of State aid risk assessments (e.g., as part of FIN48 analyses), noting that in State aid matters the recovery period can go 10 years backwards as from the moment the European Commission has started looking at an individual case or a (potential) State aid regime.
The European Commission may appeal the judgment on matters of law before the Court of Justice. The European Commission essentially lost on factual matters, which may complicate the appeal – it is likely that, like in the Apple case, the debate around the burden of proof to demonstrate a selective advantage would be the main argument.
Other pending State aid cases concerning tax rulings
The Fiat case, in which Fiat seeks in a final appeal to overturn a finding that it received unlawful State aid from Luxembourg, is pending before the Court of Justice. The hearing took place on 10 May 2021, and the date of the judgment is not yet known.
The European Commission’s appeals against the General Court’s July 2020 judgment in favour of Apple and Ireland and January 2019 judgment in favour of Belgium (in the excess profit ruling case) are also pending before the Court of Justice.
Next to the Amazon judgment, the General Court issued on 12 May 2021 its judgment in the ENGIE case, in which it upheld the European Commission’s finding that Luxembourg had granted unlawful State aid to Luxembourg companies of the ENGIE group. For more information on this judgment, please click here.
In addition, several cases are still in the phase of formal State aid investigation by the European Commission, notably Huhtamäki (Luxembourg), Inter Ikea (the Netherlands), Nike (the Netherlands) and 39 beneficiaries of individual excess profit rulings (Belgium). More investigations may still be opened.
We will keep you informed about further developments. Should you have any question, please contact a member of our EU State aid or Transfer Pricing team (which formed part of the team successfully assisting Amazon) or your trusted Loyens & Loeff adviser.